The energy transition away from fossil fuels toward renewables could put downward pressure on hydrocarbon exporting economies and issuers in the region if they are not able to diversity sufficiently quickly, said S&P Global Ratings.

"As global investors get to grips with the implications of climate change for their portfolios, they are likely to reappraise their appetite for investment in sectors and regions they perceive as most at risk from decarbonisation initiatives," said Dhruv Roy, S&P Global Ratings Head of Sovereign and Financial Institutions Ratings for Middle East/Africa.

"But GCC economies still rely heavily on hydrocarbons, and we expect the pace of diversification to remain gradual,” he added, commenting on the two reports published on RatingsDirect: "The Energy Transition: The Clock Is Ticking For Middle East Hydrocarbon Exporters" and "The Energy Transition: How It Could Affect GCC Banks".

Concentrated revenue streams and economic activity in the GCC have led to downward rating migration in the region in recent years, reflecting structurally lower oil prices.

“Our hypothetical long-run stress test of oil price declining to below $40 by 2040 suggests the average rating of Gulf sovereigns could fall by two notches from 'BBB+' to 'BBB-', although this is not our base-case scenario,” Roy said.

The downward trajectory in the average rating highlights that, including an assumed policy response and static production, the current pace of economic and fiscal revenue diversification is not sufficient to counter a gradual decline in oil prices.

However, the low cost of hydrocarbon production in the region provides GCC sovereigns some resilience to energy transition risk, helping buy time for economic diversification. Furthermore, investors may see select green diversification projects within the GCC, such as solar, as compelling investment opportunities.

Dan Klein, head of Scenario Planning Analytics at S&P Global Platts, a sister company of S&P Global Ratings, shares the view that Gulf national oil companies have some resilience to energy transition risk.

"Saudi Arabia's oil production costs are among the lowest in the world, on the order of $5 per barrel. Even under a scenario where global oil demand and price declines sharply, Saudi Arabia's oil industry will remain extremely profitable. However, oil left in the ground, even in Saudi Arabia, will not hold its value forever, particularly as the world heads toward peak demand,” Klein said.

"For GCC banks, our findings show direct exposure to sectors exposed to energy transition accounted for about 12 per cent of their lending (14 per cent of rated GCC banks) at Dec. 31, 2018," said Mohamed Damak, S&P Global Ratings Sector Lead, Financial Institutions for Middle East/Africa.

However, indirect exposure is substantially higher, as other sectors tend to correlate with its performance either directly through the supply chain or indirectly through government spending or consumer sentiment and spending.

Saudi Arabian and Qatari banks have the highest concentrations, at about 15 per cent of lending at Dec. 31, 2018, linked to the extensive oil and gas production in these countries. United Arab Emirates (UAE) and Kuwaiti banks have the lowest concentration, at about 10 per cent on the same date, which is explained by the higher diversification of the UAE economy and significant retail and real estate exposure in Kuwait.

"In our view, the effect of energy transition on oil and gas prices and investor appetite will be an important factor for the long-term creditworthiness of GCC banks. If oil and gas prices or investor appetite were to decline significantly, GCC banks could be affected through the potential deteriorating creditworthiness of their exposures to these sectors and the overall bearing on their economies. This is due to a lack of diversification and, for some systems, the lower availability of external funding sources," Damak concluded. – TradeArabia News Service