Diversification Strategy Under Deep Uncertainty for MENA Oil Exporting Countries

MENA oil exporting countries have been hit by a double shock: Covid-19 and the oil price collapse. Their short-term strategy to offset the impact of these shocks will focus simultaneously on fiscal adjustment and coordinating on oil supply cuts with other producers to support oil prices and revenues. While the degree of fiscal adjustment is constrained by its social, political and macroeconomic implications, effective output cut faces several challenges including coordination among producers and the scale of the global oil demand shock. Achieving a meaningful and sustained price increase through collusive supply response is contingent about some key uncertain factors such as the extent of the supply reductions in response to lower oil prices and the extent and duration of global oil demand contractions and the speed and shape of global oil demand recovery. MENA oil exporting countries also face long-term challenges and Covid-19 shock gives new urgency to adjusting their long-term strategy to reduce risks and improve their resilience. These countries face two major long-term issues.  First, there is no single successful strategy to shield against the long-term risks of oil price crash. Diversification works only when it offers risk reduction by the pooling of uncorrelated income streams. If these countries diversify only into sectors where inputs rely on hydrocarbon infrastructures and where both tangible and intangible relationships exist across fossil and non-fossil fuel businesses, they may not achieve sufficient risk reduction. On the other hand, if they diversify into substantively different areas that have little in common with their current primary industry, which constitute the core of their comparative advantage, they run the risk of not being competitive. Second, irrespective of the strategy taken, in the face of disruptive forces, there is a fundamental trade-off between expected return and the variance of return, i.e. the cost of reducing the long-term risks and increasing resilience is to accept lower expected return on existing assets, for instance, by investing in measures that align their hydrocarbon sector with low carbon scenarios. This lowers the overall return but reduces the risk of disruption in the long run.

By: Rahmat Poudineh , Bassam Fattouh