Middle East is building a big lead in global hydrocarbon investments

To:

Al-Monitor Pro Members

From:

Gerald Kepes 

President, Competitive Energy Strategies, LLC

Date:

Aug. 24, 2022

Bottom Line:

Global upstream oil and gas investment has fallen sharply since 2013, and while the lows of 2020-2021 will not be sustained, higher levels of investment are extremely unlikely. Yet while a clean energy future without fossil fuels assumes the end of exploration and production (E&P) activity, it is doubtful that it will happen anytime soon. Across the globe, oil and gas companies (including national oil companies) and their stakeholders have sharply differentiated strategic beliefs regarding their future. Many of these companies will persist. They will try to survive, operate and invest. Investment will take place (and is taking place), but in a much more concentrated fashion, in a smaller number of basins (areas that contain oil and gas) at a lower level of E&P spend. The MENA region possesses a number of the most attractive hydrocarbon basins worldwide, and if it makes the necessary changes, can attract a larger percentage of global E&P expenditure and capture a higher focus within the portfolios of companies able to invest and benefit from expenditures of scale.  

Background Facts:
  • There are about 500 to 600 hydrocarbon bearing basins (out of over 2,000 geologic basins globally) with proven or potential hydrocarbons of interest. Prior to 2015, approximately 250 of these basins had at least one new field wildcat well (exploration drilling) annually. That number dropped to 160 basins after 2015. The COVID-19 pandemic and the quickening pace of the energy transition has pushed that number down toward 100.
  • Wildcat well activity is a portion of exploration which itself comprises only 10% to 15% (albeit the riskiest portion) of total exploration and production spending. Exploration is a bellwether for the global upstream industry. The purpose of exploration is to identify new commercial potential in new basins or new areas within existing producing basins. An expanding industry will do more exploration, and a contracting industry will do less. Individual countries and companies have different strategic beliefs, but overall the global upstream industry is contracting. However, many basins in the MENA region are positioned to sustain or expand.
  • E&P companies make money from repeatable investments in the same basins over time, generating scale efficiencies and lowering risk. Now, fewer basins qualify for the new portfolio choices that these companies must make. This pattern of less spending overall and in fewer basins is driven by the relentless pressure on E&P companies to lower costs, improve operating performance and generate cash flow. This pressure will not abate. 
  • Given this dynamic, perhaps only 50-60 hydrocarbon basins globally will see significant investment over the next 30 years. Some of the best basins are in the Middle East and North Africa. These are largely controlled by NOCs whose investment and partnering decisions are subject to their country’s policies and finances. Most of these operating areas require the capital and operating expertise of international energy companies.
  • In addition, a number of basins in the UAE, Saudi Arabia and Iraq, for the most part, have high reserves to production ratios (R/Ps) implying significant upside to existing output. With the available capital, expertise, infrastructure and policies, these basins present lower technical risks to successful investment and production expansion.
  • Outside of these 50-60, other basins will see only modest investment, or “subsistence E&P.” Production increases will be incremental where they occur. These other basins will effectively starve due to the lack of investment.
  • Note that a number of highly attractive basins have serious above-ground risks discouraging investment from international companies despite favorable technical characteristics. Venezuela, Libya, Nigeria, Mexico, Angola, Iraq, Iran and now Russia (for some investors) are the notable examples. All have significant remaining potential but are constrained by policy, politics, instability or even war. These factors shape the list of 50-60 basins, or push otherwise attractive basins into subsistence E&P.
  • The global oil and gas services sector, on whose expertise E&P companies rely on to execute their investments, will continue to reduce operating capacity due to investment cutbacks. They will only have the capacity to offer expertise and cost efficiency in the 50-60 basins where there is enough investment activity to sustain their presence. 
  • The competitive landscape for E&P companies is changing dramatically. During the last twenty years, E&P activity had been marked by increasing transparency, including bid rounds and readily available financing. This created a diverse competitive landscape in many basins, due to the proliferation of partnerships between small and large upstream companies and internationally active NOCs. Many of the smaller upstream companies brought competitive subsurface concepts to their partnerships, but in this environment they lack the financial and operational stamina to properly appraise and develop attractive acreage. In some locales, local companies which are financial vehicles for government officials and politically connected entrepreneurs cannot provide the needed operational or financial capabilities.
  • The result: fewer capable E&P companies focused on fewer basins. The MENA governments’ challenge is to ensure that these “fewer” capable companies focus a higher percentage of their investment and strategic focus on those “fewer” basins in the MENA region.
Alternative Scenarios:

Scenario 1: It is possible that volatile and higher prices for crude oil and natural gas as a result of the uncertainty of the energy transition could blunt the financial industry’s and other stakeholders’ focus on slowing oil and gas investment. The ensuing result could be more positive for marginal basins; smaller companies could have access to a larger pool of risk capital, and break out of the subsistence straitjacket. But the same volatility has also hardened the political resolve to continue or accelerate the energy transition and discourage investment in hydrocarbons in many locales. Also, there is no magic wand to wave and change the myriad policy, political, and instability parameters which govern investment in many otherwise attractive basins. One could postulate much more aggressive Chinese, Russian and Indian NOC and private sector investment outside their traditional and current areas of focus, driving higher investment patterns. But the Chinese NOC overseas expansion effort appears to be behind us (Middle East aside); Russian companies will be highly focused on domestic challenges or foreclosed from some international areas; and Indian activity would have to greatly expand in order to make an appreciable difference on a global scale.

Scenario 2: On the demand side, global requirements for oil and natural gas could begin to decline or even increase at a slower rate. But the pandemic aside, this has not happened, nor does it appear that it will happen in the short term. Demand for oil and natural gas will need to decline for the objectives of the energy transition to be met, but it also seems clear that renewables’ supply capacity and related energy systems requirements must be much larger for that to happen. This scenario is the hoped-for-outcome and desirable, but is likely to need ten-plus years to achieve a higher probability.

Scenario 3: Finally, many MENA governments could capture a higher percentage of global E&P investment but fail to secure the higher level of sustainability protocols and renewables investments needed to meet longer-term economic, if not political, objectives. Or the lack of domestic political consensus regarding the purpose of their energy sectors (whether as a source of revenue and control, or as a means to feed a growing domestic economy) could continue to hold back the potential from achieving reality. The result: domestic energy and civil society demands soak up or constrain the investment and supply increases from the success of the higher capture. Success is thus only a short-term phenomenon.

Conclusion - Most Likely Scenario:

Almost all of the MENA countries need larger-scale external investments and partners in oil and especially natural gas. This is also true for external participation in renewable energies to participate in the global energy transition process.

Abu Dhabi began a much wider opening to foreign exploration six or seven years ago, in addition to its continued selection of partners for development and re-development projects, and the efforts have borne fruit. After some 15 years of a stagnant policy toward foreign partners, Algeria appears to have adjusted policies and begun to secure positive results; broader implementation could secure enhanced results even in Algeria’s mature sector and basins. Egypt could do a lot more to enhance activity offshore in the Mediterranean (including new areas offshore western Egypt) and even in the Western Desert. This includes clearing away sclerotic national bureaucracies, but of course these efforts involve domestic constituencies, like anywhere else.

Saudi Arabia does not seem to need external participation to meet its objectives, but Saudi Aramco has not solved its domestic gas production challenges. Iraq needs a pathway out of its ongoing policy paralysis in order to create a national infrastructure for energy and water that meets domestic demand and export requirements. In Iran, even if external sanctions are relaxed as part of a renewed Iranian nuclear deal, its energy sector policies are fully captured by domestic actors with limited capacities. The Eastern Mediterranean gas play (including the Egyptian, Israeli, Lebanese and Cyprus offshore) could see enormous investment (over and above what has already taken place). However, domestic energy security, policy consensus and instability, border agreements, not to mention Turkey’s role, all need resolution. There are positive signs.

Contributor Background:

Gerald Kepes has more than 35 years of experience as a consultant and petroleum geologist in the global energy industry. Most recently, he was vice president in energy & natural resources for IHS Markit, and previously, a PFC energy partner, where he established PFC’s global upstream consulting practice. He also held various positions with a US oil company in North Africa and the Middle East.

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