Manouchehr Takin
Centre for Global Energy Studies
London
About this report...
Opportunities for international companies, like oil production, fall short of potential in the Middle East. They exist, nevertheless. Articles in this special report show how prospects in the region differ from those available elsewhere in the world and describe challenges OPEC's Middle East members face in financing new production capacity.
Expectations about the Middle East can be summarized as follows:
- The region could and should produce much greater quantities of oil and gas than it does now.
- The countries in the region should be open to foreign oil companies for upstream activities.
The Middle East's known oil and gas reserves are huge (Figs. 1 [16911 bytes], 2 [17748 bytes]), and the region also ranks very high among the world's sedimentary basins for its undiscovered hydrocarbon resources. However, the resources are relatively underutilized: Production from the region is not as high as could be expected from its high reserves. It is also generally believed that the Middle East will have to satisfy the world's growing demand for oil.
The need for foreign participation and greater freedom in upstream operations is taken as a natural consequence of the above reserves/production status and of the world's growing oil requirements. It is argued that foreign participants could provide capital and expertise for overcoming this underutilization. The general perception in the international oil industry is that the Middle East is closed to foreign investment.
Validity of the above expectations depends greatly on the world's medium and long term oil supply/demand outlook and the future role of the Middle East. The relationship of reserves with production will affect the types of required upstream activities. Discussion of these factors provides a framework for evaluating foreign participation in the region, expectations for the Middle East's upstream sector, and the opportunities, constraints, and challenges facing the international oil industry.
Supply/demand outlook
An historical record of world oil consumption, its growth rate, and the price of oil is shown in Fig. 3 [23271 bytes]. The correlation between price and consumption is clear. Even without use of complicated econometric models, the record suggests a continuation of growth in oil demand. In particular, this is supported by the view that the price of oil will remain generally weak in coming years.
Expectations for continued demand growth are further supported if we exclude the distortion caused by the break-up of the Soviet Union. The upper consumption graph in Fig. 3 [23271 bytes] suggests that demand growth has been arrested in the last 5 years, while the lower graph shows that growth in consumption has continued unhindered since 1984.
Estimates vary for the future increase in demand, but a generally accepted view is that each year, world oil consumption will increase by about 1.5 million b/d. Asia-Australasia will show strong growth (Fig. 4 [24893 bytes]) and will constitute a main market for Middle East oil in the future.
An historical record of world oil production (Fig. 5 [20852 bytes]) compares the past performance of the Middle East and the rest of the world. Again, the growing trend is clearer if we exclude the distortion caused by the break-up of the Soviet Union.
For future growth in production, two scenarios might be considered. According to one scenario, future production in regions outside the Middle East cannot meet growing world oil demand. The resource base and rate of extraction in the regions suggest such a view. Consequently, the Middle East has to provide the incremental supply. Estimates vary, but it is possible that by the year 2010 the region might have to produce up to 20 million b/d more than it produces at present.
According to another scenario, the increasing future production in regions outside the Middle East could meet most of the growth in world oil demand. Improved technology and increased efficiency of exploration and production operations suggest greater recovery from existing resources and increased future discoveries. Consequently, the required additional production from the Middle East would be only marginal.
However, the second scenario is less probable. Demand for oil from the Middle East will increase in the coming years, though possibly not to the extent foreseen in the above estimate for the first scenario. In any case, the Middle East will remain strategically important due to the significant volume of its exports (Figs. 6 [20334 bytes], 7 [21507 bytes]).
Even with no increase in production, the region will have to maintain capacity for production of at least 22 million b/d and exports of 16 million b/d in the coming decades. Most probably the required volumes will be much greater since Middle Eastern countries have to meet growing domestic consumption as well as growing world oil demand. Maintaining these production and export volumes is a serious undertaking. Those familiar with oil industry operations are well aware of the scale of field operations and investment requirements.
Reserves and production
About two thirds of the world's crude oil reserves are located in the Middle East. However, what is not always realized is the much lower contribution of the region to the world's crude oil production (Fig. 1 [16911 bytes]).
The region is also prominent in gas resources, holding about a third of the world's reserves. Similar to oil, gas production is relatively small when compared to its reserves. In the case of gas, the relative production is even less than that of oil (Fig. 2 [17748 bytes]). The Middle East accounts for 31% of total world oil production and 65% of world reserves and only 6% of world gas production and 32% of reserves.
The disparity between reserves and production could be partly due to Organization of Petroleum Exporting Countries policies of observing a production ceiling in defense of the price of oil. However, a major difference exists between the five main OPEC producer countries with large reserves (Iran, Iraq, Kuwait, Saudi Arabia, and the U.A.E.) and the other producers holding smaller reserves (Fig. 8 [19860 bytes]). While the "Middle East Five" have relatively small production with large reserves (26% of world production with 63% of world reserves), the rest of the Middle East has relatively large production with small reserves (4% of world production with only 2% of reserves).
Examining the percentages for the individual countries is even more instructive (Fig. 9 [18038 bytes]). Note that Qatar, which is a member of OPEC, is producing at a high rate relative to its reserves. The reserves/production relationships for the Neutral Zone (the area shared between Kuwait and Saudi Arabia) and for Dubai are similar.
It appears that it is not necessarily membership of OPEC which leads to a relatively lower production in comparison with reserves. The size of reserves in a country, or even in a sector of a country, also influences the relation between production and reserves. The large-reserve countries generally have a relatively low rate of production, while the small-reserve countries have a relatively high rate of production. Almost a similar relationship exists for gas (Fig. 10 [18190 bytes]).
Investment needs
In small-reserve countries, exploration is carried out more aggressively, and development of the discovered fields (usually small) requires comparatively less investment. The provision of this capital is easier, and the fields are soon developed, making a relatively greater contribution to production.
In the large-reserve countries there is less incentive for exploration since large reserves are already available. But more importantly, development work in giant and supergiant fields requires heavy investment. The difficulties in providing large amounts of capital could be one reason why field development work is not carried out as extensively and production is not as large as might be expected from the size of reserves.
This is true for both undeveloped and producing oil fields, as well as gas fields. Some fields may have been discovered many years ago but have remained undeveloped due to their less favorable reservoir characteristics, which necessitate more-specialized production methods and improved recovery techniques. They may also have remained undeveloped because of their geographic locations requiring new infrastructure and transportation facilities. These features increase development costs. The required capital may not be easily available, which delays development of the old discoveries. Their reserves do not contribute to the region's production.
The producing fields still hold very large quantities of reserves, although they may have been producing for a number of decades. Many have passed their peak production rates and could be experiencing production problems. In some, water or gas injection has already been implemented, and gas lift, downhole pumps, and other facilities have been in use for many years.
More-sophisticated methods have to be applied selectively to the reservoirs. These are significant operations requiring heavy investments, especially for giant fields. They exacerbate the problem of heavy front-end capital requirements, and the development work is delayed. These countries might also have smaller fields which require less capital and, therefore, are brought on stream. Thus, the fields which have been in production are kept producing at a relatively low rate, although they still hold considerable remaining reserves.
Giants, supergiants
The disparity between reserves and production is also partly due to the characteristics of giant and supergiant fields.
Operating experience in these countries shows that the depletion rate of supergiant oil fields is generally lower than that of smaller fields. Their large size makes it difficult to achieve a high depletion rate in all parts of the field. A high rate in one part of the field will result in bypassing and loss of oil in other parts of the field. With a lower depletion rate, these fields make a relatively smaller contribution to production in comparison with their reserves.
For example, in the Ghawar field in Saudi Arabia, it is not practical to develop all parts of the field simultaneously. Consequently, high production should not be continued from the northern parts. The production rate in this part should be reduced until parts of the field to the south are also developed and brought on stream. The same limitation applies to production from the eastern flank of Ghawar in comparison with the western flank.
Another example is the Thamama reservoir in Abu Dhabi, where selective water injection and drilling are required for the different layers. The Asmari reservoir in Iran is another example; it has fractures from which oil has been produced. Yet there are large matrix blocks with low permeability holding considerable quantities of oil. If production from the fractures is continued at high rates, reservoir pressure drops, the blocks become surrounded with gas, and the oil is not produced.
The above explains why the actual rate of production from these fields is proportionately smaller in comparison with the size of their reserves. The Middle East nevertheless could produce at much higher rates provided the investments are committed, a large number of experts are engaged, and development operations are carried out. In fact in areas allocated to the private sector, the companies produce at higher rates in order to achieve good returns on their investments. These points are discussed in greater detail in various Center for Global Energy Studies (CGES) studies.
Gas field development requires heavier front-end investment than is necessary for oil fields. It also depends on securing long-term sales contracts, mostly with international customers. The long-term commitment of capital and purchase agreements are not easily secured. Thus, many gas fields in the Middle East remain undeveloped.
Upstream opportunities
With a few exceptions, the Middle East is considered closed to foreign participation. In fact, the region provides many opportunities for the international oil industry, although not necessarily in the pattern of traditional new ventures commencing with exploration and wildcat drilling.
Exploration will still be required, though to a lesser extent. However, as suggested above, there will be numerous opportunities for field development projects. Development of nonproducing fields and production improvement in currently producing fields constitute a major part of the upstream activities in the Middle East.
It is for this reason that the CGES has carried out detailed studies on the production potential in the United Arab Emirates, Saudi Arabia, and Iran.1 A study of Iraq is in progress. These studies are field-by-field analyses of the past performance, reservoir characteristics, production potential, and required development activities for each oil and gas field, as well as the investment requirements and public policies affecting the oil and gas sector.
Furthermore, with growing concerns about the value of natural gas, the flaring of associated gas is being reduced. Gas gathering, treatment, and processing have become important and will continue to be so.
The development of gas fields is also expanding. Gas is used in power generation, desalination and other industries, in the commercial and residential sectors, and also for exports through pipelines and LNG. Gas field development and gas treatment are now a major constituent of upstream activities in the Middle East and will become greater in the future.
Therefore, many new ventures in the coming years will involve old fields. They include fields which have been producing for long periods and are experiencing production difficulties. They also include old oil and gas discoveries which have remained undeveloped. As noted above, they need teams of experts AND high expenditure.
The terms of reference for these new ventures are better defined and carry less risk than wildcat drilling in a purely exploration venture. The contractual terms between the government and the foreign participant will differ, and with lower risks the remuneration will also be less. Nevertheless, they provide attractive returns on investment, and the foreign participant will gain access to oil supplies.
Capital crucial
The above summary identified the needs in the Middle East upstream market-their technical characteristics and their heavy front-end investment requirements. If funds are available, the countries could conduct parts or even most of the required operations through service companies and specialized consultants on a commercial basis.
The provision of capital is, therefore, a major contribution by the foreign participant. However, the competitive advantage of the foreign participant also includes the provision of technology, experience in project implementation, and management.
The international oil industry should recognize the less-traditional nature of the "new ventures" in the Middle East upstream sector, accept the challenge, and participate actively in these projects. Profits will be made in a healthy business environment.
A trend with potential for expansion involves the role of contractors and service companies. They carry out most development operations as subcontractors to the oil company or the operating consortium in charge of upstream projects. However, large contractors and service companies could take over the projects directly if they could meet the investment requirements.
This could be provided jointly with other companies or through financial institutions. In this way a "new player" would become active in the region's upstream sector. It remains to be seen to what extent this new player acts in competition with oil companies or joins them as a member of the consortia which are usually formed for implementing major development projects.
Company participation
Most countries in the Middle East have been open to foreign company participation for a number of years. Some have recently opened their doors and others could do so in the near future.
Middle East government authorities have repeatedly announced that the era of confrontation between governments and companies is long passed. The two are now recognized as complementary. Their co-operation is necessary and profitable to both. The relationships are purely commercial and business-oriented, free from political rhetoric. Therefore, it is not a valid statement that the Middle Eastern countries have been closed to foreign company participation.
The countries with present foreign company activity include Qatar, Oman, Yemen, Syria, Jordan, the U.A.E., the Neutral Zone, and recently Iran. Some of these are among the large-reserve group. Recent economic and financial developments have made the Middle Eastern countries even more open to foreign participation. Their present status is by no means comparable to the cash-rich nations of the 1970s and the early 1980s. The fall in the price of oil and also the wars in the region (the Iran-Iraq War of 1980-88 and the Persian Gulf War of 1990-91) have eroded their once huge foreign reserves. Many of them have incurred foreign debts and for successive years have had budget deficits.
Unit production costs are still very low in the Middle East. Upstream operations will definitely be very profitable for the government-i.e., the national oil company. The major constraint faced by national oil companies are cash flow and the ability to provide high front-end capital.
Following are descriptions of opportunities in the key Middle Eastern countries:
- Saudi Arabia. It does not appear that Saudi Arabia will open its upstream sector in the near future. Although foreign participants have been active in the Neutral Zone for many decades, this is unlikely for the mainland.
Saudi Arabia has more than 2 million b/d excess production capacity. Some field development has been shelved or delayed. The stated policy is that Saudi Arabia does not wish to expand capacity beyond the present 10 million b/d for several more years.
Furthermore, Saudi Arabia still benefits from the technical expertise of the former Aramco partners. Financial constraints do not seem to be a cause for concern. Aramco has borrowed in the international market in the past, and in spite of the government's financial difficulties, sufficient funds are apparently available for Saudi Aramco's investment requirements.
- Kuwait. In Kuwait, technical service agreements have existed with BP, Chevron, and Shell, as well as specialized service companies for field studies, reservoir modeling, offshore exploration and development reviews, and management. However, protracted internal discussions have considered greater participation by foreign companies.
Some factions within the Kuwaiti oil industry and the government are in favor, while the Supreme Petroleum Council and some factions in the parliament have not been convinced of the benefits of granting licenses to foreign companies. The subject is not yet closed and may emerge again after the elections in autumn. Production sharing, service contract, deferred payment, or some modification of these could be considered, and a formula acceptable to parliament and the industry could be developed.
The initial plans were for exploration and field development licenses near the borders with Iraq and Saudi Arabia, the security provided by presence of foreign companies apparently being seen as an advantage. Apparently, response of international companies was not favorable. Licenses are now being considered for exploration in some onshore areas, as well as improved recovery and enhanced recovery in producing fields. Originally, offshore areas were to be given higher priority, but recently it is reported that onshore will have preference.
- Iran. Iran annulled all foreign company agreements following the Islamic Revolution of 1979. The country's oil industry was severely damaged during the 8 year Iran-Iraq war. Systematic reconstruction was started after the ceasefire in 1988.
In the last few years the country has been negotiating with foreign oil companies and in March 1995, an agreement was reached with Conoco for developing two fields in the Persian Gulf.
However, the deal was cancelled following a U.S. presidential executive order. The development project was later granted to Total.
Several other major upstream projects have since been offered by Iran. The opportunities are for development rather than exploration and mostly in the offshore, although some onshore gas treatment and processing projects are on offer. Reportedly, negotiations were in progress with a number of interested companies in February 1996.
- Iraq. Iraq has offered very attractive opportunities, pending the lifting of United Nations sanctions. Reconstruction of facilities damaged during the war and revitalization of previously producing fields constitute major development projects.
At this stage it is envisaged that the government will undertake these projects. However, financing difficulties might open opportunities for participation from outside. In any case, service companies and contractors will be involved on a grand scale.
The development program of the older discovered but so far undeveloped fields includes some giants and supergiants. Preliminary agreements have been reached with foreign companies, but other opportunities exist. More importantly, exploration licenses are to be granted in the Western Desert.
Politics
The general view is that the Middle East is politically unstable. The international oil and gas industry certainly remembers political events that have affected it in the region: war, revolution, nationalization, and unexpected statutory changes.
Yet the industry faces challenges no less daunting and perhaps more immediate in, for example, the former Soviet Union (FSU). There, oil companies have encountered regulatory changes, revocation of export licenses, difficulties with bureaucratic systems, the many and often conflicting centers of power, and prospects for interrepublic or intrarepublic conflicts or wars.
Demonstrated political risks have not discouraged oil companies from showing great interest in upstream ventures in the FSU. By comparison, political risk in the Middle East can be argued to be substantially less. Thus, "Persian Gulf hot" could offer better potential prospects than "Siberian cold."
An important political impediment to foreign investment in the region is imposition of sanctions against countries such as Iran, Iraq, and Libya.
Here, there is irony. Since the 1973 Arab oil embargo, the mixing of politics and oil business has been globally condemned, particularly by leaders of the industrialized countries. In fact, OPEC has often been wrongly accused of that embargo.
The issue of politics and oil, coupled with the need for foreign investment, has been intensely debated in the Middle East, especially in Iran after the Islamic Revolution in 1979.
In March 1995, Iranian authorities managed to adopt a policy that separated politics from oil, reaching the agreement with Conoco. But the U.S. forced cancellation of the agreement and extended the ban not just to American companies but, by pressure, to non-U.S. companies (such as Total and BHP) operating in Iran or planning to become active in the country's oil and gas sector. Other countries have resisted the unilateral action.
The cases of Libya and Iraq are better known. They are all reminders that the analyses of political risks cannot be confined to the countries in which the oil industry is to become active. International political developments, particularly those of the U.S., should also be considered. These developments illustrate that for the evaluation of political risk in the Middle East it is now mandatory to include a prognosis of the developments in the corridors of power in Washington, D.C., the domestic politics of the U.S., and U.S. cycles of presidential election.
The expectations
In response to the question whether expectations about the Middle East are reasonable, then, we can summarize the
answers by confirming that:
- The Middle East could and should produce more oil and gas, meeting the world's growing demand.
- Upstream opportunities partly differ from more-traditional new ventures. Field development, production
enhancement, and recovery improvement are more in demand than exploration and wildcat drilling. Nevertheless, "new
ventures" do exist in abundance.
- High technology and finance can be identified as the market needs in the Middle East's upstream sector. They are
also the competitive advantage of the international oil industry.
- If a financing package could be arranged, contractors and service companies could take up the challenge without
oil companies. They will be the new players in the Middle East.
- Finally, attractive profit opportunities exist in the Middle East for all those who accept the challenge.
Acknowledgment
The author thanks E.O. Price for his valuable comments, in particular on Saudi Arabia. The views expressed in this
presentation are the responsibility of the author and do not necessarily reflect the official position of the Centre
for Global Energy Studies.
Reference
1. Centre for Global Energy Studies, "Oil Production Capacity in the Gulf," Vol. 1, the United Arab Emirates; Vol. 2,
Saudi Arabia; Vol. 3, The Islamic Republic of Iran.
The Author
Manouchehr Takin is senior petroleum upstream analyst with the Centre for Global Energy Studies. He worked for 9 years as senior officer in the Organization of Petroleum Exporting Countries Secretariat analyzing global energy and oil markets. Before that, he worked with National Iranian Oil Co., Ultramar, Amoco International, the Iranian Oil Consortium, and other oil companies.Takin holds a BS in geology from Manchester University, U.K., an MBA from the Industrial Management Institute, Iran, and a PhD in geophysics from Cambridge University, U.K.
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