The effect of energy transition on oil and gas prices and investor and customer appetite for finance will be an important factor for Gulf Cooperation Council (GCC) banks' long-term creditworthiness. In the three years since we first published a report on GCC banks' exposure to energy transition, their exposure to sectors most subject to energy transition risks has remained broadly the same.

Energy transition refers to the global energy sector's shift from fossil-based systems of energy production and consumption--including oil, natural gas, and coal--to renewable energy sources like wind and solar. We applied the same definition of sectors directly affected by energy transition risk as we did in our first report: oil and gas, mining and quarrying, manufacturing, some power generation, and public-sector lending (see "The Energy Transition: How It Could Affect GCC Banks," published Feb. 16, 2020). We found exposure to these sectors has remained broadly stable over the past three years, at around 12% of total lending on average at year-end 2022. Omani and Qatari banks are most exposed--about 15% and 13%, respectively, at Dec. 31, 2022. United Arab Emirates (UAE) and Kuwaiti banks have marginally lower concentrations--about 11% and 10%, respectively, on the same date--due to the higher diversification of the UAE economy and significant retail and real estate exposure in Kuwait.

How energy transition affects oil and gas prices and investor and customer appetites for carbon intensive sectors and markets will influence GCC banks' long-term creditworthiness. However, we still believe that certain competitive advantages--such as low extraction costs and the ability to flexibly increase production capacity--position GCC economies well in the global energy transition.

Significantly, GCC banks are trying to advance their sustainability agenda by increasing their sustainable finance offerings to customers and contributing to government efforts to decarbonize economies. A few banks have also tapped the international capital markets through sustainable bonds and sukuk, including green bonds and sukuk. We expect this trend to continue as banks seek to remain in global investors' sights. We also anticipate a progressive strengthening of climate risk disclosure.

However, we are yet to see bolder regulatory action in the region, such as through the introduction of climate stress testing, or other measures to encourage banks to accelerate their transition. This could change. Given the importance of the local banking systems in financing GCC economies, in the absence of broad and deep local capital markets we expect regulators to adopt a progressive approach.

How Energy Transition Affects GCC Banks' Creditworthiness

Banks' exposure to energy transition in the GCC takes several forms. We continue to focus on two channels identified in our previous report that we consider relevant to GCC banks' creditworthiness. These are:

Credit risk

This risk can be direct, through banks' exposure to companies depending on oil/gas price performance, and indirect, through the overall effect on the economy and government financials given GCC countries' high reliance on hydrocarbons.

Lower investor and customer appetite

This risk could take the form of a change in customer or investor behavior. Higher awareness of carbon transition could mean deposits or lending gradually shift to other banks or regions deemed more alert to such risk. This is particularly relevant for banking systems with high dependence on external funding, such as Qatar.

GCC Sectors Most Exposed Sectors To Energy Transition

Given the structure of GCC economies, we focused on banks' exposure to oil and gas, mining and quarrying, manufacturing, a portion of power generation, and direct lending to the government. We chose these sectors for their direct or indirect vulnerability to energy transition risk. These sectors have among the highest emissions and are most likely to be affected.

When compiling data, we used assumptions due to the lack of granularity of banks' disclosures. Our assumptions were informed by our analytical views on the banks we rate in the region. For example, large oil companies in the GCC tend to be government-related and banks typically do not publicly disclose the breakdown of their government exposures by sector. We therefore made assumptions based on large rated-banks' exposure, including that 30%-40% of government exposure is to companies in sectors potentially exposed to energy transition risk. This approach likely provides a representative view of the direct exposure to these sectors, but also likely underrepresents indirect or related exposures.

The oil and gas sector is vital for GCC countries. Other sectors tend to correlate with its performance either directly through the supply chain or indirectly through government spending or consumer sentiment and spending. For example, when oil prices declined in 2014 and during the COVID-19 pandemic, real estate prices and operating conditions in other economic sectors deteriorated sharply. Similarly, with higher oil prices post-pandemic and upon the outbreak of the Russia/Ukraine conflict, economic sentiment recovered rapidly in the GCC.

GCC Banks' Exposure Remained Broadly Stable

Charts 1 and 2 summarize overall and rated banks' direct exposure to the identified sectors. This shows that, on average, around 12% of banks' lending portfolios were concentrated on these sectors at Dec. 31, 2022.

Chart 1

Omani and Qatari banks are most exposed to these sectors given the significant dependence of their economies and fiscal revenues on hydrocarbons. Qatar is one of the largest producers of gas globally (and its long-term gas contracts are indexed on oil prices). Moreover, the government footprint in the country's economy is very visible. In Oman, recent increases in exposure to the government and the mining sector underpin the country's comparative position. UAE and Kuwaiti banks continue to have the lowest exposures due to higher economic diversification and significant exposure to the real estate and retail sectors, respectively. This exposure has remained broadly stable over the past year.

Chart 2

Individual rated banks and sector-level disclosures vary slightly. This is because we typically rate the largest banks in these countries, which often have significant corporate and government or government-related lending activities. Since we expect high, stable oil prices in the next 12-24 months, we do not forecast this exposure will have any effect on GCC banks' creditworthiness during the same period.

However, the effect of energy transition on oil and gas prices will be an important factor in the long-term. If oil and gas prices unexpectedly dropped significantly, GCC banks could be affected through the potential deterioration of the creditworthiness of their exposure to the identified sectors. They could also be affected by the impact on their economies, given hydrocarbons' still significant footprint. However, certain factors mitigate this risk. We believe that the low cost of extraction and potential increase in production capacity will support GCC economies' resilience in the long run.

Chart 3

Banks Step Up Sustainability

Over the past three years, all banks rated by S&P Global Ratings have published their sustainability agenda and strategies. A few banks have been more ambitious than others, publicly committing to certain levels of sustainability-related financings or a certain percentage of their overall financing. Other banks have started to tap the international capital markets using sustainable bonds and sukuk to remain on global investors' radars and raise funding to increase sustainable finance solutions for their customers. Some banks in the region have launched green products and services, such as green mortgages (with preferential terms if the property meets certain environmental standards) and financing for renewable energy and electric vehicles. These products help incentivize individuals and corporates to make more environmentally-friendly decisions. Nevertheless, they are still marginal in the overall lending book of GCC banks, although we expect their overall contribution to increase in the next few years.

Regulators Could Accelerate The Transition

Regulators in the region are yet to take bolder steps--through, for example, regulatory climate stress testing and scenario analysis--to uncover potential systemic risks and assess the preparedness of their banks to understand, manage, and mitigate climate risks. As in other countries, climate risks are not yet covered by minimum capital requirements. In the GCC, banks are well capitalized and can easily cope with any additional capital charge. Over the past 12 months, we have also seen some banks tapping sustainability-linked capital instruments to boost their capitalization and remain relevant for global investors.

Concentration Partially Underpins Previous Rating Actions

S&P Global Ratings has taken a few positive rating actions on GCC banks over the last two years due to the changes in their operating environment. Following the outbreak of the Russia/Ukraine conflict, oil and other commodity prices increased significantly. We now assume the price of oil will remain at around $90 per barrel in 2023 and $80 in 2024. This, along with reforms, has helped the operating environment in some GCC countries and improved their creditworthiness.

We think the effect of the energy transition on oil and gas prices will be an important factor for GCC banks in the long run

Another important consideration is concentration risk and how it reflects in our GCC bank ratings at the:

Sector level.   For example, in our Banking Industry Country Risk Assessment, we consider wealth volatility resulting from hydrocarbons' high contribution.

Bank-specific level.   This is generally a negative factor in GCC banks' risk profiles. The top 20 loans typically account for 20%-30% of total exposures for regional rated banks. Within the top 20, we regularly see exposure to national public and private sector champions, including national oil or petrochemical companies. National oil champions in the GCC typically have limited recourse to their local banking system and appear well positioned compared to industry peers' due to their low cost of extraction.

Related Research

• GCC Banking Sector Outlook, Jan. 31, 2023
• Gulf Nations Invest To Accelerate Deployment Of Renewable Energy, Feb. 27, 2023
• The Energy Transition: How It Could Affect GCC Banks, Feb. 16, 2020