Oil and gas have been pivotal in the history of the Middle East over the last 50 years, dramatically
increasing the region's global economic, political and cultural influence. Oil was discovered in the Middle East in 1931 and the Bahrain Petroleum Company has been in commercial production since 1932. Hydrocarbons have formed the basis of the economic development of the Middle East region; they have been the catalyst for the modernisation of the Arabian Gulf States.
Conventional oil and gas reserves have long been exploited and whilst markets for Middle Eastern oil and gas include the United States, Europe and Asia, in the medium term a shift has been taking place towards the Asian markets. The United States will not import LNG and is now moving to be an exporter. It is in the Asian markets that the highest prices are commanded. This economic shift is changing political allegiances.
For conventional oil and gas, new technologies are enabling higher recovery rates from the fields. It is not unusual to hear of the wisdom of holding oil and gas reserves for longer than anyone else (both Saudi Arabia and Abu Dhabi talk about this). The technology to recover even a small percentage more from the vast existing fields has significant potential financial implications. At the edges we see development of unconventional resources including for example the granting of concessions for both in situ and surface retorting of oil shale, which involves heating the mineral to 650-700 degrees Fahrenheit to extract the hydrocarbons. Increasing prices make tight gas deposits, which are trapped in hard impermeable rock, feasible for exploitation.
The Arab Spring has not left the petroleum sector unaffected. Subsidies are a political imperative. Labour protection is affecting pricing. Egypt's gas sector is in turmoil and there is little commercial incentive for much needed exploration and development there. Iraq and Libya have great potential for oil and gas but with the exception of Kurdistan, security issues are a serious concern.
National oil companies have grown up and dominate the maturing oil and gas markets within the region. Nevertheless, Chinese investors and contractors are likely to find opportunities in:
• new development of immature markets (e.g development of
Jordanian oil shale or in Kurdistan);
• oil sector services provision
• construction of major petroleum sector facilities (e.g; terminals,
pipelines and refineries);
• downstream energy sector development and petrochemicals.
The developing economies and growing populations within the Middle East need more electrical power. Power generation is based on burning liquid fuels and gas. It is the intention of a number of states within the region to improve the power generation resources by adding:
• nuclear (Abu Dhabi will implement nuclear power);
• wind (Egypt and Jordan have wind schemes); and
• solar and possibly other renewable sources such as waste to energy.
A number of states within the Middle East region have seized upon the opportunity to privatise power generation and purchase generating capacity and power, rather than sinking their own capital into new power plants. This began in Oman where the Manah Independent Power Project (IPP) was negotiated and ultimately signed in 1994 with Financial Close in 1995. Most new power generating capacity in Oman has been through IPPs. Abu Dhabi followed shortly after with the Taweelah A2 plant and Saudi Arabia a few years later with Shuaibah. Egypt, Bahrain, Kuwait, Jordan and Qatar have all also gone down this route. The formula is now well known; two models have emerged (one originating in Oman and the other in Abu Dhabi). Opportunities exist for the developers, EPC and Operations and Maintenance (O&M) contractors, equipment suppliers, the financial advisors, engineers, insurers and lawyers who make these large scale projects happen.
The project agreements dictate the risk allocation for the project and the EPC contractors need to understand that there is a more rigorous risk regime for IPPs than in stand-alone construction projects. Chinese contractors have not really broken into this market but ought to consider its potential and the risks associated with it.
Qatar, Oman and Egypt have set up export facilities turning their gas into Liquefied Natural Gas (LNG) and selling it overseas. Iran has substantial gas reserves, but the export and development of natural gas is politically sensitive. Egypt is over-extended and struggling to meet its commitments. Indeed Egypt has announced that it wants to import LNG.
There are currently two operational regasification facilities in the region, turning imported LNG into natural gas for local consumption: in Dubai and Kuwait. There are also advanced plans for import facilities in Bahrain, Lebanon, Jordan and Fujairah (UAE).
Locally sourced natural gas is typically priced (as pipeline gas) for between USD 1/MMBtu and USD 5/MMBtu. LNG is very expensive in comparison but supplies of pipeline gas are not evenly distributed and certainly not readily available across the region.
Natural gas has historically been seen by governments in the region as a cheap feedstock for power and industry. Prices have been kept low. With the rising cost of alternative fuels, natural gas is in high demand. The region has skewed pricing of hydrocarbons and electricity through price subsidies for consumers and industry alike. Governments, fearful of making unpopular decisions in the wake of the Arab Spring have clung to uncommercial pricing. This has prejudiced exploration and development. Saudi Arabia and Kuwait have both begun to increase electricity tariffs, in order to support a higher gas price, but progress is slow.
UAE and Kuwait have made commercial decisions to buy LNG and provide it in-country at a loss on the basis that it is competitive against the cost of fuel oil for power production. As LNG becomes a larger part of the market share, given the high costs of imported LNG, it is likely that governments across the region will be forced to increase natural gas prices towards true market value.
Qatar is committed to turning its natural gas into LNG, and has made huge investment into seven LNG trains, which depend on international market pricing. Qatar also has a moratorium on further development of its gas fields until 2015.
Security issues have troubled both Yemen's LNG liquefaction capabilityand the Arab Gas Pipeline from Egypt which now provides only sporadic and much reduced delivery to Jordan.
It appears that in the short term, for a number of countries in the Middle-East region, LNG import will be a necessity. This promises to have significant consequences on the way that the Middle-East consumes fuel. Countries which engage in costly LNG import projects will probably raise the cost of their domestic gas. This is likely to result in medium term investment in exploration and development of natural gas including tight fields.
While LNG will be integral to the Middle-East's energy mix, it is likely only to be a bridging solution, and the trend in the LNG market in the Middle-East looks inclined to focus on short term LNG supply agreements, and the hire of Floating Storage and Regasification Units, rather than the construction of more permanent (expensive) onshore facilities.
A number of Middle Eastern states are looking to invest in renewable energy, with the region well suited to solar power generation. There are environmental concerns, with the Gulf States aware that their carbon footprint per capita leads the world. Renewable energy is a potential long-term competitor to the region's fossil fuels and therefore there is interest in participating in the rise of that industry as a hedge against the future. In some places in the north of the region, cheap power is a necessity but renewable energy is far from cheap at the moment. The countries that need it most cannot really afford it.
The UAE has recently started operations at the Shams 1 solar plant. The plant generates 100 MW, using 258,000 mirrors. Shams is one of the largest such plants in the world, and the first of its kind in the Middle East. The project is worth around USD $600 million, and was financed through 10 regional and international lenders, making it one of the largest solar projects funded through project finance.
Despite being the world's largest oil exporter, Saudi Arabia has announced a program intending to generate a third of its electricity from the sun within 20 years. The project will begin feeding energy into the grid in 2015, and hopes to have 41 GW of solar capacity by 2032, costing an estimated colossal USD $110 billion (a rough working calculation is that a 1GW conventional plant in Saudi Arabia would have a capital cost of around USD $1 billion).
The region has excellent wind resources in countries such as Iran, Oman, Syria and Saudi Arabia, but as yet has limited wind farm installations. The largest operating wind farm in the region is Zaafarana, on the Red Sea in Egypt, which has been in development since 2000 and uses 700 turbines to produce 550 MW. Egypt also has the first wind turbine tower construction site in the region, at the nearby Elsewedy Towers. There are also smaller installations in Iraq, Israel and Jordan.
Many of the MENA (Middle East and North Africa) countries have had nuclear programs at one time or another, including Iraq, Israel, Kuwait, Turkey, Egypt, Libya, Syria, and Algeria. Despite the region's history of nuclear projects, there are a number of potential problems: political (internal and external) and environmental opposition and the massive initial capital cost.
In recent years Algeria, Kuwait and Egypt have all shown interest in developing a nuclear programme. Saudi Arabia has stated that it wishes to have 16 nuclear reactors in operation by 2030. In December 2009 the Emirates Nuclear Energy Corporation awarded a coalition led by Korea Electric Power Corporation a USD $20 billion contract to build the first nuclear power plant in the United Arab Emirates. The Abu Dhabi project seems very likely to happen. The others are more speculative.
Jordan has been planning for a nuclear power plant for a number of years, and in theory has a viable project, with local uranium resources. Jordan has started construction on a nuclear research reactor. The Jordan Atomic Energy Commission is hoping to start building a 750-1100 MW nuclear power plant, at an estimated cost of EUR €12 billion, but it is unclear whether this will have sufficient political support.
Countries in the Middle East will be wary of the international isolation and sanctions affecting Iran as a result of its controversial nuclear enrichment program. The UAE signed a 2009 atomic trade pact with Washington, renouncing their right to enrich or reprocess nuclear material, but the USA has been reluctant to make such an agreement mandatory for all new nuclear projects.
While the region has significant untapped gas reserves, the majority of its gas is not readily available. 70% of gas located outside of Qatar and Iran is associated gas found with oil. 75% of the gas in Saudi Arabia is contained in tight or sour reservoirs, or both. In Abu Dhabi the Abu Dhabi National Oil Company is seeking to develop the Shah sour gas field. The high sulphur content of the gas has made exploitation of the field challenging, but with increasing domestic demand the UAE is looking to invest USD $10 billion in extraction of gas from the field.
Jordan has limited conventional hydrocarbon resources, but has significant reserves of Oil Shale, with the fourth largest deposits in the world. Jordan has signed concession agreements to develop its oil shale resources with both Shell and the Estonian state owned energy company Eesti Energia.
Qatar has invested in the Gulf Pearl GTL plant which will convert natural gas into liquid petroleum products. The Pearl GTL Facility the largest facility of its kind in the world will convert 1.6 billion cubic feet per day of natural gas into the equivalent of 140 thousand barrels of petroleum liquids and 120 thousand barrels of oil. Saudi Arabia is looking at gasification of liquid fuel.
Governments and the international oil companies will directly finance much of the energy sector development. Upstream development withits uncertainties is particularly difficult to finance though other means. However, limited recourse project finance is regularly used where lenders can see a predictable revenue stream from a valuable asset (e.g, in the downstream sales of products, petrochemicals, or power generation).
Project finance in the Middle East utilises a mix of export credit agency funding, local and international bank debt, and project bonds. Projects in the region, such as IPPs, typically have a purchasing commitment of 20 years.
Multisource financing is becoming crucial to securing necessary funds for larger projects. The global economic downturn has impacted funding. Many projects in the region are competing for finance. The stability of the host state is highly relevant. Countries such as Egypt and Lebanon have non-investment grade credit ratings. Lenders prefer to lend to projects in states with oil and gas wealth, like Saudi and Qatar, or long term political stability, like Jordan and Oman. Countries like Yemen, with limited natural resources and political instability, are clearly in a difficult position when trying to raise project finance. Special challenges arise in Kurdistan where the lack of sovereign guarantee prejudices funding, though the oil sector has coped and is creating a mini-boom.
Export credit agencies (ECAs) financing plays a significant role in supporting bids for major projects. JBIC (Japan Export Credit Agency) and Kexim (Korea Export Credit Agency) provided the majority of the funding for Shuweihat 3 IPPs. Kexim has contributed USD $10 billion to support KEPCO in developing the Brakar nuclear power plant in the UAE. Korean companies have been extremely successful in winning heavy engineering projects and Kexim is responsible for much of that success. ECAs are able to lend for long terms, and take a broad view of political risk.
Contractors with access to finance win work. Using ECAs requires additional planning on the part of the project developer in the bid stage. International contractors seek early letters of support or draft commitment letters. Names like Germany's Siemens, Japan's Mitsui & Co, Marubeni, and Mitsubishi, and South Korean Hyundai and Samsung are seen on multiple projects across the region and will all regularly access ECA support. Local contractors provide civil works but for major projects the technology, licensing, heavy engineering and major equipment will be sourced from outside the region.
Middle Eastern bank funding is currently growing in importance. The global downturn has reduced liquidity for international institutions. Many local banks have largely avoided the impact of the global downturn. Islamic financing is an option which has particular significance and fits well with asset based development. Project bonds are more relevant to refinancing.
With the rise of IPPs across the region there are plenty of opportunities for companies to get involved in power generation (often combined with water: an IWPP). There are many roles available in the sector. Rabigh IPP in Saudi Arabia was the first power project in the region to involve a Chinese main EPC contractor. The market is maturing in most states and most opportunities are tendered. Only in difficult and immature markets will there be opportunities for negotiated deals (e.g, Kurdistan).
The developer role involves pre-qualification to demonstrate development and operation of power plants. Equity capital will be required. Formerly European and US energy companies were the main developers. More recently we have seen an influx of Asian consortia and cash rich local players. Developers bid an electricity tariff to the public authority (sometimes with water). An option for Chinese companies to avoid speculative development costs would be to buy a stake in an existing project (there are often lock-in provisions for initial key investors which may need to be considered).
The role of EPC Contractor will normally be offered by the developers to their favoured qualified contractors. They must demonstrate experience of plant construction. There will be indicative bids to select the EPC Contractor and then developer and EPC Contractor will need to refine the detail of the scope of work and pricing for tariff bid submission. The ability of the EPC Contractor to bring ECA finance will be of relevance. EPC Contractors are often formed in joint venture for particular projects; local combining with international (local knowledge, civil works and import logistics are the responsibility of the local party); or different international contractors contributing key equipment items.
A lead O&M contract will also be a project requirement for bid submission and tariff calculation. O&M contractors will be required to demonstrate operation of qualifying plants.
The region must keep developing its oil and gas. International demand is growing. Large international oil companies and national oil companies are involved in the exploration and development of new fields and enhanced recovery. There will be a role for the small and mid-level independent oil companies and those national oil companies from Asia who are willing to invest in the Middle East. Different strategies, different technologies and other means of adding value will create opportunities. Oilfield service companies are becoming increasingly sophisticated and many are moving higher up the industry supply chain, implementing their own proprietary technology in areas such as enhanced oil recovery, retorting, or hydraulic fracking.
Asian customers have the greatest demand for Middle Eastern oil and gas. It is natural that this will create a cross-flow of trade. Asian expertise, technology, finance and willingness to joint venture will unlock business. Some analysts have predicted that China's petroleum imports will quadruple from 2003 to 2030. The Organization of the Petroleum Exporting Countries and China established a formal energy dialogue in December 2005. National Oil Companies such as Saudi Aramco, Qatar Petroleum and Kuwait Petroleum have announced joint venture chemical plants in China and elsewhere in the Far East.
A number of opportunities currently present themselves for hydrocarbon investment across the Middle East. Potential high risk, high reward opportunities include involvement in the rehabilitation of oil and gas fields and related energy infrastructure in Iraq and Libya, as well as in similar development projects in Algeria and Egypt, both domestically and linked to exports to Europe. Large gas fields lying in the eastern Mediterranean off Lebanon, Cyprus and Israel are about to be developed.
In Kuwait, Saudi Arabia and Abu Dhabi the need to grow existing oil and gas production facilities through the introduction of new technology will be of increasing importance over the next 10 years. Abu Dhabi, for example, is due to re-tender its major onshore and offshore concessions in 2014 and 2018 respectively, partly with a view to securing enhanced oil recovery technology to help it bring recovery rates up to the 70% mark. At the same time, Abu Dhabi is tendering a series of sour gas projects aimed at meeting the UAE's own increasing appetite for natural gas. Oman remains focused on obtaining and developing the enhanced oil recovery and tight gas extraction techniques that it needs, if it is to maintain its current plateau for oil production and satisfy domestic gas demand. Qatar can be expected to continue investing in monetising its enormous resources of natural gas by moving down the petrochemical value chain. Iran, while sanctions remain in place, is faced with the on-going challenge of maintaining its domestic hydrocarbon industry in order to satisfy internal demand.
Upstream investors may tender for production sharing agreements. Other opportunities include joint venture refinery or petrochemicals projects with the region's NOCs, such as those seen in Saudi Arabia, Abu Dhabi and Qatar. Joint venture oil storage or shipping enterprises may be of particular interest to Chinese investors, as these projects have a clear link to securing mid/long-term supplies for domestic markets.
A Chinese company could enter a regional market through the appointment of a distributor or local agent, to sell products or services. Middle East trading houses who have traditionally acted as agents or distributors have grown to become sophisticated companies in their own right, with a thorough understanding of the regional oil and gas business. They are increasingly looking to join with other companies to exploit other overseas markets such as Africa and Asia, and this might provide a strategic partnership opportunity.
As the oil and gas industry matures there is a need for research and the development of new technologies to get the best returns from remaining reserves. As an example, Eesti Energia, the state owned electricity company of Estonia, has recently signed a memorandum of understanding, and a concession agreement with the government of Jordan and is planning to build an oil shale fuelled power plant in Jordan, utilising its unique expertise to good effect to do business in the Middle East.
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