Middle East Petroleum Sector Offering More Foreign Investment Opportunities

Feb. 14, 2000
During the past 20 years, the Middle East has probably received more attention globally for its regional politics and position in world affairs than for its enormous energy wealth.

During the past 20 years, the Middle East has probably received more attention globally for its regional politics and position in world affairs than for its enormous energy wealth. Indications that stability is returning to the region heralds good news at the turn of the century. History indicates that investors seeking opportunities frequently follow periods of turbulence or uncertainty. Could that also be the case across much of the Middle East?

Oman's LNG plant near Sur, with a total project cost of about $2.5 billion and now in its final stages of completion, is an example of proliferating energy sector investment opportunities cropping up in the Middle East. The project is backed by a group led by Royal Dutch/Shell.
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There are indications that international investors are becoming more-frequent visitors to the region. At the same time, there appears to be renewed interest across the Middle East in attracting foreign investment mainly in the energy and utility sectors, where substantial capital expenditures are required to meet the increasing demands of growing economies and rising population numbers. The population in the region is estimated at 200 million and is projected to grow by about 2.6% during the next 10-20 years.

It is estimated that capital expenditure of around $350 billion will be required during the next 10 years on major infrastructure projects for oil, gas, electricity, and water.

Financial pressures

Middle East countries may not be able to fund such amounts of capital expenditures from oil revenues unless oil prices averages $23/bbl or more during the next decade. Country budgets have been under pressure due to low oil prices for much of the 1990s, and the deficits are costly to fund and require to be repaid.

Financial pressures have been substantial. Oil prices at the end of the 1990s fluctuated at low levels not experienced in decades. Saudi Arabia denied reports in late 1998 that it had made approaches to the UAE for a $5 billion loan to help finance projected budget deficits. Other countries were reported to have experienced difficulties meeting budgets given the low oil price.

Many investment projects in the Middle East are longer-term and capital-intensive. Committing future funds for these projects is manageable, provided oil export earnings continue to flow at projected levels. Given the vast volumes of oil exported by Middle East countries, a movement of $1/bbl has a significant impact. For instance, in Saudi Arabia, a $1/bbl shift works out to a difference in oil revenues of about $2.7 billion for a year. At the start of 2000, oil prices were hovering above $25/bbl.

Many Middle East countries have committed substantial proportions of their oil revenues to providing subsidies and benefits to their nationals. The overall cost of this commitment has increased sharply in recent years as populations have expanded. Also, more people are reaching retirement age and drawing pensions from their former government employers.

The period of low oil prices spurred many governments in the Middle East to consider reducing subsidies to organizations that provide services to their nationals and to initiate plans to retain a larger element of the oil value chain within their direct control.

Sustained high levels in population growth are also causing problems for government budgets. Countries in the Middle East are seeking to encourage greater participation by the private sector. The governments see many potential benefits from encouraging growth in that sector. Many regional countries have started programs to privatize state-owned businesses (generally outside the oil sector) as a means of reducing subsidies and thus conserving cash resources. As part of these programs, governments in the region have begun privatizing, for example, telecommunications and electricity. Some countries have also cut budgets by reducing subsidies, cutting capital expenditures, and delaying or canceling projects.

In some Middle East countries, governments are moving towards permitting foreign investment in upstream oil projects under carefully structured financial arrangements. The governments are balancing the encouragement of foreign participation with retaining control over their oil assets. The involvement of foreign investment also leaves governments with resources for investment into other essential projects, enabling more-rapid development of the economy.

To fund the major capital programs required to further develop the region's hydrocarbon resources and meet the increasing power demand arising from population growth and industrialization, private and foreign capital will be needed. Indeed, in many countries within the region, such as UAE, Oman, and Qatar, this process has already commenced.

The following sections provide an outline to oil and gas and related (mainly power and water) investment opportunities arising in some of the larger economies within the Middle East as a consequence of these trends. This article focuses on Iran, Kuwait, Oman, Saudi Arabia, and UAE-key markets because of their large oil and gas reserves-and Egypt largely because of the size of its population.

Egypt

During the past decade, the Egyptian economy has made good progress in the wake of government reforms and an International Monetary Fund stabilization policy. Amid privatization plans for key government-owned and managed sectors, foreign investment has been actively encouraged and foreign business interests have grown considerably. The privatization program is expected to continue, and the telecommunications and energy sectors-in particular, utilities-will be part of this process in the near term.

Egypt has one of the largest populations in the Middle East, with about 60 million people. As with other countries in the region, it also enjoys a high birth rates and about 500,000 new job seekers enter the employment market annually. Egypt's government has developed a privatization program that is fundamental to its future economic strategy. The government recognizes the need to attract more foreign investment to provide job opportunities and lower the unemployment rate, which is estimated at 18% (although official figures are closer to 9%).

Egypt is a significant oil producer and is becoming an influential player in the gas market. In coming years, energy will continue to be a key element of the economy, as oil exports equate to around 40% of export revenues and major new gas fields in the Nile Delta will enable the country to be counted amongst the world's leading gas exporters.

Although state-owned Egyptian General Petroleum Co. (EGPC) controls most of the country's oil and gas assets, it does so through joint-venture arrangements and participation with private and foreign companies such as BP Amoco PLC, Repsol-YPF SA, and BG PLC. With production declining in its older fields, the involvement of foreign companies in oil and gas exploration activities has been and continues to be encouraged. In 1999, 15 concessions were offered for bidding. With economic activity in the country increasing, these new oil plays are important to help stave off the point when the country becomes a net importer of oil. New production is not limited to finds by major producers but also involves smaller independents such as Apache Corp., Seagull Energy Corp., and Tanganyika Oil Corp.

Part of the drive to conserve oil consumption during the 1990s was a major push to increase the country's gas reserves and production. Significant finds have been made in the Nile Delta and Western Desert, and in 1999 official estimates put Egypt's proven gas reserves at 40 tcf, compared with 20 tcf in 1997. Major companies in the gas sector include International Egyptian Oil Co. (an ENI Group company), BP-Amoco PLC, and Royal Dutch/Shell. The increase in gas reserves now provides an opportunity for investment in export-orientated projects, and in November 1999 Shell is reported to have submitted plans to export gas from its block offshore the Nile Delta, where it is committed to spending about $160 million.

The Egyptian electricity sector is also set to be a major area of investment by foreign companies. Electricity demand in the country is increasing at approximately 7-8%/year, and significant investment is needed to increase generating capacity. There are plans to privatize elements of this sector by selling shares to private investors, and several BOOT (build-own-operate-transfer) projects are being put in place to finance the expansion of the required generating capacity. A joint venture of Royal Dutch/Shell, Bechtel, and two local partners will develop the first BOOT project at an estimated cost of $450 million. The scheme is expected to be operational by 2001 and will be the largest private power plant in the Middle East. Electricite de France (EdF) has been awarded a second project with a total investment requirement of about $900 million.

The country also has plans to link its electricity network to neighboring counties such as Jordan, Syria, and Turkey. The link to Jordan has already been completed at a cost of $240 million.

Iran

During the past 20 years, the US, the world's largest economy, and Iran, the world's second-largest oil producer with roughly 9% of the world's oil reserves and 15% of its gas reserves, have had many political differences. Chief among them is a regime of sanctions the Clinton administration threatens to impose on non-US companies investing in Iran's oil and gas sectors. There is some recent evidence, however, that relations between the two countries could be thawing. This is important, as it comes at a time when Iran appears to be prepared to accept controlled foreign investment into its energy industry (see related article, p. 44).

With an aging energy infrastructure and a young, well-educated, and growing population, foreign investment is almost certainly required to assist necessary improvements and development of oil, gas, and electricity sector projects. Iran has a population of about 67 million, but has a low per-capita gross domestic product. It has enormous potential as a market for international goods. However, its industries and infrastructure require more investment after years of passive spending by the government.

Iran faced severe financial problems during the past decade, and such matters were only made worse as a result of the 1998-99 oil price drop. In this economic environment, with its large oil and gas reserves, the country holds huge potential investment opportunities for foreign oil and gas companies. In 1998, President Khatami called for steps to be taken to modernize the country's oil sector, and last year the government approved plans to restructure the industry. Significant progress has been made in the last 2 years to attract foreign investment to help develop the country's oil and gas assets, and negotiations have been held with several multinational companies concerning proposed buy-back contracts.

In November 1999, Shell announced an $800 million project to develop two offshore oil fields, Soroush and Nowrooz. Notwithstanding that the Shell deal is subject to scrutiny by the US, its announcement may well be the catalyst for further major deals with foreign oil companies. Non-US companies such as TotalFina SA, Elf Aquitaine, Petronas, and Gazprom have all been involved in significant deals with Iran in recent years, and others such as Lasmo PLC and OMV AG are starting to queue up to participate in other available oil and gas plays .

Iran not only needs investment to develop and rejuvenate its older fields but is also eager to press exploration initiatives. In September 1999, Iran announced the discovery of its largest oil find in 30 years, Nir Kabir, in Southwest Khuzestan province close to the border with Iraq. Such discoveries will require significant investment in the coming years, and it is likely that foreign funds will be needed.

Foreign investment in Iran is not limited to the upstream oil and gas sectors. Iran's National Petrochemical Co. (NPC) has embarked on a major, five-phase expansion program to develop the country's petrochemical sector and is actively seeking foreign partners to participate in this process. Current estimates indicate that about $7.2 billion will be needed to finance the development of the third phase, which is likely to commence this year. Phases One and Two involved 10 projects and $3.5 billion of investment. This scheme involves the creation of two economic zones in Bandar Imam and Assaluyeh, the latter of which will process gas from the South Pars gas field. Foreign companies already involved in the first and second phases include Krupp AG, Uhde AG, and Bayer AG. The Bandar Imam zone will include plants to produce products such as paraxylene, methyl tertiary butyl ether, and polyethylene terephthalate/purified terephthalic acid (PTA 1).

Kuwait

Kuwait has experienced a difficult end of the decade, but it is well-placed to recover, holding roughly 9% of the world's total oil reserves. The country has a population of around 2 million people and is one of only a few oil-producing countries that has significant excess oil production capacity.

Its government has for years applied some of its surplus oil revenues to subsidizing services for its citizens. However, world pressure on oil prices and a stated government desire to privatize state-owned businesses to reduce the government's spending on subsidies indicates a willingness to consider foreign investment or participation in previously highly controlled and financed national businesses.

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In 1999, Kuwait made a major policy change regarding involvement of foreign oil companies in upstream operations. Kuwait plans to increase oil production capacity to more than 3 million b/d by 2005 from its current production capacity of 2.4 million b/d. In pursuit of this objective, Kuwait has asked foreign oil companies to submit their ideas for boosting oil output in Kuwait's northern fields. The assistance of foreign oil companies may take the form of "operating service contracts" under which they will be remunerated by way of a per-barrel fee, along with recovery of capital investment and incentives for increasing reserves. Tenders have been called for, and in November 1999, meetings were held with qualifying foreign oil companies to discuss the opening of the upstream sector.

Regarding downstream operations, Kuwait is studying the possibility of setting up additional refinery capacity but no firm decision has been taken as yet. The country's investment focus also includes expanding its overseas operations in Europe and Asia.

The Ministry of Electricity & Water does not currently appear to be receptive to the idea of privatization. As a consequence, international investment in the utilities sector is likely to be limited to the building of new power stations and engineering consulting.

Oman

Revenues from oil account for 40% of Oman's GDP and 75% of government revenues. However, compared with other petroleum-dependent countries in the Middle East, Oman has limited oil reserves. In fact, at current production levels, Oman is expected to exhaust its oil reserves by 2020. To offset the decline in oil reserves, the country has embarked on a plan to diversify its sources of revenue and has become more receptive to foreign direct investment and assistance compared with other countries in the Middle East. The country's oil resources are controlled by Petroleum Development Oman Ltd., which is 60% held by the government and 40% by foreign oil companies, including Shell and TotalFina.

The government plans to increase current oil production capacity from 900,000 b/d to 1 million b/d by 2004. To achieve this goal, the assistance and investment of foreign oil firms is being actively sought in exploring for and developing new fields and also to improve recovery in existing fields. Several bidding rounds have been undertaken, and concession agreements have in recent years been signed with a number of foreign oil companies.

Oman is actively pursuing an economic growth strategy of exporting gas and development of industries that use gas as a feedstock. Much of the investment and development efforts by the government are focused on achievement of this strategy with participation from the private sector. Official projections call for gas projects to contribute about 15% of GDP by 2002. Action has already been initiated in this area, and the Oman LNG plant located near Sur, with a total project cost of about $2.5 billion, is now in its final stages of completion.

Based on current estimates of demand for power arising from growth in the country's population and from industrialization plans, it is anticipated that as a minimum 1,000 Mw of additional power generating capacity is required in the power sector in the coming years. This will bring significant investment opportunities for the private sector. Together with neighboring UAE, there is a growing trend in the country towards privatizing the power sector. The Persian Gulf's first independent power project on a build-own-operate basis was executed at Mannah, and tenders are expected to be called for two more independent power projects at Barka and Sharqiya by the Ministry of Electricity & Water. The government of Oman is also looking into early privatization of transmission services with the objective of achieving savings in capital expenditures.

Qatar

Qatar is a small country with a population of about 750,000. It has the third largest natural gas reserves in the world and is beginning to emerge as a major exporter of LNG.

It is also a member of the Organization of Petroleum Exporting Countries and exports about 600,000 b/d of oil. By investing in petrochemical plants, the government expects to earn more per barrel of oil equivalent produced by exporting value-added products. Such investment should also help create jobs in the private sector and reduce dependence upon government agencies for employment.

During the 1990s, Qatar was at the forefront of attracting foreign investments and funding into the region. The country has been successful in raising over $10 billion in international syndications and has partnered with multinationals such as ExxonMobil Corp., Total Fina, ARCO, Occidental Petroleum Corp., and Phillips Petroleum Co.

Notwithstanding existing foreign investment in Qatar, much of which has focused on developing North Dome gas reserves, further upcoming initiatives will help attract more foreign investment. The Doha Securities Market is to be opened to Gulf Cooperation Council citizens, and other foreigners will be allowed to trade shares of new companies through investment funds.

The general environment in the country is receptive to foreign investment, and indications are that this will continue to be so under the guidance of the current Emir. The scope of future foreign investment is likely to be on a scale smaller than the recently completed Rasgas and Qatargas grassroots LNG projects; however, new trains are likely to be added to these two projects, and plans for the NGL-4 project are well-advanced. The larger upcoming development projects will probably focus on petrochemical initiatives such as Q-Chem, Qatar Vinyl Co., expansion of Qafco-4, and a toluene di-isocyanate project.

One of the major proposed projects that is creating a great deal of interest among investors and finance providers is the Dolphin gas project backed by the UAE Offsets Group, which involves the offtake of 3 bcfd from North Dome. The project, which may involve Mobil in its upstream element, involves laying an 800-km pipeline to UAE and Oman. Initial project cost estimates are $8-10 billion. Other North Dome gas export projects include a plan by the GUSA consortium to supply gas by pipeline to Pakistan.

During the next decade, Qatar General Petroleum Corp. also plans to invest significant amounts in its existing oil fields to enhance the country's oil production capacity.

As Qatar's industrial base expands and its population grows, the addition of new electricity capacity will be a major challenge. There are likely to be opportunities for foreign companies to participate in an IWPP (independent water and power project) later this year.

Saudi Arabia

Saudi Arabia holds one quarter of the world's proven oil reserves and has the world's fifth largest gas reserves. Through the exploitation and marketing of its oil, the country has established strong ties with the US and other western economies. In 1998, Saudi Arabia supplied almost 16% of US crude oil imports.

The country's oil and gas sector dominates its economy. However, there are increasing signs that the government is seeking to diversify its income streams and is prepared to embrace privatization. There are steps being taken to liberalize the economy and reduce the reliance on government funding. In the past year, there have been major changes in the public mindset of many influential persons within the country. Such changes are seen in the proposed privatizations of Saudi Telecommunications Corp. (STC) and the country's electricity system. These developments bring with them major opportunities for foreign businesses that are prepared to face the challenges of operating within the country.

The recent increase in oil prices notwithstanding, "volatility" is a key issue and one that has hampered many capital expenditure programs. Petroleum revenues are critical to the development of the country, and optimum utilization of the country's oil and gas resources are fundamental to the well-being of the economy.

Because of the need for continued large-scale capital investment and the requirement to use current technology, the government is beginning to consider new avenues in terms of developing its hydrocarbon assets. For example, in September 1998, Crown Prince Abdullah invited proposals for investment in the energy sector from foreign oil companies. This resulted in the oil majors submitting proposals for consideration to the Crown Prince. A ministerial committee on petroleum has studied the various proposals and submitted its report to the Crown Prince in October 1999. In January 2000, an 11-member Council for Petroleum & Minerals Affairs was established to determine all matters of investment in upstream and downstream oil projects. The council is also mandated to approve the form and areas in which investment from the private sector and foreign direct investment will be sought.

The formation of the new council notwithstanding, foreign direct investment in the upstream oil sector has been ruled out by industry experts and some Saudi officials because currently Saudi Arabia has unused production capacity of almost 3 million b/d. Industry sources have indicated that Saudi Arabia is mainly looking for foreign direct investment in downstream gas and refinery projects that would help Saudi Arabia in developing and producing additional gas volumes.

Significant investment opportunities are foreseen in the power sector. The power sector's capital investment needs are estimated at $117 billion by 2020. Currently, there are no independent power projects operating on a build-to-own basis due to low tariffs and absence of regulatory framework. However, the situation is likely to undergo significant change in the next few years due to the establishment of Saudi Electricity Co. (SEC) in December 1999, which is to be run along commercial lines. The tariff structure for power has been revised effective January 2000, and the new tariffs are considered to be commercially viable and attractive to establishment of independent power projects, provided a proper regulatory framework is also established.

As an initial measure of the likely success of the initiatives in the power sector, the progress of the STC privatization will be key, because it is will set the tone for future developments.

UAE

The UAE is a key player in world energy markets and within OPEC. It has a small population of about 2.6 million but enjoys an important position in the Persian Gulf, holding roughly 10% of the world's oil reserves. The UAE has reserves sufficient for more than 150 years at current output levels of about 2.5 million b/d. It is also one of the top five holders of natural gas reserves after Russia, Iran, Qatar, and Saudi Arabia, with reserves of about 205 tcf.

The UAE is now one of the most diversified economies of all the major oil producers in the Middle East region. Nevertheless, with oil and derivative products accounting for about 78% of the UAE's total exports, the oil price crash in 1998-99 put considerable pressure on the economy.

During the 1970s and 1980s, the focus on investment was primarily oil-related. In recent years, however, OPEC oil production quotas and increased domestic consumption of electricity have provided incentives for the UAE to develop its gas reserves more aggressively. As part of this development process, the UAE has embarked on major projects costing up to $10 billion to upgrade its onshore and offshore gas extraction and distribution systems, and to transfer the Taweelah commercial district into a gas-based industrial zone. Unlike countries such as Saudi Arabia and Kuwait, the UAE, while maintaining control over its natural resources, has engaged in a number of joint ventures in developing its fields, such as with Conoco Inc., BP Amoco, Total Fina, and ExxonMobil.

Dolphin, one of the largest energy-related programs undertaken anywhere in the world, was launched in March 1999. In addition to the offtake of gas from Qatar's North field and construction of a new gas pipeline linking Qatar with the UAE and Oman, the project also envisages the construction of gas and liquid processing facilities with other downstream activities relating to the development of new and existing industrial clusters in the UAE, Qatar, and elsewhere in the region.

To add value, the emirates of Abu Dhabi and Dubai have separately sponsored projects to increase their downstream capacities. Downstream developments include Borogue, a joint venture of Borealis and Abu Dhabi National Oil Co. (ADNOC), which let a contract valued at more than $600 million to a joint alliance of Germany's Linde AG and Bechtel for construction of an ethylene plant at the Ruwais petrochemical complex. Other new downstream projects include Emirates National Oil Co.'s $300 million condensate refinery at Jebel A* and the independently owned naphtha processing plant being constructed by ISO Octane.

During 1998-99, a restructuring of various elements of ADNOC's activities saw the creation of two new companies, the formation agreements of which provide for the possible participation of private sector investors at a future date.

As a consequence of efforts to increase environmental awareness in the country, investment opportunities are also arising for businesses such as the US-Oman joint venture, Onsite Arabia, which is setting up two hydrocarbon recovery facilities in the UAE.

In the wake of the country's economic growth, the demand for electricity and water is increasing by 10-15%/year. In Abu Dhabi during the last 2 years, the privatization committee of the water and electricity sectors has taken a radical approach to the development of the utility sector, which is leading to large-scale injections of private capital.

The Abu Dhabi government has sent out a clear message that it is prepared to let the private sector participate in large-scale capital projects. Government spending can then be targeted to other areas.

These initiatives include the Abu Dhabi Executive Council passing a decree creating Emirates Power Co. (EPC), a public shareholding company with a capital base of US$116 million. The Abu Dhabi Electricity & Water Authority (ADEWA) has also recommended the establishment of a private shareholding company to develop and construct a $595 million power plant at Taweelah (A2). EPC will subscribe 60% of the capital, and CMS Generation Taweelah LTD., a subsidiary of the CMS Energy Corp., Dearborn, Mich., will pay for the remaining 40%. The CMS IPP has been very successful and is likely to act as a model for future IPPs within the region.

ADEWA is expected to set up its second and third IWPPs, at Taweelah A1 and Shuweihat 1 power and desalination plants respectively, in the coming year. As yet, Dubai has not opened the door to private sector involvement in the utility sector, preferring to implement commercially.

The Authors

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Michael J Stevenson is a partner in PricewaterhouseCoopers. He has responsibility for the firm's energy practice in the Middle East.

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Paul Suddaby is a director in PricewaterhouseCoopers. He a member of the firm's oil and gas team based in Dubai.