Monday, September 18, 2017

Are Oil Markets Finally Rebalancing?


I wrote the article “Are Oil Markets Finally Rebalancing?” as an email in response to Ms. Kamila Aliyeva’s interesting questions concerning the present state of the oil markets. Ms. Aliyeva, a business journalist, then introduced my emailed comments into her article “Expert: Gradual Decline in Oil Inventories Should Result inMore Balanced Markets in 2018,” which was published on September 18, 2017 by Azernews, an English-language Azerbaijani newspaper.   

September 18, 2017

LONDON — On September 5, Russia and Saudi Arabia discussed in St. Petersburg, Russia, about the possibility of extending for a second time the oil output-cut deal between OPEC and non-OPEC producers negotiated in November 2016. This meeting on the Russian soil was one of the preparatory meetings that oil producers must conduct if they want to try to implement a unified strategy aiming at freezing oil production levels. In addition, considering Russia’s position as the world’s largest producer with almost 11 million bpd, thinking of an oil strategy confined to OPEC members alone would not be a recipe to success.

It is certain that at the end of next November, when there will OPEC’s 173rd ordinary meeting and another meeting including OPEC and non-OPEC members, the main topic will be what petroleum policy these countries want to implement after the expiration in March 2018 of the extension of the 1.8 million bpd output cut. This first extension was agreed on last May in Vienna by OPEC and 10 non-member countries—among them there was Russia. The real problem is that defining a working strategy suitable for all the involved oil-producing countries is always very difficult.

The common denominator among all these countries is their fiscal budget’s strong dependence on their oil revenues. But apart from this, these countries have different histories, which translate into different economic and political agendas. On top of this, the difficult cooperation among OPEC members is linked to the intense political struggle between Saudi Arabia and Iran for regional influence. Under the present deal, Iran obtained an exemption to slightly raise its output, which had been reduced by years of Western sanctions. In August, Iran pumped 3.82 million bpd of crude oil.

Until a few weeks ago, with still oversupplied oil markets, it seemed that a production freeze would be not very useful because OPEC production rose to 32.8 million bpd in July (highest value in 2017)—Nigeria, an OPEC member under exemption from output curbs, pumped more crude oil. In practice, the only valid solution was a consistent production cut, which indeed was politically very difficult to agree on.      

Now, according to the latest data from the International Energy Agency (I.E.A.), oil demand is increasing faster than previously thought. In practice, the I.E.A. states that oil demand will grow by 1.6 million bpd (or 1.7 percent) in 2017. This means that oil markets are in the process of rebalancing because finally inventories are decreasing. And, although in a feeble manner, markets are reentering a backwardation phase. In addition, in August OPEC production was 79,000 bpd less than July’s production.    

Now, the next two months and a half, which lead to OPEC’s November 30 meeting, will be crucial to understand what petroleum policy the oil-producing countries will apply after March 2018. In specific, if the present, and still in its infancy, rebalancing of the oil markets continues, it could really save oil producers from being forced to implement a production cut larger than the present one, which is worth 1.8 million bpd.

Considering the current possible sustained transition toward a backwardation phase, predicting where the oil prices will be in 2018 is very difficult. Commodity price movements depend on inventories (cyclical component linked to short-term supply and demand shocks) and marginal costs (structural component linked to the long-term impact of technology, geology, and politics).

When we look at 2018, we need primarily to consider the cyclical component, i.e., inventories. In this regard, the contango phase of the oil markets, which has been a constant phase since the second half of 2014 because of the crude oil oversupply, has begun to lose ground because there has been an increase in the demand for prompt-loading oil barrels and in the expectations that the oil markets will rebalance over the next year. All this means a drawdown in crude oil stocks, i.e., an inventory reduction.    

In specific, Brent’s futures curve has continued to flatten for several months and its back end is now in backwardation. Instead, despite consecutive weeks of inventory draws, W.T.I. remains in a light contango—but, indeed, there has been a relevant decrease in the contango level. The financialization of the price of crude oil is still not entirely clear, but it has an effect because calendar spreads are able to understand better the balance between supply and demand. In addition to this, if we give more importance to futures fundamentals than to physical fundamentals, it’s evident that these expectations will be then reflected in the spot price of a specific benchmark.

It’s evident that, under the current production levels, the gradual decline in global crude oil inventories should be able to produce more balanced oil markets in 2018, which could help maintain the current price levels, if not to produce a slight price increase as well. But, much depends on what oil producers will decide next November. If they prolong their crude-oil production-cut agreement, this scenario could materialize. Instead, if they look at their long-term interest (expand their market share at the expense of the U.S. shale producers) and return to maximum production, oil markets would probably go to square one, which in this case means an oversupply of crude oil.

Wednesday, September 6, 2017

Developing Energy Infrastructure in Basra Governorate


The article “Developing Energy Infrastructure in Basra Governorate” has been initially published by the C.W.C. Group, an energy and infrastructure conference, exhibition and training company

September 6, 2017

LONDON – September 2017 — Iraq is primarily a state-run economy dominated by the petroleum sector, which, since the 1950s, has been the main pillar of the country’s economic development. Today, Iraq’s economy is the world’s most dependent on oil. Approximately 58 percent of the country’s GDP and 99 percent of its exports are hydrocarbons; oil provides more than 90 percent of government revenues and 80 percent of foreign exchange earnings.

However, Iraq’s reliance on oil doesn’t provide a broad base for economic development. Diversifying Iraq’s economy would be a rational step because it would give Iraq a stronger resilience in the face of low oil prices; however, diversifying the economy of a country like Iraq is a very complicated and long-term task.

On a short to medium term, considering the recent political turmoil and the fight against the ISIS insurgency in parts of western Iraq, it would be better for the country, to stick to producing and exporting oil. Moreover, the next spring Iraq will hold parliamentary and provincial elections, so it’s difficult to imagine how the federal government could implement these massive economic changes over the months leading to the elections. 

Iraq requires a continuous flow of revenues to redistribute to its young population—almost 40 percent of the Iraqi population is aged between 0 to 14 years. In summary, if the country won’t be able to provide the young Iraqi citizens who will enter the job market with real jobs, it should at least try to provide them with some economic assistance, which under the current circumstances could only come from the oil revenue.

In light of the above, if there is an area that has to be protected in order to continue developing, it would be the Basra Governorate. In fact, of Iraq’s more than 4.4 million barrels of oil per day (b/d), 85 percent of the barrels are produced by the giant oil fields of southern Iraq. Majnoon, Rumaila, West Qurna, and Zubair are located in Basra Governorate; Halfaya is located in Maysan Governorate. Unquestionably, the bulk of Iraq’s proven oil reserves is in the south of the country, while more than 3 million barrels a day are exported from Basra.

The oil sector requires infrastructure to enable the extraction and the export of oil, and this infrastructure must be developed at all the levels of the petroleum chain to avoid production bottlenecks as the IOCs present in southern Iraq experienced after the country’s first licensing round in 2008-09.

After some years, the infrastructural gap has been partially reduced, but still a lot of work has to be done in Basra Governorate if Iraq wants to increase its oil production, refining capacity, and export capacity. In this regard, the CWC Group, a leading events and training provider for the oil, gas, and infrastructure industries, will host in Beirut, Lebanon, on October 30-31, the Basra Oil, Gas, & Infrastructure Conference.   

This conference, which is held under the patronage of Basra Governorate, Basra Council, and Basra Oil Company (BOC) and which is now in its fourth edition, is one of the most important business platforms concerning Iraq. The conference will be a gathering point for government officials, projects stakeholders, buyers and sellers working in the southern part of Iraq across several industries in three primary business segments: oil and gas, power, and petrochemicals, infrastructure and construction, transport and logistics.

In other words, to have a successful business development in Basra Governorate, which then will have a positive impact on Maysan Governorate and Dhi Qar Governorate, it is important to work at the same time on the development of the three above-mentioned business segments. In this regard, Iraq has to attract private sector funding.  

Private investment would allow Iraq to establish business relationships with foreign countries. The federal government is currently promoting partnerships between foreign companies and lenders. Last March, the United Kingdom and Iraq signed a historic memorandum of understanding authorizing UK Export Finance, UK’s export credit agency, to work closely with the Iraqi authorities to identify suitable infrastructure development projects that will utilize UKEF’s export finance support for the UK companies. Thanks to this initiative the United Kingdom has agreed to provide up to $12 billion of support to Iraq over the next ten years. 
Building infrastructure in Iraq could serve to improve the lives of millions of Iraqi citizens, to expand private sector activities, and to create new jobs for the Iraqi population—instead, as a matter of fact, when petroleum production is up-and-running in any country in the world, it generates revenue, but it doesn’t create many permanent jobs. 

Basra Governorate is the federal government’s revenue generator, so it must be given top priority in Iraq to secure the private investment required to close the infrastructural gap. In addition, Iraq has to improve the environment of doing business, as recently underlined by the World Bank through its Doing Business indicators.

Wednesday, June 28, 2017

Lebanon Launches Its Offshore Oil and Gas Sector


The article Lebanon Launches Its Offshore Oil and Gas Sector has been initially published by Oilpro, a professional network for the oil and gas professionals

June 28, 2017

LONDON — I want to start this analysis concerning Lebanon by saying that I wish Lebanon, a beautiful country where I lived for three full years between 2012 and 2015, all the best possible luck in regard to its petroleum (oil and gas) sector development. In fact, after years of postponements, Lebanon is finally kickstarting its offshore oil and gas (O&G) industry. On January 4, 2017, the government approved two decrees, which were necessary to go ahead with the licensing procedure. Decree No. 42 defines the geographical parameters of the blocks in which Lebanon’s economic exclusive zone (E.E.Z., 22,700 sq. kilometers) is divided; Decree No. 43 sets out the tender protocol (T.P.) and the model exploration and production agreement (E.P.A.) to be entered with the bidding companies. A few weeks later, on January 26, 2017, Minister of Energy and Water Cesar Abi Khalil declared that blocks 1, 4, 8, 9, and 10, out of 10 overall blocks, would be open for bidding during the first offshore licensing round.     

Then a pre-qualification round, a second pre-qualification round to be more precise, was held between February 2, 20117 and March 31, 2017; according to this second pre-qualification round, 8 new companies qualified: 1 operator (India’s O.N.G.C. Videsh Limited) and 7 non-operators. Previously, in 2013, 46 companies had qualified via the first pre-qualification round—in specific, 12 of them qualified as operators (among them U.S. Chevron and Exxon Mobil, U.K. Shell, and France’s Total). But then, at that time, the tender process stopped abruptly. In fact, the government had never passed the decrees necessary to have a licensing round until January 2017.

In sum, because not all the 46 companies that pre-qualified in 2013 will be part of the licensing round, there are now 51 companies that have pre-qualified and should be willing to take part in the tender submitting bids in relation to the open blocks on September 15, 2017. After that day, the Lebanese Petroleum Administration (L.P.A.) will assess the received applications and send a report to the cabinet, which will decide by November 15 which companies will win the tender.

Attracting Exploration Investment by Ensuring Progressive Fiscal Regime — Source: Wissam Zahabi
Initial estimates tell that buried under the Lebanese seabed there could be 30 trillion cubic feet (around 850 billion cubic meters) of natural gas and 660 million barrels of oil. Of course, until the companies that will sign a production sharing contract (P.S.C.) with the Lebanese government start their exploration phase, it’s impossible to confirm whether these initial estimates are correct. In preparation for the launching of the first licensing round, some years ago, the Ministry of Energy and Water had assigned geophysical service companies to perform seismic activities. These surveys covered the entirety of Lebanon’s offshore territory. In particular, 100 percent of the offshore was covered by 2D seismic data and 70 percent of the offshore was covered by 3D seismic data. Thanks to this activity, data related to 10,000 kilometers of 2D surveys and all the available 3D data, once interpreted, showed well defined structural and stratigraphic traps regarded as prospective, especially for natural gas.  

Geophysical Surveys — Source: Lebanese Petroleum Administration
In other words, until companies start drilling, there is no certainty of Lebanese O&G reserves, but 2D and 3D mapping and the recent natural gas discoveries in the E.E.Z.s of Cyprus, Egypt, and Israel give the Lebanese government hope that also Lebanon’s E.E.Z. could be rich in O&G—in 2010, the United States Geological Survey estimated that there could be up to an additional 122 trillion cubic feet of undiscovered natural gas in the Levant Basin, with also 1.7 billion barrels of recoverable oil. This means that for an international oil company (I.O.C.), when evaluating whether to invest in Lebanon, the risk doesn’t lie too much in geological problems but in geopolitical problems. In fact, because we’re talking of offshore operations, if on the one hand it’s true that finding and development (F&D) costs won’t be low, on the other hand they should not be too different from other offshore operations across the globe. For sure, if the price of a barrel of oil went down to $20 a barrel—a possibility that cannot be completely ruled out—there would be great difficulties in achieving breakeven.

So, the real problem for an investor is the geopolitical risk, which in Lebanon may be split into two main components: Lebanon’s very complex and dysfunctional internal politics and Lebanon’s difficult relationships with its neighbors.

With reference to the first component, it’s difficult to look to Lebanese politics with trust and hope. In fact, Lebanon’s politics is based on religious divisions (a confessionalism including 18 recognized religious sects). In practice, the highest offices are reserved to representatives from certain religious communities. For example, the president of the republic must be a Christian Maronite, the prime minister a Sunni, and the speaker of the Parliament a Shia. Similarly, seats in the Parliament are confessionally distributed but elected by universal suffrage. Each religious community has an allotted number of seats in Parliament, although all candidates in a particular constituency must receive a plurality of the total vote, which includes followers of all confessions. Indeed, it’s a complicated system, but, it’s the system that was introduced with the National Pact of 1943 (slightly changed in 1990 after the end of the Lebanese Civil War). The logic of this system is that it should be able to reduce the possibility of armed violence between the different components of Lebanon’s society, but at the same time its result is a big drag on the speed and meritocracy of Lebanon’s politics. Also, the members of the L.P.A. have been selected according to sectarian lines.  

Doing politics in Lebanon is quite difficult. Among the main political problems that Lebanon has recently experienced in the last years five years—and I just go by memory—there are the following issues

  • Absence of the president of the republic for more than two years (29 months)

  • Absence of a continuous supply of electricity

  • Acts of violence across the country, Beirut included

  • A high level of corruption at all levels of Lebanon’s society

  • A high public debt at 146 percent of the country's G.D.P. in 2016

  • Garbage crisis and related environmental issues

  • More than 1 million of Syrian refugees, but the number could be close to 2 million

  • Parliamentary elections, to be held in 2013, postponed until at least mid-2018

  • Poverty with around 28 percent of the population living under the poverty line

  • Savage privatization of public land across the country

With reference to the second component, Lebanon and its southern neighbor, Israel, are still technically at war. Moreover, to add an additional layer of complexity, there is an 854-square-kilometer wedge of sea between the two countries claimed by both Beirut and Tel Aviv. In the last years, the U.S. has tried to figure out a solution, or at least to avoid that this dispute could escalate into something more dangerous. In this regard, the U.S. has discouraged Israel and Lebanon from conducting O&G operations in the disputed wedge of water.

The Disputed Wedge of Water — Source: Menas Associates
In Israel, Noble Energy, a U.S. energy company quite active in Israel, and Israel’s Delek Group held the license for block Alon D, which stretches into the disputed area. This license expired in March 2016. Several reports have explained that the Israeli government has prevented drilling in the license area Alon D. Another controversy with Israel was linked to the discovery of the Tanin and Karish gas fields by Noble Energy in 2012 and 2013. These fields are located in Israeli-licensed areas Alon A and Alon C. And Alon C is only 4 kilometers away from Lebanon’s block 8 and 9 kilometers from block 9. Tension between Israel and Lebanon when Noble started drilling in the Karish field, which according to Noble Energy is 10.6 kilometers from Lebanon’s block 9, while according to Lebanon is just 4 kilometers away from the block. As a consequence, Lebanon’s government immediately voiced its concern regarding Karish field operations because these could affect the Lebanese gas reserves, either by drilling in a contiguous gas resource, or through horizontal drilling—Nabih Berri, the speaker of the Lebanese Parliament strongly voiced its concerns regarding the disputed offshore territory. Today, after a series of business transactions, the license to the Karish and Tanin fields is held by the Greek company Energean Oil & Gas.

Israel's Offshore Fields — Source: Offshore Energy Today
But now, Lebanon’s first offshore licensing round might create trouble. In fact, 3 blocks (block 8, 9, and 10) out of 5 of the blocks to be licensed cover the length of the offshore border between Israel and Lebanon, i.e., they include the disputed wedge. Why that? In March, at Eastern Mediterranean Gas Conference (E.M.G.C.) 2017 in Cyprus, Mr. Wissam Chbat, chairman and head of geology and geophysics of L.P.A. explained that

  • Block 1 has high-to-moderate hydrocarbon potential, with gas, possible condensate, and oil expected to be discovered

  • Block 4 has moderate potential for gas, oil, and possible condensate

  • Block 8 has high potential for gas and some condensate

  • Block 9 has very high potential for gas, condensate, and oil

  • Block 10 has very high potential for oil, condensate, and some gas             

Open Blocks for the First Licensing Round — Source: Lebanese Petroleum Administration
The government justification for the green light to proceed with block 8,9, and 10 is that they have a high potential. And in order to lure I.O.C.s’ interest in Lebanon’s offshore, it’s better to offer immediately the most promising areas, especially in the present environment of low oil prices. The idea is that it’s always better to start with the right foot.

In addition, as mentioned above, with reference to the three southern blocks, in the past, several times Lebanese politicians raised the issue that Israel, which is quite ahead of Lebanon in its offshore operations, via infrastructure located in its own E.E.Z. could extract natural gas located in Lebanon’s E.E.Z. These fears could be considered another justification to immediately put under a license those three blocks. Moreover, it’s worth mentioning that Lebanon and Syria didn’t complete the demarcation of their land and maritime borders either—Lebanon’s E.E.Z.’s northern border and Syria’s E.E.Z.’s southern border. And now demarcating maritime borders with Syria will probably be impossible until the end of the conflict in Syria. 

One initial consideration is that Lebanon should have already begun the development of its petroleum sector. Indeed, if the licensing phase had been completed in 2013, it would have been better for the coffers of Lebanon’s Treasury. In 2013, Brent crude prices averaged more than $100 a barrel. It’s true that petroleum operations, if successful, could span at least three decades, which means that an I.O.C. will always experience over the course of a specific project high oil prices as well as low oil prices, but it’s also true that when a government organizes a commodity licensing round, it’s much better if the price of the concerned commodity is quite high. The only real advantage that Lebanon could have right now is the low costs of oil services. Timing is not so good for Lebanon as it was four years ago. Instead, in the eastern Mediterranean region both Cyprus, Egypt and Israel are quite ahead with their projects.

Geographical Location of the Main Recent Gas Discoveries in Offshore Eastern Mediterranean — Source: European Parliament, Energy: A Shaping Factor for Regional Stability in the Eastern Mediterranean?, June 2017
In 2009, Noble Energy announced the discovery of the Tamar field (280 billion cubic meters of natural gas) in the Israeli E.E.Z. Then, still Noble Energy announced in 2010 the discovery of the Leviathan field (620 billion cubic meters) in the Israeli E.E.Z. and in 2011 of the Aphrodite field (140 billion cubic meters) in the Cypriot E.E.Z. Last but not least, in 2015, Italy’s E.N.I. announced the discovery of the giant Zohr field (850 billion cubic meters) in the Egyptian E.E.Z. These three countries are much ahead in their projects than Lebanon is. In fact, 

  • In Israel, natural gas is already extracted. The Tamar field was quickly developed and early 2013 it became operational supplying Israel with 7.5 Bcm per year; the Leviathan field’s Phase 1A will produce 12 Bcm per year starting in 2019.

  • In Cyprus, thanks to three licensing rounds (in 2007, 2012, and 2016) block 12 (Noble Energy, Delek, and Shell), 2 (E.N.I. and Korea’s Kogas), 3 (E.N.I. and Kogas), 9 (E.N.I. and Kogas), 11 (Total and E.N.I.), 6 (Total and E.N.I.), 8 (E.N.I.), and 10 (Exxon Mobil/Qatar Petroleum) have been awarded.

  • In Egypt, E.N.I. will start producing from Zohr in the 4th quarter of 2017—E.N.I. is the operator while British Petroleum has a 10-percent stake and Russia’s Rosneft a 30-percent stake. It’s possible that Zohr will be the first of a series of discoveries in the area. BP is proceeding with its development of West Nile Delta project, which could produce 12 Bcm, per year starting in 2017.     

All this said, despite a not-so-perfect timing and despite internal and external problems, Lebanon has probably to try to develop its offshore resources. When I.O.C.s and a country sign a petroleum contract, let’s say a P.S.C., they could arrive at the signature starting from distinct positions, but when they sign, they have, hopefully, found an agreement satisfying both parties. There is a caveat: under the current low oil prices, I.O.C.s may find several different investment opportunities; if a company doesn’t see an investment opportunity as sufficiently profitable, it can easily switch to drilling in other localities. Instead, a country doesn’t have the same privilege. Oil and gas deposits are fixed in a specific place. In brief, a country has to do with what it has.

Indeed, a country has to maximize its profits, but it has also to do a reality check. And, in the case of Lebanon, this reality check may be done with an eye to the amount of dollars that every year Lebanon must use to satisfy its energy requirements. In 2013, a year with high oil prices, Lebanon imported oil and derivatives for an amount of $5.11 billion, i.e., 11.4 percent of its G.D.P. Moving to 2016, a year of low oil prices, there was an 8.20 percent yearly rise in value of oil imports to $3.72 billion, which is equal to 98.21 percent of mineral products’ import value. These numbers would probably be a sufficient reason for Lebanon to try to develop its hydrocarbons sector. In fact, in addition to spending less money, by developing its own offshore natural gas deposits, Lebanon could start using natural gas rather than oil to produce electricity with many environmental benefits, give its citizens and industrial sector a continuous supply of electricity, permit its industrial sector to gain competitiveness in pricing and exports, and increase its energy security. On top of these improvements, Lebanese politicians, who are always overoptimistic, already envisage the possibility of creating new industries like petrochemicals—this idea is very premature.   

Until now, citizens and large-scale manufacturers have relied on their own electricity generators to ensure uninterrupted electricity supply—in some parts of the country there is no electricity for 18 hours a day, while at the same time current expenditures for Electricit√© du Liban, the public body controlling 90 percent of the activities of production, transportation and distribution of electricity in the country, are still the third most important point in the budget after debt service and public wages. Losses from intermittent energy supply and the utilization of private generators have translated into a considerable loss of competitiveness of Lebanese products on global markets. According to the Association of Lebanese Industrialists, the average energy factor cost is 5.7 percent of the companies’ selling price, but this cost is as high as 35 percent of the selling cost for energy intensive industries like manufacturing.

By developing its offshore natural resources, Lebanon could increase its overall energy security in order not to repeat the problem Lebanon is currently facing with its two natural gas power plants. In fact, presently Lebanon has already two combined cycle gas turbines (C.C.G.T.s), Zahrani (460 MW) and Deir Ammar (460 MW), in operation but they are not working properly because they use fuel oil and not natural gas, which, in light of external political and economic circumstances, is not currently exported to Lebanon. 

Corruption is a huge problem. Transparency International, a global civil society organization, in its corruption perceptions index ranked Lebanon 136 out of 176 countries in 2016. And the idea of getting rid of corruption is probably just wishful thinking. Think of Angola, which is a good case in point. From 2002 to 2015, this country’s exports totaled almost $600 billion, nearly all of it from oil. According to the Catholic University of Angola’s Center for Studies and Scientific Research, oil revenue brought the government coffers $315 billion. At the same time $28 billion from government budgets remained unaccounted for and up to 35 percent of the money spent on road construction vanished. And in relation to Lebanon, it’s important to underline that immediately after the first pre-qualification phase, already in 2013, serious transparency problems had emerged concerning two of the three qualified Lebanese companies.

One positive, but limited, note for the possible investors is that Lebanon has announced its intention to join the Extractive Industries Transparency Initiative (E.I.T.I), which is a voluntary initiative through which the government of Lebanon will commit to publishing reports on how the government manages the oil, gas, and mining resources. In practice, the participation in the E.I.T.I. will promote transparency in the hydrocarbons sector. It would be quite important that Parliament approved a draft law, which was prepared in the last two years, regarding transparency in the O&G sector before November.       

The E.I.T.I. Standard — Source: E.I.T.I.
There is a final question: What companies could really be interested in investing in Lebanon? It’s difficult to have an answer. U.S. Exxon Mobil, Chevron, and Anadarko, Brazil’s Petrobras, Italy’s E.N.I., Denmark’s Maersk Spain’s Repsol, U.K. Shell, Norway’s Statoil, France’s Total, Japan’s Inpex, Malaysia’s Petronas, and O.N.G.C Videsh Limited all pre-qualified as operators—12 in 2013 and 1 in 2017. Indeed, these companies are among the best I.O.C.s at world level. But it’s quite probable that the interest they had in 2013 is not present any longer in light of all the considerations developed above.

Recently, a few days ago, Foreign Minister Gibran Bassil while meeting with his Chinese counterpart, Wang Yi, encouraged China to invest in Lebanon’s oil and gas sector. Normally, this type of exhortation would be perfectly in line with the meeting. But when you are the foreign minister of a country that is currently carrying out its first licensing round to which no Chinese company will participate, such a behavior raises the doubt that the pre-qualified companies haven’t until now shown excessive interest in the licensing round and that Lebanon has to develop a plan B. Of course, this could easily be just a simple conjecture because companies will submit their tenders only on Sept. 15, 2017.     

In particular, in view of the considerations developed in this analysis, it could be difficult for an I.O.C. to develop a good business case and decide to invest in one of the three blocks comprising the disputed wedge of water. Moreover, Lebanon does not have the naval capabilities to protect militarily its future O&G installations, while Israel has powerful naval means.

But there is something more. The sectarian divisions of Lebanese society, which are mirrored in the country’s political institutions, until now have consistently and only slowed the development of an O&G sector in Lebanon. What if instead the energy sector with its consistent revenue stream became a new lever capable of kindling another time Lebanon’s society internal conflicts?             

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Tuesday, May 30, 2017

The U.S. Vision of Iraq's Oil Production


The article The U.S. Vision of Iraq's Oil Productionhas been initially published by Oilpro, a professional network for the oil and gas professionals
May 30, 2017
LONDON — Last week, I attended Iraq Petroleum 2017, a conference organized every year by The C.W.C. Group, which is the world-leading events and training producer for the oil, gas and infrastructure industries — still with reference to Iraq/K.R.G., The C.W.C. Group is currently organizing in Beirut, Lebanon, Basra Oil, Gas & Infrastructure Conference (planned for Oct. 2017) and in London, U.K., Kurdistan-Iraq Oil & Gas (planned for Dec. 2017).
This year’s edition of Iraq Petroleum (the eleventh edition) gathered over 200 senior industry professionals and government representatives with the main goal of discussing new strategies for Iraq’s energy sector. In specific, this edition focused on the focus was on Iraq's oil and gas #infrastructure development projects and on the global trends in #crude oil #trading in light of Iraq's increased #exports.Iraq's oil and gas infrastructure development projects and on the global trends in crude oil trading in light of Iraq’s increased crude oil exports.
The Conference — Source: The C.W.C. Group Press Service
Very interesting, and in a certain way quite direct and frank, was the speech of Mr. Alan Eyre, director of the Office of Middle East and Asia of the Bureau of Energy Affairs with the State Department. Mr. Eyre clearly defined what the U.S. vision of the new energy landscape is. He was part of the panel called “Iraq a Major Oil & Gas Power: Strategies for the New Energy Landscape.”  
The Panel "Iraq a Major Oil & Gas Power: Strategies for the New Energy Landscape" — Source: The C.W.C. Group Press Service
The State Department’s position — and consequently the position of the U.S. government — supports the U.S. shale oil and gas producers to push ahead as much as they can with their shale operations on the American soil, no matter what an increased U.S. shale oil production might mean to the oil price internationally. Technological advances in the past few years have made U.S. shale oil production now profitable at $40 to $50 per barrel.
In other words, the U.S. government calls for an oil price based on a pure free market approach. If U.S. shale oil producers make a profit, they stay in the market, if they don’t, they have to exit the market. It’s a simple but very clear approach. This vision does not make room any longer for cartel restrictions, such as those that OPEC has always tried to implement over the course of its existence.
In specific, with reference to the last two years and a half, since the end of November 2014 OPEC has been playing a commercial battle with the U.S. shale producers with the final goal of pushing them out of the market. In fact, despite plunging oil prices, in November 2014, OPEC members decided not to cut output. At that time, cutting output was a move required to support oil prices, but strategically OPEC members preferred to maintain (if not to enlarge, this, at least, was their initial idea) their market share. As a consequence of their decision, oil prices bottomed out in January 2016 when Brent was less than $30 per barrel. Then, in November 2016, with the Brent price partially higher at around $45 a barrel, OPEC ministers secured a cut in OPEC’s oil production from 33.8 million barrels a day (b/d) to 32.5 million b/d for the first six months of 2017 to prop up prices. Then, just a few days ago, at its May 2017 meeting, OPEC decided to extend its production cut by nine months. At the time of this writing, Brent is around $52 a barrel. Currently inventories haven’t stopped rising and supply continues to outstrip demand — this explains why the price of oil is not really rising. In addition, shale production is increasing at the same rate as it was before 2014. To counter its lost political power, OPEC might try to expand its base and access to producers.
The U.S. vision of the new energy landscape is well in line with the new U.S. administration’s concept of “America First” (implemented at the energy level as well) and with the present inherent value of fossil fuels. With reference to the first point, the White House has clearly affirmed that it wants to maximize the use of American resources, freeing the U.S. from dependence on foreign oil. Here, putting politics aside, this economic target makes sense: If U.S. shale oil producers are able to generate profits, they will be on the market and this will be beneficial to the U.S. economy overall. The second point, the present inherent value of fossil fuels, needs to be consistently enlarged.
Time after time, Arab countries have always released statements where it was written that the correct price of oil was a certain amount of dollars per barrel (for instance $70, $90 and so on). And they have always closed their statements affirming that the stated price per barrel could guarantee a sort of win-win agreement between producing/exporting countries and importing/consuming countries.
The reality is that we don’t know what the correct price of a barrel of oil should be, especially on a medium- to long-term basis. According to a free market logic, the price of an item, oil as well, should be based on the balance between supply and demand. In other words, the price of oil is a moving thing. Of course, when talking about oil there are also political and security considerations that enter the picture. But, in times of oil abundance in the U.S., these political and security considerations can be played down. See at this regard, President Donald Trump's proposal to sell half of the U.S. strategic oil reserve. This proposal well highlights a reduction in the U.S. reliance on imports — and a weaning off OPEC crude — exactly when the domestic U.S. production soars.
Another layer of complexity for those who invest in oil, but this is also true for natural gas and minerals, is the long lead time of the projects, i.e., the time between the initial stage of a project and first commercially viable production. In other words, from the final investment decision (F.I.D.), but, in reality, an investor has already used important economic resources at this stage, to the moment when the first barrel of oil will be commercially produced, there could easily be 7 years, 10 years, if not longer times. And this means that the profitability envisaged at the F.I.D. time could no longer be present when you have the first barrel of oil. This is a real problem for commodities — instead, a manufacturer who produces for example t-shirts has very a short lead time between the ideational phase and the production phase thanks to reduced entry barriers. 
But let’s put aside political considerations, security considerations, and long lead times, and let’s focus our attention on the concept of the price oil deriving from the balance of supply and demand. Persian Gulf’s oil producers artificially would like a high oil price, which on the basis of the number of oil producers across the world and the pace of the world economy in 2017 is not achievable right now. If in the coming months there were a war in a major oil-producing country, a complete reduction of the inventory levels of crude oil, or difficulties maintaining the present level of oil production because of the reduced oil investments of the last two years, things could be very different and the oil price could spike again also consistently. Indeed, the decline in upstream investment in 2015 and 2016 ($450 billion and less than $400 billion respectively from around $650 billion in 2014) could materialize in a severe shortage in the medium-term.
Business theory tells us that with a successful differentiation strategy, a company is able to offer products or services perceived to be distinctively more valuable to customers than are competitive offerings, while maintaining more or less the same cost structure used by competitors. But with commodities this is not possible. With commodities, and crude oil is a commodity, a producer (especially if it works only upstream) cannot differentiate its product in order to present it as more attractive to buyers. It’s true that crude oils are different according to different A.P.I. grades and sulfur content, but it’s also true that the final products deriving from crude oil are exactly the same (for instance at the pump station when you fill your tank it doesn’t matter what gasoline brand you use) and that we can consider the A.P.I. grades and sulfur differences as just initial cost differences and not as a real final differentiation of the product. For more information about the concept of competition please see the extensive research done on the topic by Professor Michael Porter of Harvard University.
So, logic wants that with commodities in a competitive market low-cost producers are the winners. With reference to crude oil this means that if there is a place in the world where crude oil should ideally be produced, it’s exactly in the Middle East and in particular, in Iran, Iraq, and Saudi Arabia as a consequence of their finding and development (F&D) costs, which are probably less than $10.
In a perfect world, these three countries should be the hard-core oil producers at world level. In addition, although they would not be able to satisfy all the world’s oil demand (they would not be monopolists), they would still gain a lot from being price takers. In fact, all their low-cost oil production would be sold at the price asked to cover the production cost of the highest-cost producer necessary to satisfy the last barrel of oil required by world demand.     
Arab countries want high oil prices because their economies are almost exclusively based on the export of oil and gas. But, under the current circumstances, for Arab countries, obtaining, let’s say, $100 per barrel of oil in order to balance their fiscal budget is impossible. In this regard, at the conference resounded quite loudly the idea of diversifying Iraq’s economy. Personally, I think the expression “diversifying the economy” in relation to Persian Gulf’s producers is not correct. I believe it would be more correct to say “partially reducing the dependence on O&G exports.”
In fact, for a commodity producer, and especially for one located in the Middle East, reaching economic diversification and maintaining it, is never an easy task. In confirmation of this point think of Norway, which has always been considered the poster-boy of how an O&G producer should develop its petroleum sector. As oil prices started to fall in 2013, it became apparent that the Norwegian economy had become incredibly unbalanced. "The oil and gas industry became too strong in our economy, especially during the last four or five years” said Prime Minister Erna Solberg in an interview with the BBC News website in 2016. And then she added that the Norwegian economy had to diversify. Norway has the same problem as the Arab countries. In fact, Norway’s Johan Sverdrup field (expected resources of  1.9 to 3.0 billion barrels of oil equivalents), a huge field that will start production in 2019, now could probably reach breakeven at $20 to $30 per barrel, but the government requires $70 per barrel oil to balance its fiscal budget. Also Norway is a one-path economy, mostly dependent on oil and gas exports (around 60 percent of exports).
The two pictures below show Norway's unbalanced export sector and the U.S. much more balanced export sector.
What Did Norway Export in 2014? — Source: The Atlas of Complexity, Harvard University
What Did the U.S. Export in 2014? — Source: The Atlas of Complexity, Harvard University
In practice, at the conference the State Department’s suggestion to Iraq was to produce more oil, i.e., to develop a real economy of scale in the petroleum sector. The idea was to try to make up for the decreased government revenues of the last years with more millions of oil exported on a daily basis. But the implementation is not easy. Indeed, infrastructural problems are among the most important hurdles. In fact, in the last years Iraq has already lowered its ambitious oil production targets. When the technical service contracts (T.S.C.s.) were signed, the federal government and the IOCs had set an initial production target of more than 12 million b/d by 2017 from a dozen oil fields. Later, after renegotiating the signed contracts, the federal government and the companies planned to reach 9.0 million b/d by 2020. It’s now probable that Iraq will lower the target down to 6.0 if oil prices stay low. In fact, in addition to infrastructural problems, Iraq has been forced to revise its expansion plans because under the current T.S.C.s low oil prices have a particularly damaging effect on the government’s income.
The State Department’s suggestion to Iraq echoed David Ricardo’s theory of comparative advantages. For the most part, countries all try to do what they are relatively best at and trade for everything else. A country has an absolute advantage in relation to those products in which it has a productivity edge over the other countries. This means that it takes this country fewer resources to produce a certain product. A country has a comparative advantage when a good can be produced at a lower cost in terms of other goods. Countries that specialize based on comparative advantage gain from trade. A country has an absolute advantage in producing a good over another country if it uses fewer resources to produce that specific good. Absolute advantage can be the result of a country’s natural endowment — and this is the case of Iraq with oil.
The concept of comparative advantages doesn’t want to deny the idea of the importance of economic diversification in order to reduce economic risks (this principle is absolutely valid for personal investment portfolios, for companies’ operations, and for countries’ G.D.P. composition). But when considering Middle Eastern oil producers, if on the one hand economic diversification is important, on the other hand it has to be taken cum grano salis. The reason is that for these countries diversifying their economy will be extremely difficult. So, oil and gas will continue to be for these countries the main pillar of their economies. And, if this weren’t the case, these countries would fall into chaos more than they are now. Consequently, a more realistic approach is needed otherwise we risk falling into pure wishful thinking. One thing is what we want to do, another thing is what we are able to do.
In addition, the State Department’s invitation to Iraq seems to underline one point: Oil producers have to export oil now that it has a value. Maybe it doesn’t have the per-barrel value that Arab countries would desire, but it has a value. In twenty or thirty years many things could change. It’s true that according to many forecasts there will be an increase in energy (and petroleum) consumption globally, but forecasts on a long-term basis are never easy and could contain a higher probability of fallacy.
Marcus Antonini, Shell Iraq's Vice President & Country Chairman (right), and Alessandro Bacci (left) — Source: The C.W.C. Group Press Service