Forgotten Treasure: Unconventional Oil in the Middle East
By Marin Katusa, Casey’s Energy Report
January 15th, 2011
As the conventional and cheap oil and gas start to dry up in the Middle East… a bigger, even better opportunity seeks to replace it.
For many who aren’t familiar with the region, the Middle East comes across as an updated version of Lawrence’s Arabia, only with lots of oil. But this mosaic of cultures isn’t made up of only Arabs or Muslims, and most Middle East countries are neither awash with heavily armed, rather excitable citizenry… nor with black gold, which is what we’re interested in. Twenty-three countries comprise the Arab League, but only Saudi Arabia, Iraq, Kuwait, the United Arab Emirates (UAE), and Iran are major oil producers.
No matter; with the exception of Kurdistan in northern Iraq, none of the oil heavies are currently open to us investors anyway. We’re digging for other finds, with three basic criteria. We’re looking for countries in the Middle East that:
- Have potential for unconventional production, such as oil shales
- Have incentive to develop it, and
- Are either net importers of oil or soon will be.
Why? In short, conventional production is in decline, but demand for oil isn’t. That means the state-owned oil companies and large companies operating in the region either need to find new fields and basins or apply new technology to get more out of established ones. Or both, of course. Nowhere is this reality more critical than in the Middle East, the world’s most important oil region, where oil production is the lifeblood of governments.
Our analysis, gleaned from data and on-the-ground experience alike, points to investment opportunities in new, unconventional technology and resources. Exploration costs will likely be lower, as companies aren’t starting from scratch. And in what we see as early days in the national drives for energy security, it makes sense to look close around your own turf.
We believe that blue-sky potential lurks in companies operating in the Middle East with expertise in unconventional production, access to good source rock, and management that can marry the two.
The Proving Grounds
It’s still early in the game, which can mean both good (high returns) and bad (high uncertainty) for investors. We believe the potential upside of unconventional development in the Middle East is just too big to ignore, however. So what we’ve done, is track down and lay out the most likely go-to countries for those explorers with the right stuff.
The following chart will narrow further the countries that meet the three criteria we outlined above. That is, who’s “in the red” when it comes to oil?
We see here that six countries currently rely on imports for their crude oil: Egypt, Cyprus, Lebanon, Jordan, Israel, Turkey.
In addition, two countries appear on their way to becoming net importers of oil: Syria and Yemen.
Outlook: The oil and gas industry are an essential sector in Egypt's economy, and the country’s reserves convey its potential to become a significant producer. In 2009, Egypt produced 678,300 of barrels of oil per day, while consuming 683,000 barrels per day. Egypt has traditionally been a net producer, but production peaked in 1993 and has been in decline. Combine that with its increase in domestic consumption, and Egypt is now a net oil importer.
Consequently, the Egyptian government has reversed its previously much harsher fiscal regimes and now actively encourages the exploration of domestic oil, which has resulted in an industry dominated by foreign players.
Natural gas, on the other hand, has tripled in production in recent years due to some major discoveries. Thus Egypt is a net producer here, and more important in the broad picture, a source for European natural gas. European countries are usually eager to decrease their reliance on Gazprom, the state-controlled gas giant from Russia.
Egypt has a developed network of pipelines to export its natural gas to Southern European and eastern Mediterranean countries. It also sends liquefied natural gas (LNG) to Europe, Asia, and the Americas.
However, as natural gas represents over 80% of Egypt's source of electricity, the government has slowed plans for export expansion to ensure all domestic demands will be met before any further moves.
Outlook: Cyprus has no oil or gas production currently, and so must import all it needs. However, an oil deposit has been found recently in the seabed between Cyprus and Egypt. An oil licensing round took place in 2007, when 11 blocks were offered to potential investors.
This first round took place against a backdrop of opposition from the Turkish government. As a result of this territorial dispute, companies chose not to bid, and as of now, only Noble Corporation has a production-sharing agreement (PSA) with the Cyprian government.
In May 2010, Cyprus announced it was close to commencing a second oil licensing round for several offshore blocks. It’s again under Turkish protest. Turkey has even warned Lebanon and Egypt against working out a deal with Cyprus for oil exploration.
Outlook: Lebanon also has neither oil or gas production at this time. However, Cyprus has signed lineation agreements with Lebanon and Egypt to exploit large hydrocarbon reserves that cross borders offshore, as we mentioned above, and hope to begin exploration by 2012.
And according to Lebanon’s parliament speaker, Nabih Berri, gas reserves found off the coast of Israel are located in Lebanon's territorial waters as well. These fields, however, may run into developmental difficulties as Israel and Lebanon to this day still dispute their maritime borders, leaving large fields such as Leviathan and Tamar in a state of limbo.
Outlook: Large corporations have been eyeing the unconventional potential in Jordan for quite some time, but were put off due to both political as well as economic reasons. However, with advancements in oil shale technology and a gradual shift towards liberalization by the Jordanian government, which has long been envious of the hydrocarbon wealth of its neighbors, Jordan’s government has established plans to liberate the oil market in the next five years. If that happens, it will be a first for investors since 1958. Under the National Energy Strategy’s initial phase, four companies will be offered 25% of the kingdom's reserves. The remaining 75% will remain under the control of the state-owned Petroleum Refinery Company (JPRC) until full liberalization.
This development will pave the way to exploit Jordan’s oil shale resources. Oil shale deposits underlie more than 60% of the Kingdom of Jordan and have enormous potential. The World Energy Council estimates Jordan's oil shale reserves at approximately 40 to 60 billion tons, making it the second richest state after Canada in rock oil reserves.
Furthermore, the oil shale quality is very high compared with the oil shale in the United States. Jordan has recently signed a deal with Shell Oil to extract oil shale in the central part of the country. First commercial quantities are expected by 2020, with an estimated amount of 50,000 barrels of oil per day.
Modest natural gas reserves were discovered in 1987, and the Risha field near the Iraq border produces approximately 30 million cubic feet of gas per day. However, production is pretty flat and looks to stay that way. That means imports.
Outlook: Israel relies on importing resources to meet the majority of its energy needs. It boasts no major reserves, and thus oil production is minimal. However, as we said above, Israel has found substantial natural gas reserves located in Mediterranean deep water. This discovery has prompted increased exploration off Israel's coastline, not to mention increased territorial disputes.
The U.S. Geological Survey reports that Israel's offshore reserves could hold 122 trillion cubic feet of recoverable gas. That makes it one of the world's richest deposits.
As a result of this discovery, Lebanon has rushed through approval of a law that outlines the guidelines of surveying, exploring, and producing of gas. The legislation also calls for a sovereign wealth fund to manage the potential revenues.
Nevertheless, Lebanon is still three to four years behind the Israelis, as it still must secure investors, select bidders, and begin exploration work. Israel is already well on its way.
Outlook: Although Turkey has both oil and natural gas reserves, the country is a net importer for both resources. It may become energy independent as new oil and natural gas reserves have been discovered off the coast of the Black Sea, Eastern Thrace, the Gulf of Iskenderun, and in the regions near the borders of Syria and Iraq.
Due to its location, Turkey is vital in energy transportation between major oil-producing areas, in the Middle East and the Caspian Sea, and consumer markets in Europe. In 2009, the pipeline network in Turkey covered over 3,636 kilometers for crude oil and 10,630 kilometers for natural gas.
One of the pipelines, the Baku-Tbilisi-Ceyhan, is the second largest oil pipeline in the world. It’s responsible for delivering crude oil from the Caspian Sea to the port of Ceyhan on Turkey's coast. From Ceyhan, the crude oil is distributed to oil tankers, which will further transport it to the world's markets.
Another pipeline, Nabucco, is in the planning stages. It is expected to provide European markets with natural gas from the Caspian Sea basin.
Outlook: Compared with some of its neighbors, Syria's oil and gas production is fairly unassuming. On the other hand, Syria is the only significant producing country in the Eastern Mediterranean region. Oil production had declined, then flattened out for several years before new fields were discovered. They’re expected to bump up future production.
Syria's known oil reserves are located mainly near the Iraq border and along the Euphrates River, while some smaller fields are located in the central part of the country. Upstream production is controlled by the state-owned Syrian Petroleum Company (SPC). The main foreign consortium which is currently producing is Al-Furate Petroleum, a joint venture made up of SOC (50%), Shell Oil (32%), and a collection of other companies.
Contracts have been awarded to Shell, in 2008, and TOTAL, earlier this year, for exploration at greater depths in existing oil fields in the Euphrates and central areas. Offshore exploration came up dry in 2007, but recently there’s been renewed interest. The SPC has commenced plans to issue tenders for the offshore blocks in the future.
Syria is also strategically important as a transit hub and will provide a larger role with the ongoing plans for pipeline network expansions in the area.
As for gas, new fields are expected to ensure that Syria's domestic demands are met after several years of decline in production. About 35% of natural gas production is reinjected into oilfields for enhanced oil recovery techniques, with the remainder going mostly to generate electricity and for domestic use. By the end of 2010, Syria expects to double its natural gas production.
Outlook: Like Egypt, Yemen is a strategic hub for oil shipping. More than 3.7 million barrels of oil pass daily through shipping lanes off its coast. The alternative is a very costly trip around the southern tip of Africa, so governments and oil companies are anxious to avoid any disruptions.
Hydrocarbons currently account for approximately 25% of Yemen's GDP and over 70% of government revenues. Accordingly, the government is actively seeking to increase foreign capital in this sector.
Barring significant change, however, its harsh fiscal regime is strangling exploration. Yemen is currently a net producer of oil, but it won’t be for much longer at this rate. Production is currently limited to two major sedimentary basins, but another 10 basins are believed to hold oil reserves.
A number of companies are interested in the area of Yemen’s border with Saudi Arabia, though activity has been very limited due to a combination of limited infrastructure and continued security concerns. An initial licensing round in 2007 for offshore exploration also stirred interest, but the rise of Somali pirate activity in the Gulf of Aden has more or less put the kibosh on that. A fourth round of bidding was postponed in August 2009 because of the pirates and the exorbitant insurance rates that companies would need to pay to operate in the region.
Up until 2009, all natural gas produced was reinjected to provide enhanced oil recovery. Natural gas export only became viable when a milestone agreement was signed in 2005 with Korea Gas Corp. Yemen also signed an agreement Swiss GDF Suez Company and TOTAL. All three contracts run for 20 years.
Yemen's first liquefied natural gas (LNG) plant, located on the port of Balhaf on the Gulf of Aden, went online in October 2009. Yemen has the ability to export over 200 million cubic feet of LNG per year, and much of the future investment into Yemen is expected to be used in the natural gas infrastructure.
What It All Means
So the question is, what do we have and, more importantly, how can we make money?
When investing in the Middle East, there’s evaluating infrastructure, fiscal policies, and, perhaps most important of all, Middle East politics.
Much of the Middle East is well developed, particularly around urban centers. But many places where a company would be looking for unconventional oil are a ways off the beaten track, and that means additional infrastructure. A prominent example is Kurdistan, where billions of dollars’ worth of infrastructure upgrades are needed to turn the region into prolific oil-producing center. A junior company alone could not possibly have the connections to build such infrastructure. Countries such as Yemen and Oman have similar stumbling blocks to investment and development. The Catch-22 is that these places are precisely where the remaining “elephant deposits” could be hiding.
Behind the scenes in the Middle East is always politics, much of it nuanced and layered by generations of history and family ties.
It takes a management team that has been in the arena before and knows the intricacies of the particular area of interest. A good security detail may be a must in some places as well.
Lastly, the fiscal systems in the Middle East are relatively tough compared with the rest of the world, and in some countries, such as Saudi Arabia, there are very few, if any, opportunities for foreign companies to even come in and share the wealth.
Countries with the highest petroleum shortfalls tend to have the lowest government take. But that’s relative. Any company that operates in the area needs to remember the Middle East holds the dubious record of the highest number of “two-stars” (80-90% government take) and “one-stars” (90%+ government take) in the world, leaving contractors with very little with which to recuperate their costs and justify their investments. Southern Iraq and Kuwait can even reach 95%+.
Who’s Got It
Nevertheless, opportunities are definitely available for those looking for them. Some are conventional, but the big upside that we see in the Middle East is in its unconventional potential. Reconnaissance and seismic data for the region are readily available due to decades of exploration in the area, saving companies millions, if not billions of dollars that would have been needed to do the same work. There are also a good number of pipelines here that, where geography and geology meet, can convey a premium to any unconventional oil production. As several countries begin to look for the oil shale opportunities, the unconventional story has the potential to be the biggest boom in the energy market in decades.
[Month after month, Marin and his energy team analyze the global energy markets to find the best small-cap companies that provide vast upside potential. And with oil prices shooting up again, returns could easily match – or even surpass – the 400% and 818% gains subscribers made within the past year. Try Casey’s Energy Report now for 3 months with full money-back guarantee… details here.]
By Marin Katusa, Casey’s Energy Report
January 15th, 2011