Trouble In Paradise – The Widening Gulf Gas Deficit

With much of the world’s energy supplies located in the Middle East Gulf, this resource-rich region should be the last spot on Earth for a ‘gas crisis.’ However, while much global expectation is focused on the Gulf for additional gas in an already tight market, the Gulf countries have experienced their own, perhaps self-induced, gas shortage. The gas crisis is directly related to the rapidly increasing domestic demand for electric power generation, with increased demand especially emanating from the power generation sector.

This article will give a detailed look at the Gulf’s gas deficit, and track the myriad actors who attempt to craft solutions, and their range of options, such as the Gulf Cooperative Council’s (GCC) plan to institute regional nuclear power capability within the next decade. The article will also examine the manner in which the gas availability crisis will impact the European Union’s (EU’s) efforts to diversify its gas supply, and determine if, in fact, the Gulf will be a stable EU supplier. The paper argues that with regard to the EU’s short to mid-term outlook, there is no credible hope for offsetting Russian gas dominance with significant quantities of gas from the Gulf. The EU will be forced to compete on price with other regions for the available LNG supply, especially that from Qatar and a smaller amount from Oman.

Even the rapid expansion of Qatari LNG supplies remains uncertain until the North Field moratorium is lifted in 2012 and the results of the reservoir analysis are deciphered. Qatar’s refusal to further cross subsidize its neighbors’ industrialization, with low priced gas in the formerly planned expansion of Phase Two of the Dolphin project, reflects the region’s recalculations, albeit slowly and haphazardly, that take account of international market prices in the domestic market.

Strain On Supply Capacity

Gas supplied to the Gulf domestic market is extremely inexpensive. The Gulf region’s rapidly expanding economies, backed by record oil and gas prices, the increase of disposable income, rapid domestic industrialization, and below-market pricing for domestic gas supply, are straining the ability of the Gulf countries to adequately supply their domestic markets. For example, the UAE faced a severe supply/demand gap that stretched to 1bn cfd in 2007. Unless firm action is taken, the Gulf countries’ domestic gas crisis will impact the region’s economic expansion, and dampen hopes that additional supplies – beyond those of Qatar – will be available for the global market. Some of the proposed solutions bandied about in the Gulf, such as fast track gas development, increased regional pipeline imports, improved energy conservation and enhanced energy efficiency in power generation, as well as nuclear and alternative energy sources, contort the problem without solving it. The main problem is that the gas crisis is spawned to a significant degree by the low domestic pricing prevalent throughout the region (see table).

Reported Domestic Gulf Gas Feedstock Prices 2007 ($/Mn BTU)

Source:Natural Gas Market Review 2007.

Understandably, the UAE is not the only Gulf country to wrestle with this crisis: Oman, Kuwait, Bahrain and Saudi Arabia all experience difficulties in meeting surging domestic gas demand. For the past two years, Kuwait has had crippling power blackouts, and Oman has restricted its LNG exports to make up for domestic shortfalls. Saudi Arabia announced a moratorium on new gas-fired power plants, and declared that any additional demand will be met by plants using crude oil or heavy fuel. Gulf domestic policy makers live daily with these ironies: the region is the home of some of the world’s largest gas reserves, with Iran holding the world’s second largest at 993 trillion cu ft (tcf), Qatar with the third largest at 895 tcf, Saudi Arabia the fourth largest at 250 tcf, and the UAE the fifth largest reserve holder at 214 tcf.  

The Gulf’s electric power consumers are pampered by domestic gas prices that rarely reach beyond $1/mn BTU, while the average gas cost from development projects hovers around $4/mn BTU. Yet, understandably (and perhaps myopically), regional gas customers violently reject anything approaching market pricing. Although some quarters are beginning to recognize the need for change, long-term contracts still rarely break above $1.50/mn BTU. Still, there are incipient signs of evolution because some short term contracts have reached higher levels, such as $5/mn BTU.

Natural gas expert and head of the Oxford Institute of Energy Studies Natural Gas Program, Prof Jonathan Stern, stated that unless domestic gas prices rise to at least $5/mn BTU consistently, and even more optimally to $7.50/mn BTU, the GCC countries will remain chronically short of gas because, simply put, nobody will invest in exploration and production. It is understandable that many in gas producing countries may view cheap gas as integral to the social contract or perhaps even as a godsend. Proper pricing will, however, discourage the frivolous consumption of gas in the face of an almost mythic abundance. Prof Stern concluded that at these enhanced prices, the respective governments would find out the ‘real’ demand for gas.

UAE Gas Shortage

The gas shortage in the Northern Emirates is especially foreboding, because it has now precipitated electricity and water (desalination) shortages. In June 2007, UAE Oil Minister Muhammad al-Hamili stated that as much as 50% of UAE natural gas was used for power generation during the summer months. Although the crisis impacts all of the emirates, the energy hungry north, which is more significantly impacted, is attempting negotiations with Iran to import gas from the offshore Salman field. The negotiations are continuing and the infrastructure is set up, so that theoretically, if a pricing agreement is reached, the gas supplies could be brought online quickly.

However, the current price reality has shifted to such an extent that agreement is difficult. In a 2001 contract, the National Iranian Oil Company agreed to supply the Northern Emirates with 500mn cfd of gas, aligned to an average oil price of $18/B. Now the Iranians insist on higher prices. Because spot prices for LNG in Asia have reached $25/mn BTU, Tehran is satisfied that it can get a better price for its gas. The only country that enjoys a clear abundance of gas in the region, Qatar, has placed the planned Phase Two expansion of the Dolphin project (with gas deliveries of 3.2bn cfd) on hold, as part of the gas moratorium on further expansion, until a North Field feasibility study is completed in 2012.

The Northern Emirates of the UAE offer an interesting case study as possible harbingers for the wider region, which should observe their overall experience, against the impact and response to the gas deficit. In the GCC as a whole, the past four years have witnessed sharp spikes in electricity demand that amounts to 10% annual increases. To meet this increase, the GCC will require investments that reach approximately $7bn annually until 2015. Concurrently, power generation production capacity must increase by 60gw, which is approximately 80% of the presently installed capacity.

To match demand and power generation capacity, the two largest emirates, Abu Dhabi and Dubai, are switching to coal. Abu Dhabi has indicated that it will migrate to coal-fired power plants in a bid to save its dwindling supplies of natural gas, and Dubai, ahead of the others, is currently constructing four coal-fired plants to reach a combined generation capacity of 4gw.

When natural gas was produced from low cost associated gas reserves, internal pricing that ranged from $0.75-1.25/mn BTU was feasible. However, now that international market prices are much higher ($9.01/mn BTU Henry Hub at the time of writing), and all other costs in the gas industry have increased, including those for qualified personnel, equipment and the difficult to produce sour and tight gas reserves, the region heads toward a herculean quagmire in attempting to uphold the previous price paradigm.

Power Options Unfeasible

To forestall the inevitable rise in prices, many Gulf countries contemplate everything from nuclear power to extensive solar power arrays. Saudi Arabia’s government-sponsored vision statement outlines the steps to become a major producer and possible regional exporter of solar power in the coming decades. As stated in the introduction, the heart of the problem is administrative gas pricing. Power and gas prices are set according to domestic objectives, not the true production costs, or the higher purchase price of the international market. The low domestic cost inhibits gas sector investment, because local national oil companies find it unfeasible to produce and supply the domestic market without government subsidization guarantees. None of the posited programs, alternative energy, nuclear energy, energy efficient power generation, can help the GCC escape from this unpleasant truth. 

The EU, desperately wanting to avoid the entanglements inherent in Russian gas dominance, has been searching for other potential supply regions. While searching for different regions to factor into its natural gas diversification program, the EU should not lay its deepest hopes on additional gas supplies from the Gulf, beyond what is available from the current LNG trains. When commenting on the prospects for new gas availability from the Gulf States, Prof Stern explained that, “It is now doubtful that any pipeline exports to the EU will occur.” He affirmed a basic market reality that, if EU countries pay the price, they will be able to compete for the available LNG tankers. If not, these tankers will go wherever they can garner the highest price.

In the end the EU will not be able to count on Gulf or Middle Eastern countries for added gas supplies on any other basis than price competition for already available supply. In its bid to escape highly politicized Russian gas, the EU may also have to compete with the Gulf’s highly subsidized, and to some extent, self-undermining domestic markets.