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.