Middle East may become net importer of natural gas

The Middle East – albeit holding four of the five largest gas resources in the world – is in danger of becoming net importers of gas if it fails to invest significantly in gas infrastructure. According to a report by Morgan Stanley, the region is struggling to meet the increasing domestic demand due to its limited gas infrastructure. Gas consumption has risen by 48 billion cubic feet per day (bcfpd) since 2000 globally, with the Middle East representing 23 per cent.

Some of the largest producers are also experiencing some of the highest growth rates in consumption. Demand continues to grow as gas, which used to be flared or vented, is now considered the ideal energy for power generation and water desalination plants as it is cleaner and more cost effective than oil.

According to Meed estimates, GCC natural gas demand is expected to grow by 6.6 per cent per annum over the 2007-2012 period because of the increasing demand from electricity generation, petrochemical production and gas re-injection.

The region, as per industry estimates, would require new power capacity of about 60,000MW and would need to double desalination capacity to five billion gallons a day by 2015. Chemical Market Associates (CMAI) projects ethylene capacity – whose major feedstock is gas – is set to increase by more than 80 per cent in the Middle East.

In addition, some countries re-inject large quantities of gas in mature oilfields to maintain production. Iran for one uses 2bcfpd of gas for re-injection purposes.

"With demand growing rapidly, governments need to invest significantly in the short term to avoid becoming net importers of gas. This would also imply that less gas would be available in the medium term for international markets," the report said.

Because of very small economic incentives in the past, there has been little investment in vital gas pipelines and other infrastructure. Domestic end user prices are below $1 per million btu in many countries, substantially less than international prices.

There are also few large-scale cross-border projects, the most notable being the UAE's Dolphin pipeline project with gas supplied from Qatar's North field. Elsewhere, Crescent Petroleum is attempting to import gas from Iran, and Bahrain is also pushing for more cross-border co-operation. Today, however, the cheap gas era, which has accelerated efforts to develop more expensive domestic supply, has ended.

Gas production is generally tougher and more complex and many gas projects involve moving higher up the technology curve towards producing from more complex reservoirs and fields.

Middle East gas is deeper, tighter and harder to extract than North American gas. A new set of technologies is currently under development in the region geared towards local needs. For example, Gulf reservoir rock can be two-to-three times harder than the most difficult US formations, bottom-hole temperatures can reach 290-320 F (making it tough on chemicals), pressure can reach 20k psi (above 13k psi is considered high risk) and the gas is sour, which makes completion highly expensive.

Fracing, imaging, underbalanced drilling, light weight cementing and extended reach drilling are only a few examples of fit-for-purpose technologies used in the region, driving natural gas costs substantially higher than those of light oil.

So now, according to PFC Energy, the single biggest obstacle to future regional gas deals is the gas price. It said less than one decade ago, Dubai was offered gas from Iran's Sirri Field at 80¢ per mbtu only to reject it as being too expensive, while a reported 65¢ per mbtu price negotiated in 2000 all but derailed Sharjah's plans to import 500mcfd from Iran, now four years overdue – despite construction of the necessary facilities and pipeline having been completed.

"The one successful pipeline delivering the UAE and Oman with 2bcfpd from Qatar's North Field at $1.35/mbtu is a deal of the past, and almost certainly will not be replicated, even as a political gesture of goodwill," PFC Energy said.

It said Dolphin's partners – Occidental (24.5 per cent), Total (24.5 per cent) and Mubadala (51 per cent) – currently derive their profit from 90mbpd and 30mbpd of condensate and LPG sales, rather than the gas sold into the price-capped domestic markets. "A new agreement to fill the pipeline's 3.5 bcfpd potential – requiring additional compressors – will not be achieved without a significant increase in the price paid for the gas, of probably ten-fold or more," it said.

However, despite this acceptance of a drastically new price paradigm, there still seems to be a reluctance to accept similar prices for pipeline gas: a fact reflected by the absence of any operational projects (Dolphin aside) regionally and in other emerging markets.

"As the portion of incremental gas supplies under higher prices grows as a fraction of total demand, so too does the burden on government budgets," it said.

"A fundamental modification to align the additional costs of supply with heavily subsidised gas markets will be required, even if detrimental to economic growth in the short term. This will need to happen sooner rather than later."

The challenges of the Middle East countries vary. In the case of Qatar – which took over Indonesia as the world's largest LNG exporter in 2005 – absolute domestic consumption volumes are not significant in themselves, but the emirate's future output commitments of 16bcfpd and repeated assertions by state officials that future monetisation of gas will favour domestic requirements paints a less-than-rosy picture for those waiting in line to access Qatar's gas.

If and when the moratorium on new gas projects is lifted, though this looks increasingly unlikely, Qatar's neighbours will come further down the priority list, behind domestic industrialisation and petrochemicals.

On the upside, a rapprochement between Qatar and its neighbours over the past two years does provide a degree of political will to strengthen relations through a gas pipeline agreement, although government policy aimed at maintaining gas production for two to three generations means that any future decisions will be deeply scrutinised by the gas industry experts.

Morgan Stanley said the country's revenue stream should increase materially in the next two years. "However, following the wave of projects signed at the beginning of the decade, we have seen substantially fewer commitments," it said.

"A five-year moratorium on projects using North Field gas was announced in 2005 and is set to be extended potentially to 2013. The Qatari Energy Minister has indicated that security of supply for domestic industrial users (particularly petrochemicals) will be a priority, and we, therefore, argue that the upside for gas supply into international markets is limited. This underpins our view that global gas markets could remain tight for the foreseeable future," it added. The UAE on the other hand is focused on meeting increasing domestic demand but is hindered by the fact that a great deal of its gas reserves are tight and/or sour and, therefore, require additional capital expenditure and time to develop.

Morgan Stanley said there are unlikely to be significant gas exports, given that earlier this year Shell signed a 15-year sale and purchase agreement to supply LNG into Dubai from the Qatargas 4 project via a new regas terminal in the Jebel Ali port of Dubai.

Kuwait's gas reserves are smaller than those of neighbouring countries in the region, and power generation needs are met by more expensive fuel oil.

Saudi Arabia's focus remains on developing the vast oil reserves and executing on several large start-ups and ramp-ups. Any increased gas capacity has already been pencilled in to meet a growing local market and demand from the petrochemicals industry. Furthermore, the scheduling of the Karan field with 1.8tcfpd capacity due on-stream in 2011 is being reassessed.

In Oman, the lack of near-term availability has already meant delays to full capacity production at the Qalhat LNG project, which is now envisaged for 2009 after start-up at the end of 2005.
Challenges in Iran are more severe given the 70-million strong population, hefty industrial sector dependent on gas and substantial re-injection volumes for oilfield pressure maintenance.

Facing increasingly tight oil product balances, Iran has also been driving policies aimed at substituting gasoline and diesel with gas in industry as well as transport. Tehran's resource mismanagement in the past means that it is simply over-extending itself in trying to do everything.

The investment pace in oil and gas infrastructure has been slower than that of its neighbour Qatar. Export LNG projects have been pushed back while CNOOC and SKS (Malaysian) have held talks without any firm commitments being put forward.

Elsewhere, the Iran-Pakistan-India pipeline has been delayed from an original start-up date of 2011, while options are being considered for a possible pipeline to China.