It may come as a surprise to many that the UAE, home to 3.3 per cent of the world’s gas reserves, is facing a gas supply crisis. But years of sweetheart intra-GCC deals and bad pricing are putting the future of power, petrochemicals and industrial projects in jeopardy.

Occidental stands to make a 10-12 per cent return on investment. In terms of sulphur prices, it is marginal

Manuel Santiago, Royal Bank of Scotland

A glance at the numbers highlights an acute problem. According to figures from state petroleum distributor Emarat, the UAE produces 4.65 billion cubic feet a day (cf/d) of gas, 3.85 billion cf/d in Abu Dhabi and 0.5 billion cf/d in Dubai. At current rates of production, the UAE’s 214.4 trillion cubic feet of reserves will last 126 years. With demand projected to grow at 5 per cent a year, reserves are estimated to last 50 years. Shortages loom, caused by failure to price gas to encourage new exploration and recovery.

Rising gas demand

The UAE is not self-sufficient in gas. In 2011, UAE gas demand was estimated at 6.6 billion cf/d. Emarat says the country imports 2-2.3 billion cf/d of gas from Qatar. The UAE’s total production and imports of 7 billion cf/d, of which 2 billion cf/d is used for reinjection and liquefied natural gas exports from Abu Dhabi, leaves 5 billion cf/d available for power generation and industry.

Demand is expected to reach just under 25 billion cf/d of gas in 2025.

Over the past three years, Dubai and Abu Dhabi have witnessed rapid industrial growth. The continued expansion of its industrial base is central to the UAE’s long-term economic diversification. To meet the increased demand for gas, Abu Dhabi must boost gas supplies, adapt alternative fuels such as nuclear power and coal, and improve efficiency.

Abu Dhabi Gas Industries (Gasco), an Abu Dhabi National Oil Company (Adnoc) subsidiary, is working to make up the shortfall and is currently developing two major gas schemes to raise output: the $10bn Shah sour gas development and the integrated gas development (IGD).

In July 2009, Gasco awarded contracts worth $10bn on the IGD. The scheme will transfer 1 billion cf/d of high pressure gas from the offshore Umm Shaif field to onshore processing facilities at Habshan and Ruwais by 2013.

But nothing has underlined the challenge to increase production so much as the progress on the Shah gas development. In August 2007, Adnoc received bids from ConocoPhillips, ExxonMobil, Occidental Petroleum, all from the US, and the UK/Dutch Shell Group to develop the Shah gas project. It awarded the build-own-operate contract to ConocoPhillips in January 2008. But in April 2010, the US energy major pulled out of the scheme after the global economic crisis forced it to reassess engagement in the region.

The firm was also thought to be unhappy with a payoff of $5 a million BTUs from the scheme.

Nine months later, Adnoc found a new partner for the project. In January 2011, the firm signed a new joint venture agreement with Occidental Petroleum.

“[Occidental] didn’t win much work previously [in the UAE], but is now well placed for opportunities,” says Samuel Ciszuk, an energy consultant with UK-based KBC Process Technology. “They are able to grow in Abu Dhabi and there is new potential upstream.”

Shah gas scheme progress

The success of the Shah gas scheme is crucial to the development of the UAE as it will provide access to additional gas supplies and help address the growing imbalance between demand and supply. But the project faces unique challenges.

The sour gas is 23 per cent hydrogen sulphide and 10 per cent carbon dioxide and the desert terrain is difficult to operate in. The volume of the gas for recovery is 1 billion cf/d, with only 0.5 billion cf/d of it dry gas.

“Health and safety will be a major factor, since hydrogen sulphide is highly poisonous and heavier than air,” says Manuel Santiago, managing director and head of oil and gas at the UK’s Royal Bank of Scotland’s global banking and markets division. “It is pungent at low concentrations, but as these increase, it deadens the sense of smell and at poisonous levels is difficult to detect.”

Contracts worth $5.7bn have been awarded so far on the project. The US’ Flour Corporation won the project management contract in 2009. Italy’s Saipem was awarded three contracts worth a combined $3.5bn for the gas processing facility, sulphur recovery plant and the product pipelines. South Korea’s Samsung Engineering was awarded a $1.5bn contract for utilities and the offsites package. A joint venture of Spain’s Tecnicas Reunidas and India’s Punj Lloyd won a gas-gathering package worth $500m. The scheme is expected to produce its first gas in 2015-16.

The project economics are also challenging. Occidental Petroleum envisages a capital expenditure of $4bn from 2011-14, reflecting its 40 per cent stake in the project.

“Occidental Petroleum stands to make a 10-12 per cent return on investment. In terms of sulphur prices, the economics are pretty marginal. At a 10 per cent discount rate, it will have earnings of $1.5bn. If costs rise by 10 per cent, which is entirely possible, it won’t make any profit at all,” says Santiago.

“We understand the key contractual difference is that Occidental will be paid a low price for the gas, whereas ConocoPhillips were not entitled to any revenue from the gas stream, only from sulphur and liquids.”

Monetising gas

Occidental Petroleum will be paid up to $1.20 a million BTUs for gas, he says. It will also receive payment for natural gas liquids and sulphur. Sulphur prices have been volatile in the past three years. The supply/demand balance in 2012-14 is expected to give way to a “moderate surplus” in 2015, say analysts, with world production growing at 6.7 per cent a year.

“Sulphur was one of the best-performing commodities in 2011 due to fertiliser demand,” says Robin Mills, head of consulting at Dubai-based Manar Energy Consulting. “Prices have been falling since December. With prices around $220 a tonne, sulphur revenues are highly significant [for the Shah project], probably some $700m a year, about half the natural gas liquids revenues. But sulphur is also expensive to transport and a lot more sulphur is expected to hit the market in the next few years as plants come online.”

Lower sulphur prices are likely to make the investment less attractive for Occidental Petroleum. The low pricing for gas is a major issue in the UAE, as it offers no incentive for developing and exploiting new production. The Dolphin pipeline delivers Qatari gas for as little as $1.20 a million BTUs. Fuel sales to customers are also heavily subsided, making distribution an unprofitable business.

Hakim Darbouche, research fellow at the UK’s Oxford Institute for Energy Studies, says that by 2015, serious changes will need to be introduced to the UAE’s energy pricing system.

“I think the events of the Arab uprisings have somewhat had a negative impact on the momentum for change that had been building up in the region over the last few years. The outcome of the Iranian experience with its ongoing subsidy removal programme will likely have an impact too.”

Future gas scenario

There is a sense that Abu Dhabi is facing pressure to become a little more generous with project participants. On the other hand, the government is squeezed by the fact that the gas will be sold domestically at highly subsidised prices. “Abu Dhabi needs the project, but are negotiations still continuing on its tight terms?” asks Ciszuk.

In the short term, the UAE will look to increase imports from Qatar and elsewhere. Imports are expected to reach 5 billion cf/d by 2016. In the longer term, the right pricing structure and investment terms need to be agreed upon to encourage investment in gas projects.

Failure to increase gas availability will result in shortages. This could lead to power outages and hold back the UAE’s industrialisation aims. Abu Dhabi’s investment in nuclear power will free the equivalent of 1.5 billion cf/d of gas and plans for coal plants will also help but shortages are imminent.