Economist Carole Nakhle, the founder and director of London-based advisory, research and training company Crystol Energy, is a recent addition to NRGI’s advisory council. She is an expert in the structuring of oil and gas deals, as well as a key player in the movement to support women working in the sector. (See box below to learn more about her work on gender.) In a wide-ranging interview, she shared her impressions of the global hydrocarbons market, as well as some thoughts on key producers in the Middle East and North Africa.
NRGI: What does the current state of the oil market mean for new investments, especially in developing countries?
Carole Nakhle: Since summer 2014, the oil market has entered a new phase, with prices hovering around USD 50 per barrel. Up until 30 November, OPEC focused on upholding market share, breaking its longstanding tradition of implementing production cuts to defend a certain price threshold. Instead, market forces—that is demand and supply—have been allowed to set prices. On 30 November, the organization returned to its old habit, announcing production cuts of 1.2million barrels a day, effective January 2017. It remains to be seen whether such cuts are sufficient enough to put sustainable upward pressure on prices.
The typical industry reaction to lower oil prices is cost cutting. Often, this takes the form of announcing cuts in capital spending: expensive or challenging development projects are deferred or canceled. Cuts in capital expenditure and investment are important in rebalancing markets and prices over the long term—those cuts today mean less production tomorrow. That is the mechanism that will eventually bring prices up again. It is, however, very difficult to evaluate these kind of effects with any precision: Although specific figures are being circulated (as big as a trillion dollars over a five-year period), we should asses the value of these cuts with a huge degree of caution. It’s often unclear what is caused by the oil price and what is determined by other factors.
Like all investors, international oil companies allocate their capital to projects that offer the most attractive risk-reward balance first. During periods of sustained lower oil prices, companies become more selective and cautious investors. Investing in countries with small, costly or hard-to-extract oil and gas resources, with limited or no infrastructure and high political risk, becomes much less appealing. All else being equal, these are precisely the projects that are being curtailed first. In such circumstances, governments find their bargaining power weakening in comparison with the oil companies. Therefore, they will be tempted to offer concessions to restore the competitiveness of their business regimes to avoid investment cuts.
What are long-term trends in the global oil market?
If we look at the next 20-30 years, fossil fuels—oil, gas and coal—will continue to dominate our worldwide energy mix.
Meanwhile, greener sources—mainly solar and wind—are expected to maintain their rapid growth. However, because they are starting from a relatively low base, it will take them some time to play a significant role in the world’s primary energy mix. Today, only 10 percent of all commercial energy is not generated from fossil fuels. Besides, their contribution is largely limited to power generation. Therefore, they will compete more directly with coal and gas than with oil, which dominates the transport sector. Over time, given concerns about climate change, the dominance of fossil fuels will lessen, though not necessarily proportionately. Natural gas, for instance, has been gaining popularity as it replaces dirty coal, which emits the most CO2 in power generation compared to both oil and gas.
We should keep in mind, however, that over the long term many uncertainties remain, starting with the possibility for technological breakthroughs, but also including future prices and policies. Few, for instance, foresaw the shale revolution a few years ago; before 2008, advocates of “peak oil” were quite vocal. Many experts believed that oil demand in OECD countries peaked in 2005; however, last year it showed an increase as a result of the decline in the oil price. Who is to say what will happen should prices go down further?
Do you observe a trend of revisions of contracts and fiscal incentives?
Contract revisions, including changes to fiscal terms, are a common feature of the oil and gas industry and they are often triggered by substantial changes in oil prices. Of course, they are not always easy to implement, especially if there are stabilization clauses or if fiscal terms have passed a country’s legislative process. In practice, most modern oil contracts are designed to allow some degree of renegotiation if conditions change significantly.
Usually, high oil prices lead to higher taxes, and, in extreme cases, to expropriation and nationalization as host governments demand a bigger share of the perceived higher profitability of the industry. The latest examples are Venezuela before 2008 and Argentina in 2012. Such developments are most notable in countries where the fiscal regimes are regressive and don’t automatically capture the additional rents accruing from higher prices.
When oil prices are low, there is a limited scope for higher taxation—and we tend to see the opposite, namely a relaxation of the fiscal terms. This reaction is most notable in countries which have been struggling to increase production and attract investment, including those that rushed to tighten their fiscal terms and limit foreign oil companies’ access to their reserves during periods of high prices. In general, low oil prices exacerbate an already dire situation and prompt anxious governments to revise their fiscal terms to stop production conditions from worsening further; Algeria and the U.K. are recent examples.
It is worth noting, however, that host governments’ reactions to lower prices tend to be slower and more erratic than their reaction to higher prices. As ever, generalizations are difficult to make; while the oil price is global, each country has specific conditions that play a role in shaping its policy choices.
Let’s turn to MENA. What are the strategies of Saudi Arabia, Iraq, Iran, Libya and Algeria under these conditions? Can new fields be developed in Israel, Lebanon or Egypt?
The Middle East and North Africa sit collectively on the world’s largest proven oil and gas reserves and on those that are the cheapest to develop and produce. The region includes key members of OPEC, which still supplies more than 40 percent of global oil. A related feature of many of these countries is the significant dependence of their economies on oil and gas revenues.
On an individual level, there are interesting developments which will shape the global oil market.
Saudi Arabia announced earlier this year an audacious economic reform program with its Vision 2030, aimed at diversifying its economy. As part of this plan, the kingdom also announced an IPO for part of its crown jewel, Saudi Aramco, thereby indirectly opening the oil sector to private investment.
Saudi Arabia, already the largest producer in OPEC, and its neighbors Kuwait and the UAE are all producing at record levels, according to the International Energy Agency. A race appears to be taking place between them, Iraq and Iran, in which Iraq and Iran are increasing their share of production within OPEC, which is getting close to that of the Gulf Cooperation Council countries.
Iraq had the world’s largest increase in production in 2015, according to the BP Statistical Review of World Energy. Iran is also expanding its production rapidly to restore it to pre-sanction levels and is hoping to increase it further after its next licensing round, which will see a new type of contract offered. According to Iran’s authorities, this new type of buyback contract, the Iran Petroleum Contract (IPC), will attract significant international interest. In practice, however, it is difficult to judge the competitiveness of the IPC before the “nitty gritty” details of the contracts have even been published.
For North African producers, Egypt is in the best shape compared to its neighbors, with the discovery of Eni’s large Zohr field in 2015 positively changing the country’s outlook. Libya remains entangled with its civil conflict, which severely limits any production expansion despite all the available potential. Algeria seems to have managed to strike a balance, with stable oil and gas production. In reality, however, the country is still waiting to see the much-hoped-for increase in investment and production in conventional and unconventional oil and gas, which it expected following the legislative and fiscal changes introduced in 2013.
For the Eastern Mediterranean region, the picture is more intricate and it is, so far, limited to gas. Lebanon is yet to announce its first licensing round; it’s been delayed on several occasions, largely because of domestic political infighting. The country has not made any discoveries to date. By contrast, Israel has made several large discoveries offshore since 2009; some are already producing for the local market. The development of Leviathan, Israel’s largest discovery, remains uncertain because no final export option has been agreed upon. Recently, Israel announced its first open licensing round; previous licenses were allocated on the basis of direct negotiations.
Hear more insight from Carole Nakhle in this video.
Max Brett is NRGI’s communications officer.