Industry NewsDespite the long running - and often fraught - geopolitical issues surrounding the Middle East, it continues to be a key player in the global production of oil, with plans afoot to develop its gas reserves on a previously unseen scale. Dr Craig Lowrey, Head of Energy Markets at leading independent energy consultancy EIC, takes a look at the oil and gas situation in the Middle East and evaluates the impact this vast region has on prices, production and the global market.
Long seen as the key global region for producing oil, Middle Eastern countries are now turning their attention towards dramatically increasing their gas production in response to the ever-growing demand for the commodity %u2013 not to mention its rising price. It's a major shift in perspective for nations that have typically seen gas as a poor relation to oil. The gas associated with oil extraction is often treated as a waste by-product and flared off, whereby it's burnt off into the atmosphere.
According to the most recent data provided by the World Bank, the main oil-producing nations of the Middle East flared off gas volumes equivalent to around one-third of the UK's annual gas demand. As such, the organisation has been swift to propose alternative economic uses for gas that would otherwise be flared off - such as using it for power generation or processing it into products like propane or butane - in order to demonstrate its potential for generating revenues.
Probably the greatest focus for Middle Eastern gas production has been liquefied natural gas (LNG), with particular emphasis on the role played by Qatar. With a planned increase in production facilities, the country aims to overtake Indonesia as the world's leading LNG supplier by the end of the decade, with the largest proportion of its supplies going to the US market. Industry speculation estimates Qatar's LNG exports could increase to more than 100 billion cubic metres per year (bcm/yr) from less than a third of that level at present.
Furthermore, Qatar is expected to account for more than a quarter of global LNG supplies by 2012, with the market predicted to double in size in that time to reach just under 400 bcm/yr, increasing to around 700 bcm/yr by 2030. It's set to achieve this ambitious target through state-owned Qatar Petroleum's stake in the North Field which, although geologically linked to Iran's South Pars reservoir in the Persian Gulf, is separated by territorial waters. If viewed together, the two fields hold approximately ten per cent of total global gas reserves.
Despite the anticipated growth in Qatar's LNG production, neighbouring Iran has been relatively slow to increase its gas production - an outcome that has been attributed to several factors; the contractual structures surrounding state involvement in oil and gas investments in the country; the imposition of sanctions by America; and the fact that gas has historically been used for reinjection into oil fields in Iran to boost reserve recovery.
The country has particularly ambitious targets for LNG, with state-owned Iranian LNG targeting first deliveries in 2010. Despite StatoilHydro and Total hampering these plans by announcing their partial withdrawal from the Iranian oil and gas sector due to pressure from the US State Department, this has not stopped other European companies from investing in the country. Plans are afoot to tie Iran's gas reserves into the Nabucco pipeline project; set to supply gas to the European Union from the Caspian region from 2013.
With the main oil-producing nations in the region part of OPEC, there is also the question of how the interrelationships between the countries affect production and prices. One of the main factors which has affected investment in the region, over and above the geopolitical factors, is the requirement under law to have a strong state presence in any oil and gas development. In some countries this has been a positive step given the experience and knowledge of the companies involved. In others %u2013 notably Iran %u2013 it has hindered exploration and production. With potential investment returns becoming limited by the greater control and oil revenues sought by the state, future participation is far less attractive for overseas companies.
Given that Saudi Arabia has the largest known oil resource in the world, it's not surprising that it forms the core of production in the region, with aspirations to boost investment in production and refining over the coming years to maintain this position. As well as investing in new facilities, state-owned Saudi Aramco has also indicated that it intends to dust off some of its heavy crude oil facilities to bolster the production from its lighter crude fields, such as the Khursaniyah field, brought online earlier in 2008.
These moves will help Saudi Arabia to not only maintain its market position, but also to generate greater flexibility in its oil production capabilities. Given the nation's long-standing relationship with the US on the oil front, the country has been more responsive to the needs of its "traditional" customer base of Western economies than some of its neighbours.
Iran is also making progress in new developments, although its ambitions have been hampered by the geopolitical factors influencing the region. Although it plans to increase output sharply, this has been challenged by an aggressive decline in rates on existing assets, while the start-up of new fields has reportedly been delayed by national requirements on local company participation. This has not stopped the country from reportedly selling its entire output of heavy crude for 2008, reflecting an anticipated increase in refinery utilisation and hopefully maintaining oil supplies from the country.
One of the other major Middle Eastern (and OPEC) nations that deserve comment is Libya, where US oil companies have returned following the lifting of economic sanctions against the country in 2004. Since Anglo-Dutch major Shell committed the first significant post-sanction funding in 2004, investment has increased steadily with BP announcing plans in 2007 for an initial $900 million commitment to the Libyan oil and gas sector as part of plans to explore the country's offshore and onshore reserves.
The greatest uncertainty in terms of Middle Eastern oil production is in Iraq where, July 2008 saw licensing thrown open to foreign companies for the first time in 35 years. Although Iraq has proven oil reserves of 115 billion barrels - making it the third largest holder of reserves in the world behind Saudi Arabia and Iran - developing this potential has long been affected by the military and civil unrest in and around the country.
Whilst current oil production from Iraq stands at approximately 2.5 million barrels a day, it's hoped that this will increase to around 4 million barrels per day by 2013 through the development of six key oil fields, with an additional two gas fields also made available. With such a tempting investment on offer, it's no surprise that an estimated 35 companies have already expressed an interest, including the UK's BP and Shell and America's ExxonMobil and ChevronTexaco.
Turning to OPEC, the potential for disagreements between cartel members was highlighted earlier this year by the unrest following Saudi Arabia's decision to increase production, despite the lack of consensus on the move by its fellow members. As an organisation, the cartel is also facing the prospect of an economic recession within its "traditional" customer base of the OECD (Organisation for Economic Co-operation & Development) nations, while its newer customers in the Asia-Pacific region continue to see growing oil demand.
OPEC has been at the core of price setting in the global oil market for more than 30 years. However, the ability of the cartel to shape the direction of the sector has become ever doubtful in recent times, as a combination of speculative pressure and the absence of adequate spare capacity to deal with increasing demand have served to erode this ability. Diminish this capability, diminish its power.
While the price-setting ability and level of market control held by OPEC was probably at its highest during the remainder of the 1970s and the early 1980s, the global economy took more than a decade to adapt to the change in the oil sector's status quo. Indeed, it was not until the mid 1980s that non-OPEC production began to increase considerably. This, coupled with the erosion in OPEC's global market share and concerns over the sustainability of the cartel's pricing approach, led to the crash in the market in 1986.
With production from the cartel governed by quotas for each individual member, these are frequently breached by the smaller members that are particularly reliant on their oil revenues for the stability of their economies. Indeed, the use of production cartels in such a dynamic market as oil is something of a blunt instrument, particularly given the extent of speculative positions in the market. This, combined with any internal discontent within OPEC and a high proportion of non-OPEC output, effectively serves to dilute the cartel's ability to set prices.
However, these two factors have paled into insignificance compared with the greatest challenge facing the cartel's price setting ability, namely the absence of spare production and refining capacity in the face of ever increasing demand. As global oil demand increases - as has been the case since the start of the decade - the cartel's ability to influence price (specifically, attempts to keep prices down) has fallen as its spare capacity has dropped.
While the role of the Middle East in the oil and gas sector in the coming years will remain strong, longer term the ability of the region to maintain this role will be dependent upon the anticipated growth in supplies from Russia %u2013 notably for gas %u2013 and whether the potential for Arctic oil and gas production can be achieved.