Running on empty – how to survive in the Middle East in the era of cheap oil
06 May 2016 09:00
by Chris Crowe
Falling oil prices have hit the Middle East and forced advisers to radically reshape strategies in the region.
Oil price volatility is a fact of life in the Middle East. At below or around $40 a barrel, the region has been dealt a hard dose of realism. Developing economic models that rely less on oil and gas revenues is now the order of the day, while national governments have had to rein in notoriously lavish spending programmes.
Law firms that rushed into the Middle East as it became a significant driver of global economic activity amid soaring oil prices a decade ago, now have to review their strategies.
Rahail Ali, Hogan Lovells’ Dubai managing partner, sums up the mood: ‘It would be foolish for anyone to say that the level of legal business is not affected by the oil prices. It dictates the amount of liquidity in the region and the appetite for substantial transactions. Oil is a volatile commodity. You have to take the rough with the smooth.’
Michael Kerr, Dentons’ Middle East managing partner, agrees that the region’s sudden impression on global legal consciousness circa 2008 is no longer as powerful: ‘We are now seeing the fiscal reality that exists because the high levels of activity that came with the Middle East’s awakening naturally abate over time. This new fiscal reality is also currently seeing the short-term impact from the fluctuations of the petrocarbons market.’
Oil and gas-rich states such as Abu Dhabi, Qatar and Saudi Arabia no longer have bottomless wealth and seemingly endless spending plans. In February, Standard & Poor’s downgraded Saudi Arabia’s credit rating to A- and took away Bahrain’s investment grade status.
Certainly the shift in economic outlook has not bypassed the legal profession. A string of international firms have decided to overhaul their Middle East strategies, some radically. In the April 2015 edition of Legal Business, we reported on Latham & Watkins’ decision to close its Abu Dhabi and Qatar offices and concentrate its resources in Dubai and Riyadh, Saudi Arabia’s capital.
Latham’s move was followed by a number of competitors, who also retreated from Abu Dhabi as firms finally recognised the limited number of clients and mandates available in the historically oil-rich emirate. ‘There are not too many organisations with attractive legal budgets,’ admits one partner at a leading UK-based international law firm.
Simmons & Simmons announced the closure of its Abu Dhabi office in January 2016, indicating that existing Abu Dhabi clients would continue to be served from Dubai. It is a proposition that would have held little credence a few years ago when the Abu Dhabi government and government-linked companies demanded that their legal advisers show a commitment to the jurisdiction by having a physical presence there. Firms now recognise that this stance has softened, but also that the small number of major institutions that frequently use outside counsel are usually tied to their preferred legal advisers. One partner at a major UK-based international law firm says that he has given up trying to curry favour with Mubadala, the hugely affluent Abu Dhabi sovereign wealth fund, because of its entrenched relationships with firms such as Shearman & Sterling.
Big in Tehran: will lifting sanctions lead to Iran’s re-acquaintance with global trade?
Viewed as the ‘last great emerging market’ according to Clyde & Co’s Christopher Jobson, Iran’s gradual reintegration into the global economy is gaining momentum with a nuclear energy deal with the US, UK, France, Russia, China and Germany, and the European Union’s lifting of sanctions against the Islamic republic. ‘It is viewed by many as one of the few sources of growth in an otherwise sluggish world economy,’ Jobson says.
Yet for decades Iran stood out as an international pariah. Ever since the Iranian Revolution of 1979, it has been regarded as a highly volatile nation and hotbed of Islamic extremism. Even among its neighbours and other Gulf states, it is viewed with genuine enmity, thanks to the ongoing division between Shia and Sunni Islam.
In Yemen, the current administration has accused Iran of backing local anti-government Shi’ite rebels. And with Saudi and UAE forces deployed to support the Yemeni army, the geopolitical tensions in the Gulf could hardly be more acute. Saudi and UAE military personnel have suffered significant casualties in the conflict.
Even so, Iran’s hydrocarbon wealth and large and well-educated population make it a potentially powerful economic force. CMS launched a Tehran office in February this year, the first international firm to do so and Amir Kordvani, the head of the Iran desk at CMS Dubai, notes the firm’s keen interest in the jurisdiction: ‘There are advantages in terms of a population of 80 million people and two-thirds of the population are below 30 years of age, who are very well educated. There are a large number of young people with postgraduate degrees and two or three languages. There are many that have been educated in foreign countries who want to come back and contribute. Some say it has the largest gas reserves in the world. It has huge hydrocarbon reserves and there are opportunities in all sectors. Iran offers an unprecedented 21st century opportunity in terms of an emerging market.’
UAE-headquartered Al Tamimi & Company is another firm actively pursuing Iran mandates having set up an Iran desk in Dubai in October 2014, headed by senior associate and Iranian native Hamid Mojtahedi. Richard Parris, Clifford Chance’s Middle East head of energy and projects, is also a regular visitor to Tehran and is working on a number of projects in the jurisdiction.
Law firms are naturally attracted by Iran’s alluring fundamentals, but they are having to walk a fine diplomatic line, especially if they also happen to operate in states that are hostile towards the country. ‘Leaving aside the promise of further sanctions being lifted, it is still a volatile region,’ concedes Hogan Lovells’ Rahail Ali.
And with US sanctions against Iran still in place, it is far from being a market that is fully open to business. ‘There is no free run into Iran,’ Baker & McKenzie’s Erik Scheer says. ‘The reality is that there are still severe sanctions in place, which are very restrictive. This is especially true for US persons and the definition of US persons is quite broad.’
Despite the expectations surrounding Iran’s reintegration into the global economy, there is still a great degree of circumspection within firms about promoting their interest and expertise in Iran-related deals. ‘There are issues at play with Iran,’ says Dentons’ Michael Kerr. ‘It is not a complete reopening of the market. There are those geopolitical sensitivities that require law firms to be careful in how they position themselves in the context of Iran. But there is a recognition that Iran has opened up and it has created opportunities and it will become more active come what may.’
Bank Muscat, Oman’s largest lender, announced in February that it was opening a branch in Iran. Oman is one of Iran’s few allies in the Gulf and is eager to develop trade links between the two states. Notably, many of the growing number of Iran-focused conferences in the region are being held in Oman.
Kordvani believes that outbound transactions from Iran are also likely to become more significant: ‘There are many local entities that want to engage in international business. They want to get out of the boundaries of the country and get involved in Africa, central Asia and other regions. The current finance limitations restrict that ability, but I am positive that they are on the right course. Things will get easier rather than more difficult.’
Shearman has been present in Abu Dhabi for over 40 years and its longstanding relationships have enabled it to advise Mubadala on its development of Dolphin Energy and Sheikh Mansour bin Zayed Al Nahyan, the deputy prime minister of the UAE, on the acquisition of Manchester City Football Club. Way back in 1971, it advised on the creation of the Abu Dhabi National Oil Company (ADNOC), a client that it still represents today.
With a small number of firms taking the lion’s share of the big Abu Dhabi mandates, it is not surprising that firms such as Herbert Smith Freehills and Baker Botts have recently shut down their local branches and pulled team members north to Dubai.
Shane Morton, head of recruiter Taylor Root’s Middle East operation, says that Abu Dhabi’s status has faded: ‘Eight years ago, many firms thought Abu Dhabi would grow to be a rival financial centre to Dubai, but that didn’t occur. Dubai’s place as the principal regional hub is now cemented.’
A year ago Latham surprised the market by announcing that Doha and Abu Dhabi could be and would be serviced from a consolidated office in Dubai. Subsequently, three of its Dubai partners – Charles Fuller, Andrew Tarbuck and Anthony Pallett – joined Hogan Lovells.
However, Christopher Jobson, Clyde & Co’s Abu Dhabi managing partner, says: ‘What we are seeing is not a contraction of the market but a shakeout of the firms that had no real understanding of the market they were operating in or had limited sector specialism. Further office closures are inevitable as there are firms operating on the margins of people and profitability.’
Doug Peel, head of White & Case’s Middle East practice, says many firms made poor decisions on the basis of market hype a decade ago: ‘Many firms rushed into the Middle East during the oil price boom believing that the spending spree would go on ad infinitum. It is natural now for them to head for the door.’
The effect of geopolitical tensions that exist in part due to Iran’s gradual reintegration into the global economy and the ongoing conflict in Yemen should not be underestimated. While the West is principally focused on the war in Syria, the Gulf has been consumed by war in Yemen, where UAE and Saudi Arabian troops have suffered multiple casualties. This has eaten further into Saudi Arabia’s already depleted budget, along with its involvement in supporting anti-government militia in Syria.
Despite the gloomy outlook, international firms are far from giving up on the region. This month, Clyde & Co promoted two new partners in Abu Dhabi and one in Dubai, while Freshfields Bruckhaus Deringer also made up two partners in Dubai.
Jobson believes that firms with larger resources and a more full-service approach are better equipped to ride out a capricious climate. ‘Inevitably, low oil prices mean changes in the market. Undoubtedly governments are looking to operate differently and look to restructuring, outsourcing, streamlining and innovation, and different governments are talking about privatisation. It gives us two opportunities; when you see a contraction in the market you will see a spike in disputes, but it also raises opportunities in the corporate space, whether that be M&A activity, restructuring or consolidation. We have to show flexibility and have the nous on the ground to adapt and change. When you have 40 partners, 300-odd staff and a full-service capability, you can work on both sides of the equation, more so than when you are one partner and three assistants.’
Kerr holds a similar view: ‘As the regional economies and governments become more mature and the business community becomes more mature, you will find there is an increasing expectation from those that distribute the work and government work, that the law firms that benefit are the ones that are in and of the community. There will be some markets, but not all, where if you want the work, you will have to be there.’
A report by Natixis Commodities Research predicts that oil prices will rise to $54 per barrel towards the end of 2016, providing a much-needed fillip to the Middle East’s flagging economies. It provides another reason to be optimistic, although prices will still be some way off the point where traditional oil-rich nations begin to replenish their budget reserves.
Robin Abraham, Clifford Chance’s Middle East managing partner, says the region has a long way to go before the economy roars again, but believes that government-led programmes are going to make a difference: ‘The UAE and Qatar have break-even oil prices at around $60 to $70 a barrel before they have to raise new funds or dip into their plentiful reserves. The position is different in Saudi Arabia, which is reported to need oil prices to be north of $100 to balance its books, and there is lots of noise about breaking up the Saudi economy, privatisation and opening up more to foreign investment. We sense that politically there is momentum to do it.’
The typical Middle East economic model of big oil and gas revenues and low taxes is beginning to shift. Economic diversification initiatives are taking hold in a variety of Gulf states. Saudi Arabia has introduced a new five-year plan, which will include a wide-ranging privatisation programme and the introduction of new taxes. The 2016 to 2020 National Transformation Plan is likely to include the IPO of Saudi Aramco, making it the most valuable listed company in the world. The privatisation of several of its subsidiaries is also planned, according to recent statements by deputy crown prince Mohammed bin Salman al Saud (see box, ‘Opening up’).
Governments in the Gulf are striving to increase revenues from industries other than oil and gas. The Gulf Cooperation Council (GCC) – which includes Saudi Arabia, Bahrain, Kuwait, Oman, Qatar and the UAE – is also developing new income streams through the introduction of corporate tax and VAT over the next three years.
Sam Habbas, senior partner of Kuwaiti firm ASAR – Al Ruwayeh & Partners, says that Kuwait’s government is likely to respond with a package of corporation tax, a privatisation programme and less-generous benefits for Kuwaiti citizens. Habbas also suggests this has resulted in heightened activity in the ‘debt capital markets area as local issuers consider now being a good time to tap the capital markets to shore up their balance sheets’.
In another blow to the region’s low-tax status, Dubai Airports is introducing a passenger fee to help finance new infrastructure and to boost capacity. Dubai Airports is expected to serve 118 million passengers by 2023, according to its chief executive Paul Griffiths. Kerr believes that each GCC government is developing a materially different economic mindset: ‘It has become clear across the region that there is a pressing need to be more diversified and less dependent on petrodollars.’
Equally, law firms have recognised the need to be less reliant on government-linked work as Gulf states have pulled back on investment and certain infrastructure projects in order to address their more parlous fiscal situation.
‘The Saudi market is much less penetrable than other markets. It is about who you know.’
Martin Amison, Trowers & Hamlins
‘Demand is changing,’ observes Husam Hourani, managing partner of Middle East firm Al Tamimi & Company. ‘You can basically downsize, do less and reduce the number of lawyers and employees, or you can change strategy and discover that there are plenty of opportunities. For instance, our employment law practice is booming and we have never seen as much regulatory work as in the last few months.’
Pervez Akhtar, Freshfields’ Dubai-based managing partner for the MENA region, is also sanguine about the climate: ‘Law firms that are reliant on government-linked work are going to be affected more disproportionately than others, but those whose practices are more focused on high-end M&A continue to be very busy. We’ve actually been massively busy over the last year.’
Hourani says that Al Tamimi’s once-frenetic IPO practice has slowed enormously over the last two years, but suggests that activity has shifted: ‘Most banks in the GCC are looking to capital increases to support their balance sheets, which provides opportunities, whether plain vanilla or convertible bonds. There are lots of new ideas here, but they are different in nature to what law firms are used to. This change of mentality is easy for some and more difficult for others.’
Riding a different wave
In 2015 Shearman launched an office in Dubai and entered into an affiliation with Dr Sultan Almasoud & Partners in Saudi Arabia. Marwan Elaraby, the firm’s Middle East managing partner, comments: ‘Abu Dhabi remains our hub in the Middle East but the evolution of our business into Dubai and Saudi Arabia ensures that we can best capitalise on the diversification in economic activity that is taking place across the region as a whole.’
Meanwhile, Holman Fenwick Willan announced the launch of three new associations in Saudi Arabia, Kuwait and Lebanon in January this year. Erik Scheer, a member of Baker & McKenzie’s global executive committee who has responsibility for the Middle East, says that his firm’s regional practice had a very strong final quarter of 2015: ‘Oil prices have become the new reality and clients have begun to adapt and focus on ways to benefit and the opportunities out there.’
Middle Eastern resilience - Richard McLerie, JLegal
Key legislative developments in the UAE - James Bowden, Afridi & Angell
Hogan Lovells takes a similar view, having hired three new partners in Dubai from Latham at the end of last year, and Ali says the firm is not disheartened about the collapse in commodity prices: ‘The firm’s view of the region is that it fully recognises that the Middle East is an emerging market and is subject to the vagaries of an emerging market, but fundamentally we have a hugely positive outlook for MENA. We are bucking the trend and have recruited three great guys when others are cutting back.’
Firms report a relatively buoyant M&A scene as opportunistic investors, such as private equity houses, are taking advantage of more attractive valuations. ‘If you have a client that is sitting on a cash pile for some reason it is a great time to buy another company in the hydrocarbon industry,’ Peel comments.
Opening up: Saudi Arabia liberalises its economy
For all the debate over where firms need to be located in the Middle East, Saudi Arabia is the significant economy that most are intensely focused on. It is a market that many firms have been part of over the decades, largely through exclusive associations with local firms, although Clifford Chance and Clyde & Co were the first to establish joint Saudi and foreign-owned law partnerships in 2014.
Most firms run lean operations in Riyadh, Jeddah or both and provide additional expertise and resources from Dubai and other Gulf offices.
The slump in oil prices has clearly affected the hydrocarbon-rich state, but its plans to further liberalise the economy and encourage inbound investment will be welcome to international law firms.
The planned partial privatisation of Saudi Aramco though has captured most of the headlines with its potential market capitalisation of some $1trn. The kingdom has brought in advisers such as McKinsey & Co and Boston Consulting Group to help draw up economic reforms.
Aside from the headlines generated by its plan to privatise Saudi Aramco, it is looking to do the same with a multitude of other businesses. In November last year, the General Authority of Civil Aviation revealed plans to privatise all 27 of the Saudi Arabian airports that it has control over.
In an interview with The Economist in January, deputy crown prince Mohammed bin Salman al Saud said that non-oil earnings had increased by 29% in 2015 and the introduction of VAT in 2016 or 2017 would provide another valuable source of revenue.
The size of the kingdom’s economy and its liberalisation plans should please international law firms, though it still remains a market that is tough to penetrate, not least because it is not the most attractive location for expats to work in.
‘The Saudi market is much less penetrable than other markets. It is about who you know, local connections and building up that trust takes an enormous amount of time,’ Trowers & Hamlins partner Martin Amison comments. Further still, there are a limited number of Saudi natives that are bilingual, have been educated overseas, and are legally trained in Western jurisdictions.
While most expats are naturally drawn to the more liberal and Western-oriented centres such as Dubai, White & Case’s Doug Peel says that a career in Saudi Arabia is becoming more appealing, not least because it provides young lawyers and ambitious partners with exposure to a steady diet of high-value and complex deals.
He also believes that the social environment for expats is improving: ‘To have and raise small children, Saudi Arabia can be a really comfortable place to live. There is a vibrant social life for Saudis and expats.’ Peel points to the firm’s flourishing capital markets practice in Saudi Arabia, led by Robert Vydra. Last year, he led the team that advised Saudi Hollandi Capital on the rights issue by Saudi Arabian Cooperative Insurance Company.
Deals in this sector continue, although Mergermarket data indicates that there were just five Middle East M&A transactions valued in excess of $1bn in 2015, the two largest being in the oil and gas sector. In the biggest deal of the year, Latham advised Kuwait-based Equate Petrochemical Company on its $3.2bn acquisition of MEGlobal International in the UAE. Shearman & Sterling advised The Dow Chemical Company on the sale of its interest in MEGlobal to Equate. Elaraby says: ‘Regional M&A deals are proceeding as a result of depressed public valuations, limited reliance on leverage and committed equity that needs to be deployed.’
In another regional oil and gas deal, Freshfields and Irish leader Arthur Cox advised Emirates National Oil Company (ENOC) on its $2.83bn acquisition of an additional 46.1% stake in Dubai-based Dragon Oil, to become the sole owner of the company. Allen & Overy and Dublin-based Mason Hayes & Curran advised Dragon Oil.
‘What we are seeing is not a contraction of the market but a shakeout of the firms that had no real understanding of the market they were operating in.’
Christopher Jobson, Clyde & Co
Freshfields continues to service a number of regional and international private equity sponsors through its Middle East offices. In November 2015, it advised Warburg Pincus and General Atlantic on their acquisition of a 49% stake in Network International, the UAE-based payment-processing business focused on the Middle East and Africa, from The Abraaj Group. It also represented International Finance Corporation and Abraaj on the sale of Saham Finances, the Morocco-based insurance company, to South Africa’s Sanlam, the largest insurer in Africa.
Akhtar believes that private equity houses are looking beyond macroeconomic instability and unearthing attractive energy assets. ‘International private equity houses see the collapse of the oil price as an opportunity to find targets and more accessible sellers that are more amenable to bringing in a partner or fresh capital that they can’t access locally.’
Even with pressure on public finances, construction and projects still appear to be plentiful. Richard McLerie, the UAE general manager of JLegal, the recruiter, says there is a real dearth of project finance lawyers in the Middle East in contrast to the demand for this expertise. He believes that construction work is buoyant for both contentious and non-contentious work: ‘There is a lot of arbitration and front-end work which tells you that a lot of key projects are still going ahead.’
Transport systems, such as Riyadh’s 85-station metro, are another means by which governments encourage economies to diversify.
Dubai is the one state to pioneer infrastructure development and economic diversification and become the gold standard in the Gulf. It opened its own metro system back in 2009 and has built a business environment that other Gulf cities can only dream of matching. With Abu Dhabi and Qatar’s capital Doha noticeably affected by oil values, Dubai has managed to further solidify its position as the pre-eminent financial centre in the Middle East.
With the world’s busiest airport and air connections to all parts of the globe, its prominent worldwide status looks assured, especially given its ability to ride out the effects of the global financial crisis, which put its major institutions and real estate sector in severe peril – it was however forced to ask for a $10bn bailout from Abu Dhabi in 2009.
Firms now view Dubai as the principal centre to base their Middle East teams and service regional work as well as local mandates. Ali remarks: ‘Dubai has very clearly emerged as the centre for the whole region. It provides a very stable environment for corporates and professional advisers to operate in.’
While many firms recognise the importance of having a presence in key economies such as Saudi Arabia, most are happy to resource much of the work out of Dubai. It provides a relatively appealing business and social climate for both expatriates and natives.
‘Dubai is a crucial part of our Middle East strategy,’ Scheer says. ‘It is where a lot of cross-border deals take place and we also see many of our global clients using Dubai as a hub for regional investments and the management of subsidiaries in Africa and the region. We certainly don’t expect that to change. Dubai is a very attractive location to set up shop and have a regional base.’
It is a dramatic turnaround for a city that many felt would never recover from the 2009 bailout but Dubai now stands unchallenged as the regional’s legal capital. In the age of low oil prices, that domination looks set only to increase. LB