Finance turns green
MENA region’s fixed income markets plan a much greener future
For many years, the Middle East has been home to many of the largest carbon dioxide emitters in the world relative to the size of their economies. These markets, especially the countries in the Gulf Cooperation Council (GCC) – Bahrain, Kuwait, Oman, Saudi Arabia, Qatar and the United Arab Emirates – have also remained off of the radar of fixed income investors because large resources from oil meant there was little need for companies and governments to issue bonds.
Although issuance was small for both companies and governments, the sovereign pipeline was particularly small prior to the fall in oil prices where governments have turned to capital markets to fill budget deficits. In 2016, the region accounted for nearly onesixth of global emerging market bond issuance. With the increased issuance, there is a new priority to broaden the potential investor base. According to National Bank of Abu Dhabi, issuance by sovereigns in the GCC markets accounted for $29.3 billion during the whole 2010 -15 period before soaring to $40 billion in 2016 alone. Sovereign issuance in the GCC is expected to reach $29.6 billion for 2017, having already crossed $20 billion by mid-April. As oil prices tumble, the accelerating shift in the region’s economy away from oil and toward other industries may also shift expectations among investors. Whereas in the past the underlying natural resource wealth has been a buffer for investors, there is now increasing concern about stranded asset risks. The risk facing investors in the GCC and broader MENA region is that the Paris Climate Agreement, if fully implemented, will limit global usage of fossil fuels in favour of cleaner alternatives lowering the value of the oil and gas resources remaining in the ground. The shift in viewing the wealth of natural resources as an asset to one that is potentially a vulnerability will not happen overnight. However, investors will increasingly consider the possibility that the expected future value of oil and gas reserves will require significant valuation discounts if the 2 degree target (for global average temperature increases over pre-industrial levels) is met. In this scenario, some large proportion of all fossil fuel energy resources will have to remain unused which will dramatically reduce their value as reserves. GCC countries, to a greater or lesser degree, are preparing for this future through sovereign wealth funds which have accumulated a share of their past earnings from fossil fuel revenue. These sovereign fund assets will act as a buffer against stranded asset risk by providing an alternative source future income for regional governments for the post-oil future that most countries have been planning for through their efforts at economic diversification. The size of the stranded asset risk will depend not only on the size of the sovereign funds today and their expected future value based on projected investment performance. There will also be an important factor created by the speed at which the region’s economies can use their energy resources more efficiently while still growing their non-oil sector. As the table shows, the GCC countries are alongside the large industrial and industrialised economies as being significant CO2 emitters relative to their economic size.