Middle East poised for breakthrough in European energy markets

To:

Al-Monitor Pro Members

From:

Gerald Kepes

President, Competitive Energy Strategies, LLC

Date:

July 11, 2022

Bottom Line:

European energy markets, especially in Germany, have just been given a crash course on national energy security given their dependence on Russian supplies, and more critically natural gas. For the MENA region’s national oil companies (NOCs) and well-positioned international energy companies (IECs), this presents a significant opportunity to provide Europe with alternative natural gas supplies. Moreover, this is a unique moment for the MENA region to secure badly needed large-scale renewables projects needed to achieve national energy security (NES) for their own markets. For Europeans, this is an opportune time to rebuild a lower-risk energy transition bridge required for robust national energy security, based on reliable, affordable and sustainable (clean) energy supplies.

Background Facts:
  • The European Union currently relies on Russia for roughly 40% of its natural gas and 25% of its crude oil imports. Rewiring European economies that have long depended on cheap Russian energy will not be achieved overnight. It will require the building of new or expanded LNG infrastructure and, to a degree, pipeline capacity. A serious rerouting away from Russian piped gas cannot be reversed easily. A new system will be in place for at least 20 to 30 years. And of course, investment in renewables will necessarily be ramped up at the same time, but seems less likely to deliver the reliability required for European NES concerns in the medium term.
  • Replacing coal and crude oil demand have dominated the efforts to mitigate climate change and promote an energy transition in the last decade. However, the supply side of the equation has been neglected, misjudged and mishandled. This is a global phenomenon, but nowhere more clear than in Europe right now.
  • The opportunity for MENA is not just an expanded export platform displacing Russian energy, especially natural gas, in European markets. MENA’s existing natural resource base, energy infrastructure, geostrategic position and understanding of the energy business position it well to take advantage of European markets. More significantly, this is a golden opportunity to establish new (NES) strategies for the MENA countries by pairing energy investments in renewable supplies alongside the expanded opportunity in natural gas and liquids. This will put many MENA countries on the pathway to building their sustainable energy systems while meeting rapidly growing domestic energy demand (intimately tied to domestic political demands), which has begun to cut into their ability to sustain or grow energy exports.
  • The opportunity to achieve NES for the MENA region, at the same time as it contributes to a reforging of national energy security in Europe, has additional benefits for MENA exporters. It provides leverage for MENA energy sectors when they compete for Asian energy markets. After 2004, all eyes have been focused on energy demand growth in Asian markets. While this will continue, a diversifying European energy market, less dependent on Russian energy supplies, will disrupt the trend of the last 15 years. China and India have been in an advantaged negotiating position since they were the only large growing energy markets in the world. The European market will again vie for MENA exports, giving optionality to regional producers who can swing between the two large markets.
  • Within the MENA region, the UAE and KSA are advancing their post-hydrocarbon energy sector plans by investing in larger-scale renewables projects. But few renewable energy projects are planned in Algeria, Libya, Egypt, Israel, Iraq, and Oman. Also, Morocco, Tunisia, Palestine and Lebanon need alternative energy supplies given either maturing hydrocarbon sectors or lack of hydrocarbon resources to start with.
  • Each of these countries have different combinations of challenges, risks and natural resource endowments, not to mention investment and institutional capacities and constraints. This shift in the competitive environment for access to European energy markets is large enough to offer opportunities to regional governments to reorganize their sectoral policies, increase institutional capacity and open up new spaces for domestic and international capital.
  • Other than a few regional NOCs, who will make these investments? The international energy companies (IECs) have responded to the challenge of the energy transition in different ways, but they all aspire at a minimum to reduce the carbon impact of their oil and gas businesses, especially the crude oil component. These companies want to pursue an overall portfolio approach, whereby carbon-neutral or carbon-negative parts of their portfolios compensate for fossil fuel production in order to reach an operational net zero emission profile across their entire portfolio at some point in the future.
  • They still need to continue to invest in their upstream businesses to maintain sufficient cash flow for the next 10 to 20 years in order to provide competitive returns to investors and pay for the massive capital outflows required to complete the energy transition successfully. This will entail pursuing a much more narrowly focused portfolio management strategy, i.e. fewer, high-efficiency operating areas and a shift to natural gas with tightly executed protocols for methane handling. While focusing on high-profitability traditional investments, the IECs seek to incorporate renewables investments to extend the productive life of their traditional assets, secure new business areas, and to ensure that local civil societies and the financial community will allow them to retain their social license to operate. Their challenge is to find and develop large-scale renewable energy projects, especially in developing countries.
  • Most if not all MENA countries need large-scale external investments in renewable supplies to establish national energy security. That is true even for the UAE and KSA. With few exceptions, the trend so far has been small-scale investments in renewable energy. For capital-constrained governments with aspirations for large-scale, national energy projects, these IECs have the financial, operational and strategic stamina to lead sector-wide development and infrastructure projects.
  • One scenario in response to the opportunity depicted here is that Qatar, Egypt, Cyprus/Israel and Algeria leverage the change in Europe’s competitive energy imports landscape and capture sizable new investments in natural gas and (to different degrees) scalable renewables investments in host countries at the same time. The caveat is that meaningful changes in fiscal terms and domestic energy sector architecture will have to take place, as these new bundled natural gas and renewables investment packages cut across existing national energy company jurisdictions and understandings.
Alternative Scenarios:

Scenario 1: On the supply side, US and sub-Saharan African LNG exports could increase rapidly and out-compete new MENA supplies into European markets, leaving new MENA LNG/pipeline volumes only incremental gains, which will have to be directed away into highly competitive markets in Asia. However even these competitive regions have their supply constraints. Offshore Mozambique and Senegal/Mauritania will be important sources of new LNG, noting that diminished exploration activity elsewhere in sub-Saharan Africa is less likely to discover additional sources. From the US side, evolving climate policy and financial market demands for returns will continue to constrain potential natural gas investments. Higher natural gas prices will spur additional LNG projects, but likely insufficient to capture the majority of the new European market opportunity. In any event, after its Russian experience, will Europe really want to become overly dependent on US energy supplies?

Scenario 2: On the demand side, parts of the EU, chiefly Germany and to some degree others, could impose only a temporary embargo on Russian supplies. Once the geopolitical situation changes, they could opt to repurchase cheaper Russian gas. This would shut down the market space opening available to new MENA gas supplies. In addition, investment policies of European financial institutions may continue to eschew support for natural gas projects, placing them in the same category as crude oil and coal. This scenario is completely plausible. But the longer Russia’s invasion of Ukraine continues, the more likely political sentiments against imports of Russian energy will harden and be enshrined first in policy and then in infrastructure.

Scenario 3: From an investment point of view, a majority of MENA governments may fail to make the changes needed to attract bundled natural gas and renewable investments and so not achieve the longer-term NES objectives. These failures may occur due to institutional resistance maintaining the separation of upstream and power sectors, commercial negotiating failures or political and policy instability, which would all combine to condemn the newly envisioned national energy security programs. High energy revenues for the regional exporters could mask national economic and energy challenges leading to complacency and a continuation of the status quo. Still, the confrontation between business as usual versus deepening challenges in economic and employment growth, rising food prices and domestic political pressure for affordable energy may yet spur governments to make these changes and execute different political arrangements. The need for change is highest among the North African states and Iraq. Having greater resources and institutional coherence, the UAE and KSA have already begun to make changes in their energy sectors, in large part due to domestic political, economic and environmental pressures.

Conclusion - Most Likely Scenario:

Almost all of the MENA countries need large-scale external investments in renewable energies to participate in the global energy transition process. While this is made clear in many policy papers and think tank reports, in reality the investment gap between “aspirational” demand and actual renewable energy investments needed to meet net-zero 2050 objectives is widening. With few exceptions, the trend so far has been small-scale investments in renewable energies (most “green” investor money is fixated on the OECD and BRICs) while pools of traditional oil and gas risk capital have evaporated. For a number of the countries in the MENA region, the timing could not have been worse.

Russia’s invasion of Ukraine in February 2022 shattered Europe’s national energy security calculations (in sharp contrast to the invasion and annexation in 2014). The longer Russia’s invasion of Ukraine continues, the more likely political sentiments in Europe against imports of Russian energy will harden and permanent changes be made.

Barring Russian gas supplies from European markets, whether wholly or in large part, represents a renewed or unparalleled opportunity for MENA governments to capture additional and differently structured energy investments designed to compete for the newly created access to existing EU demand AND require scale investments in renewables for their host countries. Participating MENA countries can establish longer-term national energy security for their domestic populations and economies at the same time that they reap the gains from contributing to Europe's refashioned NES calculations.

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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