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The coming gas supply shock in the Gulf

BY MATEIN KHALID (At Home) / 24 July 2008

IT IS ironic that the Arabian Gulf, which contains two thirds of the world’s proven oil reserves and is the epicentre of the energy business, faces a regular gas shortage, possibly as high as 7 billion cubic feet in the next decade. This is going to have a seismic impact on the GCC’s oil production, consumption and exports, a major factor in crude oil prices.

Only Qatar among the GCC states has the scale of reserves, production and infrastructure to ignore gas supply constraints in industrial production in some of the highest nominal GDP growth economies in the world.

Cheap energy is the feedstock for many of the GCC’s industrial diversification strategies, such as the giant aluminium smelting companies of Dubai and Oman or Saudi Arabian downstream petrochemicals venture at Yanbu. Gas, in particular, powers the electric utilities, aluminium, fertiliser and water desalination plants in the GCC.

These industries are the backbone, the very DNA of the Gulf’s new twenty first century industrial constellation. Electricity demand in the GCC is growing at as high as 10 per cent a year, higher than China, thrice the growth rates of the West. Water desalination plants are literally a matter of life and death for the new economic complexes in the Arabian Desert. Yet the Gulf’s industrial future is now threatened by a gas supply deficit only aggravated by some of the most generous gas subsidies in the world.

Gas was traditionally a poor cousin to crude oil in the Gulf, suffering from chronic underinvestment in the 1990’s because there was simply no financial incentive to upgrade infrastructure at a time when oil prices had crashed to $10 a barrel and Asia’s currency meltdown threatened both oil and gas gluts for GCC gas. Yet the last decade has witnessed a spectacular U–turn in the world gas market.

Oil prices have soared from $20 to $135 a barrel in only five years as demand from the emerging, energy extensive economies of the Pacific Basin coupled with geopolitical shocks as diverse as war in Iraq, sabotage in the Niger Delta and strikes in Venezuela created the perfect storm for the world’s third oil shock since 1973. This has meant a seismic change in the economies of GCC gas production, export and pipelines. Moreover, the development strategies of the Gulf have emphasised energy and capital intensive for downstream petrochemical industries, which increasingly require various grades of sour gas and condensates. This is the reason Saudi Arabian annual gas production has tripled to almost 90 billion cubic meters since the Iraqi invasion of Kuwait in 1990.

Access to cheap reliable gas supplies is increasingly becoming as critical an ingredient as access to syndicate international bank credit for the success of the new downstream energy industries in the Gulf. The Saudi Gas Initiative has not lead to any increase in proven gas reserves and Total, France’s oil supermajor, has pulled out of the initiative, selling its stakes to Shell and Saudi Aramco. Since Total’s abandonment of its Saudi gas exploration projects in the Kingdom’s Empty Quarter, Saudi Arabia could well face the surreal prospect of becoming a gas importer in the next decade. Twilight in the desert could well be gas, not oil for the Kingdom that has acted as Opec’s swing producer, the proverbial central bank of black gold, since Sheikh Yamani’s tenure as Saudi Oil Minister in the 1970’s.

The gas deficit has compelled Oman to construct coal tired power plants and the UAE to use expensive crude and diesel liquids for power plants and the UAE to use expensive liquids for power generation during periods of peak summer air conditioning load times. The Dolphin Project is the largest cross border venture in the GCC, helping to bring Qatari oil to the UAE market.

However, Qatar cannot supply the sheer magnitude of the gas demand that will arise from the lower Gulf’s power generation, aluminium smelting, water desalination, petrochemicals and iron ore industries. Qatar has even declared a moratorium on new projects in the North Field till 2010, an ominous indicator of a future GCC gas squeeze. While Qatar and Iran have some of the world’s largest gas reserves, Iran is prevented from US Treasury sanctions from the billions of dollars in international bank credits from converting its gas into viable new production and supplies. Regional politics preclude Iran from emerging as a significant gas supplier to Saudi Arabia and the rest of the GCC. The gas supply deficit in the region could well provide both the impetus and strategic opportunity for the evolution of a nuclear power industry.

The worldwide shortage of gas exploration assets, equipment and personnel means the Gulf states have to dramatically rethink their economic growth and industrial models of the future as power generations rates surge. Sour gas, the Gulf’s primary geological gas assets, also is corrosive and inappropriate for the state-of-the-art downstream industries now emerging in the region. This prevalence of sour gas is the reason the UAE, blessed with the world’s fifth largest gas reserves, imports gas from Qatar in the Dolphin Project.

Other than US Treasury sanctions against Iran, “resource nationalism” in the Gulf also prevents significant foreign investment in regional gas production. For instance, the Kuwait Parliament has vehemently opposed granting foreign oil companies any equity in its domestic oil and gas business. Since Big Oil has no stake in Kuwaiti oil reserves, its incentive to transfer the latest gas exploration technology is simply not there. Technology, cost, geopolitics, water, power, petrochemicals and project finance will also define the evolution of the Gulf’s gas industry in the next decade.

Matein Khalid is a Dubai-based investment banker and economic analyst

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