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Assessing Global Demand and Future Export Markets for Caspian Oil and Gas
by Julia Nanay
Julia Nanay is director of the Petroleum Finance Co.
Summary
Development plans for Caspian oil and gas have been caught between volatile oil prices and high-stakes political games being played in the region. Plans for investing in infrastructure to export Caspian oil were scaled back in light of the 1998 slump in global oil prices. Even as prices recover in 1999, investors remain cautious, and there is uncertainty over the future strength for both oil and gas in Europe. Integrating Iran into the Caspian export picture will be essential for accessing growing Asian markets for oil. Turkmenistan faces the greatest challenges in getting its resources to market: exporting electricity through Iran might be their most viable option. * * *Caught between Volatile Oil Prices and High Political Stakes
The subject of my talk today is "Assessing Global Oil Supply & Demand and Future Export Markets for Caspian Oil and Gas." Had we addressed this subject a year ago, the outlook would have been different and probably tinged with more uncertainty and pessimism. In late 1998, oil prices were on the brink of dropping to single digits, as depressed worldwide oil demand and a supply glut coalesced to force some important changes in how the oil industry approached the oil business. Upstream budgets in the Caspian were cut dramatically. The construction of multiple multi-billion dollar pipeline projects in this region was called into question. With the exception of the Caspian Pipeline Consortium''s (CPC''s) oil pipeline from the Tengiz field in Kazakhstan to Russia''s Black Sea port of Novorossiisk and the AIOC''s pipeline from Baku to the Georgian Black Sea port of Supsa, there did not seem to be much hope for progress on the transport front. And, during this process, a series of mergers and acquisitions meant that eight companies that were active in the Caspian lost their independence (Union Texas, Amoco, ARCO, Petrofina, Mobil, PennzEnergy, Monument, and Elf).
The prognosis going forward was bleak and the fate of countries and companies, in this region and elsewhere, seemed to hang in the balance. Which way the balance would tip ultimately hinged on two of the world''s biggest oil producers and their willingness to initiate significant production cuts. Then, as today, all eyes were on the Middle East. It depended on the determination of two Middle Eastern leaders, Saudi Arabia''s Crown Prince Abdullah and Iran''s President Khatami, to put aside their differences and agree to remove nearly 900,000 barrels per day (b/d) from world oil supplies. Their agreement encouraged other producers to fall in line, and today, total voluntary production cuts are over 4 million b/d (mmbd). {Slide: Supply will be artificially constrained in 1999 by OPEC Policy}.
The market reaction since the cuts went into effect on 1 April 1999 has been extremely positive. Oil prices have risen dramatically, although where prices will settle is still a matter of some speculation. Observance of the output cuts over the next months will be key to keeping prices up. With shut-in capacity of over 6 mmb/d, the oil markets remain very much at the mercy of the major oil producers. This excess capacity will continue to build and could eventually act as a depressant on the markets. {Slide: 1999 Price Recovery will be Undermined by High Levels of Idle Capacity}.
With the competition curtailed in the Caspian, and many lessons already drawn from operating in a region of such high political and economic risks, companies now weigh their investments carefully.
Had oil prices stayed at $10-$11a barrel or dropped below that, investments in existing upstream projects in the Caspian would have stayed at much reduced levels and it would have been difficult to get new pipeline projects off the ground. Even today, the oil price situation remains precarious and depends on whether producers hold the line or cheat. At the same time, most companies have drawn clear lessons from last year''s oil price slide: it''s better to test all projects against oil prices of $10-$12 a barrel. {Slide: Oil Price Outlook}
Current prices are of great comfort to the industry in the Caspian, where the high costs of transporting resources to markets mean that companies rely on prices of $18-$20/bbl as the break-even point for upstream developments because of the additional burden of high transport costs. Break-even prices will be reduced with the reduction of transport costs. The debates are ongoing about the best way to minimize transport costs, focusing on the construction of new exit routes.
Last year''s low oil prices and the resulting financial constraints do, however, have a long-term impact. Countries in the Caspian region and their Western company partners have reassessed their approaches to oil sales and pipeline projects. The "geostrategic" importance of building certain pipelines is recognized, but only economic and commercially viable projects will get funded. At the same time, while transport solutions are determined by economics, we all know that their ultimate success or failure is governed by politics.
What complicates the outlook for the Caspian region is that increasing gas discoveries, particularly in the southern Caspian, have led to new competitive pressures among all the gas-rich countries of this region. There could be too much gas chasing few economic market outlets. {Slide: The Top 27 Countries in Gas Reserves}.
The Markets for Oil
When we speak about markets for oil, what do we really mean? The markets are broken down by regions. {Slide: The Regions}. Different regions have different current and future consumption requirements. {Slide: Global Demand, Fundamental Shift in Outlook} (Slide: Asian Demand vs. Atlantic Basin} {Slide: Asian Oil Demand vs. European Demand}
The most talked about markets for Caspian oil are to the West of the Caspian: refineries in Western Europe/the Mediterranean; refineries in Turkey and Israel; and refineries in the Baltics, Finland, and Eastern/Central Europe (including the Black Sea region). 448,000 barrels of crude from Kazakhstan''s Tengiz field was even shipped to the US to be tested in Chevron''s Pasacagoula, Mississippi refinery. While shipping to the US remains a costly proposition, the experiment was seen to be a success since the refinery handled the crude well. Future shipments of crude to the US are anticipated.
One line of argument goes that by 2005, North Sea oil production will decline by up to 1 mmb/d and Caspian crudes can fill the gap North Sea crude will leave in European markets. But Caspian crudes will be competing with increasing supplies from the Middle East (including Iraq) and from North Africa (including Libya), and this competition is sure to drive margins down. The profitability of selling Caspian crudes into European Mediterranean markets will thus be depressed.
The Markets for Gas
In terms of gas, the major target market currently is Turkey, with some potential also seen in Eastern/Central Europe. However, the Turkish market is complicated by unease over actual demand as Botas'' gas future demand estimates appear much too high in light of the August 1999 earthquake. What that earthquake implies for the speed of infrastructure construction, which will be necessary to absorb the gas, has not been assessed. The volumes needed by Turkey over the next decade may be less than forecast. Couple this with a large number of suppliers targeting this market and it makes for fierce competition for a possibly limited upside. {Slide: Turkey: Gas Supply Options}. In terms of supplying Eastern/Central Europe, the gas has to flow through Russian pipes, hence sales to this region will require Gazprom''s acquiescence.
For the Turkish gas market, which is geared to the growth of electricity demand and the construction of new power projects, one solution that is already being closely examined by Turkmenistan is that of selling electricity instead of gas. This would be gas-based electric power from Turkmenistan via Iran to Turkey. The installed electrical generation capacity of Turkmenistan is 3,600 megawatts with all but 200 megawatts powered by natural gas. The annual consumption of electricity by Turkmenistan is roughly 10 billion kilowatt hours (kwhs). This means that the country''s current load factor is around 33 percent. In theory, the Turkmens could export about 20 billion kwhs/year. However, in most cases utilities want to achieve a load factor of 65 to 70 percent, which means they could export 10 to 12 billion kwhs/year (or about 1,500 megawatts, which would require about 10 bcm/y of gas). The cost of electricity at the bulk rate in the US is around 4.5 cents per kwh (in Turkmenistan it is much less). Over 80 percent of the cost of electricity is based on the fixed capital (namely building the plant); the fuel cost is only 5 percent of the total cost. Thus, the majority of the money that will be collected from any buyer (Iran or Turkey) is for the depreciation of the equipment. The revenue collected from burning more natural gas is a small portion of the total amount. The major limitation to the transfer of electricity will be the size and the voltage level of the transmission lines between the two countries. The Turkmen and Iranian power grids are supposed to be linked by the end of 1999.
In the case of both Turkmenistan and Azerbaijan, gas exports to northern Iran are also being considered as a solution for a market outlet. {Slide: Iran Oil and Gas Consumption}
As we saw in some of the previous slides, the growing markets for both oil and gas are in Asia. In terms of accessing Asian markets for oil, the Caspian countries (on the eastern side of the Caspian) and their Western company partners will need to traverse either Kazakhstan or Iran. An oil pipeline from Kazakhstan to China has been deemed too costly at this time. Kazakhstan''s President Nursultan Nazarbayev is concerned about finding a second major export route, in addition to CPC''s pipeline to Novorossiisk. He has stated in public forums in the US that he sees Iran as the most economic route (in addition to CPC) for oil exports from the eastern side of the Caspian. US sanctions remain a deterrent to this export option, but the expiration of the Iran Libya Sanctions Act (ILSA) in August 2001, makes the future outlook for exports through this southern route a viable option. Progress on oil swaps from Kazakhstan and Turkmenistan to Iran''s four northern refineries has been hurt by the failure of the Iranian side to build a new swap pipeline. This pipeline is not likely to be completed before the 2002-2003 timeframe approaching the period when ILSA might expire. For Turkmenistan, Kazakhstan, and their Western company partners, sanctions have been an impediment to their being able to access southern transport routes. But even as the swap line from the port of Neka to the Tehran refinery has been delayed, new studies are surfacing for the construction of a pipeline from Kazakhstan via Turkmenistan to Iran, which could negate the need for this swap pipeline. Integrating Iran into the Caspian export picture will be essential for accessing growing Asian markets for oil -- provided that significant increased volumes of oil are found in Kazakhstan and eventually, Turkmenistan. If only limited extra oil volumes are discovered in Kazakhstan -- for example, offshore in the Caspian, where drilling is currently underway -- it may be possible to tanker these to Baku and feed them into a major export pipeline along the Baku-Ceyhan route once that pipeline gets built.