Rising oil prices threat to growth

07 March 2011

The spike in crude prices that has followed the Middle East unrest is fuelling fears that the uprisings in the region could trigger a slowdown in the global economy

Fears that political unrest in the region could lead to restrictions in energy supplies have seen oil prices spike almost 30 per cent in the first two months 2011. Brent crude topped $116 a barrel on 7 March, compared with $90 a barrel at the end of 2010.

While the increase in oil revenues might provide a short-term boost to producers, it has raised real concern that if prices remain high, they could lead to a global slowdown.

Although the outbreak of unrest in Tunisia and Egypt had little impact on the global energy markets, it was news that oil production had been severely disrupted in Libya that pushed the European benchmark Brent crude above $110 a barrel. The London-based Centre for Global Energy Studies (CGES) estimates output from Libya to have fallen by as much as 75 per cent. The country produces about 1.65 million barrels a day (b/d).

Saudi support

Although the oil producers’ group, Opec has not yet convened an emergency meeting, Saudi Arabia, the world’s largest oil producer, has pledged to make up any shortfall. Brent prices fell to about $112 a barrel on 8 March when Saudi oil minister Ali al-Naimi said the kingdom had 3.5 million barrels a day of spare capacity. Nonetheless, the disruption to Libyan supplies has raised fears over where the protests may spread next. And with no knowing how long the political turmoil in the Arab world may last, it has raised the prospect of national oil companies missing targets for production increases due to delays in exploration programmes.

News that oil production had fallen in Libya pushed the European benchmark Brent crude above $110

Scene of the bloodiest upheavals since the Arab protests began in late December, the attention of the oil and gas industry is focused for now on Libya. The country’s oil production lies floored after international oil companies (IOCs) evacuated their staff and transportation has been hit by bottlenecks and blockades. Estimates of lost production range from 800,000 b/d to 1.2 million b/d. Although some production appears to be ongoing in spite of the absence of foreign workers, exports have ground to a halt.

The IOC presence is concentrated around the Sirte Basin in the east of Libya, which has been abandoned by government forces. Although shielded from the fighting by their remoteness from urban centres, there have been isolated attacks on installations. China National Petroleum Corporation (CNPC) said on 25 February that one of their facilities had been attacked. Reports of looting have also surfaced. 

The Al-Zuwayya tribe has threatened to attack Libya’s oil and gas infrastructure – estimated by the UK’s Barclay’s Capital to be worth about $200bn – if the violence by forces loyal to Muammar Qaddafi in the west does not abate. Installations near Marsa el-Brega were the scene of heavy clashes in early March, but anti-government forces retained control of oil facilities. Employees at some installations are striking, blocking the flow of oil and gas from the territories under opposition control to Qaddafi strongholds, while at the same time protecting their places of work. Fighting has also taken place in the oil towns of Ras Lanuf and Zawiya.

The wave of geopolitical uncertainty is likely to impact foreign investment significantly

Amrita Sen, Barclays Capital

Gas exports have similarly been disrupted. Italy’s Eni was forced to shut down the Greenstream pipeline connecting the two countries as the security situation deteriorated. The Greenstream pipeline has a capacity of 9 billion cubic metres of gas a year – more than 10 per cent of Italy’s consumption.

IOCs exit

International oil firms that have suspended operations and evacuated staff from Libya, include Germany-based BASF’s exploration arm Wintershall, Italy’s Eni, Spain’s Repsol, France’s Total and Austria’s OMV. Eni has the biggest exposure to Libya among the IOCs, according to analysts, with country accounting for more than 30 per cent of its total oil and gas production.

Exploration activity has been equally affected by the turmoil and this will likely delay the delivery of new projects. Respol has suspended all its exploration work, as have the UK’s BP and the UK/Dutch Shell Group, both of which are still in the exploration stage in Libya. BP was due to start drilling in the Ghadames Basin imminently. The UK oil major signed a controversial $900m deal in 2007 to explore around the Ghadames onshore basin and the offshore Sirte basin.

Capital expenditure assigned to North Africa projects will be diverted elsewhere in the portfolio

Catherine Hunter, IHS Global Insight

The unstable political situation in Libya will curtail activity in its oil and gas sector for the foreseeable future, but IOCs are unlikely to abandon the country altogether. Having the largest hydrocarbon reserves in North Africa, estimated at 44.3 billion barrels, Libya is an attractive market to be in.

“US and European oil and gas companies are too well established there to be affected by this in the medium term,” says an industry source. But in the short term, uncertainty could cause investors to shy away from committing to new projects and Libya may now miss its target for increasing production. Its goal, set in 2009, is to raise oil production to 2.3 million b/d by 2013.

Oil and gas infrastructure sabotage

Furthermore, sabotage of oil and gas infrastructure, although so far not evident, cannot be ruled out. Some commentators have evoked the spectre of the Iranian revolution in 1979, when an industry crippled by sabotage had to cope with the lack of modern technology and outside investment after the regime change.

“In the longer term after a change of regime, oil production can drop rapidly,” the CGES said in a February briefing note. “It can take years to recover due to difficulties replacing key personnel and repairing infrastructure, the repercussions of the revolution in Iran in 1979 being a case in point.”

At worst, the country could be plunged into a protracted civil war and that would be disastrous for the oil and gas sector, which is in urgent need of both foreign capital and technology. A long standoff between Qaddafi loyalists and rebels could make the oil and gas industry a vital pawn in the hands of the competing factions, further undermining its commercial viability for IOCs.

“The relatively unorganised nature of the popular uprising means that tribes and urban political groups might find themselves competing over the control of oil and gas assets,” says Samuel Ciszuk, Middle East energy analyst at London consultancy IHS Global Insight. “They could use the parts of the infrastructure or reserves that they control to underpin their own influence in the jostling for future political power.”

In the long term, the likely departure of Qadaffi, who has been a thorn in the side of IOCs active in Libya by unilaterally changing agreed contract terms and allowing for bureaucratic delays, could provide a major fillip to the sector.

“The revenue imperative for a new regime will likely be quite high and hence may dampen any enthusiasm for radically altering the existing energy contracts, especially since international economic sanctions were only recently lifted,” says Amrita Sen, oil analyst at Barclays Capital.

Elsewhere in North Africa, the situation in Egypt, following the overthrow of Hosni Mubarak, president for more than 30 years, is far less threatening for the IOCs. Located away from the cities where the protests have taken place, Egypt’s production of 700,000 b/d of oil and 6.5 billion cubic feet a day (cf/d) of gas, has been unaffected by the political turmoil.

Work resumes

Some exploration work was briefly interrupted due to communication and logistical problems, but most of the affected operators have resumed work. At the height of the protests, the pipeline supplying the Levant and Israel with gas was attacked and damaged, interrupting supply. But Egypt continues to export the pre-crisis levels of about 2 billion cf/d of gas.

The five main international upstream players in Egypt are the US’ Apache Corporation, Eni, the UK’s BG and BP, and Malaysia’s Petronas. Eni, Spain’s Gas Natural/Union Fenosa, BG, Petronas and France’s GDF Suez own gas liquefaction infrastructure, while the Nile Delta remains a significant centre for exploration activities for BP, Russia’s Statoil, Eni, Germany’s RWE, BG, Petronas and Shell.

While these companies are unlikely to leave the country, they could take a cautious view on further investment. Analysts say they are focusing on securing their existing assets.

The longer the uncertainty over the country’s political leadership exists, the higher the potential for delays to projects. Under these circumstances, it is therefore unlikely that Egypt will launch a new set of licensing rounds in the near future.

Algeria resilient

In Algeria, President Abdelaziz Bouteflika has to date managed to resist calls for him to resign. The unrest has so far not affected the country’s oil and gas industry, with the bulk of IOCs operating in remote parts of the country. Unlike Egypt and Libya, Algeria’s national oil company owns most of storage and pipeline infrastructure, so dissidents have not been able to block exports. Much like the government itself, the country’s oil and gas sector has proven resilient to turmoil over the years.

“Algeria’s oil infrastructure has survived relatively unscathed from long periods of civil war in the past and we would expect no difference this time around,” says Barclays Capital’s Sen.

Like its neighbours, Algeria is dependent on foreign investment to boost production. The current risk perception of the region among investors means it will have little choice but to postpone the licensing round it planned for March.

“The wave of geopolitical uncertainty in these countries is likely to impact foreign investment significantly,” says Sen.

When protesters deposed Tunisia’s president Zine el-Abidine Ben Ali from power in mid-January, it set in motion the chain of events that is still dominating headlines to this day. From an oil and gas perspective, however, Tunisia is relatively significant, with only limited production and exploration, much of it offshore. The political situation does not seem to have affected the industry. There is some concern that a new government will try and raise transit fees for the gas flowing through the country from Algeria on its way to Italy. In Algeria, as in the rest of the region, fresh foreign investment in the sector does not seem likely for the time being.

“There is a low risk of pullouts from any of the major players at present,” says Catherine Hunter from IHS Global Insight. “It would be premature to do otherwise given that this is still early days in political change, but capital expenditure assigned to North Africa projects will be diverted elsewhere in the portfolio.”

The protests in the Arab world have spread as far as the Gulf, but there has been little impact on its oil and gas industry. Demonstrations in Bahrain, which elicited a violent response from the authorities, have not disrupted activity in the hydrocarbons sector. Quite the contrary, in early February, Bahrain’s National Oil & Gas Authority announced the kingdom had made its first increase in oil production since the 1970s, boosting output to 40,000 b/d from 32,000 b/d after a successful overhaul of its main oil field.

The US’ Occidental Petroleum and the UAE’s Mubadala Development Company agreed to invest $15bn to develop the Bahrain field in 2010. Bahrain hopes to reach 100,000 b/d by 2017.

Staff evacuations from Oman

Some companies are taking no chances, however. Italy’s Saipem evacuated the families of its employees to the UAE from Sohar in Oman, where up to six people were killed by security forces attempting to disperse a demonstration near the industrial port in late February. Saipem is working on a deepwater bulk jetty project worth $247m in Sohar.

Working in Iraq had been risky long before protests swept the region and contractors based there are now used to the conditions. But even Iraq has not been spared from the unrest.

Rampant corruption and the persistent lack of electricity prompted demonstrators to take to the streets in Baghdad on 25 February, following demonstrations in the Kurdish city of Sulaymaniyah on 17 February, where three protesters were killed and more than 100 were wounded as armed militia responded with violence.

Prime Minister Nouri al-Maliki has given his ministers 100 days to improve their performance or risk being fired to address the public’s growing frustration over the socio-economic conditions in the country.

Iraq has some $9bn-worth of energy projects planned or under way, focused on raising oil production to pay for much-needed post-war reconstruction. It has set a target of lifting output to 12 million b/d by 2017, from about 2.4 million b/d today.

There is strong appetite among the international community to invest in the sector, but many key projects have been delayed by the government’s inability to make decisions. Baghdad was crippled by the lack of a clear winner in the March 2010 elections, leaving it with little authority to sign new contracts.

The new coalition government has been in place only since the end of December. For now, it is bureaucracy rather than civil unrest that is holding back progress in Iraq’s energy sector.

The government is seeking to diffuse tensions. Ministers have cut their salaries, promised better food provisions and lower electricity tariffs. The protests have so far not affected oil production, but there is a danger that another sweltering summer with only two hours of electricity a day will prompt more to take to the streets.

The other country to have witnessed sustained protests in the region is Yemen, the poorest nation in the Arab world. The fiercest demonstrations have occurred in the southern port city of Aden, which has long been home to secessionist movements.

While they have dropped demands for independence, the protesters have called for President Ali Abdullah Saleh to step down, which he refuses to do until his term ends in 2013. Anti-government riots have also been held in the north, where the Yemeni government has spent the past few years fighting Houthi rebels.

Yemen oil sector vulnerable

According to regional projects tracker, MEED Projects, there are 14 engineering, procurement and construction (EPC) projects in Yemen’s oil and gas sector currently planned or under execution, worth approximately $952m. Projects so far have not been impacted by the demonstrations.

But the conditions for the situation to deteriorate further remain. Chronic under-development is the lingering root of Yemen’s problems.

“Yemen is a mess. My feeling is the president will hang on just, but it is in danger of going tribal like Libya in which case mayhem will ensue. But I think the big tribal families won’t let that happen,” says an executive working in the country.

Yemen LNG says there has been no disruption to gas production and it expects to ship its 100th cargo at the end of March to South Korea. The firm has two production trains with a combined capacity of 6.7 million tonnes-a-year (t/y).

At a cost of $4.5bn, the Yemen LNG project, which was completed in 2010, was the largest industrial scheme ever undertaken in the country and forms part of a move away from crude oil production, which has fallen to only 290,000 b/d from a peak of 440,000 b/d in 2001.

France’s Total held unsuccessful talks earlier in 2010 with Qatar Petroleum to take on a share in a third liquefaction train for Yemen LNG, in which the European oil major has a 39.62 per cent stake. Total will want a new partner in place before starting preliminary work, according to a source close to company.

The largest of Yemen’s planned projects is the upgrade of the Aden Refinery, which was built by BP in 1952 and is one of the oldest refineries in the region. Designed to handle 170,000 b/d, the refinery suffered heavy damage during Yemen’s 1994 civil war and has only been partially rebuilt.

The government hopes to restore and expand capacity by 2015 by launching EPC tenders next year, although it is not clear how the scheme will be financed.

With tension mounting in the country, potential partners on both schemes may now be wary of taking on work in Yemen.

By far the biggest fear in the oil and gas sector is that the unrest could spread to Saudi Arabia. Opposition voices in the kingdom have been emboldened by the success of the protest movements in Tunisia and Egypt and have planned a “Day of Rage” for 11 March. As the world’s largest oil exporter, any disruption to production would have serious consequences for oil markets and the global economy. King Abdullah, now 86, returned to the country on 23 February after a three-month absence for medical treatment. His first action was to sign off $36bn in new public spending, widely interpreted as a move to preempt demonstrations. The king is undoubtedly popular and the country has had little history of major civil unrest since the 1970s. But Riyadh is clearly worried; in early March it announced a ban on public protests.

As Libya has shown, oil wealth does not make regimes immune from civil unrest. Saudi Arabia has a restive Shia population that forms the majority in the oil-rich eastern provinces. They have long complained of discrimination.

The outbreak of political protests in neighbouring Bahrain will have caused sleepless nights just across the border in Al-Khobar and Dammam, where an estimated $28bn-worth of hydrocarbon projects are planned or under way.

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