The Middle East Oil Scene in Uncertain

Times

Bassam Fattouh

JOGMEC ANNUAL INTERNATIONAL SEMINAR, TOKYO, 26 FEBRUARY 2015

Oxford Institute for Energy Studies

Structure of the Presentation

• Middle East oil in the current global context

• Saudi Arabia’s policy response: Was it really unexpected? What factors can explain the recent behavior? What are the implications for the oil market?

• The Middle East energy scene outside the GCC

• Middle East long-term investment and supply prospects

• Conclusions

Middle East and the Current Global Oil Market Context

Global Supply Disruptions Easing and US Supply Rising

Supply disruptions eased by around 1 million b/d between May and October 2014 but increased again due to the Libyan disruption

OPEC and Non-OPEC Crude Oil Unplanned Outages, mb/d

Source: EIA, Energy Aspects

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Non‐OPEC OPEC

Non-OPEC supply growth has been robust driven largely by US shale growth

Y/Y Change in Non-OPEC Crude Oil Supply, mb/d

OPEC did not Adjust its Output to Support Prices

Saudi Arabia oil output, mb/d

Saudi Arabia oil output continues to be elevated at above 9.6 million b/d

Source: Energy Aspects

OPEC oil output, mb/d

OPEC did not adjust oil output to the new changes and remained above 30 million b/d

Inventories expected to accumulate in H1 2015

With current level of OPEC output, inventories continue to build well into the first half of 2015 on the back of strong stock builds in 2014

Brent forward curve, $/barrel, 16 February 2015

Market in contango to provide incentive for over-ground and floating storage

Stock Builds, mb/d

Source: Energy Aspects, Reuters

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Is the Oil Market Out of the Woods Yet?

Dubai time structure 1-2 month, $/barrelICE Brent, $/barrel

Recent rebound could be explained by multiplefactors both technical and fundamental

Also reflected in the time structure where theextent of the contango has eased

Changes in Expectations as the Number of Rigs Fall and Companies Cut Capital Expenditure

The fall in the number of rigs has beenspectacular falling from a peak of 1600 to around1200

And companies have been slashing their capitalexpenditure budgets

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US Oil Rig Count, kb/d Capital Expenditure Cuts by Selected Companies

Source: Energy Aspects

But On-Land and Floating Storage on the Rise…

Refinery turnaround yet to peak in April this year resulting in lower demand for crude

Crude stocks in the US have been rising fast as it remains one of the few places with available storage capacity

Crude Oil Stocks, Million Barrels Refinery Turnarounds, mb/d

Saudi Arabia Response and OPEC Cohesion

Saudi Arabia Response: Was it a Surprise?

• Before the fall in oil price, Saudi Arabia sent clear signals that it is unlikely to reduce output unilaterally and is unhappy about the quota system– ‘we (Saudis) have learned our lesson.

Every time we go to quotas, who bears the brunt? Us. We have learned the lesson. We are no longer the swing producer. Who needs quotas?’ (MEES, Dec 6, 2013 )

• Mabro (1998): ‘The point that Saudi Arabia has been making consistently since 1985, backed by its policy in 1986 which was a genuine price war, seems to have sunk in. Saudi Arabia's willingness to cut output on its own to influence the course of oil prices could not be taken for granted. In fact nobody could realistically expect to see such willingness ever emerging again’.

Saudi Arabia Oil Production

What Could Explain Saudi Arabia’s Response?

• Does Saudi Arabia desire a lower oil price?

• Is Saudi Arabia using the ‘oil weapon’ for geostrategic purposes?

• A price war on US shale producers?

• Is Saudi Arabia helpless in balancing the market?

• Not willing to cut output unilaterally

– Naimi (Dec, 2014): ‘If I reduce, what happens to my market share? The price will go up and the Russians, the Brazilians, US shale oil producers will take my share’.

– Especially in a more competitive environment 0

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Saudi Arabia Exports, mb/d

Some Traditional Exporters Shut Out of the US Market

Crude Oil Imports from Nigeria (mb/d) Crude Oil Imports from Saudi Arabia (mb/d)

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Some traditional light crude oil exporters to the US such as Nigeria have been completely backed out from the US

Others such as Saudi Arabia reduced exports to the US as US benchmark prices started falling

Source: EIA, Energy Aspects

Accelerated Shift of Exports to Asia

WAF Exports to Asia (mb/d)

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Latam FSU

Latin American and FSU exports to Chinamb/d

WAF producers turning to key growth marketAsia to sell their cargoes

So are Latin American and FSU producerswho are turning to Asia

Generating More Competitive Pressure Among Middle East Producers

Iraq and Saudi OSPs to Asia$/barrel

Chinese imports by countryMb/d

Source: China Customs, Bloomberg, Energy Aspects analysis

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Saudi Iran Iraq

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Iraq - Basrah light Saudi - Arab Light

….reflected in better terms and adjustment ofprice differentials

Competition intensified between MiddleEast producers trying to increase marketshare in Asia

Competition Not Only Limited to Crude Oil Market

US Distillate exports, mb/d US Propane Exports, mb/d

Shift in trade flows not only limited to crude but also products particularly diesel as US turns into world’s largest exporter of diesel

….but also other products such as propanewhere US propane is reaching Asian andEuropean markets affecting petrochemicalfeedstock choice

Saudi Arabia Refinery Expansion

Thousand b/d

Start Up

Saudi Aramco Share (%) Partner

Satorp, Jubail 400 2013 62.5 Total

Yasref, Yanbu 400 2014 62.5 Sinopec

Jazan 400 2017 100

Refinery Expansion in Saudi Arabia

Saudi Arabia refining capacity has risen fast as drive towards vertical integration and creation of more value added accelerates

Most of the refining capacity is geared towardthe middle of the barrel (diesel and kerosene)

Middle East (ex-Iran) diesel output mb/d

‘Wait and Watch Approach’ and Loss of Feedback Mechanism

• Leave it to the price mechanismto clear the market

• High uncertainty– Magnitude– Timing

• Implies that an important feedback mechanism on downside has been lost or can no longer be taken for granted– A higher tendency to undershoot and

for prices to become more volatile– Era of low price volatility and price

stability within a narrow range maybe over

• Longer-Term implications– Risk premium in the oil industry

increased affecting investmentdecisions

Crude Oil Price Volatility

Saudi Arabia Can Withstand the Low Oil Price Period…

Saudi Government debt as a % of GDP

Government debt to GDP is quite low with no foreign debt

Foreign assets provide a sizable buffer for Saudi Arabia

Source: JADWA, EIA

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But Structural Challenges Remain

Source: IMF, JADWA

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GCC Non-GCC CCAOE

Sources: National authorities; and IMF staff calculations.

Fiscal Balance, Oil Exporters, 2012-19 (% of GDP Budgeted expenditure, SR Billion

GCC countries large fiscal surpluses expectedto turn into deficit; cover fiscal deficit throughgovernment borrowing or use of financialassets

But also adjustment in expenditure but cuttingcurrent expenditure very difficult; the impactwill be felt on capital expenditure

MENA (Outside the GCC): Things Can Always Get Worse!!!

Weak States and Rise of Non-State Actors

• The eclipse of the state and its formal institutions– Inability of states to protect borders,

control territory and resources – Weakening of state’s formal institutions

(Army, Judicial System, Parliament, etc….)

– Questions about legitimacy of transitional governments (Egypt, Yemen, Iraq, Libya)

• The rise of the non-state actors– Hizbollah (Lebanon), Houthis (Yemen),

IS (Iraq, Syria,), Libya Dawn (Libya)– Established a ‘state’ within the state

challenging formal authority – Ability to dictate their own agendas

• Strong links to regional powers• Decision to initiate and stop wars• Engage in wars outside borders

Nature of conflict and geopolitical risks have changed with new set of challenges

Oil Output Disruptions

Syria oil production, mb/d

Syria’s oil production collapsed to low levels as energy assets being targeted to erode central government’s revenue base and secure an important source of funds

Yemen oil production, mb/d

Yemen’s production on a downward trend and increased risk of output disruption as the country goes into the abyss

Libyan Production Goes Yo-Yo and Major Source of Uncertainty

Libyan oil production mb/d Libyan oil production mb/d

Despite strong recovery in 2012, Libyan production has fallen sharply in recent months and has become much more volatile

Regular attacks on port terminals and strikes mean that production has to be shut in; No political solution in sight with the risk of IS filling the vacuum 

Source: MEES, Energy Aspects

Iraq: The Tale of Two Regions

Crude Oil Exports from South, mb/dCrude Oil Exports from North, mb/d

Crude oil exports from the north remains plagued by disruptions, sectarian violence + struggle on who takes control of oil field and exports

In the south, exports have been on the rise but  maintenance and infrastructure constraintslimit the growth potential

Iraqi Finances Being Squeezed

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Million Barrels Revenues (Billion US$)

Despite increase in exports, monthly oil revenues declined sharply as oil prices fall

Iraq Monthly Revenues and Production

….At a time when the security situation is deteriorating and the spending on security and defense is rising

Source: Iraqi Oil Ministry,  Financial Times

Kurdistan: Potential Large But Challenges Remain

Field (operator) mid-13 end-14 end-15 vs ‘14

Tawke (DNO) 100 125 210 85

Taq Taq (Genel Energy) 120 136 150 14

Khurmala Dome (KAR) 105 100 150 50

Shaikan (GKP) 5 24 60 36

Hawler (Oryx) 25 40 15

Akri Bijeel (MOL) 10 35 25

Atrush (Taka) 25 25

Garmian (Western Zagros)

5 0 25 25

Khor Mor (Dana-Crescent)

14 20 20

Sarsang (HKN) 1 15 15

Ain Sifni (Hunt Oil) 15 15

TOTAL 350 440 745 305

Oil production from  Kurdistan is expected to increase substantially in 2015 by 300 thousand b/d

Production could be hindered by unreliable route of exports and fractious relations between KRG and the federal government

Kurdistan Exports, mb/d

Source: MEES, Energy Aspects

Long Term Implications

• Deterioration in security

• Unrest colours preception of regional risk as a whole as risk of contagion continues– Raising cost of finance

• Political instability and policy uncertainty– Weighs on investment decisions

• Inability and delay in implementing large infrastructure projects (water injection, pumps, pipeline, etc…)

• Weak institutions and bureaucratic delays– Customs procedures, clearance, visa

processing, port regulation, etc…

Iraq Oil Production Forecast, mb/d

Source: IEA

Long Term Implications

• How to distribute revenues internally become a key issue encouraging separatist tendencies

– Iraq: Central government-Kurdish region; Oil provinces trying to gain greater control

– Libya

– Yemen

• As power of central government weakens, new local powers will emerge

– Local powers can’t be sidelined

– Local powers in contest and challenging central government

– Adds new complexity for foreign players’ relationship with governments and local players

Source: Barclays

Investment and Supply Prospects

Supply Prospects from Middle East Limited

Domestic Consumption Rising Faster Than Production

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Oil Consumption and Production in the Middle East (Index: 1980=100)

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Production Consumption

Gas Consumption and Production in the Middle East (Index: 1980=100)

Domestic consumption has been rising faster than production affecting the export capability of some Middle East countries

Despite the massive gas reserves, many countries in the region have become net importers of gas

Source: BP

Increase in Energy Intensity

Energy Intensity in Selected Economies

CAGR (1985-2010)

Overall growth (1985-2010)

3.8% 48%

-0.5% -18%

-0.8% -32%

-0.9% -46%

-0.4% -11%

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Energy intensity(BOE per $1,000 GDP real 1996 prices)

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KSA

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Energy intensity in the GCC keeps rising contrary to global trends

….in part due to lack of price signals needed to rationalize energy demand growth

Fuel Price Paid by Power Producers International Price

Heavy Fuel Oil 0.43 15.43

Natural Gas 0.75 9.04

Diesel 0.67 21.76

Crude Oil 0.73 19.26

Source: Electricity & Cogeneration Regulatory Authority (ECRA) Annual Report 2012

Prices Paid by Power Producers in Saudi Arabia compared to International Prices in 2012 ($/MMBTU)

Conclusions• Many uncertainties, but oil market balances will look

different as supply-demand start adjusting to the low price environment changing expectations and sentiment in the process

• The perception of the loss of an important supply feedback affecting market sentiment, increasing volatility and increasing the risk in investment in energy projects

• GCC has more resilience to deal with current slide in oil price, but long-term structural challenges remain

• The deterioration in the political scene in many ME countries have implications both on short-term output and long-term investment and supply potential