Saturday, May 16, 2015

Lebanon's Offshore Natural Gas: A Complicated Story

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May 16, 2015
BEIRUT, Lebanon
I have recently participated in a couple of conferences related to the possible development of an energy sector in Lebanon. Although one of the conferences covered in a very intelligent way also the possibility of the development of renewable energy sources in Lebanon (the country is quite gifted in this regard), the country's energy future seems to be strongly linked to fossil fuels (especially natural gas) located offshore. According to Spectrum, a Norwegian company working in the seismic services market, Lebanon could have up to 25.4 TCF of recoverable offshore gas reserves. In other words, the real game changer will be natural gas buried in the eastern Mediterranean. At the time of this writing surveys are being conducted with reference to Lebanon's onshore territory and some results will be released soon. It is worth remembering that no oil or gas has yet been found in Lebanon’s waters, but that the surveying activity to date has indicated that Lebanon has much potential.
During the two events and then in the following days some people wanted to have my opinion about the possibility of the development of the Lebanese natural gas sector. In fact, according to many participants in the conferences, things are not progressing as quickly as they should; across the audience and the intervening lecturers there was certain disillusionment in relation to the possibility of really kick-starting the gas business in a reasonable time frame — it should be clear that even if Lebanon sped up the gas development, it would not become a gas producer before 2025. As a matter of fact, in order to advance with the gas business it is necessary (a conditio sine qua non) that the government approve a couple of decrees.
The first one concerns the demarcation of 10 maritime blocks (and it is linked to the division of the Exclusive Economic Zone (E.E.Z.) into several blocks that are not entirely equal). Some of the southern blocks straddle a contested area between Lebanon and Israel — technically Lebanon is still at war with Israel, and surely a good idea for both countries would be not to proceed with offshore activities in the straddling areas. The second one concerns the details of the production sharing contracts (P.S.C.s) to sign with the international oil companies (I.O.C.s). The scheme below (below the map of the blocks)  shows the envisaged design of the Lebanese P.S.C. The government take would be structured around three components: royalty (in cash or in kind), profit petroleum and income tax. On paper, this type of contracts could be valid but there are still too many elements to specify (for instance, cost oil recovery, the different profit-sharing percentages according to various levels of production, and state participation) that do not permit a comprehensive evaluation.
      
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The Offshore Blocks — Source: Lebanese Petroleum Administration (L.P.A.)

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Without these two decrees it is not possible to have the auction for the assignment of the selected blocks. The auction had to be held for the first time in October 2013, but since then it has been postponed several times. Now it is not anymore confirmed that all the 46 companies (12 as operators) that pre-qualified for the auction will continue to show interest for Lebanon's natural gas (For more information see: BACCI, A., Forty-Six I.O.C.s Will Bid for Lebanon's Offshore Hydrocarbon Exploration, April 2013). The result is that the government started to authorize surveys concerning the onshore territory putting on hold the development of the offshore resources. Clearly, the energy companies require a detailed framework in order to participate in a bidding process.   
In addition, there is a quite complete 2-D and 3-D analysis of offshore Lebanon (around 70 percent): This means that what could be done at the geologic level without starting to drill has already been done. These data are property of the Lebanese state. Now it is time for Lebanon to decide really whether — and this is a big 'whether' — it seriously wants to go ahead with the development of its hydrocarbons. Be it clear, this is not an easy decision, and it is always very difficult in any country desiring to develop a hydrocarbon sector.
This paper will try to focus its attention on the most pressing and real issues related to the development of offshore natural gas in Lebanon. The Lebanese government and Parliament should decide only on the basis of what the development of a hydrocarbon sector may bring to Lebanon. All possible political considerations linked to connections with foreign actors requiring Lebanon to develop or not to develop an energy sector should be put aside. The reason is simple: Today's shaky political alliances, which could change consistently in the coming years, could stop irreversibly the development of an economic sector that would have an economic impact for approximately 30 years. This is the time frame of a fossil-fuel business. Will today's political alliances and compromises still be valid in 10 years, 20 years or 30 years? It's difficult to say, but it's probable that there will be some transformations in the Middle Eastern energy markets in light of the fact that many countries are already implementing policies oriented toward an increase in their hydrocarbons production. For this reason, an additional oil and gas producer will always be an additional competitor for all of the other Middle Eastern producers — friendly countries and unfriendly countries too. This means that patronage connections existing today could go bust or lose value — of course it's too early to figure out the outcomes.
So, summing up, Lebanese oil and gas should help Lebanon and should be evaluated purely on the basis of the benefits for Lebanon's society. Among these benefits:
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Source: International Energy Agency (I.E.A.)

2) Reducing the country's public debt. Gross public debt reached $66.2 billion in the last months of 2014. Gross public debt accounts for 146 percent of Lebanon’s G.D.P., compared to 140 percent of G.D.P. in December 2013. Public debt is rising and the country simply does not have many available options to break this debt cycle. Petroleum could enlarge the economy so that the debt to G.D.P. ratio could be reduced.   
3) Creating a sovereign wealth fund (S.W.F.) for the benefit of future generations and using the residue for public investments. Gas is a country's natural capital that cannot be regenerated (nonrenewable form of wealth), so for a producing country it's all-important to replace the sold assets (natural gas) with new physical capital, human capital, social capital or natural capital.      
In this regard, Article III of the Offshore Petroleum Resources Law states:
Article 3: Principles for the Management of Petroleum:
1- The aim of this law is to allow the State to manage Petroleum resources in Waters.
2-The net proceeds collected or received by Government arising out of Petroleum Activities or Petroleum Rights shall be placed in a sovereign fund.
3- The statute regulating the Fund, the rules for its specific management, the principles of investment and use of proceeds shall be regulated by a specific law, based on clear and transparent principles for investment and use of proceeds that shall keep the capital and part of the proceeds in an investment fund for future generations, leaving the other part to be spent according to standards that will guarantee the rights of the State and avoid serious, short or long- term negative economic consequences.   
In brief, if the two above-mentioned decrees are not passed because there are some doubts about the economic side of the development of an offshore natural gas sector in Lebanon, this kind of substantiated opposition is perfectly acceptable and could be logic (of course it needs to be explained). But, if the two decrees do not advance for political reasons, this does not serve the long-term interests of Lebanon.
The idea that the presence of petroleum (oil and/or gas) will always be a windfall (manna) for the concerned country is never 100 percent true. In fact, there are two types of problems when we consider a fossil-fuel business. The first one is the so-called 'Resource Curse', while the second one is whether the development of an energy business may really produce a win-win solution for the involved parties, i.e., the government side and the involved I.O.C.s. "Petroleum wealth is overwhelmingly a problem for low- and middle-income countries, not rich, industrialized ones" (Ross 2011); and Lebanon belongs to this group of countries.  
The three main problems that Lebanon could face if it decides to develop a gas sector are:
  • 1) Are Lebanon's public institutions capable of managing a petroleum sector?
  • 2) Will the full-cycle costs of the extracted gas be competitive on the gas markets?
  • 3) If there are sufficient quantities of gas for export, 'where' and 'how' will Lebanon export the produced gas?            

The first problem is completely linked to the issue of the resource curse while the second and the third pertain to the real economic profitability of a petroleum business.

LEBANON'S FIRST PROBLEM — Are Lebanon's Public Institutions Capable of Managing a Petroleum Sector?
The importance of top-notch public institutions is one of the most important factors for the successful development of a petroleum sector avoiding (or at least partially avoiding) the worst effects of the resource curse — for a clear definition of resource curse please check the infographics below.


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Petroleum revenues have at least four characteristics that make them very difficult to manage. They are:
1) Their exceptionally large size. It is quite normal that the petroleum industry (it's important to remember that petroleum reserves in general belong to governments) generates more revenues than the other industries present in a country. In order to have an idea of this phenomenon, let's consider the latest data by the Energy Information Administration (E.I.A.) for two petroleum exporting countries, Norway (a prosperous mixed economy) and Kuwait (an economy that absolutely needs diversification). In 2012, in Norway, crude oil, natural gas, and pipeline transport services accounted for 52 percent of exports revenues, 23 percent of G.D.P., and 30 percent of government revenues. In 2013, in Kuwait, petroleum export revenues accounted for 60 percent of the country's G.D.P., 94 percent of export revenues and 89 percent of government revenues. The numbers are clear. In practice, the petroleum sector (public) becomes the largest industrial sector, and in some countries, because of the so-called Dutch Disease (see the infographics above for more details), this overstretched public sector may fail to boost private-sector growth with the subsequent decline in a country's manufacturing and agricultural sectors.          
2) Their unusual source. Governments are normally funded by 'taxes', but, when a country, is a petroleum producer its government becomes increasingly less dependent on taxes and starts to depend more on 'nontax revenues'. For governments it is "bureaucratically easier and politically more popular to collect revenues from their oil sectors than to collect taxes from thepopulation at large" (Ross 2011). Of course, collecting revenues (it would be more correct to say rents) from the petroleum sector has relevant consequences at the political level. On the one hand, governments may tend to badly spend the petroleum revenues in order to stay in power, while, on the other hand, citizens might want to obtain large benefits and low taxes closing an eye in relation to the absence of complete democratic institutions.            
3) Their lack of stability. A year a country has relevant petroleum revenues, the following year it earns a lot less. Why? This volatility depends on three factors: changes in oil prices (which in some cases have an impact on gas prices like, for instance, in Japan), changes in the production rates, and changes in the contracts between governments and energy companies. Price volatility is primarily based on the fact that supply and demand for petroleum are in the short term price inelastic. During the time frame of a petroleum project, production may vary consistently, i.e., increasing or decreasing — although it's true that changes in production are always anticipated years in advance. Finally, with reference to petroleum contracts, it's honestly difficult to design a contractual infrastructure capable of withstanding the market modifications of a 30-year time frame. And today, petroleum contracts give I.O.Cs. a relatively fixed part of the profits, while governments collect a larger share, which is also more volatile. The problem is that many times governments sign contracts that destabilize their revenues — see what is currently happening in Iraq proper where, after the decrease in the price of oil since June 2014, the government needs to renegotiate its contracts with the I.O.C.s in relation to the fieldsin southern Iraq.          
4) Their secrecy. It is very simple for governments not to disclose their petroleum revenues. Of course there are countries like the U.S., Norway or New Zealand where all petroleum activities are transparent, but in many countries this is not the rule. Secrecy, which, many times, is obtained through unreported off-budget accounts, derives from two features. First, petroleum reserves belong to the state (not in the U.S.), and the energy companies can access them only through contracts with the hosting country or its national oil company(N.O.C.); these contracts are long, complex and typically secret. Second, the prevalence, since the 1970s, of N.O.C.s.; in many undemocratic countries the budget of the N.O.C. is exempted from parliamentary oversight or when it is submitted to the parliament it is rarely comprehensive.   
Under these premises, if Lebanon's authorities decide to go ahead with the petroleum development, it immediately emerges the necessity of a full commitment and an improved transparency of Lebanon's public institutions. In fact, given the difficult task of setting up a petroleum sector, a less-than-complete commitment by the government, Parliament and the Lebanese Petroleum Administration (the L.P.A., which is under the guidance of the Ministry of Energy and Water) would end up in a failure. Also a country like Norway, which is often and correctly mentioned as an example for successful petroleum development, has been through difficult times since the beginning of its petroleum adventure in the 1960s — difficulties both at the contractual and working level. For instance, at the contractual level, the first large discovery, the Ekofisk oil field, which came online in 1971, was under very poor contractual conditions and, in practice, there was a limited Norwegian stake in the project. At the working level, in April 1977, an oil well blowout occurred at the Ekofisk Bravo platform because of an erroneously installed downhole safety valve (an estimated 80,000 to 126,000 barrels were released into the water); similarly, in March 1980, Alexander L. Kielland, a semi-submersible drilling rig capsized while working in the Ekofisk oil field killing 123 people.

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The Semi-Submersible Drilling Rig Alexander L. Kielland
Source: kosori.org

The petroleum business is a complex one, but Lebanon could start its offshore petroleum sector fifty years after Norway. This means that Lebanon could well use all the offshore petroleum knowledge developed in the last fifty years and avoid some possible faults. But to get there Lebanon needs responsible and committed institutions; and this is the problem. In Lebanon, there is always rampant corruption when dealing with the public sector. As Globalsecurity.org, a publishing company related to defense, security and geopolitics information, recently pointed out:   
In December 2014, Lebanon dropped nine places to 136th out of 175 in Transparency International’s annual survey on perceptions of public sector corruption, placing it alongside the likes of Nigeria and Kyrgyzstan. According to TI’s 2012 Corruption Perception Index (CPI), Lebanon ranked 128 out of 174 countries worldwide and 14 out of 21 MENA countries. Although this ranking represented an improvement of six spots in TI’s worldwide ranking compared to 2011, Lebanon remained among the top 50 most corrupt countries in the world.
TI noted that the country’s “deeply entrenched nepotism networks” made civil society efforts against corruption very difficult, while anti-corruption legislation exists but is not properly enforced. The LTA [Lebanese Transparency Association] blames political paralysis for preventing the passage of various legal reforms (including draft laws against illicit enrichment, access to information, and whistleblower protection) on which the organization has been closely involved to combat corruption. The index measures the perception of corruption by public officials and politicians and focuses on corruption in the public sector, defined as an abuse of official power for private interests.
There is no need to add other tables or graphs because these data are definitely quite evident and scary, and surely it won't be easy for Lebanon to eventually avoid the resource curse. In addition, it is true that, at least partially, the country is already experiencing some effects linked to the resource curse. This is due to the country's important dependence on foreign remittances. According to the World Bank, expatriates' remittances to Lebanon were approximately $8.9 billion, i.e., 17.8 percent of the G.D.P. in 2014 (the 11th such ratio in the world). The World Bank estimated remittances to Arab countries in 2014 at $52.5 billion, which is equivalent to 2 percent of the region's G.D.P. last year.  

LEBANON'S SECOND PROBLEM — Will the full-cycle costs of the extracted gas be competitive on the gas markets?
Notwithstanding the importance of full-cycle costs, too many a time conferences and the media only lightly touched on this subject. The full-cycle costs of the extracted gas (of course, if discovered) is a huge unknown. Until the energy companies start exploring for gas, find gas, and carry out an appraisal well, it is almost impossible to have a precise idea. Lebanese gas resources are located below the seabed at a depth from 1,000 meters to 2,500 meters so that top-notch oil-extraction expertise is required. These depths mean deepwater (between 500 and 1,499 meters) and ultra-deepwater activities (1,500 meters and more); and generally speaking, the deeper the water, the higher the extraction costs.

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Source: World Ocean Review

Because of gas extraction from deepwater and ultra deepwater, it seems quite difficult to have full-cycle costs competitive with reference to the U.S. Henry Hub spot price, which in April 2015 stood at $2.61 per million of British thermal unit (MMBtu). Scarce competitiveness versus the American price is a hurdle because the U.S. gas industry is planning to flood world markets with important quantities of natural gas. According to Secretary of State Ernest Moniz, the first wave of shipments may already have the green light before the end of 2015 or at the beginning of 2016. Mr. Moniz believes that in the L.N.G. business, already in this decade, the U.S. could be on par with Qatar, which exports 100 billion cubic meters (BCM) and is the world's largest L.N.G. exporter. Australia is currently the second largest exporter, but, during this decade, it could overpass Qatar as the largest L.N.G. exporter thanks to projects in Queensland and Western Australia — although Australia has become a very expensive place for the development of new L.N.G. projects (contract prices of at least $11 per MMBtu for a brownfield expansion and $14 per MMBtu for greenfield projects). In brief, the U.S. may have a serious cost advantage in the gas business.    

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Things are not exactly much better when we consider the other two most important natural gas benchmarks: the U.K. National Balancing Point (N.B.P.) and the Japan Crude Cocktail (J.C.C.). In April, the U.K. N.B.P. had an average price of $6 to $7 per MMBtu, while the average price of spot-L.N.G. imported into Japan was $7.6 MMBtu. These numbers do not leave a lot of margin for a natural gas producer who could have a high break-even point.
Many commentators have immediately praised Lebanon's geographic proximity to Turkey and Europe but they have probably overlooked Lebanon's difficulty in providing Ankara and the other European capitals with a competitive gas price. Russia and other gas providers could really do a better job. Among them, there is Qatar whose production costs are among the lowest in the world (if not the lowest) while this country plays already a certain role in determining gas flows to Europe. In fact, Qatar's production is partially non-contracted and may serve the spot market.
Most of this L.N.G. flows to Asia.  But when Asian spot prices are weak and liquidity is poor, additional volumes can act to drive prices even lower.  It is not in the Qatari’s strategic interest to drive a slump in spot prices in their primary market.  So, surplus L.N.G. is typically sold into Europe ... (Perry, March 2014). 
The possibility that Lebanon's natural gas could be expensive to produce is confirmed by the recent study "Export Infrastructure and Monetizing Options for Lebanon’s Natural Gas" by Johannes Ardiant and Ahmed Warfa of Harvard University. This preliminary study considers Lebanon's different export possibilities and proposes the break-even prices. In specific:
1) Onshore L.N.G. = $9.92 to $14 per MMBtu
2) Floating Liquefied Natural Gas (F.L.N.G.) = $9.07 to $18.73 per MMBtu
3) Egypt: Direct Sales Option = Lifting costs are lower than the contracted price with the Egyptian government, currently $2.65 to $5.88 per MMBtu, and Lebanon could negotiate with the Arab Gas Pipeline (A.G.P.) transit countries for favorable transit fees and regulations.   
4) Egypt: Lease Option = This option would be economically feasible if liquefaction tolls anchored at around $3 per MMBtu and are less than the feedstock costs.   
5) Egypt: Expanding the existing Egyptian L.N.G. plant at Idku by adding more L.N.G. trains = $5.99 to $10.22 per MMBtu
The break-even prices for the construction of an L.N.G. or an F.L.N.G. in Lebanese territory are quite high. And all the three Egyptian options — L.N.G. (2 types) and pipeline (1 type) — are difficult to evaluate because there are many unknown factors; not to mention the geopolitical considerations because Lebanon would completely rely on a foreign country (will it be a stable or an unstable country?) for the export, i.e., the monetization of what will probably become Lebanon's most important industrial sector — this would be a real gamble.          

LEBANON'S THIRD PROBLEM — If there are sufficient quantities of gas for export 'where' and 'how' will Lebanon export the produced gas?
Once the exploratory phase confirms the presence of commercially recoverable offshore natural gas, Lebanon will have to decide how to employ its gas. Of course, completely replacing fuel oil in the power sector will be of paramount importance. Presently, natural gas is completely absent from Lebanon's energy mix. In 2009, the Arab Gas Pipeline started to supply Egyptian gas to Israel, Jordan, Lebanon and Syria — there was a branch from the Arab Gas Pipeline main axis arriving in Tripoli, in north Lebanon. But at the end of 2010 the deliveries stopped.

The Arab Gas Pipeline — Source: Wikipedia

If the discovered quantities permit Lebanon to export gas, the country will have to decide to which countries, and how, it wants to export its natural gas. A simple look at the map clarifies that Lebanon is well positioned in order to export petroleum. But, export problems completely emerge when we factor in the strained political situation of the countries of the eastern Mediterranean. In a peaceful Levant, the most logic path to exporting Lebanese gas would be through pipeline. Lebanon could still use the Arab Gas pipeline, through which it could easily serve Syria, Egypt and Jordan. But, at the moment, as a result of the current events in Syria, this road is out of question. It's true that Lebanon won't be a gas producer before 2025, so it's possible that the situation in Syria may stabilize, but, for the time being, this is not an open option. If the discovered quantities were significant (around 12 TCF), probably the most flexible and most secure option for both Lebanon and the I.O.C.s would to export gas via L.N.G. tankers to Europe and Asia. It is already evident that an L.N.G. business requires long-term contracts (duration of at least 15 to 20 years). Thinking of developing an L.N.G. business only with spot sales is economically not viable. Lebanon could also decide to develop its L.N.G. business through an F.L.N.G., but this road has never been tested as the only exporting vehicle for a country's L.N.G. export. There are construction and financing risks. The coming years will provide some additional information in this regard because Australia is considering several F.L.N.G.s — it has already experienced an increase in its initial cost estimate in the range of 25 percent. In addition, there are some talk of developing a joint L.N.G. facility between Cyprus and Lebanon.  
With reference to kick-starting its gas business, Lebanon has lost a lot of time and this could strongly reduced its export possibilities via pipeline as well as via L.N.G. As Bassam Fattouh and Laura El-Katiri of the Oxford Institute for Energy Studies recently pointed out:
By the time Lebanese LNG might be available — not before the mid-2020s — Lebanon will be competing with new entrants with considerably more market weight, including Australia (expected to bring some 56 mtpa on stream by the early to mid-2020s), East Africa (20 mtpa by the early 2020s, 30-40 mtpa by 2028) and, potentially, North America (up to 125 mtpa). Existing contracting for Australian and East African LNG suggests that by the early 2020s, before Lebanese gas comes on stream, a significant share of the market will be locked up in long-term supply contracts. Given likely production costs, Lebanon may also find it difficult to compete on price.


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Mountain of New Supply over the Next 5 Years
Table from the website www.timera-energy.com

In practice, despite an oversupply, the L.N.G. market will grow consistently in the coming five years. The real problem — and this will be critical for Lebanon — is to understand whether additional L.N.G. demand growth from Asian countries will absorb this new supply.  Similarly, with reference to pipeline exports, Jordan could be a very interesting market (although there are no common borders between Lebanon and Jordan), but there it seems the Israel may have the upper hand because it has already started producing its offshore gas. In September 2014, the partners of the Israeli Leviathan gas field signed a memorandum of understanding with the Jordanian Electric Power Company (Jepco) to export $15 billion worth of natural gas over 15 years. The Leviathan partners have to export 3 to 4 billion cubic meters (BCM) of gas each year for a total of 45 BCM. Because of bureaucratic technicalities related to the structure of Israel's natural gas sector the agreement has still to be signed. But, notwithstanding this delay, now Israel would like to finalize the agreement and to exclude Jordan from its overall export quota in order to be able to deliver more gas to Jordan. The reason is quite simple Jordan needs desperately natural gas — in this regard there have already been talks to buy gas from Palestine's Marine field, 35 kilometers off the coast of Gaza — and Israel has it. Similarly, in April 2015, Israel authorized a $500-million gas deal with Jordan. Under the terms of this contract, "the Tamar natural gas reservoir partnership will sell 1.87 billion cubic meters of natural gas to Jordanian companies Arab Potash and its affiliate Jordan Bromine over the next 15 years". The final consideration is that Lebanon will probably have available natural gas in 2025 while some of its neighbors want gas now in 2015.


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