Wednesday, November 18, 2015

The Importance of Regular Export Payments to the I.O.C.s Producing Oil in the K.R.G.


November 18, 2015


The reduction in the price of crude oil that has occurred over the last year and a half is taking a relevant toll on the fiscal policies of the Middle Eastern producers. In specific, the current troubles in the oil markets are compounded in Iraq proper and in Iraqi Kurdistan (the Kurdistan Regional Government, the K.R.G.) by the ISIS insurgency. As a result, the international oil companies (I.O.C.s) producing crude oil in the K.R.G., among them Genel Energy, are experiencing some financial difficulties (i.e., a substantial negative free cash flow) because the K.R.G., in light of the mentioned problems, has not been able to establish a regular flow of payments in relation to the produced oil.       


The reduction in the price of crude oil that has occurred over the last year and a half is taking a relevant toll on the fiscal policies of the Middle Eastern producers. A barrel of oil in June 2014 cost around $110, while current prices stay close to $42 for W.T.I. and $45 for Brent. Notwithstanding some dissenting positions, the OPEC members under the guidance of Saudi Arabia have decided not to curb their oil production. OPEC's idea is to maintain its market share while trying to push out of the market high-cost oil producers (for instance U.S. shale oil producers). This policy was decided during the OPEC meeting of fall 2014 and is still applied today. Indeed, in the Middle East the oil price decline has reduced the governments' spending power, which has been the engine of the non-oil economy during the last years. Now, Middle Eastern countries have fiscal balances severely affected by the current low oil prices. It's true that some of these countries, Kuwait, Saudi Arabia and the U.A.E., have accumulated consistent financial buffers that may permit them to implement the necessary fiscal adjustments in a more gradual manner. But, most of the countries in the region are not able to balance their budgets when oil prices are under $60 a barrel. The figure below shows the fiscal break even oil prices according to the International Monetary Fund (I.M.F.)   



As a consequence of the fewer available economic resources and of the necessity of maintaining their current oil production, Middle Eastern oil producers are postponing the investments necessary to reverse natural field decline and to sustain production in the long term with new oilfields. For instance, Saudi Arabia, the U.A.E. and Qatar are delaying to 2016 non-essential maintenance work at oilfields; this work was planned for the fourth quarter of 2015. Maintenance work increases production in the long term, but in the short term it always reduces the output from the oilfields under maintenance and check; and, as explained above, right now OPEC wants to maintain its production, which is around 31.6 million barrels per day (bbl/d), in order to win its price war against high-cost oil producers. Similarly, oil majors are cutting spending and are shelving several new projects.

The current troubles in the oil markets are compounded in Iraq proper and in Iraqi Kurdistan (the Kurdistan Regional Government, the K.R.G.) by the ISIS insurgency. As a matter of fact, ISIS still controls vast swaths of Iraqi territory, primarily the western and northern parts of Iraq proper (For more information please see: BACCI, A., Iraqi Kurdistan's Occupation of Kirkuk Oil Field Will Deeply Affect the Iraqi Oil Sector, June, 2014). This insurgency, which is creating additional fissures and cracks to that already shaky edifice that is the Iraqi state, has a high human and economic cost for both Baghdad and Erbil. In this regard, the Iraqi Oil Ministry has already issued a warning where it affirms that it will reduce significantly spending reimbursement to independent energy companies in 2016; this could inhibit maintenance and expansion of Iraq's planned production goals.

At the world level Iraq proper is actually the fastest source of oil-supply growth; Iraq is OPEC's second biggest producer after Saudi Arabia. Iraq's output was around 4.2 million bbl/d in the third quarter of 2015, while in September 2015 oil sales surpassed 3.052 million bbl/d. Later, October 2015 saw a sales reduction at 2.7 million bbl/d because of primarily bad weather conditions during the last days of the month. It should be noted that Iraq's 2015 federal budget envisaged an average sale price of $56 per barrel from exports at an estimated rate of 3.3 million bbl/d (including oil from the K.R.G. and the Kirkuk area under Kurdish control). These numbers are far from real. For instance, October average sale price for Baghdad was $39, i.e., every single day Baghdad lost $45.9 million (2.7 million bbl/d * ($56-$39)) in comparison to the price written in the 2015 federal budget. It's evident that this calculation is quite 'rough' and 'oversimplified', but it gives at least an idea.    


It's worth remembering that as a consequence of the dispute over export rights and budget payments between Erbil and Baghdad, shipments from Iraq's north via Ceyhan, in Turkey, by Iraq's State Oil Marketing Organization (SOMO) stopped in September. In practice, the K.R.G. stopped delivering Kirkuk oil to SOMO in Ceyhan. This means that since September Baghdad has been exporting oil only from fields located in southern Iraq, while Erbil has been exporting oil also from fields in northern Iraq (For more information please see: BACCI, A., Why Do I.O.C.s Have to Invest in Iraqi Kurdistan and/or Southern Iraq?, February 2015). Very realistically this outcome was expected despite the signature between Erbil and Baghdad in December 2014 of an agreement concerning the distribution of oil revenues in Iraq. 



The December 2014 agreement specified that Baghdad should have paid Erbil 17 percent of Iraq's national budget (in the past years this 17 percent accounted for 95 percent of the K.R.G. revenues) as specified in the Iraqi Constitution, while Erbil would have provided the central government with 250,000 bbl/d of Kurdish oil at Ceyhan for export. In addition, the K.R.G. would have also exported via the newly built Kurdish pipeline 300,000 bbl/d of oil extracted from the oil fields of the area around Kirkuk (Bai Hassan, Dubis and Havana fields). These oil fields are under federal jurisdiction, but they are currently under Kurdish control. The Kurdistan region’s share of Iraq’s 119.5 trillion dinar budget for 2015 amounted to 14.8 trillion dinars ($13.3 billion), based on the 17 percent share to which Erbil was constitutionally entitled; this means that Erbil was expecting from Baghdad a little more than $1 billion monthly.  

At the time of the signature, in December 2014, under Iraq's dire economic, political, legal and social conditions the agreement appeared as probably the best solution for the concerned parties. In other words, this deal was immediately understood as a temporary agreement that was not supposed to solve completely the friction points between Erbil and Baghdad, but that, at least, could have permitted Iraqi Kurdistan and Iraq proper to improve their coffers and, thanks to this, to wage with better means a war against their common enemy, which was — and sadly is today — the Islamic State. For Baghdad this deal was useful because through the newly built Kurdish oil infrastructure (from Kirkuk to the K.R.G. and then from the K.R.G. to the border with Turkey where two Kurdish pipelines enters the Kirkuk-Ceyhan pipeline) it was again able to export oil from Kirkuk's fields. In fact, since March 2014 oil from these fields had not being exported anymore because the Iraqi leg of the Kirkuk-Ceyhan pipeline — the only means of transportation — had been sabotaged by terrorist attacks (For more information please see: BACCI, A., The Iraqi-Kurdish Oil Deal, December 2014). 

The problem is that since December 2014 until now this agreement has never been correctly implemented. For the first three months of 2015 Erbil was in the impossibility of exporting the established quantities and, consequently, Baghdad paid less than agreed. Then, in April Kurdish exports from the K.R.G. and from the Kirkuk area reached 562,000 bbl/d and Erbil delivered to SOMO 534,210 bbl/d. In May, Kurdish exports totaled 577,621 bbl/d of which 448,889 bbl/d were delivered to SOMO. At the same time, Baghdad's payments did not proportionally increase in order to reflect the increased quantities of oil shipped by Erbil. In brief, during the first five months of 2015, Erbil received only a third of its budget entitlement.    

Later, on June 24, the K.R.G. (with the approval of the five political parties in the coalition government) decided to start selling oil independently of SOMO. During the following three months, Erbil continued to deliver SOMO reduced quantities of crude oil, but in September it stopped completely. The slide below clarifies the K.R.G. exports of crude oil from April to October 2015.



The K.R.G. is now able to export from the K.R.G. and the Kirkuk area oilfields via its new infrastructure around 600,000 bbl/d (in October precisely 595,528 bbl/d, of which 439,073 bbl/d from the K.R.G. oilfields and 156,455 from the Kirkuk area oilfields). Erbil is committed to exporting 900,000 bbl/d by the end of 2015.     

For the K.R.G. direct exports sales are the consequential conclusion of a financial crisis that started early in 2014 when then Prime Minister Nouri al-Maliki of Iraq stopped budget payments to the K.R.G. because the latter was trying to sell its crude oil independently of Baghdad's authorization. The war against ISIS and the influx in the K.R.G. of more than 1.8 million of displaced Iraqis and Syrians added to the already present financial problems. Many Kurdish companies bankrupted and consequently thousands of people lost their jobs; in recent months protests over the staff and workers’ salaries delay have taken place across Iraqi Kurdistan. In October, Head of Foreign Relations Department Falah Mustafa Bakir told the U.N. General Assembly that Erbil has a delay of three months in paying out the salaries to civil servants (among them the Peshmerga forces battling against ISIS). In practice, in light of the economic crisis, direct exports were the only available alternative path. Minister of Natural Resources Ashti Hawrami had supported direct sales immediately after the initial misunderstanding with Baghdad following the December 2014 agreement. The revenue gained from direct sales is still below Iraqi Kurdistan's 17 percent share of the national budget, but it's indeed higher than the economic resources transferred by Baghdad on a monthly basis. This is also due to the K.R.G. difficulty in finding purchasers for its crude oil. In fact, especially last year, many buyers, despite their interest, did not decide to purchase Kurdish oil for fear of retaliation on the part of Baghdad (for instance, suing the companies that were lifting oil via the K.R.G. pipeline). For this fear, some of the cargoes loaded with Kurdish oil departing from Ceyhan delivered their cargo via ship-to-ship transfer after having turned off their satellite transponders (For more information please see: BACCI, A., The Emergence of the K.R.G. as an Oil-Exporting Area, August 2014). Now, probably because of the internal chaos, Baghdad is slightly less aggressive with reference to Erbil's independent exports. Today it's sure that some Kurdish cargoes go from Ceyhan to refineries in Israel, Italy, France and that Kurdish oil is traded by Vitoil and Trafigura, which are among the world's biggest oil traders. At the end of August the K.R.G. affirmed that it had received more than $1.5 billion in oil payments during the previous two months. In other words, some money started to flow toward the K.R.G. although still with some difficulties linked to banking procedures.   


These companies are presently experiencing relevant cash shortfalls. It's important to underline the word 'producing'. In fact, in the K.R.G. there are approximately 50 I.O.C.s that are doing petroleum operations, but most of them are only in the exploration phase. These companies (producing companies and exploring companies as well) have all signed production sharing contracts with the K.R.G (in general there is 10 percent royalty and a 40 percent cost recovery limit for crude oil and associated natural gas). This means that company during the exploration phase will not be reimbursed for the incurred costs; things of course change after a first commercial declaration — it's a very standard P.S.C. 


Among the major I.O.C.s only for the moment active in the exploration phase there are U.S. ExxonMobil and Chevron, and France's Total; it goes by itself that these majors have quite larger financial resources than the medium-sized petroleum companies (in any case they are not wildcatters) already in the production phase in Iraqi Kurdistan (For more information please see: BACCI, A., Chevron and Total Continue Investing in the K.R.G. A Brief Analysis of Baghdad's T.S.C.s vs. Erbil's P.S.C.s, June 2013). These major companies retain certain flexibility because in the future according to the political, legal, and economic conditions affecting Iraqi Kurdistan they could implement three different strategies:
  • STRATEGY A: Go ahead with the production phase if the exploration is successful.
  • STRATEGY B: Shut down their operations if exploration is not successful and/or if the political, legal and economic conditions affecting Iraqi Kurdistan do not permit them to carry out a profitable petroleum operation.
  • STRATEGY C: Enter in one of the projects already producing oil in the K.R.G.

Of course, Strategy A could also be developed together with Strategy C, while the latter could be developed together with Strategy B.      

Instead, things are completely different for the companies already producing oil. In this regard, the K.R.G. recognizes that since May 2014 these companies have received hardly any payments for their Iraqi Kurdistan operations. And, since the beginning of the exports a couple of years ago as of August 2015 these companies received only $100 million despite the revenues were in the order of billions of dollars. Erbil owes the producing I.O.C.s more than $1 billion.    


Apart from the Khurmala Dome (the northern tip of Kirkuk), which has a production capacity of 110,000 bbl/d (Energy Information Administration, E.I.A., January 2015), but that it's locally developed by KAR Group, a Kurdish privately owned group, in the K.R.G. there are three main oil producing fields under the operatorship. They are:
  • TAWKE (Production 152,000 bbl/d) Norway's D.N.O. is the operator (55 percent) and the remaining partners are Anglo-Turkish Genel Energy (25 percent) and the K.R.G. (20 percent)
  • TAQ TAQ (Production 85,000 bbl/d) Genel Energy is the operator (44 percent), and the remaining partners are China's Sinopec (36 percent) and the K.R.G. (20 percent).
  • SHAIKAN (Production 40,000 bbl/d) U.K. Gulf Keystone is the operator (75 percent), and the remaining partners are Kalegran Ltd. (100 percent subsidiary of M.O.L. Hungarian Oil and Gas Plc. with 20 percent) and Texas Keystone Inc. (5 percent).   

Licenses & Energy Infrastructure 
Source: AFREN
Click Here to Open the Map


Finally, in September 2015, the Ministry of Natural Resources authorized a $75-million tranche of regular payment to the I.O.C.s. The tranche was divided as follows:
  • $30 million to Taq Taq Operating Company (Genel Energy and Sinopec)  
  • $30 million to D.N.O. in relation to Tawke
  • $15 million to Gulf Keystone in relation to Shaikan 

These payments are useful, but they are really a trickle in comparison to what the companies are owed by the K.R.G. 


These producing companies are cash-strapped, and it will be impossible for them to continue exporting at the current levels without a stable flow of payments. In addition to covering expenses, CASH is of paramount importance in order to plan for further investments in the oil fields boosting the K.R.G. production. In other words, in the K.R.G. oil sector, it's possible to understand a basic financial concept, i.e., PROFIT and CASH are two different elements, both of which need to be present in order to have a healthy company. Financial books are full of stories of profitable companies that have been forced to bankrupt because they simply ran out of cash. And right now the balance sheets of the companies producing in the K.R.G. are full of ACCOUNTS RECEIVABLE, which are promises yet to be collected. Only once collected these promises become real cash for the I.O.C.s.




What is happening in Iraqi Kurdistan explains us that the problem does not lay in the production phase; COGS (COST OF GOODS SOLD, which in the oil business may be divided in EXPLORATION COSTS, LIFTING COSTS and NON-INCOME RELATED TAXES) are really competitive in the K.R.G. For instance, Genel has overall COGS in the order of less than $10. Of course, to get FINAL COSTS we need to add back SG&A (SALES, GENERAL and ADMINISTRATIVE EXPENSES), DEPRECIATION and INTERESTS, but the basic idea is that the pure production costs in the K.R.G. are very (very) competitive at the world level. And the profit any petroleum company is able to do is primarily linked to its COGS. So, in the K.R.G. while oil production is very cheap, then it's difficult to sell the oil and to receive the related payments. If there weren't political, legal and security difficulties, which partially eat away the COGS advantage, the main producing I.O.C.s would already be the big names of the petroleum business. The slide below shows information concerning the cost of producing a barrel of crude oil in the K.R.G.  

Source: AUBLINGER, C., How Much Does It Cost to Produce 1 Barrel of Oil in Kurdistan (DNO and Genel in 2014)?, May 2015

Current production in the K.R.G. is already too big in order to be sold locally (with discounted prices around $30; in the last six months some I.O.C.s have increased their local sales because they have been unable to get a steady flow of payments from Erbil with reference to the pipeline exports). Similarly, it's not possible to use trucks for such a big quantity: It's very expensive and also quite complex from an infrastructural point of view. In other words, with a production of already more than 500,000 bbl/d the only economically viable way of exporting crude oil is for Erbil via pipeline.

So cash is the real problem for the I.O.C.s already producing crude oil in the K.R.G. How long will these I.O.C.s be able to continue producing crude oil without a steady flow of cash? They have already borrowed money (with bond emissions) and could probably do this again, but is it really viable in the medium to long term? Any business company wants profit and wants to transform profit into cash in reasonable timeframe. Publicly traded companies may deviate from such a behavior only temporarily when they have other goals that can be better served by carrying out unprofitable operations — for instance, in Kuwait, I.O.C.s have signed Enhanced Technical Service Agreements (E.T.S.A.s) mainly because they wanted a working relation with K.O.C. (Kuwait Oil Company), so that, if Kuwait in the future proposes better contracts, the companies will have more chances of signing the new and improved petroleum contracts because they are already working in Kuwait (For more information please see: BACCI, A., Kuwait's Oil and Gas Contractual Framework and the Development of a Modern Natural Gas Industry, December 2011). In the same way, when any national oil company (N.O.C.) deviates from profit and cash, in generally, it does so for political reasons. But it's also true that in the last decades many N.O.C.s have really started to act more in a business-oriented manner.


Let's focus our attention on Genel Energy, which is the largest independent oil producer and the largest holder of reserves and resources in the K.R.G.


Checking the data released by Genel Energy in August in relation to the results of the first six months of 2015 and in October in relation to the trading and operations update demonstrates the paramount importance of a steady flow of payments by Erbil.




The pictures below show the condensed consolidated cash flow statements and the income statements for the last years.



Genel Energy has petroleum operations in the K.R.G. and in four areas in Africa (Somaliland, Ethiopia, Morocco and Ivory Coast). The African operations are still in the exploration phase, so they do not generate revenues but only relevant costs. For instance, in the fiscal year 2014, Genel Energy had exploration expenses of $476.8 million, which originated completely from the African operations — while exploration expenses related to the K.R.G. were zero in that year; of course not all the years are the same. But, this means that for the time being, Genel Energy is able to generate its revenues (and consequently, its profit and its cash) only from its Kurdish operations. If Erbil is unable to pay its dues to Genel Energy, it's quite probable that the company will have to sustain some financial difficulties.

In all of the considered periods the balance between CASH FLOWS FROM OPERATING ACTIVITIES and CASH FLOWS FROM INVESTING ACTIVITIES was always negative. In addition, it's worth noting that in all of the periods the company obtained relevant proceeds thanks to bond emissions, the last of which was done in March 2015 for a value of $230 million — currently Genel Energy has a $730 million debt (7.5% senior unsecured bond with 2019 maturity).

The other two producing I.O.C.s, D.N.O. and Gulf Keystone, are similarly experiencing some financial difficulties — in June 2015 the K.R.G. owed D.N.O. almost $700 million and Gulf Keystone $283 million. In particular, Gulf Keystone has a more complex situation, and it could be interested in attracting a farm-in partner or a strategic investor to progress with its Shaikan investment. Despite Gulf Keystone economic troubles, proved and probable reserves at Shaikan have recently been increased to 639 million barrels gross from 299 million barrels gross. So, one more time it's possible to fathom the important business truth present in the expression "Cash is king".


Saturday, October 31, 2015

Are I.O.C.s Still Interested in Lebanon's Offshore Natural Gas?

October 31, 2015

During the conversation I had at the end of July with Lebanon Gas and Oil ("Interview With Alessandro Bacci About Lebanon's Oil & Gas Future" by Mark Ayoub, July 2015) one of the topics that we partially touched upon was to try to understand whether, notwithstanding the delay from the Lebanese government in approving the two necessary decrees, I.O.C.s are still interested in investing in Lebanon's offshore natural gas. It's worth remembering that, without the approval of these decrees, it will be impossible to open up the Lebanese economic exclusive zone (E.E.Z.) to petroleum investments. The first decree is related to the division of the E.E.Z. into ten blocks, while the second one is related to the exploration and production agreement (E.P.A.), i.e., the petroleum contract that Lebanon wants to sign with the international energy companies interested in Lebanon's hydrocarbons.
After some months of a protracted standoff as for the approval of the decrees, it seems now that I.O.C.s have a tepid interest concerning Lebanon's offshore natural gas. Why? In this regard, there is not a single factor, but there is probably a combination of several. The very general, but most of the time, correct answer is that I.O.C.s do not invest in a country if they are not fully convinced of the profitability of their investments (PROFITS = PRICE - COSTS). And for companies an investment has to be positively linked to a company's financial performance — the financial measure that best captures and analyzes the financial profitability is the return on invested capital (ROIC), which weights the profit a company is able to generate versus of all of the funds invested.
Sometimes I.O.C.s have performed petroleum investments in some countries despite harsh economic conditions, i.e., scarce profitability, but these investments were done with the idea that the companies were initially putting a foot in the oil and gas markets of those countries in order to be ready to reap better contracts in the future; once those countries would open up their energy markets (see for instance the buy-back contracts in Iran or the technical service agreements in Kuwait). In practice, companies carry out these kinds of "marketing" operations on the premise that the countries receiving the investments have a relevant petroleum potential to be exploited in the future. This is not the case for Lebanon, which is a country probably gifted with 25.4 trillion cubic feet of natural gas — data about offshore oil reserves are less clear (some estimates put them between 440 million barrels to 675 million barrels of oil reserves). Indeed, good numbers, but not a game changer on world petroleum markets.
So, when considering Lebanon's offshore natural gas projects, I.O.C.s have to check the necessary prerequisite of profitability. And concerning this point, under the current economic and political circumstances, it's not evident that companies could be lured to invest in Lebanon. For companies the main problems lie in high extraction costs (deep and ultra-deep offshore, between 1,000 meters and 2,500 meters under the seabed), in deciding where and how to export the gas (of course, if there are sufficient quantities), and in the big question mark related to the Lebanese institutions' ability to manage a petroleum sector during the present tense political situation in the Levant. In light of these considerations companies may have some doubts and may presently be interested in a wait-and-see strategy in Lebanon.
Companies invest in projects where they are able to make money even in the current weak environment. In the natural gas market this is the great competitive advantage of Qatar that, according to I.H.S., a market-research company, is able to produce and liquefy a million British thermal units (MMBTU) for just $2. Similar big projects in the United States, East Africa and Australia have all higher costs (from $8 to $12). Now, it's premature to have a reliable forecast for Lebanon's cost per MMBTU, but it already seems that the L.N.G. option to both Europe and Asia would be more expensive than the cost of some of Lebanon's competitors. Asia is — it would be more correct to say it has always been — a huge market for L.N.G. According to I.H.S., in 2014 five Asian countries purchased more than 70 percent of global L.N.G. imports (Japan 36.6 percent, South Korea 15.6 percent, China 8.2 percent, India 6.0 percent and Taiwan 5.6 percent). But for Lebanon, transportation costs to Asia from the Mediterranean Sea are higher than those of some of its rival L.N.G.-producing countries. Pipeline exports under the current political situation in the Middle East (and in specific in the Levant) are quite complex, to say the least. In 2009, the Arab Gas Pipeline started to carry 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. Under the current political circumstances, thinking of using the Arab Gas Pipeline to ship Lebanon's natural gas is literally out of question.
I.O.C.s are accustomed to doing business activity in difficult environments (at both the geographic/geologic and political level). Surely, Lebanon's fragmented and scarcely unified political institutions do not help a company that is deciding whether to invest in Lebanon. So, a multifaceted political environment, possible high extraction costs and complex export routes are not the best business card for a country desiring to become a new petroleum-exporting player. But, it is also true that until the moment when it was initially supposed to adopt the two mentioned decrees, the Lebanese government had acted in a correct manner, as it was required for a country new to the petroleum business, which in the case of Lebanon is also a complex one (deep and deep offshore natural gas).
I.O.C.s complain that postponing the adoption of the two decrees shows the absence of a full commitment on the side of the Lebanese institutions with reference to offshore natural gas. In fact, without these two decrees it is not possible to have the auction for the assignment of the blocks — an auction which has been postponed several times since October 2013. But, in this regard, a possible explanation could also be the presence of a classic vicious circle between the I.O.C.s and Lebanon's government. In other words, if on the one side, the energy companies would like the Lebanese government to pass the two decrees in order to provide more clarity and stability to Lebanon's nascent petroleum sector, on the other side, the Lebanese institutions, sensing the difficulty in   investing in relation to Lebanon's offshore natural gas, prefer to postpone the auction.
The advantage of an auction procedure resides in its competiveness and transparency; a well-designed auction can really maximize revenues for a government. The problem is that it's not absolutely guaranteed that there will always be many competing bidders; this means that with limited bidders the government could cash in very limited economic resources through the auction, unless it has been able to set up reserve prices or sealed-bid mechanisms. And the problems do not end here. What governments have absolutely to avoid is a failed auction, i.e., an auction with no bids submitted. A failed auction gives a very bad signal to petroleum markets about the quality of the blocks on offer and/or the excessive economic requests on the part of governments. And later, after a failed auction, it's hard for governments to implement another auction without being forced to give out contractual terms quite favorable to I.O.C.s. Indeed, the fear of a failed auction could be another reason for the current stalemate in relation to the adoption of the two decrees. At the same time, notwithstanding this fear, if the Lebanese government does not want to develop the offshore petroleum sector, or if it wants to postpone this development, it has to state its decision in a clear manner.

Friday, July 31, 2015

Interview With Alessandro Bacci About Lebanon's Oil & Gas Future


July 31, 2015
BEIRUT, Lebanon

Dear friends,

I would like to share with you the interview that I have recently given to Marc Ayoub of Lebanon Gas and Oil, Lebanon's most important gas and oil media platform.   

You may read "Interview with Alessandro Bacci About Lebanon's Oil & Gas Future" of July 2015 on the website of Lebanon Gas and Oil or alternatively you may find below the unabridged text of the interview copied below. 


Marc Ayoub 
July 2015

Exclusive interview with Energy Specialist Alessandro Bacci: “The current situation may not be one of the best, but there is still HOPE in Lebanon!”

After the nuclear agreement between Iran and the P5+1 group that was reached on July 14th in Vienna, experts around the globe will carefully be looking on the implementation steps of this deal, which is expected to have direct implications on both the political and economic situations in the Middle East region.

What about the deal’s impact on the Oil & Gas Sector? Will Iran’s re-entry to the world market affect again oil prices? Or will the immediate post-Iran deal period be a period of hesitation and testing until the time is ripe for broad arrangements?

Lebanon Gas & Oil interviewed Energy Specialist Alessandro Bacci, with whom we had an interesting discussion on all these topics and especially the industry’s situation in Lebanon. Mr. Bacci, who is active in the fields of Policy, Government and Public Affairs in the Middle East and North Africa, is currently a member of the Italy-Kuwait Association. Mr. Bacci's activity is related to the implementation of best practices for creating sound energy institutions and governance, ensuring robust fiscal policy and competitiveness, and transforming energy resources into broader long-term development.

After the Iran nuclear deal, will Lebanon and the Middle East catch the opportunity? Will we see a change in the global O&G scene? (We started hearing that Iran is getting ready to return to the Oil and Gas market.)

Let's start from the O&G scene. According to the perspective one looks into this topic, you can have contradictory results. For example, let’s focus on OPEC, where you have already struggles and different opinions concerning production.. On the one hand, as a consequence of the reduction in the price of oil, OPEC countries are currently earning less money in comparison to last year when in June the price of a barrel was around $105. But under the tight guidance of Saudi Arabia, OPEC countries have decided not to cut their production but to maintain their market quota. The idea was to push out of the market U.S. shale oil producers who have higher extraction costs. Some OPEC members like this strategy, some others are reluctantly following it. So, if the Iranians re-enter the market, it won’t be very easy to accommodate them. In fact, more oil in time of low prices will not increase the price of oil although it's true that it will take time to Iran in order to augment its production. Some estimates of Iran's capacity to restart its oil production in just half a year (six months) are literally too optimistic. One year and a half (18 months) is a more credible possibility when you talk about an additional 1 million BPD in the market.

On the other hand, some OPEC countries already have plans to increase their production. One of these countries is Kuwait, which is now producing around 3 million BPD but it's willing to increase its production by 2020 by an additional million. . So does Iraq, Kurdistan, etc… — all wants to produce more barrels. Thus, I am not so sure that the re-entrance of a super player like Iran could be immensely useful in this transition period for the region and this could probably affect the oil price, which could go lower.

As for the impact on Lebanon, my advice to the politicians is to start thinking in the industry without linkages to other countries because alliances won’t stay the same, and each country would like to run by itself. When we talk about Iran and its interest to return to be more involved in the petroleum sector on a global scale, I think that we have to understand a few things in relation to what this may mean for Lebanon.

In fact, on the one hand, it's quite improbable that a more direct Iranian involvement in Lebanon could really permit the Lebanese government to start with its offshore natural gas program. If Lebanon decides to go on with this program, it will be through an auction for which 12 operators already prequalified. Among them: Chevron, E.N.I., ExxonMobil, Petrobras, Shell, Statoil and Total. Who are these companies? They are the best you may find. In addition, Lebanon's offshore natural gas is not easy to extract because it's deeply buried in the seabed of the eastern Mediterranean. In practice, Lebanon needs this kind of companies. Companies having financial resources and top-notch skills. And if I remember well, the National Iranian Drilling Corporation was one of those companies that were not selected in order to participate in the auction. Similarly, it would not serve the interest of Lebanon to cancel the idea of implementing an auction with many players and start a direct negotiation with some Iranian companies. I repeat if Lebanon decides to move on with the offshore gas it has to do it with the best players out there. Moreover, Iran now in order to restart its petroleum production requires significant external investment. On the other hand, Iranian investments may be very helpful for some other projects linked to the petroleum sector. We know that Iran would like to implement some projects in Lebanon with reference to the construction of refineries and power plants. These projects, if implemented, may well serve the interest of both countries. And for sure Lebanon has to upgrade its downstream petroleum sector”.

What is your opinion about the Lebanese Oil and Gas Industry, especially that you have already published a recent paper of all the aspects of the industry? Until when do you think that the deadlock will remain?

Well, it is true that the situation is not totally amazing. When some companies talk about security reasons, I think it is more as an excuse right now to gain additional time. There need to be patience  in order to work in this part of the world; the situation has stayed the same since two years, at least it has not worsened  in comparison to when the companies were here, asking for data and participating in many conferences that were happening in Lebanon. Many factors together brought us to this standoff situation.

First of all, when we are talking about Lebanon, companies are waiting for the famous 2 decrees to be adopted by the Government. Without the 2 decrees, they cannot understand what the potential of this country is.  The first one delineates the blocks and we know that there is a borders dispute with Israel and companies prefer to know what the blocks will look like. The second decree is the one related to fiscal issues or the Production Sharing Agreement with the IOCs. There is a draft copy, but it has not been approved yet, so companies need to know what the definitive text will be. When you have an official text that is approved by all the entities, you will have something concrete and precise to show to companies.

Then of course, with reference to the situation, there are many different things to be considered: you want to invest in a place that is safe, where you know what your costs are, and what you are extracting and where you are exporting. It’s not the geological conditions that are really scaring to the companies which are accustomed to working in difficult environments, but the cost of working offshore. I believe that the standoff derives from a true combination of all these factors together as well as the current conditions in the petroleum sector.

At this junction of time in Lebanon, officials should decide what they have to do. What they should have done, such as surveys, studies, etc..., has been accomplished well. Right now, you have to do the deals, otherwise, you have to go and tell the people why you cannot go ahead in this. Is it only economical wise? Is it because of companies' competitiveness? You have to give an answer.

What about the EU crisis with Greece? And how will it affect the industry and the European markets? What about Iran and the EU?

Well, for me the EU crisis with Greece is one thing, while the EU energy necessity to diversify its energy providers is a different thing.

The European Union strongly relies on Moscow for almost a third of its overall natural gas demand. But alternative options are not so easy right now, as the EU will look in the near future to Iran, especially after the deal we have talked on, but you have to pass through Turkey and build new infrastructure.

But, I don’t think there will be a connection between the EU crisis with Greece and the EU energy consumption as the EU is always looking into different ways to satisfy its energy needs. At the EU level the current crisis with Greece is not related to energy issues.  

Instead, Iran could be an important provider for the European countries. Let me tell you some statistics:

Combining oil and gas together, Iran is in the third position after Russia and Venezuela. In fact, Iran has the fourth largest oil reserves in the world after Venezuela, Saudi Arabia, and Canada and has the second largest natural gas reserves in the world — Russia, Iran.

Thus, in order to diversify its supply, Europe has to look into these numbers and see what the options available are. It is not easy, I know it, but the Iranian option could be doable at least in the long run.

Speaking about the low current oil prices, how long in your opinion will this last? What are the real causes of this drop?

The economic crisis has an impact on the price of oil. The demand is not very strong, and this is depressing the prices. You have a production of more than 94 million BPD but the demand is not as much as this. Add to that the actual problems in China, which was for the Middle East one of the most important markets. I should mention here that most of the oil of the Gulf goes to Asia (Japan, South Korea, India, etc...), so as a result I don’t see the current oil price moving amazingly up in the next 6 months at least. All this said, there are so many variables that affect the price, so it is very difficult to judge what will happen in the future. One thing we need also to monitor is what is happening in the United States. In fact, the US is diminishing the rigs, for the shale oil and shale gas, but the production is at the same time varying around the same numbers. Probably, in the coming months, there will be a decrease in the barrels produced unconventionally.

You have attended all the conferences that were held in Lebanon since January 2015 concerning the O&G sector. What do you think about them?

Conferences are something that you have to do in Lebanon. Otherwise, you risk losing the grip. If you want to achieve a project, you have to maintain the fire under the project, and the LPA has done this very well. You should always inform people and companies to keep them updated, keep in touch with the Media and tell them where you stand.

Can the Lebanese people still HOPE of a healthy O&G industry?

There’s always HOPE, because what you have as hydrocarbons wealth could be very interesting. The moment is not maybe one of the best in time, but at least you should have good stuff. People should try to identify what the political reasons behind the deadlock are, and I push politicians to move forward today. As I said before, alliances will not probably remain the same in the next 10-15 years, and Lebanese should think about themselves, and what is economically and socially useful for the Lebanese citizens.

Interviewed by Marc Ayoub

Twitter: @Marc_Ayoub