2012 Economic Commentary

Wrapping Up Volume Seven of Our Economic Commentary

As with previous editions this compilation assembles into one single volume – the seventh of its kind – all issues of our ‘Economic Commentary’ published during 2012. This offers the opportunity to highlight key insights gained from our research activities. In addition, we expect the compilation to help take stock of progress to date and elicit new ideas and thoughts for the year ahead.

In the course of its progress the publication has benefited from valuable comments and feedback from many readers around the world. To them and to all those who have shown interest in one way or another, we would like to express our thanks and offer our best wishes for the festive season… [Details]

Economic Commentary Volume 7 No 12 – December 2012 : MENA Natural Gas Endowment Is Likely to Be Much Greater Than Commonly Assumed

Recent assessments of natural gas reserves and resources outside the Middle East and North Africa (MENA) have greatly expanded the world’s potential resource base. Already, large conventional discoveries offshore East Africa, together with unconventional gas developments in North America, have transformed the energy landscape and outlook. This build-up has somewhat turned into a hype-driven rush for business opportunities. Feeding the hype, prominent Middle Eastern companies have been reported as either seeking to export LNG from the US or contemplating moving some of their petrochemical investment there. Except Iran, which has managed in recent years to add large volumes to its huge reserves, there is a tendency to discount MENA natural gas prospects. This may stem from the current perception of scarcity in parts of the region. Indeed an increasing number of apparently well-endowed countries have been unable to balance their domestic natural gas market, shifting supply to oil products or filling the gap with imports, both at a very high opportunity cost.

Few studies have sought to shed light on this “MENA gas puzzle”. Unfortunately, they could not offer any deep insight into the region’s gas reserves and resources. Others have either ignored the issue or simply overlooked the most significant part of the region. The latter case is exemplified by current assessments of world shale basins – with or without resource estimate – which have tended to exclude the Middle East – and Russia for that matter. It is as if the source rocks of these omitted world’s richest hydrocarbon regions were not rich enough compared to those of North America, Western Europe, China, India, Australia, Brazil or even Argentina.

Our commentary seeks to contribute to filling that research gap. More specifically, it aims to offer an empirical analysis supporting the view that, notwithstanding the present critical supply situation, MENA natural gas endowment is likely to be much greater than commonly assumed. The analysis is in two parts. The first draws on BP Statistical Review of World Energy (BP) to evaluate the extent MENA natural gas reserves are being depleted and in what way the resulting supply pattern is evolving. The second builds on the latest assessment by the US Geological Survey (USGS) to ascertain MENA natural gas endowment. Because of the selective and limited data made available by USGS so far, the second part should be taken as research in progress.

Our findings confirm and extend our previous results showing that on aggregate MENA proved reserves are substantial and their combined dynamic life is a little beyond the traditional 30-year strategic planning horizon for E&D. However, reserve depletion in more than half our large sample of countries has critically neared – if not already reached – the point that warrants drastic actions to curb demand and support a supply response. The opportunities for the latter will be driven by a vast potential for reserve expansion. On a country-by-country basis the potential appears to be the greatest in Iran, Saudi Arabia and Qatar, followed by Iraq, the UAE and Algeria. Prospects also seem favorable in Egypt, Oman and Libya. As the opportunities available will be increased by unconventional gas, they will entail significant challenges. Confronting the region’s natural gas paradox – a paradox of scarcity amidst plenty – requires both a demand and supply response. As far as the supply side is concerned, MENA policy makers need to rethink critically their E&D policies and the corresponding economic incentives… [Details]

Economic Commentary Volume 7 No 10 – October 2012 : MENA Energy Investment Outlook: Capturing the Full Scope and Scale of the Power Sector

Our Economic Commentary for October is released under the title “MENA Energy Investment Outlook: Capturing the Full Scope and Scale of the Power Sector”.

As usual during this period of the year, the commentary presents APICORP’s main findings of its rolling five-year review of energy investment in the Middle East and North Africa (MENA). While continuing to extend the oil and gas value chains to include the generation of electricity, we have managed for the first time to capture the full scope and scale of the power sector by adding capital requirements in transmission and distribution (T&D). Naturally, in order to maintain a coherent set of reviews past series have systematically been revised accordingly.

The immediate context of the 2013-17 review is the protracted socio-political turmoil in parts of the region and the negative perception it has created for investment. In the larger context, despite a weak global economy and declining oil demand, the review assumes that OPEC will be able to keep the value of its basket of crudes near its members’ output-weighted average fiscal-breakeven price of about $100/bbl. Investment climate permitting this should encourage the development of oil-based projects. For natural gas, while domestic-oriented projects are likely to go ahead no matter what, export-oriented projects face significant market uncertainty. Not only have international gas prices greatly deviated from oil parity, but they have kept diverging between regional markets. Looking forward we assume that natural gas prices will evolve between $3-$5/MBtu in fully liberalized markets with abundant domestic supplies and $12-15/MBtu in markets relying on imports under traditional long-term contracts.

Against this background, this commentary is in three parts. Part One presents the review methodology. Part Two outlines the new trends that shape the outlook. Part Three extends the discussion to the major challenges facing investors ahead.‎‎

Our conclusions:

MENA total energy capital investment is expected to amount to $740bn for the five-year period 2013-17. Compared to past assessments, which have been consistently revised to fully reflect adjustments in the power sector, investment appears to be on the rise again. However, in a context clouded by sluggish global economic growth and protracted regional socio-political turmoil, capital requirements have mostly been driven by a catch-up effect and unrelenting escalating costs.

In this context, a little more than three quarters of energy capital investment are located in seven countries among the biggest holders of oil and gas reserves. Obviously, the geographical pattern has favored countries that have not faced the turmoil. On a sectoral level, adjustments in the rapidly expanding power sector have led to a more evenly distributed pattern between the three major value chains, i.e. oil, natural gas and power.

The review has also highlighted serious policy challenges. In addition to the deteriorating investment climate which forms the background of the review, three issues continue to confront investors: rising costs, scarcity of natural gas supply and funding limitations. Of the three, the latter is the most critical. Given the structure of capital investment stemming from the review, internal financing could only be secured if oil prices remain above OPEC’s fiscal break-even price, which we have estimated to be around $100/bbl. In contrast, external financing, which comes predominantly in the form of loans, is likely to be daunting in face of dwindling lending resources. Faced with more pressing social demands, MENA governments may not be able to bridge the funding gap. Going forward policy makers in the region should focus their commitment on improving the investment climate and restoring investors’ confidence. [Details]

Economic Commentary Volume 7 No 8/9 – August/September 2012 – ADDENDUM : Our Readers’ Contentions about “Fiscal Break Even Prices Revisited…”

Some of our readers have expressed contentions about “Fiscal Break-even Prices Revisited…” (our Economic Commentary dated August-September). Their arguments and our refutations have been published in the op-ed section of MEES dated 20 August as reproduced in this Addendum. People have a right to their opinion no matter how misguided. [Details]

Economic Commentary Volume 7 No 8/9 – August/September 2012 : Fiscal Break-even Prices Revisited: What More Could They Tell Us about OPEC Policy Intent?

Our Economic Commentary for August-September is released under the title “Fiscal Break-even Prices Revisited: What More Could They Tell Us about OPEC Policy Intent?”

Unarguably, oil producing countries’ fiscal positions are far from being a determinant of international prices. Yet energy economists – especially oil market analysts – are tempted to embrace the concept of a fiscal break-even price, realizing that it could provide a useful guide to price and production policies within the Organization of the Petroleum Exporting Countries (OPEC). In this context the concept is commonly defined as the oil price that balances government’s budget.

In light of significant budgetary changes in key OPEC member countries, in particular the expansion of spending programs in Saudi Arabia and the contraction of fiscal revenues in Iran, we have updated our previous findings. While focusing our efforts on improving the underlying modeling assumptions, as well as data collection and interpretation, we have kept to the methodological framework developed in the past. This consists of articulating short term and long term approaches to assess current fiscal positions and future fiscal sustainability.

In the first part of the analysis we have re-drafted the fiscal cost curve for OPEC member countries in an attempt to shed timely light on the likely individual and group policy behavior. On the one hand, it can be claimed that fiscal break-even prices are dependable predictors of price preferences within the group. On the other hand, member countries’ failure to develop a common policy may be attributed to their heterogeneous and, for some, uncertain fiscal positions. This is no matter how close to OPEC’s output-weighted average fiscal break-even price – currently in a range of $90-110 per barrel – the most influential member, Saudi Arabia, may be.

In the second part we have focused on an inter-temporal fiscal sustainability analysis, assuming OPEC – taken as a group – would be investing its surplus funds in financial assets. In doing so we have implicitly admitted that the bulk of budget spending are current expenditures that yield no long term returns. The consequence is that spending is implicitly kept low to enhance future financial returns. If we assume instead that government expenditures include a non-negligible investment component then spending upfront may be a better course of action. This is valid provided the returns from domestic social and physical investment are higher than those from financial investment abroad. Using oil and gas revenues today to diversify their economies and progressively shift their reliance away from hydrocarbons may enable OPEC member countries to secure a more viable and sustainable economic development. Whatever their resulting spending patterns might be, it would affect their fiscal break-even prices and hence their oil price preferences and production policy intents. The challenge that still remains is to translate these intents into a common and credible policy.[Details]