Tackling the Gulf’s gas shortage

23 February 2011

The GCC states have fallen into a ‘paradox of plenty’, where huge gas reserves cannot be developed quickly enough to satisfy rising demand from industry and utility providers

Key fact

Middle East and North Africa proven natural gas reserves are estimated at 84.5 trillion cubic metres

Source: Apicorp

September 2009 is likely to go down as a significant date in the annals of the Middle East’s hydrocarbons and power sectors. The arrival of the first liquefied natural gas (LNG) cargo in Kuwait that month may well be seen as a turning point in how the region is dealing with its gas supply problems.

Rather than continuing to burn expensive fuel oil, Kuwait Petroleum Corporation showed itself ready to pay market rates for spot LNG cargoes, taking at least 33 shipments in 2010 as it battled to meet a feedstock crisis afflicting its power sector. It is now seeking an additional 10-14 LNG cargoes for power generation during the summer of 2011, as part of a fast-track LNG scheme that will help free up more crude oil for export.

Gas pipelines are passe and don’t allow you to take advantage of arbitrage opportunities

Justin Dargin, Harvard University’s Dubai Initiative

The four-year LNG supply contracted signed with Shell International Trading in 2009 represents a change in the Gulf states’ response to what has been termed the ‘paradox of plenty’. It is a region sitting on substantial reserves of natural gas, but unable to develop these to help maintain a steady supply of electric power.

Gas demand dilemma

Kuwait holds a substantial 63 trillion cubic feet (cf) of gas reserves, but it is a long way from developing this endowment. It is not alone in this dilemma.

Other gas-rich Middle Eastern economies have become net importers of gas as a result of rampant domestic demand. In 2008, for the first time, the UAE consumed more gas than it produced domestically, with consumption growing 21 per cent to 59.5 billion cubic metres.

GCC gas shortage 
(billion cubic metres)
e=Estimate; f=Forecast. Source: Booz & Company

Both the UAE and Bahrain are now following Kuwait’s lead in importing LNG cargoes, with the former taking delivery of its debut LNG cargo from the Golar Freeze floating storage vessel in Qatar last year.

Dubai Supply Authority has commissioned a new LNG receiving terminal at Jebel Ali port and Shell delivered the first LNG cargo from Qatargas in early December 2010 to supplement the emirate’s existing gas supplies during the summer. 

Bahrain Petroleum Company is set to follow suit, with the award of the engineering, procurement and construction contract for its planned $1bn Bahrain LNG import terminal expected in the first quarter of 2011.

These initiatives reveal a belated response to the critical gas supply shortage confronting the region. For Gulf states, paying international market prices for gas also creates a precedent in a region where natural gas has previously been considered a low-cost, subsidised feedstock for power plants and downstream industries.

The next five years will see more effort put into [unconventional gas resources] than the past five to 10 years

Gulf-based oil executive

If Kuwait, the UAE and Bahrain are ready to compete with Asian buyers for LNG cargoes, it also suggests the possibility that the region’s gas-rich states may be preparing to take another look at pricing structures that have failed to drive gas production and dampen furious demand at the retail end.

In the UAE, the sour gas they are producing is not a game changer, it’s a necessity

Gulf-based oil executive

The Gas-starved Gulf states will wait in vain for another Dolphin Energy-style pipeline project to deliver large volumes of gas at below market prices. “The idea of a pan-GCC pipeline is dead as the only country with sufficient reserves is Qatar and it has made so many significant investments in LNG that it need to recoup the capital investments,” says Justin Dargin, an energy analyst at Harvard University’s Dubai Initiative.

GCC gas production and consumption
(Billion cubic metres)
Kuwait 1999200220062009
Source: BP

“Qatar is really looking at LNG as a driver of economic growth. Gas pipelines are passe and don’t allow you to take advantage of arbitrage opportunities.”

The region as a whole remains gas-rich, with proven natural gas reserves estimated at 84.5 trillion cubic metres, representing 45 per cent of the world’s total. According to estimates from Saudi Arabia’s Arab Petroleum Investments Corporation (Apicorp), this should yield a reserve life of 146 years. Yet despite the abundance, the region accounts for barely 12 per cent of global gas production.

Feedstock switch

The region is under intense pressure to secure more gas to hasten the switch from using oil in power generation, as well as to ensure the success of downstream energy-intensive industries – the bedrock of diversified economic development initiatives. Gas is also needed to aid injection into oil reservoirs as part of enhanced oil recovery programmes.    

GCC gas production and consumption
(Billion cubic metres)
Source: BP

According to most estimates, gas demand in the Middle East has been rising by about 5-7 per cent a year, outpacing regional production. Demand growth is underpinned by the economic expansion evident across large tracts of the region, interrupted only by the 2008-10 economic downturn, which provided a breather for countries that experienced acute supply shortages at the height of the 2006-07 boom.

“The global economic crisis was a blessing in disguise. You still have gas shortages in many industries, but you are not seeing the amount of feedstock shortages there were back in 2006-07,” says Dargin.

GCC gas production and consumption
(Billion cubic metres)
Saudi Arabia1999200220062009
Source: BP

Various steps are being taken to mitigate shortages, including investing in alternative sources of energy, raising electricity prices and developing more challenging gas formations.

Governments across the region are looking to develop civilian nuclear power programmes, as well as solar and wind projects. Some are even considering the potential of coal and oil shale as sources of energy.

GCC gas production and consumption
(Billion cubic metres)
UAE 1999200220062009
Source: BP

Tariff reform is back on the agenda. Electricity prices have been raised in the UAE and in July 2010, Saudi Arabia increased electricity tariffs for all customers, except households. Although levels are still below the cost of production, it shows governments are ready to take a stand and raise the cost of electricity for many consumers.  

Gas pricing in the Gulf

To resolve regional gas supply shortage, national oil companies are having to ramp up their gas exploration and development programmes, boost their LNG and pipeline infrastructure and tackle gas pricing. Domestic gas prices in the Gulf states are about one-tenth the level of gas prices in the Far East and less than one-twelfth of the energy equivalent price of oil.

Despite some incremental changes in the price of gas supplied to power companies in Saudi Arabia and Kuwait, these are not yet at a level that would encourage more rationalised usage and provide a clear commercial incentive to develop untapped reserves.

The boldest pricing moves have come from outside the Gulf. In May 2008, Egypt’s government announced an increase in gas prices to energy intensive industries of nearly 60 per cent, yielding the benefit of major cuts in the state budget. 

Cheap gas feedstock has been a cornerstone of national industrial development strategies across the region. Prices of about $1 a million BTU have acted as an incentive to international petrochemicals and aluminum smelter developers to establish new plants in the Gulf. Without these subsidies, it will be more difficult for industrial projects to be competitive.

Reform advocates have attempted to encourage incremental changes in pricing. For example, enabling industrial users to pay prices that reflect the increasing cost of more difficult domestic gas production and the increasing proportion of supplies coming from imports.

These, however, have had little serious impact. “They have enough gas resources to sustain themselves, but they simply haven’t monetised it and incentivised production,” says Dargin.

Unconventional gas reserves

The need for commercial pricing incentives will become even more acute with an increasing proportion of future gas expected to found in capital-intensive unconventional gas reserves.

Saudi Aramco last year unveiled plans to tap shale formations found in the Eastern Province, while Oman and the UAE are also targeting sour and tight gas deposits. The manpower and technology required to develop these reserves means the development process will take time.

“The next five years will see more effort put into developing those resources than in the past five to 10 years,” says one Gulf-based international oil company executive.

Another problem facing Middle Eastern producers is that large volumes of untapped gas are located in associated accumulations linked to oil fields. Of the currently known accumulations totalling more than 70 trillion cubic metres, Shell’s upstream executive director, Malcolm Brinded, estimates almost 80 per cent lies in just two countries, Iran and Qatar. Of the remaining volume outside these two countries, about 70 per cent is associated gas.

Oil major Saudi Aramco, which boasts reserves of about 276 trillion cf – the world’s fourth largest – is planning a sustained effort to build up its gas reserves. It aims to target areas such as deep offshore, sour gas, shale gas and tight gas reservoirs, in addition to conventional onshore gas.

Aramco chiefs believe intensified exploration and new recovery technology could boost the company’s gas production by more than 50 per cent by 2020, giving it a chance of keeping pace with domestic demand.

New gas discoveries

The firm’s chief executive officer, Khalid al-Falih, told an industry conference in Montreal in September 2010 that new discoveries and higher recovery rates had pushed up the country’s non-associated gas deposits to more than 50 per cent of the total gas resources at the end of 2009, from about 25 per cent in 1990.

However, according to Brinded’s calculations, delivered in a speech in Kuwait last year, of the estimated remaining 100 trillion cf of Saudi Arabia’s ‘free’ gas, 75 per cent is in accumulations that are sour or in tight reservoirs, or both. This leaves just 25 trillion cf of ‘easy’ conventional free gas to be developed – insufficient to satisfy the kingdom’s significant long-term energy requirements.

Abu Dhabi, too, has been prompted to focus on unconventional gas reserves to meet rising domestic demand, with existing associated gas increasingly being used for reinjection purposes to boost oil output. Much will hinge on Occidental of the US’ plans for the sour Shah gas field, the country’s first major unconventional gas project.

Delays to that scheme, following the withdrawal of the initial chosen partner, ConocoPhillips, also of the US, have come at a cost. “In the UAE, the sour gas they are producing is not a game changer, it’s a necessity – they could have done with that gas three years ago,” says the Gulf-based oil executive.

Although aggregate proved reserves in the region are substantial, there is another problem facing regional gas producers. According to Apicorp, the acceleration of field depletion appears to have reached a critical rate in several countries.

It warns that if gas production continues not to be replaced in Algeria, Bahrain and to a lesser extent Iraq, this could lead to a major supply crunch. Oman, Syria and Tunisia would face a similar prospect in the absence of imports through the Dolphin Pipeline, the Arab Gas Pipeline (sending Egyptian gas to Jordan, Syria and Lebanon) and the transit pipelines to Europe from Algeria.

Domestic gas priorities

There are other supply challenges that will have to be met. For Eastern Mediterranean countries that receive Egyptian gas, the recent political events in the country may prove to be a grim sign of future supply. In the wake of the popular uprising, authorities in Cairo are likely to redouble their efforts to supply the domestic market and avert the blackouts that have long been a source of complaint for many Egyptians.

In 2004, Jordan and Egypt agreed for 2.48 billion cubic metres a year of Egyptian gas to be sent to Jordan via the Arab Gas Pipeline.

However, Egypt’s power demand is growing at rates in excess of 11 per cent a year and any new administration in Cairo is likely to seek to address local load-shedding issues ahead of commitments to keeping regional neighbours well supplied.

The next four years will be critical for the region’s power sector. Gas shortfalls may become more pronounced through to 2015, as demand revives in line with resurgent economies. Governments are still a long way from completing the strategic investments that could help to bring supply and demand into equilibrium. The uneconomic burning of fuel oil in power plants and increased LNG imports during the peak summer months will continue to bridge the gap until a long-term solution can be found.

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