Declining output threatens Yemeni economy

26 July 2012

Recent attacks on energy infrastructure have highlighted Yemen’s dependence on hydrocarbons revenues. Investment in the sector is vital if Sanaa is to avoid a financial crisis

Key fact

Attacks on pipelines have cost Yemen $4bn in lost revenues

Source: MEED

With production in decline, the new administration in Sanaa needs to invest in the energy sector if it is avoid a financial crisis. Before the political turmoil of 2011, Sanaa raised 50 per cent of state revenues through its share of oil exports, while 80 per cent of the value of all Yemeni exports came from hydrocarbons.

The government used the earnings to heavily subsidise fuel sold in the country, at a huge cost to state finances. In 2010, the Central Bank of Yemen calculated that 22.2 per cent of all state expenditure was allocated to fuel subsidies. According to the Washington-headquartered World Bank, the 9 per cent of gross domestic product that Yemen spent on average on subsidies in the years leading up to 2011 made the country the biggest spender on fuel discounts in the Middle East and North Africa.

Cost of living

The subsidies helped keep the cost of living down for Yemenis, the poorest people in the Arab world, and were among the few public services the state provided. Figures from the Sanaa-based Central Statistical Organization published in 2009 show that on average 55 per cent of household income was spent on food, water, and energy, rising to as much as 70 per cent for the poorest families. Most water in Yemen is produced using pumps powered by subsidised diesel, while food and water are transported across the country by road using diesel-powered trucks.

Most of Yemen’s foreign currency reserves are generated by hydrocarbons exports, while 80 per cent of wheat and 100 per cent of rice consumed in the country is imported. Oil receipts also help the central bank defend the value of the riyal and provide domestic traders access to international markets through dollar currency in the banking system.

However, the subsidy system also encouraged widespread corruption and benefited the country’s small wealthy elite the most. In a 2008 report, the then prime minister Ali Muhammad Mujawar claimed that up to 80 per cent of the YR800bn ($3.7bn) spent on subsidies went to wealthy Yemenis, big businesses and fuel smugglers, who accounted for around a third of all domestic fuel consumption.

“Attempts were made to repair the [Marib] pipeline throughout the year, but with little success”

Government officials and international institutions, such as the IMF and the World Bank, have long recognised that Yemen’s dependence on oil and gas revenues and subsidies is unsustainable. According to the UK’s BP, oil output declined significantly between 2002 and 2010, from a peak of 457,000 barrels a day (b/d) to 264,000 b/d, a fall of 42 per cent over eight years. In 2009, analysts at UK think-tank Chatham House said that because of declining oil output, Yemen could become a net oil importer by 2019, although by some accounts the country could reach that stage by 2016.

“It has been clear for a long time that the dependence on oil is unsustainable,” says a senior executive at a major development agency working in Yemen.

“The government and the central bank have only really been able to prevent fiscal meltdown in recent years because of the high price of oil. They are hopeful that LNG [liquefied natural gas] will help soften the blow, but it won’t really make that much of a dent.”

In October 2009, Yemen LNG, a multinational consortium led by France’s Total, started exporting liquefied gas from Yemen after investing more than $4.2bn on infrastructure at Marib in the north of the country. This included a 320-kilometre pipeline linking Marib with a gas liquefaction and export terminal at Balhaf in the south.

Total estimated in 2009 that the scheme would add $30bn-50bn to state coffers during the project’s 25-year lifespan. The scheme has yet to become a major revenue contributor for Sanaa, however. Sources with knowledge of the deal say that state income from the project will probably not reach $300m a year until 2014, and will not top $500m a year until nearly the end of the decade.

Pipeline attacks

Government revenues have been severely hit over the past six months due to the sabotage of vital energy infrastructure. In March 2011, tribesmen blew up a key pipeline linking the Marib oil field controlled by state energy firm Safer Exploration and Production Operations Company with export and distribution facilities at Ras Issa on the Red Sea coast.

The pipeline carries up to 150,000 b/d of oil, most of which is processed at the nearby Aden refinery and is the main source of domestically-produced fuel. The government estimated at the time that the loss of the pipeline cost it $250m-400m to replace lost fuel products by buying them on international markets and $150m in sales.

The impact on the country was huge. Fuel shortages and power outages became widespread and the cost of fuel, food and water on local markets rocketed. Queues for fuel at gas stations reached seven hours. Attempts were made to repair the pipeline throughout the year, but with little success.

In mid-July, Oil Minister Hisham Sharaf was quoted as saying the loss of crude had cost Yemen $4bn. The country’s new president Abdrabbu Mansour al-Hadi in June ordered troops from three military brigades to protect oil infrastructure in Marib and has told the ministry to prioritise the pipeline’s repair.

On 11 July, a government spokesman said repairs had been completed on 20 out of 22 damaged sections of the pipeline. On 17 July, Sanaa said it began pumping oil to Ras Issa.

The only reason the government was not bankrupted by the sabotage, say sources with close ties to the Finance Ministry, is that Saudi Arabia made donations of crude and oil products worth in excess of $2bn in 2011 and 2012, the last shipment of which was due to arrive in July.

Maintaining output

A big challenge for the transitional government and its successor in Sanaa will be maintaining production levels at state-run fields and encouraging new investments in the country. Energy executives say there should be enough oil to maintain current production levels.

There are also still considerable volumes of gas available for use in new power schemes. Pre-2011 studies seen by MEED suggest that there could be up to 1.9 trillion cubic feet of gas reserves available for use over the next 10-20 years, even after accounting for Yemen LNG’s offtake.

However, many are worried about the ability of state companies to maintain current production levels. Most of Yemen’s oil is located in two basins, Marib-Shabwa and Sayun-Masila. The two main reservoirs within the basins are Block 18 in the Marib basin, also known as the Marib field, and Block 14, known as the Masila field. The two fields produce about half of Yemen’s oil.

Before 2005, Yemen Exploration and Production Company, a joint venture of Hunt Oil and ExxonMobil, both of the US, held a production sharing agreement (PSA) to produce oil from Block 18. Canada’s Nexen had a similar agreement for Block 14. In 2005, Yemen’s parliament blocked an agreement to extend the Hunt-ExxonMobil agreement by five years, in a major blow to both companies. The block was taken over by the newly-created Safer.

Around 2008, Nexen entered into negotiations to extend its PSA, but found the government increasingly difficult in its push to get the best possible terms on the deal. Executives close to the firm said they were still hopeful that a deal could be reached before the end of the original deal, which was due to expire in December 2011. But it was also pushed out.

“The Nexen case was a little different,” says a source in Sanaa. “There was a new transitional government in place. Although they were favourable towards Nexen, politically the first thing they did couldn’t be extending a contract with a big oil company, given the amount of tension there is over the oil industry. They didn’t have much choice.”

A new state-run company, Masila Company for Petroleum Exploration and Production (PetroMasila), was set up to take over the field. The company is largely run by Yemeni workers, who had previously been employed by Nexen, including Mohammed bin Sumait, its new head. Sumait was vice-president for finance at Nexen Yemen and officially took over as general manager in February 2012.

As Sanaa has taken over the two companies, it now receives all the revenues from the fields rather than the share of production it previously received. When it took over at Marib, state revenues rose and with oil prices above $100 a barrel for much of 2012, it should benefit from the additional revenues from Masila. The question is whether the new administration will understand that it has to spend money to make money, says a Sanaa-based oil executive.

Fresh investment

“The Safer guys have complained in the past that there hasn’t been much investment in the Marib field, and that has made it really hard to get production to stand still, let alone rise,” says a source in Sanaa. “So we will see if the same thing happens in the future now that they have both the big fields.”

Sources who have talked to the oil minister since he was appointed to the transitional government cabinet in December 2011, say that he understands these problems, but could face stern opposition if he starts approving new multimillion-dollar projects in the near future, especially given the reputation the industry has for corruption.

At current production rates, Yemen’s oil revenues will last another 32 years, while gas deposits survive 50.7 years. Without new discoveries, the government will find its main sources of income dwindle in the decades ahead.

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