The UAE is looking to cement long-term trade partnerships in Asia to help manage the changing nature of global oil trade flows, the impact of the Opec deal and the return of US shale. Rebecca Spong reports.
In March, the Abu Dhabi National Oil Company (Adnoc) signed two three-year deals to sell 1.5 million tonnes of the oil product naphtha – used as a feedstock to produce petrochemicals – to Japan’s Idemitsu Kosan and Thailand’s SCG Chemicals.
The agreement came just weeks after a similar deal was inked with a Malaysian company, Lotte Chemical Titan, agreeing to provide up to 1 million tonnes a year of the same product. Both deals form part of the UAE national oil company’s strategy to increase its focus on its downstream oil business to meet the growing demand in Asia for refined and petrochemical products.
The downstream industry includes refining, processing and marketing of products derived from crude oil such as petrochemicals. Adnoc aims to increase its domestic petrochemicals production to 11.4 million tonnes a year by 2025.
The company’s shift in strategy reflects the wider changes happening throughout the Gulf, as the region’s oil producers try to navigate the changing nature of oil trade flows that have emerged since global oil prices plummeted in mid-2014.
With oil dipping below US$30 a barrel in 2016, Gulf States have had to rethink the balance of their economies and diversify their revenue streams, be that through investing in tourism, financial services or their downstream petrochemical industries.
The oil prices began to creep back up in 2017 as a result of the so-called Opec Plus deal that came into force at the start of the year. It involved Opec members agreeing to remove 1.2 million barrels of oil a day from global production if non-Opec countries – including Russia – agreed to cut down by 600,000 barrels a day.
Another shift in the market came with the re-emergence of US shale producers last year, which – encouraged by the rising price of oil – decided to restart production. The increase in US energy exports has led to fears that Opec-backed efforts to rebalance the market will be hindered, and prices will not rise as quickly as hoped.
With oil prices of US$100-plus a barrel now a distant memory, the UAE, alongside other Gulf nations, needs to adapt growth plans to better deal with the increasingly competitive market and future fluctuations in oil prices.
Oil price collapse
The slump in oil prices hit the UAE hard. Oil exports from the UAE fell from US$101.9bn in 2014 to US$61.5bn in 2015 and an estimated US$50.9bn in 2016, according to figures from the International Monetary Fund (IMF).
Weaker oil prices forced some public infrastructure projects to be postponed as the UAE’s revenue streams dried up. Growth slowed to 3% in 2016 from 3.8% the previous year, the IMF reported in its July 2017 country report. As the Opec deal began to stabilise the price of oil in 2017, the UAE’s economy started to strengthen. However, the IMF still urged the country to continue to adjust its economy to the “new oil market realities” in order to safeguard a share of its oil income for future generations.
Adnoc stepped up to the plate last year when it announced its new expansion strategy that will see it spend more than Dh400bn (US$109bn) over the next five years on both its upstream and downstream expansion projects.In terms of downstream investment, it wants to increase its crude refining capacity by 60% and more than triple its petrochemical production by 2025.
As part of these measures, Adnoc is developing one of the largest integrated refining and petrochemical complexes in Ruwais in Abu Dhabi. When complete, it will convert one fifth of the company’s crude oil into chemicals, which can then be exported. An increasing number of these oil product exports are destined for Asia. According to local press reports, Adnoc is planning to unveil more downstream opportunities at an industry conference in Abu Dhabi in May.
“We will engage in strategic, long-term overseas investments across the downstream value chain,” said UAE minister of state and Adnoc CEO Sultan Ahmed Al Jaber in an official statement. “Acting alone, or in partnership with others, we will focus on investments that bring attractive returns, grow market access for our products and allow us to develop a truly international footprint.”
These partnerships will likely involve large Asian companies, says Christopher Haines, head of oil and gas at BMI Research.“There is both a growing willingness to bring large Asian national oil companies into upstream projects in the Middle East, while Middle Eastern exporters are looking to secure long-term demand from growing downstream markets,” he says.
And it is not only the UAE which is looking to secure these kinds of trade and investment ties: other Gulf countries are implementing similar strategies. At the end of March, Saudi Aramco signed two joint ventures with Malaysia’s national oil company Petronas for a refinery and petrochemical integrated development project. This project will see Saudi Arabia provide 50% of the refinery’s crude feedstock, with the option of increasing to 70%. The refinery will have a capacity of 300,000 barrels of crude a day, and will produce refined products such as diesel and gasoline.
“This agreement strengthens Saudi Aramco’s position and growth in Southeast Asia through crude supply and world-scale downstream operations,” says Saudi Aramco senior vice-president of downstream Abdulaziz Judaimi in an official statement.
More investment plans are brewing. “Saudi Arabia is in talks to secure a majority stake in a proposed refining and petrochemical complex in Maharashtra, India, while there is also a similar agreement fixed with Pertamina at Indonesia’s Cilacap refinery,” says Haines. “Given Asia is the oil demand growth market and the Middle East is the oil supply growth market of the coming years, deals like this will continue.”
Trade finance bankers are keen to support this growing flow of trade between the Gulf and Asia.
“The increasing need to finance trade flows between Asia and the Middle East has been a growing trend over the last five years,” says Sunil Veetil, regional head of global trade and receivables finance at HSBC Mena. “Asia is a key export destination and the relationships between Middle East national oil companies and Asian buyers have continued to be strong and mutually beneficial,” he tells GTR.
The changing nature of today’s oil market has also pushed Gulf oil producers to reconsider how to manage their finances. “We have been seeing a rapid transformation in the way national oil companies have been managing their funding requirements,” says Veetil.
“This is because while the capital markets and corporate loan market remain readily accessible, pricing and depth of the market are also key factors in determining financing structures.”
Adnoc, for instance, is looking to partly privatise some of its businesses in an effort to become more competitive. At the end of last year, it put 10% of its fuel distribution arm up for an initial public offering (IPO) on the Abu Dhabi Exchange (ADX).
At the time, Al Jaber said the IPO would allow the company to “better manage our capital and portfolio of assets and expand our range of new and existing partnerships – from the upstream to the downstream”.
Adnoc also raised a debut US$3bn bond last November, with the issuance three-and-a-half-times oversubscribed as regional and international financiers flocked to invest in the company.
Bankers note that the low oil price environment has led to more interest in using trade finance techniques to fund exports and imports.
Emre Karter, head of treasury and trade solutions for Middle East, North Africa, Pakistan and Turkey at Citi, says that oil sellers are looking to make their trade transactions far more efficient.
“Given the squeeze in oil prices, an opposing pressure has been created on the working capital cycle of the sellers, who are looking for enhanced methods in creating working capital efficiencies – especially where they can recoup their receivables sooner. In this regard, receivable discounting and supply chain financing structures become very topical,” he adds.
Veetil has also seen the use of pre-export financing in the region – a form of financing far more commonly used in regions such as Russia and the CIS. “Pre-export financing and other commodity financing structures are increasingly becoming an attractive source of alternative liquidity,” he says.
Last September Oman Oil signed a US$1bn five-year pre-export deal arranged by international banks including Natixis, Société Générale and HSBC Oman. Such financing structures are seen as a means for Gulf exporters to cement longer-term relationships with their buyers by providing potentially more favourable payment terms.
US oil production is soaring, according to the International Energy Agency’s (IEA) February report. With the Opec deal helping to push prices up to a level that made shale production viable again, US producers jumped at the opportunity to restart the pumps. In November last year, Opec and non-Opec members agreed to extend the oil production limits until the end of 2018. In the three months to February, US crude output had increased by a “colossal” 846,000 barrels a day, and will soon overtake the output of Saudi Arabia, the IEA report finds.
“Today, having cut costs dramatically, US producers are enjoying a second wave of growth so extraordinary that in 2018 their increase in liquids production could equal global demand growth. This is a sobering thought for other producers currently sitting on shut-in production capacity and facing a renewed challenge to their market share,” the report says.
“It is not just a matter of production,” the report continues. “Trade patterns are changing. Recently we read of a shipment of condensate from the US to the UAE. Such a development would have seemed incredible a few years ago, now it looks like the shape of things to come.”
According to Bloomberg reports, the UAE purchased condensate, a form of ultralight oil, from the US in December, possibly as an alternative from buying the oil product from Qatar because of its diplomatic rift with the country, which has been ongoing since last year.
While some see the rebound of US shale as a threat to the Gulf producers currently constrained by Opec limitations, many analysts say the growing Asian market has enough room for the American and Middle East producers.
“I don’t see how the US will ‘steal’ or take the barrels away from the Gulf producers in a large and growing market as Asia, which will be able to absorb both US and Gulf barrels,” says Carole Nakhle, CEO of UK-based consultancy Crystol Energy. “If the US is to squeeze some suppliers to Asia out, it will be those that provide the same oil – that is light sweet and that we see coming from West Africa and Libya for instance.”
Others agree that Gulf producers will continue to hold onto, if not grow, their market share in Asia due to the type of oil they can provide compared to the US offering.
“Longer term, Asia is a big place and its crude oil import needs will continue to rise as refined product demand increases and as their indigenous supply of crude declines,” says Aaron Brady, director of oil market research at IHS Markit. Asia will continue to need the mostly heavier, more sour crudes that Middle East producers export, he adds.
Haines from BMI Research agrees that the US is unlikely to get much more of a foothold in Asia than it already has. “Most refiners in the region favour the medium sour crudes of the Middle East, and this is a product that the US does not have to export. India is a prime example of this, it is a large growing market with a relatively modern refining sector set up to take medium or heavy crudes,” he says.
India’s refining capacity is around 4.7 million barrels a day, and yet the country only took in about 35,000 barrels a day of US crude in the second half of last year.
“In our view, growing US exports are more likely to head to European markets,” Haines says. Nakhle dismisses those overly concerned about the threat of US exports as being “too focused on the short term and on particular markets”. She says, “In reality, neither is useful to understand the oil market which is a slow-moving beast – and global: so local market shares provide an incomplete picture,” she says.