Physical risks from climate change are rising globally, and GCC countries could become more vulnerable to their economic and financial impacts over the next few decades if investments in adaptation and resilience stagnate.

Why it matters:   On average, absent adaptation, in a slow transition scenario, about 8% of the GCC region's GDP could be at risk per year by 2050--slightly greater than the amount of GDP at risk in 2020--mainly to extreme heat and water stress. This is according to our "Sustainability Insights Research: Lost GDP: Potential Impacts Of Physical Climate Risks," published Nov. 27, 2023, on RatingsDirect (hereafter, the Lost GDP report; see the appendix for models used).

What we think and why:  The GCC's economic geography is relatively concentrated, which makes it highly exposed to water stress, extreme heat, and occasional flooding after extreme rainfall. This is because most GDP is created in cities, hydrocarbon-producing facilities, or import/export free zones. Adaptation and resilience measures can help soften or avoid impacts in some cases. S&P Global Ratings believes most GCC sovereigns have significant resources to continue their efforts in this area.

Water Stress And Extreme Heat Are The GCC's Main Climate Hazards

Water stress and extreme heat events are not uncommon in the GCC, which consists of the United Arab Emirates (UAE), Saudi Arabia, Kuwait, Qatar, Bahrain, and Oman. Generally, higher temperatures raise energy requirements for cooling, while compounding water stress. There's also a risk of potential damage from pluvial flooding, which occurs during heavy rainfall.

The region is slowly heating up.   As a proxy for changing exposure to extreme heat, S&P Global Sustainable1's Physical Risk dataset uses the frequency that the 95th percentile of the baseline daily maximum temperature is exceeded annually. The average annual 95th percentile temperature in the GCC is 42 degrees Celsius (42 C), ranging from 38 degrees in Oman to 45 degrees in Kuwait. This was exceeded on average for the equivalent of two months in 2020. In 2050, the temperature is projected to exceed this threshold for three and a half months per year under a slow transition scenario (SSP3-7.0), absent adaptation. Alongside generally higher temperatures, additional extreme heat events will likely accelerate physical asset degradation and even capital loss rates.

Economies may find it challenging to keep up with increasing demand for water.   Water stress occurs when total water withdrawals within an area exceed the available surface and ground water resources. As the region's populations expand, the climate warms, and economies develop, water demand will increase. The region's water stress ratios (projected water withdrawals to total renewable water supply in a given area) are among the highest globally. They are already more than double the 0.4 threshold for high water stress set by the World Resources Institute, according to the Lost GDP report. At the same time, greenhouse gas emissions related to energy-intensive water production could build, without substantial development of power generation from renewable sources.

High surface-water runoff in arid and urban areas can lead to flooding, even during moderate rainfall.   Most of the GCC's climate is hot desert or dry land, based on the Köppen-Geiger classification, with limited vegetation to absorb rainfall and moisture. These factors expose the region's main economic centers to pluvial flood risk. A higher incidence of extreme heat could compound pluvial flood risk, increasing the amount of surface-water runoff and precipitation volumes by 2050--absent adaptation--according to our analysis.

Climate hazards add to global economic risks.   The Lost GDP report found that, by 2050, if global warming does not stay well below 2 C, up to 4.4% of the world's GDP could be lost annually, absent adaptation. This is at least one-third greater than in the Paris Agreement's scenario--consistent with Shared Socioeconomic Pathway 1-2.6 (SSP1-2.6)--in which 3.2% of global GDP may be at risk annually, according to the report. GDP at risk rises to 5.1% under a limited mitigation scenario, where emissions are high (SSP5-8.5; see chart 1).

Chart 1

Economic Concentrations In The GCC Imply High Exposure To Physical Climate Risks

Variations in climatic conditions are evident across the region. However, according to most classifications, GCC countries display a high degree of climatic homogeneity around their main centers of economic activity. With relatively limited agricultural capacity, and rural populations, the main centers of economic activity are in cities or in hydrocarbon production and processing zones.

This concentration of economic output exposes almost all of the region's GDP to water stress and extreme heat, alongside occasional pluvial flooding (see chart 2). For example, for water stress, we display the projected ratio of water withdrawals to total renewable water supply in a given area; for extreme heat, the chart shows the projected annual fraction of days with maximum temperature warmer than the 95th percentile local baseline daily maximum temperature.

Chart 2

The region's high exposure to these climate hazards does not mean a corresponding amount of economic output will be lost as a result of a hazard occurring. By exposure, we mean the share of GDP or population likely to be affected by climate hazards. The Lost GDP report estimates the potential economic impact of these hazards, under SSP3-7.0 and excluding adaptation measures. Compared with other regions, the GCC shows the third largest GDP at risk (almost 8%) annually by 2050 without adaptation (see chart 3; the GCC forms part of the Middle East and North Africa region but is separated for comparison). That said, this was also largely the case in 2020. GDP at risk is the share of GDP that could be lost annually due to exposure to physical climate risks. This metric is based on a static view of the economy, so it doesn't account for adaptation to climate risk, changes in the economy's geography and structure, or any other growth dynamics. It also assumes all hazards occur every year.

Chart 3

Some Adaptation And Resilience Measures Are Already In Place

With limited groundwater resources and some of the highest average (and absolute) daily temperatures globally, extreme heat and water stress are already commonplace in the GCC. As a result, decision-makers throughout the region have--to differing extents--embedded adaptation and resilience measures into their countries' infrastructure. These measures may help reduce the potential impacts of physical climate risks. Yet they may also contribute to increased greenhouse gas emissions, particularly where additional energy is required, such as for desalinization and cooling.

The use of air conditioning and desalination technologies is widespread.  The GCC is estimated to hold 44% of the world's total desalinated water production capacity, according to a 2022 World Bank report (Jägerskog and Barghouti). Estimates vary on the extent to which the region's desalination capacity will meet its future water needs. Moreover, regional policymakers recognize that continued investment in resilience measures is a prerequisite for sustainable economic development.

The region is generally well placed financially to implement future adaptation and resilience measures.  GCC governments have some of the highest assets-to-GDP ratios among the countries we rate. Consequently, they have significant financial means to invest in adaptation and resilience measures--including retrofitting--which can be extremely expensive, especially when coupled with large national diversification plans.

Albeit to differing extents, the region's policymakers have been integrating net-zero commitments into national economic diversification plans.  They are planning for the energy transition and therefore implementing sustainable steps to reduce the region's overall economic and revenue dependence on hydrocarbons. We expect investments in renewables to generate electricity and to increase water production capacity will continue to expand across the region.

What This Means For GCC Sovereign Credit Ratings

The findings of our Lost GDP report reinforce our view that physical climate risks are likely to become more material to our sovereign credit rating analysis over time. Such risks may lead to economic losses and a potential drag on fiscal budgets as recovery and adaptation needs increase. As chronic and acute risks become more frequent and severe, better data will become available and uncertainty about the materialization of impacts will likely decline.

The need for adapting to these three climate hazards in the GCC--and the cost to do so--will likely rise.   This is because, even under the most optimistic climate scenarios, both water stress and extreme heat events are anticipated to worsen over the next two or three decades. Given the lock-in effect of historical emissions, many of the physical risks of climate change will materialize irrespective of today's policy choices. Financing adaptation and resilience investments, while transitioning away from hydrocarbons and meeting net-zero commitments at the same time, will pose greater fiscal and economic pressure in GCC countries with a weaker capacity to implement or support funding of further resilience measures.

At the same time, GCC governments' income remains subject to oil price changes, with an average 75% of revenue coming from oil-related receipts.   This leaves required adaptation and resilience measures and net-zero targets potentially vulnerable to a prolonged period of depressed hydrocarbon prices, despite efforts to increase the share of non-oil activity. In particular, this would be the case for governments with low asset stocks and high fiscal break-even oil prices. Added to this, demand for fossil fuels from other countries is projected to level off or even fall (see our hypothetical oil price stresses in "Energy Transition: Competitive Advantages Shield GCC Sovereigns," published March 8, 2023).

We believe most of the region's governments are in a financial position to achieve their adaptation and resilience objectives, but the total costs are uncertain and could increase.  Significant efforts are being deployed to achieve sustainable, net-zero-compatible economic transitions throughout the GCC. Regional governments have pledged to reach net zero by 2050 (UAE, Oman) or by 2060 (Saudi Arabia, Kuwait, and Bahrain). Policies--including those that support adaptation and resilience--and investments in renewables are being embedded into national economic development plans. However, as extreme heat and water stress increase in frequency and intensity, the speed of transition and implementation of adaptation and resilience measures could also play a role in determining related investment costs. We believe climate change will represent an additional risk to the region's longer-term growth prospects and fiscal health.

Appendix

• The research in "Sustainability Insights Research: Lost GDP: Potential Impacts Of Physical Climate Risks," published Nov. 27, 2023, provides insights into the potential exposure and readiness of 137 rated countries to different types of climate hazards. It uses CMIP6 (Climate Model Intercomparison Project), which is essentially the results of about 100 distinct climate models that simulate the physics, chemistry, and biology of the atmosphere, land, and ocean in detail.
• These models include the amount of future emissions and concentrations of greenhouse gases, aerosols, and other "climate forcings" to project what might happen. These are all based on specific socioeconomic assumptions for individual geographies, called Shared Socioeconomic Pathways (SSPs).
• The results are based on SSP3-7.0, which is a moderate-to-high emissions scenario, in which countries increasingly focus on domestic or regional issues, with slower economic development and lower population growth. A low international priority for addressing environmental concerns leads to rapid environmental degradation in some regions. This SSP projects a global temperature increase of 2.1 C (1.7 C-2.6 C) by 2050 or 3.6 C (2.8 C-4.6 C) by the end of the century.

Related Research

• Lost GDP: Potential Impacts Of Physical Climate Risks, Nov. 27, 2023
• Global Credit Conditions Q4 2023: Resilience Under Pressure, Sept. 28, 2023
• Energy Transition: Competitive Advantages Shield GCC Sovereigns, March 8, 2023
• Is Climate Change Another Obstacle To Economic Development?, Jan. 16, 2023
• Climate Change Will Increase Output Volatility, Jan. 5, 2023
• Weather Warning: Assessing Countries’ Vulnerability To Economic Losses From Physical Climate Risks, April 27, 2022
• The Heat Is On: How Climate Change Can Impact Sovereign Ratings, Nov. 25, 2015
• ESG Overview: Global Sovereigns, Feb. 3, 2021
• Storm Alert: Natural Disasters Can Damage Sovereign Creditworthiness, Sept. 10, 2015
• Climate Change Is A Global Mega-Trend For Sovereign Risk, May 15, 2014

External Research

• Water Risk Atlas (World Resources Institute)
• Advancing Knowledge of the Water-Energy Nexus in the GCC Countries, World Bank Group (Jägerskog, A. and Barghouti, S.) 2022
• Present And Future Köppen-Geiger Climate Classification Maps At 1-km Resolution, Nature.com (Hylke E. Beck, Niklaus E. Zimmermann, Tim R. McVicar, Noemi Vergopolan, Alexis Berg, and Eric F. Wood) 2018

Editor: Bernadette Stroeder