Middle East prospectsOpportunities for Scottish business

Middle East SeminarScottish Development international

Glasgow, 2 March 2016

Richard ThompsonEditorial Director, MEEDrichard.thompson@meed.com

MEED

The Middle East opportunity• Dynamic high-growth market

• Growth driven by visionary policy making

• Investment in infrastructure and industry

• Need to meet expectations of young population

• Home to the world’s most abundant oil and gas reserves

• Geocentric hub between Europe and emerging Asia, Africa

• Desire to harness innovation and technology

Three years of ‘ideal’ scenario

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015F

2016F

2017F

2018F

12

14

15

17

18

0

28

55

83

110

138GCC oil production (m b/d)Oil price ($/barrel)

Peak?

Market changing fundamentally• Biggest sustained fall in oil prices in history

• Economic focus is structural reform

• Political focus has shifted to security

• Shockwaves of 2011 Arab uprisings still resonating

• Civil wars in Libya, Syria and Yemen

• Rising sectarian tensions across region

• Lifting of nuclear sanctions on Iran

There is no Middle East 350m people in 22 countries, and many more cities

Broadly 4 groups:

• Wealthy oil-exporting Arab countries of the Gulf - GCC

• Oil importing states - Jordan, Egypt, Tunisia, Morocco, Lebanon, (Algeria*)

• Failing states - Libya, Syria, Yemen

• Emerging markets - Iran, Iraq

Markets by size…

…or by wealth

The new environment Source: ft.com

• Oil prices set to stay low as global supply is outpacing demand growth

• Regional oil producers maintaining production to retain market share

• Prices will remain in the $20-50 a barrel range in 2016

• IMF Forecast for Brent average $50-70/barrel until 2020

Impact of low oil prices

• In January, IMF downgraded GDP growth forecast

2016: MENA = 3.6%, down 0.3%; KSA = 1.2%, down 1%

2017: MENA = 3.6%, down 0.5%; KSA = 1.9%, down 1%

• Mea oil exporters lost about $360bn in oil revenue in 2015

• GCC ran $700bn deficit in 2015, 13.2% GDP

• Saudi’s fiscal deficit 21.6%

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016-6.0

-3.0

0.0

3.0

6.0

9.0

0.0

27.5

55.0

82.5

110.0

137.5

World Advanced economies MENA GCC Oil prices

Opec basket oil price ($/barrel)

GCC growth

Source: IMF; OPEC

Economic outlook

Strong financial buffers•$2.1tn of reserves built up enabling deficit spending but

unsustainable

•Financial buffers mitigated need for sudden adjustment in fiscal policy

•Reforms such as the removal of subsidies and new taxes needed

“Many countries have built up buffers, and have started to consolidate their fiscal position but fiscal deficits, averaging almost 13 per cent for Mena oil exporters, are likely to persist for years. Sizeable, sustainable fiscal consolidation is needed.”

Masood Ahmed, Director, Middle East and Central Asia, IMF, 21 Oct 2015

• Fiscal and current account balances deteriorating sharply

• MENA oil exporters need $1tn in financing over next 5 years and will exhaust buffers

Reserves of strength

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 20130

100

200

300

400GCC current account, 2002-13 ($ bn)

$2.1tn GCC current account surpluses since 2001

Tough decisions ahead • Fall in revenues put pressure on governments to make savings.

• Policy options limited:• Oil production already running close to full capacity (Saudi)• Non-oil revenues through taxation unpalatable• Spending cuts as the main option

• Regionally, primary focus on capital spending cut• Public sector wages are protected• Some governments looking at fuel subsidy cuts • Slowdown in the rate of hiring in the public sector

• Direction has become clearer over past two months• Budgets signal spending cuts and deficits• Government restructuring and job cuts• Reform programmes• Focus on healthcare, education, energy

$3.26tn projects planned or underway in the Gulf. $2.7tn in GCC

Market shrunk 2.1% over past year, GCC down 2.9%

Lowest mark of year, 20 Nov

Saudi fallen 13.8% to $1.0tn as real estate schemes placed on hold, still 38% of GCC total

UAE, Kuwait, Bahrain grown

Infrastructure, industry and real estate are priorities

Iran up 12%, Iraq down 9.8%

GCC Project Pipeline

Source: MEED Projects

Saudi Arabia has biggest pipeline of planned projects, with about $800bn

The UAE is second, with about $600bn of planned projects

Qatar at $200bn of planned projects

Kuwait at about $175bn

Construction sector – buildings, property and real estate – offers the biggest segment of future projects, with a pipeline of about $1tn

The pipeline of power and transport projects in the GCC each shows about $400bn-worth of schemes planned

• GCC contract awards will be down about 16 per cent in 2016 to just over $140bn.

• Worst affected will be Saudi Arabia• UAE, Kuwait, Qatar and Oman will be marginally down on last year• Iran and Egypt offer strong potential, but progress depend on the political

situation

• The most wasteful region in the world

• Remove subsidies

• Diversify energy mix

• Renewables drive

• Investment in technology to drive efficiency• Big Data• IoT• SMART

Energy policy reform

FinanceAs liquidity in the region tightens and project clients look for new sources of funding, opportunity for new models of project finance

Private finance for infrastructure through banks and bonds has risen back up the agenda. About $42bn of project finance needed in MENA at start of 2016

Many governments setting up PPP units (Kuwait, Egypt) or introducing new PPP laws (UAE, Oman)

Contractors providing or facilitating equity for the projects they work on.

International contractors are less likely to invest, but some are playing an active role in facilitating funding with institutional support from their home countries

Iran • 79 million people

• World’s biggest gas reserves

• Region’s second biggest economy (GDP =$404bn)

• Trade and investment opportunities

• Key sectors: Energy Petrochemicals Mining Finance Power Water Rail Ports

Technology Tourism Metals Manufacturing

But

• Impact on energy prices

• Tense geopolitical relations

Opportunity Iran • Nuclear sanctions lifted on 17 January 2016

• Potential for rapid growth of 4% - 5.5% growth in 2016/17 driven by higher oil production and lower trade and financial transaction costs

• But severe structural challenges -Lower oil prices, banking system faces high non-performing assets that have led to high interest rates and stagnant credit

• Comprehensive reforms critical for macroeconomic stability and high growth

“Llifting of economic sanctions brings a unique opportunity…Prudent policies have allowed the economy to return to positive growth last year and to reduce inflation to around 15%. The authorities have also regained stability in the foreign exchange market and advanced with subsidy reform.”

Martin Cerisola, IMF Iran mission leader, 6 Oct 2015

• Risks to the outlook are significant will depend crucially on the depth of reforms

• Uncertainties about the implementation of the nuclear agreement could constrain foreign direct investment and capital inflows

Impact of sanctions on projects

Iran punches far below its weight in the project market, reflecting impact of sanctions

$244bn worth of projects planned or underway in Iran

Sixth biggest market in Gulf, about 8% of $3.4tn of overall Gulf market

Grown at 3.5% over past 12 months

Peaked at about $330bn in Dec 2009

Priority projectsIncrease in exports, unfrozen assets and an inflow of investment will enable Iran to move on a large pipeline of strategic projects $800bn of investment required

Oil & Gas: - Enhanced oil recovery projects and LNG export facilities - Petroleum Ministry is preparing New Iranian Petroleum Contract

Petrochemicals: 2nd-largest pets industry with plans to be biggest methanol producer

Mining: Increase steel, copper and alumium production by 2025

Power: Electricity demand to grow at 6.5% p.a. until 2020 Iran needs 25.6GW of new generating capacity over this period. $70bn investment required

Infrastructure: Plans for thousands of kms of new railways, metro lines and upgrading ports and airports.

Hospitality: Tehran faces a severe shortage of hotel rooms,

http://buy.meed.com/product-p/opportunity-iran-2015.htm

Risks• Collapse in world oil prices due to intra-OPEC competition • A collapse of the sanctions relief programme, either due to objections in the US

or by the failure of the Islamic Republic to adhere to the conditions of the deal. This will immediately lead to the re-imposition of at least some of sanctions

• Supply bottlenecks particularly in Iran’s defective transport and logistics infrastructure

• Poor financial management that could lead to asset bubbles, hyperinflation and a new wave of currency depreciation

• A serious deterioration in regional stability involving Iraq, Syria, Afghanistan and other countries that neighbour Iran

But beware• The business environment can also be challenging and complex

• Investors will need to assessment as to how any of the recent developments in the local Iranian legal and regulatory environment would affect their business in Iran

• Snap back risk: One of the major concessions by Iranian negotiators in Vienna appeared to be the “snap back” clause on the removal of sanctions

• The snap back is a commercial risk that every company has to take [but] I think the snap back after such a long discussion is not going to be a reality

• Legal complications with investing, risks of association with still-sanctioned entities, and problems with implementing monetary transfers, initial foreign investment is likely to be slow going

• Sanctions against key entities in Iran’s energy industry – such as affiliates of the Iranian Republican Guard Corps (IRGC) – due to terrorism links “ could make initial work in the Iranian energy sector challenging”.

Big themes for 2016 • Low oil prices continue

• GCC oil producers cut capital expenditure in 2016 budgets

• Priority projects included in budgets but non-critical projects cut

• Social infrastructure – Education, Healthcare, Housing

• Transport – Rail, airports

• Oil & gas – new production, downstream diversification

• Security

• Iran and Egypt

• Alternative funding and contract models – PPP, etc

• Liquidity, payment delays and cash flow

SummaryOur business landscape is changing fundamentally

• Oil prices will stay low• Geopolitical and security tensions will remain high• Governments will rein in spending• Iran

But in this region, unpredictable change is to be expected • Don’t lose sight of what is driving regional policy• Many challenges but the opportunities are great

Strategic conclusion• Stay focused and consistent • Understand your customer’s needs• Remain committed • Be flexible

Appendix: Middle East policy drivers

1. Population growth • 350 million to 602 million by 2030

Significant challenges

• Youth bulge, more than 50% under 25, 67% under 30

• Need to create jobs and develop skills

• Meeting expectations of living standards

• Closing wealth gap and maintaining social cohesion

• Role of women

2. Diversification• Heart of regional policy for decades

• Dependence on oil is unsustainable

• Region driving new industries

• Manufacturing, tourism, finance, logistics, ICT

• Private sector is key

• Entrepreneurs are key

3. Energy demand • Rising population and growing industrial base

increasing demand for energy

• 34% increase in generation capacity 2020

• 2.2 billion gallons a day of desalination capacity is required by 2020

• Current supply cannot meet demand

• New sources needed – renewables, nuclear, EOR

• Energy efficiency – new approach

4. Urbanisation • The growth of cities – Dubai, Riyadh, Doha,

Abu Dhabi

• Congestion, pollution, leisure, jobs, community

• Cost of living, house prices, social issues

• New approach needed for social infrastructure, transport, energy consumption

• Technology solutions – SMART cities & The Internet of Things

• Dubai – the world’s smartest city

5. Investment in education

• Skill up local workforce to compete – academic and vocational

• Knowledge transfer a priority

• Support diversification, jobs, retain talent and self sufficiency

• Drive investment - $21.8bn projects in GCC

• Also education reform - maths, sciences, and critical thinking

• Dubai, Abu Dhabi and Qatar aim to be regional hubs for higher education

• Saudi Arabia pushing technical training

6. Localisation • Major challenge for policy makers

• Youth bulge – 67% under 30

• 4 million jobs needed in KSA in 5 years

• Saudi unemployment - 12%

• Private sector has only 1 million

• Almost half unemployed have degree

$3.26tn projects planned or underway in the Gulf. $2.7tn in GCC

Market shrunk 2.1% over past year, GCC down 2.9%

Lowest mark of year, 20 Nov

Saudi fallen 13.8% to $1.0tn as real estate schemes placed on hold, still 38% of GCC total

UAE, Kuwait, Bahrain grown

Infrastructure, industry and real estate are priorities

Iran up 12%, Iraq down 9.8%

7. Capital projectson

8.Finding finance • Major challenge for markets with high debt and

limited hydrocarbons – Dubai, Egypt, Jordan

• Regional banks highly liquid and prepared to lend

• Region looking for innovative financing solutions Sovereign bond issues Private finance models e.g. PPP Equity raising through IPOs Export credit agency support Contractor finance

9. Structural reform • State main driver of growth and jobs for decades

• Unsustainable -Expensive and inefficient

• Roll back the state and stimulate the private sector

• Reforms will be needed

• Open up for private sector – PPP

• Stimulate entrepreneurship

• Taxation – diversify state revenues

10. Supporting enterprise • 60% of UAE GDP in 2011 and 92% of companies

• Businessses relocating to Dubai as hub - Logistics, tourism

• Start ups rising - Most in retail, services and manufacturing

• Initiatives to increase access to capital and reduce costs

• Big family firms dominate and benefit from patronage

• SMEs differentiate on quality but drives up cost

• New regulations – proposed SME law and new companies law

• Red tape, licences and visas

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