120112 perspectives on gas exports final · 2019. 8. 26. · perspectives on gas exports from...

consulting

busin

ess e

nviro

nm

ent • st

rategy • business improvem

ent • transactions •

Strategy with Substance

Wood Mackenziegas and power consulting

Perspectives on Gas Exports from IsraelDecember, 2011

Perspectives on Gas Exports from Israel

December 2011 Page 1 of 17

1. Introduction

In the last few years the Israeli energy sector has undergone a complete reversal of fortunes. From a situation where the country was largely dependent on imports of energy to satisfy domestic demand, the discovery of large quantities of natural gas in the deepwater Levantine basin has allowed the country to contemplate a level of energy self-sufficiency that had never previously been considered possible. Indeed the scale of discovered reserves as well as the potential for further discoveries has lead to the debate around the potential for natural gas exports.

Since 1999, Israel has seen its upstream industry transformed by the discovery of significant offshore gas fields. Noble Energy discovered the Noa and Mari-B fields in 1999 and 2000 respectively, which had combined reserves of over 1.2 tcf. Although now over 70% depleted, Mari-B has contributed to much of Israel's domestic gas consumption since being brought onstream in 2004. However in early 2009, Noble Energy’s discovery of the Tamar gas field in much deeper waters off the coast of Haifa gave the signal of a new energy future. At 9.1 tcf, Tamar has changed the gas dynamics of the country considerably with sufficient reserves to supply the domestic market for at least two decades. Noble Energy plans to bring the field onstream in 2013 as production from Mari-B, declines. The Tamar discovery was closely followed up by the discovery of Leviathan, which at 16 tcf is almost twice the size of Tamar. These discoveries have proven a new resource play in the offshore Levantine Basin and significant upside exists across the basin.

The scale of the two recent discoveries has also expedited further offshore licensing activity in Israel as well as in neighbouring Cyprus, Lebanon and Syria which share the same basin. However, since Tamar gas could meet the bulk of the domestic market over the next 20 years, the questions surrounding the development of Leviathan and other future discoveries becomes key in defining the future of Israel’s natural gas sector. The country is presented with a significant opportunity associated with gas exports and with the potential for significant exploration in the coming years (around 15-20 exploration wells could be drilled in the next two years) some certainty around the timing and scale of gas monetisation is needed by the industry. Upstream companies are unlikely to invest in further exploration unless they can see how the gas that they may discover will be commercialised.

From a gas infrastructure perspective, the country has seen the development of offshore and onshore infrastructure on the back of the Mari-B discovery and imports from Egypt. Indeed, it is expected that with the growth in supply associated with the Tamar development, further expansions will push gas north and east in the country allowing existing plant conversions to gas and new gas fired plants to be constructed. However as the gas infrastructure develops and Israel’s power sector (and industrial sector) becomes increasingly dependent on gas supplies, the need for flexibility and system security will also become greater. As has been seen with the EMG pipeline in recent months, disruptions to supplies can and do happen and any future gas pipeline system needs to be suitably robust to minimise the risks of catastrophic shortages for the country. While the LNG receiving and regasification terminal, if built, will provide some short term flexibility, in the long term, more infrastructure will be required.

In the context of this seismic shift in the energy resource picture for Israel, the country faces some key challenges in developing a long term, sustainable natural gas industry, namely:

How can Israel realise the country’s full resource potential?

How can Israel ensure long-term security of supply?

How can Israel maximise its income and wealth generation for the country?

How can Israel develop a sustainable export industry?

In this paper we investigate each of these drivers and examine the range of issues which are involved. We consider the experiences of other countries in the form of case studies and examine the implications for Israel with particular focus on the balancing of domestic requirements with export options.



2. The fundamental drivers behind the development of an Israeli gas sector

2.1 Realising the country’s full resource potential

One of the key challenges for any country with indigenous natural resources is to ensure that all commercially exploitable resources are discovered and extracted. In the context of natural gas, this means that the cycle of exploration, development and production must be maintained to ensure ongoing exploration investment. If, for whatever reason, the cycle is disrupted (e.g. the discovered gas cannot be commercially developed and produced) then exploration will decline and investment will slow and eventually stop. As such governments are challenged to ensure that the necessary incentives are in place to ensure continued investment in exploration until the full potential of the resource base is realised.

Since the world for exploration investment is a competitive one, countries must be able to provide international E&P companies with suitably attractive and competitive conditions if they are to attract investment. These will include factors such as fiscal terms, costs, pricing for products and, in the case of natural gas, assured market demand. If these conditions are not competitive and do not provide suitable economic returns then investment in exploration will be directed elsewhere.

The challenge of a large resource base and a small domestic market

Over the last few years, Israel has had considerable exploration success with over 710 bcm of gas already discovered. Combined with a relatively small domestic market demand, the reserve position presents the country with significantly more gas than it is likely to consume in the next 20 years (Figure 1). Add to that the potential for up to a further ~1100 bcm in yet-to-find reserves (based on Natural Gas Authority) and the level of market coverage is even greater.

Leviathan reserves

YTF fields

Tamar reserves

Other discovered prospects

0

200

400

600

800

1000

1200

1400

1600

1800

2000

Demand (2011 - 2030) Discovered f ields

bcm

Figure 1: Expected demand for the next 20 years versus existing and yet-to-find reserves, Source: Demand - Natural Gas Practical Guide, 2011, MNI website, Reserves - YTF figures provided by Yeoshua Stern, Israel’s Natural Gas Authority; other discoveries provided by Delek



However with this success comes a problem. Based solely on the supply of the domestic market there is little incentive for companies to invest further in exploration when any discoveries would be unlikely to see development for 20 or 30 years. Without exploration, no further discoveries can be made and the identified resource potential cannot be realised.

In addition, due to the nature of the existing discoveries (large single fields, over 100 km from shore, over 1300 m of water) a critical level of plateau production is required to ensure economic viability and optimum value creation for both the developers and the government. While the Tamar discovery can likely be developed under a near optimal development and production scenario (as shown below), the Leviathan field or other discoveries are presented with significant challenges if they are to be used to meet additional domestic needs alone.

In the chart below (Figure 2), the domestic demand (base case) is shown along with supplies from fields already in production or under development as well as imports. By the end of this decade demand is expected to exceed existing supplies and new production will be needed. However the initial profile of unsatisfied demand grows relatively slowly from around 0.4 bcma in 2022 to only 5.5 bcma in 2030 and 17.1 bcma by 2038.

0

5

10

15

20

25

2011 2016 2021 2026 2031 2036

bcm

Existing production Field under development Production shortfall

Import Demand

Figure 2: Base case demand and supply

If existing or new discoveries are to be used solely to meet this unsatisfied demand, the slow ramp up in production presents huge commercial challenges for the developer. Such developments require multiple billions of dollars in up front investment and thus require a critical mass of production (and thus revenue) to ensure economic viability. Indeed, with such a slow ramp up in incremental demand, a new project development would likely need to be delayed until the demand requirement increased and a more economic profile of production was achieved. Such a delay would obviously result in a shortfall of supply for the domestic market for a period of time and Israel could found itself in the same situation as it is experiencing today – substantial reserves of natural gas in the ground without the infrastructure or the logistics in place to supply market demand in time.

However, if the domestic market supply is developed in conjunction with exports, the production profile can be brought forward and the economics optimised. This allows a development to achieve critical production levels to ensure economic viability while ensuring that the necessary requirements of the domestic market are met. Indeed such a combined strategy can provide the domestic market with a higher level of flexibility thus enabling greater supply security.

With the objective of continuing to promote exploration and development of gas reserves in a commercially expedient fashion, a policy focused purely on satisfaction of the domestic market presents significant challenges. Not only is the rationale for further exploration activity completely undermined (and thus potential reserves remain undeveloped) but developments of existing discoveries become sub-optimal resulting in considerable ‘value leakage’ for both government and developers. It is estimated that in a scenario where the full potential of the basin’s reserves is achieved, involving exports and domestic supply, the income for the Government through taxation could be over US$100 billion greater than for a pure domestic supply strategy (Figure 3).



Figure 3: Government income comparison (in 2011$), Assuming total estimated reserves of reserves ~65tcf, $5.6/MMbtu domestic price, $7.3/MMbtu for export net back; Long term inflation is 2% nominal

Favourable pricing of gas is a key driver for exploration Assuming that a near term market for potential gas can be identified, then a second consideration for the explorer is the price which can be achieved for the gas in the market. Indeed favourable pricing for gas (both in the domestic market and netbacks from export) can provide a significant stimulus for exploration. In the example below (Figure 4) from Egypt a significant change in the domestic gas pricing policy in 1993 lead to a rapid increase in exploration activity and in the country’s reserve base. Since many of the country’s offshore prospects were sub-commercial under the old pricing regime, a significant uplift in the pricing terms provided a stimulus for new exploration.

Following a significant upturn in exploration success throughout the 1990s, the sanctioning of gas exports via LNG in 2000 created a further stimulus for explorers. The prospect of high netback prices from LNG sales to Europe, allowed exploration to move into deeper water where costs and risks were greater. This expansion of activity resulted in further significant success.

Clearly any development needs a minimum price to achieve a commercial rate of return and the higher the market price the more challenging the potential exploration targets can become. However, within a domestic market, pricing alone is not enough to stimulate investment and drive the exploitation of the country’s resource potential. If the market cannot absorb the gas which has been discovered then the pricing of the gas in that market is largely irrelevant.

Israel’s inputs into the power sector have historically been dominated by imported coal, indeed in 2010, coal made up 65% of electricity inputs. As illustrated in Figure 5, gas priced at $9/mmbtu is still competitive with alternative fuels. Therefore even domestic price that would significantly encourage exploration, the Levantine gas should have a positive impact on the power generation mix.



0.0

0.5

1.0

1.5

2.0

2.5

1980 1985 1990 1995 2000 2005 2010

tcm

Figure 4: Egyptian gas reserves development (Source: BP Statistical Review 2011)

0

20

40

60

80

100

120

140

160

180

200

Gas C

CGT -

$6/m

mbtu

Gas C

CGT -

$9/m

mbtu

Coal

PF

Fuel

Oil C

CGT

Nucle

ar

Offsh

ore W

ind

$/M

Wh

(rea

l 201

1)

Fixed O&M Cost Fuel Cost

Figure 5: Comparative costs for power generation (Source: Wood Mackenzie)

The potentially high netback prices associated with exports (particularly as LNG) and scope for accessing much larger export markets will evidently impact the overall attractiveness of the offshore Israeli sector to potential explorers and developers.

Competition is stimulated by favourable investment conditions Israel is largely dependent on international oil and gas companies to provide the technical capabilities for the exploration and development of oil and gas (i.e. there is no capable state company). A high level of competition between companies can ensure that the most efficient approaches are adopted and that the country itself is able to extract maximum rent from its own resources. If companies can see the potential for making significant hydrocarbon discoveries and the ability to commercialise those discoveries such that they can make a favourable rate of return then the more likely they are to wish to actively compete for a position.

If we compare the experiences of Bangladesh and Western Australia (Figure 6) over the last ten years it is clear that the ability to make significant discoveries and commercialise them has had a significant impact on the level of activity in a particular country. While it is perceived that Bangladesh has a relatively high potential for new gas discoveries at relatively low cost (most prospects are onshore) the low prices paid for gas in the domestic market and a restriction on exports means that few companies are interested in taking acreage and exploring. As such the country has seen the number of companies involved in exploration actually decline and those that are there have done only limited amounts of exploration.



0

20

40

60

80

100

120

140

2000 2003 2006 2009

Num

ber o

f act

ive

com

apni

es

Bangladesh W. Australia

Figure 6: Comparison of company participation in Bangladesh and Western Australia

Conversely, in Western Australia, despite the relatively high costs associated with deep water exploration, the number of companies involved in the sector has increased significantly over the last 10 years and it is generally perceived as being one of the global “hotspots” for gas. The considerable exploration successes that have been achieved along with the prospects for developing new or Brownfield LNG export projects has increased the level of interest dramatically. In the last decade we have seen the proposal of numerous new LNG projects and the sanctioning of some major LNG endeavours such as Pluto, Gorgon, Wheatstone and Prelude. Australia is seen as a place where new projects can be moved forward and where the industry can make a favourable return on a large scale. Indeed, with much of the prospective acreage now under licence one of the challenges for potential new entrants into the Western Australian exploration sector is actually finding quality positions which can be acquired. Most companies involved do not wish to sell down.

Indeed, Israel itself has experienced the impact of exploration risk reward balance decisions. In January 2007, despite having identified a number of large prospective structures (including Tamar), BG decided to relinquish its position offshore. They had previously tried to relinquish part of their share by approaching 120 companies but did not get any interest. Although the geology was considered favourable, the conditions for the monetisation of any gas discovered (market scale and pricing) were seen as insufficiently attractive to warrant the exploration investment. And even today, despite the recent successes, many in the E&P market consider the risk reward balance in Israel to be less favourable than alternatives, in part due to geopolitical concerns but also due to the transparency and stability of the country’s natural gas policy, and in particular, its position on exports.

It is therefore evident that in order to maximise the level of competition in the market, the global E&P sector needs to see the prospects for the discovery and commercialisation as favourable versus other countries. Without the option of exporting gas from Israel, it is hard to see how the sector would be able to attract further companies to explore. Indeed, while many companies are extremely interested in the potential of the Levantine Basin, they may look to other countries such as Cyprus and Lebanon to fulfil their ambitions if Israeli exports are significantly restricted or prohibited.

2.2 Managing domestic gas demand and security of supply

With the discovery of significant amounts of natural gas offshore Israel, the primary challenge for the country is to ensure that this considerable resource provides the country with an appropriate level of long term fuel security while at the same time allowing the whole gas industry to grow and develop. The development of a large natural gas sector can provide considerable flexibility to the domestic market and thus enhance overall supply security.

However, it should be noted that gas in the ground (even discovered reserves) does not necessarily provide a country with supply security. Since the timing of its development cannot be guaranteed, due to factors such as project economics, corporate priorities, etc., there is significant potential for periods of shortfall. To ensure supply security developers need to have the necessary incentives to ensure timely exploration and development of reserves.



Meeting the domestic requirement for gas Around the world certain countries have developed specific policies to ensure sufficient supplies of gas continue to be available to underpin long term energy security and economic development. The challenge, however, has always been to ensure that while the domestic market has the necessary supplies of gas it needs, further exploration and development of the country’s resource base is incentivised.

From the chart below (Figure 7) it is evident that there have been varying degrees of success in managing this balance. While some countries have been highly successful in ensuring overall security of supply, others such as Egypt have found themselves exposed. In order to demonstrate some of the lessons learned from different countries we have highlighted a number of country case studies.

Bangladesh

Egypt

Norway

W. Australia

Nigeria

AlgeriaNetherlands

Realised resource development

Secu

rity

of s

uppl

y

Note: Illustrative based on Wood M ackenzie Analysis

Figure 7: Success in ensuring security of supply versus realised resource development

Bangladesh In 2000, after a number of significant gas discoveries, Bangladesh had proven gas reserves of 14.5 tcf and had an R/P ratio of over 38 years (domestic consumption of around 1.1 bcfd). Based on Petrobangla’s own view of gas demand, the country had supplies to cover around 18 years of demand (WM view at the time was 22 years). The IOCs (in particular Unocal and Shell) put significant pressure on the government to consider allowing exports. The country had considerable resource potential but with 20 years of domestic demand covered there would be no incentive for additional exploration unless alternative markets could be sought (e.g. India). In 2002, the Government eventually decided that it would not allow exports unless indigenous domestic proven reserves covered 50 years of domestic demand. In addition, the government set a low domestic gas tariff and limited prospects for any increases. As a result, Shell pulled out of the country in 2003 citing inability to export as one of the reasons. Exploration activity declined and reserve additions since 2001 amount to only 270 bcf. Since then, reserves have declined steadily as demand has increased and, unbelievably, a proposal for LNG imports is now being considered.

While the industry still believes Bangladesh has considerable upside for exploration, the combination of limited domestic market demand, a ban on exports and low domestic gas pricing suggests that there will be little investment until something changes.

Egypt After having evaluated potentially significant reserves of gas, the government changed the pricing of domestic gas in 1993, linking it to the oil price, and changed the fiscal terms for gas. This resulted in a significant uptick in exploration for gas and a rapid expansion of the gas reserve base from 12 tcf in 1993 to over 45 tcf by 2000. In 2000, the government proposed a policy allowing one third of the reserves to be exported, one third to be allocated to the domestic market, and one third to be kept as strategic reserve. In 2000 and 2001, two separate LNG export projects were sanctioned committing around 15 tcf to the export market thus, consistent with the policy. Furthermore, a large industrial sector dependent on cheap subsidised gas developed throughout the years. However, despite some exploration success during the following few years (particularly in deep water), the string of new discoveries began to dry up. Cognisant of the large



and growing indigenous demand, by late 2007, the government placed a moratorium on new export projects. It is however expected that there will be a domestic supply shortfall by the end of the decade.

Despite warnings by the industry, the state gas company was overly optimistic in terms of the expectations of future gas discoveries. While two thirds of the discovered gas were retained for the domestic market, the low cost of gas to industry stimulated significant demand growth (industry weaned on cheap gas) which rapidly consumed the dedicated reserves. Without further exploration success the reserve base began to fall and the country may have to consider imports by the end of the decade.

Netherlands In 1959, following the discovery of the enormous Groningen field, the Dutch government established a policy (the Small Fields Policy) where new discoveries were given priority access to the market with gas sold to Gasunie at the going market price (based on alternative fuels). This policy stimulated exploration and development of new fields and used the extremely low cost Groningen field as the balancing producer. The Small Fields Policy stimulated exploration, allowed gas fields to be produced in a way that maximised value for the developers and allowed gas to be exported into other European markets. As a result, the Netherlands has managed to retain a large strategic reserve for the last 50 years and produce it in a measured way while the use of alternative fuels for the pricing of gas stimulated the development of a robust infrastructure system in both the domestic market and beyond.

Western Australia (WA) Western Australia’s R/P ratio is currently nearly 60 years, but exploration continues with material discoveries being made annually. Domestic demand was historically limited (< 10 bcma) but has grown as the mining and minerals sector has expanded during the last decade. To some extent, domestic growth has also been constrained by a lack of available supply, as players couldn't develop gas purely for the local market given the limited market size, the lower netbacks than from LNG and the scale/cost of their large offshore discoveries. To monitor security of supply, the WA government introduced a small domestic market obligation (DMO) on (most) LNG export projects. As part of the process of securing export approval for the LNG Project, the producers have to ensure that circa 15% equivalent of LNG feedgas would be sold into the local market (assuming that the project is commercially viable). In order to provide the suppliers with some flexibility, they can also meet their DMO in “kind” by:

Investing in new shale / tight gas developments

Investing in domestic gas targeted exploration

Investing in new domestic gas storage

Providing 3P access to gas gathering and processing infrastructure

As a result of this policy, players have remained incentivised to explore for additional gas/develop existing reserves as they can still pursue LNG as their primary focus, while maintaining gas supply to the growing local market. The fact that several LNG projects are now being built in parallel creates the possibility of potential oversupply in the local market, particularly if demand comes under pressure. However, the government is prepared to work with the producers to ensure the timing of supply is appropriate for the market demand and does not impose undue commercial hardship.

The key lessons from these case studies suggest that it is possible to manage domestic demand while ensuring that exports provide the necessary incentives for further exploration and realisation of a country’s full resource potential. A focus on the domestic market alone (without exports) can be devastating for ongoing exploration (as was seen in Bangladesh) but the allocation of gas to exports needs to be managed in co-operation with the industry to ensure long term domestic supplies are adequate. It should be noted that while there are generally no restrictions on the export of gas in most OECD countries, the countries where domestic supply security is actively managed (e.g. Canada), the approach is one of monitoring rather than actual restriction.

Infrastructure development to ensure supply security Israel has seen the development of offshore and onshore infrastructure on the back of the Mari-B discovery and with the Tamar development, the facilities of 'Yam Thetys' will be upgraded to carry over 10 bcma. As such most, if not all, of Israel’s gas requirements will be dependent on one single receiving point. As has been seen in the past, a lack of flexibility within a country’s infrastructure can have catastrophic effects if there is a failure. In 1998, in Victoria, Australia, the Longford gas plant exploded and cut off supplies from the Bass Strait. Since Longford was the only point at which Bass Strait gas was brought ashore the explosion shut down all production and customers throughout the whole state of Victoria and 1.8 million households found themselves without gas for over 3 weeks.

A policy encouraging both the development of exports and the supply of domestic gas in tandem can, however, enhance the integrity of a country’s overall domestic infrastructure through:



increasing the number of supply points (field developments) and the number of landing points

promoting the development of larger projects with larger infrastructure thus providing greater absolute flexibility

greater levels of interconnection between pipelines and development of offshore and onshore storage

With a focus on satisfying the domestic market only it is difficult to envisage the development of anything more than a larger version of the existing system with more gas flowing through Mari B and landed in the south of the country.

If Israel is to become heavily dependent on the supply of gas from offshore, any future gas pipeline system needs to be suitably robust to minimise the risks of catastrophic shortages for the country. The development of exports can incentivise the investment of the industry in key pieces of infrastructure (on a commercial basis) such as a pipeline connecting offshore fields to the north of the country and LNG storage tanks which provide potential short term security in the event of a disruption. Without the development of exports it is difficult to see how any of this could be successfully achieved on a commercial basis.

Industry collaboration Collaboration with the Upstream Industry is key in achieving security of supply for the domestic market. Since Israel has no state oil company, it is wholly dependent on the industry to provide the necessary commitments and safeguards to ensure that the domestic market requirement is met from offshore production both safely and reliably. It is therefore imperative for long term supply security that the government and industry are clearly aligned in this primary objective.

For this to be the case, the government must be able to demonstrate to the upstream companies the commercial value of being involved in the development of the country’s gas sector – from the development of smaller fields to the construction of supporting infrastructure. However, without exports it is difficult to envisage how a compelling investment strategy could be presented.

In addition, the industry is vital in helping the government manage the balancing of reserves between exports and the domestic market and understanding the risks of future exploration. In Egypt, the failure of EGAS to heed the warnings from the industry regarding future exploration potential was undoubtedly a factor in the expected shortfalls of later this decade. A close relationship with the industry would have allowed them to take a more conservative approach to balancing the future domestic market.

2.3 Maximising income and wealth generation for Israel

With the discovery of large gas reserves offshore, not only has Israel the opportunity to develop considerable levels of energy self sufficiency but it has the potential to create significant government revenues and wealth within the economy. While such wealth generation would seem prime face to be nothing but positive for the country, the experiences of other countries provide some salutary lessons around the management or mismanagement of the opportunities that a fledgling gas sector presents. In the following section we examine the main areas for potential wealth creation and examine some of the potential pitfalls.

Generation of tax income The development of a large offshore gas sector has the potential to generate significant income for the government through direct taxation. Indeed the implications of including exports would have a considerable impact on the potential value generated for the Treasury. In the example used in Section 3.1, we examine the government income created for Israel under a Domestic Only supply view and for a combined LNG and Domestic option. While in both cases the net impact on value is considerable. From a government take perspective the income for the Government through taxation could be over US$100 billion greater than for a pure domestic supply strategy. In addition the percentage of Government take is higher in the export option since the profitability is greater. From a direct taxation perspective, the development of an export industry is clearly better but there are some country experiences which suggest that management of any income from petroleum profits needs to be closely monitored.

In the Netherlands the massive increase in gas related income resulted in an effect referred to as “Dutch Disease”. The increase in revenue from natural resources boosted the nation's real exchange rates, resulting in domestically produced products/service becoming less competitive and thus less exportable and the labour force and capital to migrate to the booming sector.

In other situations, less developed economies, inactive government has resulted in reforms being neglected as limited effort is needed to generate large incomes for government. This proves hugely impactful when reserves start to deplete and government income declines.



These risks are known to lead to the “resource curse” where growth in natural resource revenues leads to a decrease in overall growth. However, dollars in the bank are worth significantly more than cubic feet in the ground and most developed countries have found ways to insulate their economies from the downside of resource based revenues:

Norway has successfully implemented a sound monetary policy, open trading and investment regimes and has experienced growth in all sectors and is now one of the richest country in the world on GDP per capita basis

The Netherlands suffered a decline in manufacturing exports in the 1970s when resource extraction was at its strongest however, when resource exports fell the manufacturing sector rebounded. The economic performance of the Netherlands was also strong compared with that of the OECD countries over subsequent years

In Australia, although, the non-mining private sector’s growth has been sluggish, overall, the impact on employment and businesses has been significant and the public sector has been able to compensate for the slow down in the non mining sector. Furthermore, many argue that Australia is experiencing necessary structural change in the economy i.e. by diversifying away from lower margin industries which can not compete against China

Overall, developing countries are more commonly affected by the “Resource Curse” than developed countries and Israel can protect itself by putting in place strong education policy and regulatory reform and by investing in sufficient long term projects that would pay off once the resource export declines.

Promotion of low price gas based industries or social policies With the discovery of large gas resources, many countries have seized the opportunity to provide the domestic market with low priced gas, as an effective subsidy to both the residential/commercial and/or industrial sectors. This has often been carried out in combination with higher value exports, with the exports providing the commercial support for the development of the country’s resources. But while this can have some positive near term effects the long term implications can be potentially detrimental to the country’s economy. In this section we examine the experiences of two countries, Egypt and Saudi Arabia and consider the lessons and implications for Israel. Egypt As a large gas resource holder, Egypt utilised relatively low cost supplies (supported by additional government subsidies) to provide the residential, commercial and industrial sectors with low price gas. This was driven by a number of factors:

Enhancing the competitiveness of its export industries in international markets

Promoting industrial development and employment

Reducing dependence on imports of fuel (particularly oil)

Making energy more affordable for everyone

While the policy was successful in achieving some of their initial objectives, there were some major downsides. As a result of the low price gas, gas-based industries flourished and demand rose dramatically. Electricity consumption also saw considerable growth. In effect a large part of the Egyptian energy sector had become ‘hooked’ on low cost gas which drove demand and, with a decline in exploration success post 2003, reserves began to decline. The current prognosis is that the domestic market will start to go short off gas by the end of the decade.



0

5

10

15

20

25

30

35

40

4519

91

1996

2001

2006

Natural gas dem

and (bcm

)

Fuel Inputs to Electricity Industry

Transport RCA

Figure 8: Egyptian natural gas (Source: IEA)

-160,000

-140,000

-120,000

-100,000

-80,000

-60,000

-40,000

-20,000

-

20,000

1991

1996

2001

2006

Rea

l Egy

ptia

n £

Net Govt. Balances

Figure 9: Egypt net Government balance (Source: Central Bank of Egypt)

In addition to the somewhat ‘artificial’ growth in gas demand driven by cheap gas, the Government was also experiencing considerable pain in terms of its balance of payments. With a decline in oil revenues, the cost of government subsidies in the gas sector (and indeed other parts of the energy sector) was beginning to have a massive toll on the economy.

Saudi Arabia Saudi Arabia is pursuing an aggressive development plan for its industrial sector. This will encourage continued expansion or new refinery projects in new economic zones and plans for 12 new specialised industrial cities, such as the King Abdullah Economic City. Despite relative diversification, the current structure of industry will continue to be dominated by basic industries including petrochemicals, plastics, minerals and basic metals. Saudi Arabia Basic Industries Corporation (SABIC) is the world’s second largest ethylene producer and is also one of the world’s largest chemical, fertiliser, plastics and metals producers. Its dominant position as a petrochemical producer is the result of access to cheap oil and gas feedstocks, supplied by Saudi Aramco. Gas into industry has experienced growth of around 14% per annum over the last decade and has been driven by the petrochemicals sector.

Indeed, petrochemical producers enjoyed ethane prices of US$0.75 per mmbtu. This rapid development supported by very low feedstock prices has been putting enormous pressure on other petrochemical producers around the world. Furthermore, the Middle East countries have logistical advantage with regard to Asia and China, which are the fastest growing petrochemical consumers. Although the cost of ethane is set to increase to $2/mmbtu by 2014, any price increase is likely to allow Saudi petrochemical products strong competitive advantage to be maintained.

Although developing industries centred around low cost gas feedstocks perhaps may appear attractive to Israel, there are considerable downsides. While these industries may initially be competitive, as gas reserves dwindle and the cheap gas supplies are no longer available, their outlook has to be questionable. While employing large numbers of people in these subsidised industries is one way of reducing unemployment, there are significant issues around their long term sustainability.

While it could be commercially viable for Levantine gas to supply the indigenous petrochemical/fertilizer industries which meet domestic demand, industries centred on cheap indigenous gas and focused on export would experience severe pressure from global competition. Indeed, industrials in the MENA region enjoy low gas feedstock prices ranging from US$0.75/MMBtu to US$2.35/MMBtu, low or no tax and low labour costs. Israel will have to evaluate the opportunity cost in the development of any industry based on gas. While one can secure LNG netbacks of >$7/mmbtu, methanol netbacks are typically around $4.50/mmbtu. Also, it can not be determined that methanol industry will necessarily create more employment than the development of an LNG terminal: at the peak of its construction, Qatar was employing around 100,000 people to build its LNG facilities.

Exploitation of the ‘multiplier’ effects



While the direct income from taxation of gas profits can be clearly evaluated, the additional indirect multiplier effects that the oil & gas industry has on other economic activity can be significant. Industries and services which are developed to support the oil and gas sector can have a significant impact on local and country level economics.

Some countries have placed considerable emphasis on these multiplier effects. Indonesia, for example, requires the participation of a local contractor in the development of any fields (including construction of offshore facilities) as well as support in community development programs which are aimed at enhancing the surrounding community’s access to better social and economical conditions. It has also established offshore support bases which host a wide variety of support services to the offshore industry and has encouraged job creation and specialised training of local staff.

The approach of a country with regard to the development of associated support industries and employment will depend on the country’s current economic situation and objectives:

Is large scale employment an important goal for the development of a gas sector?

Does the country have the necessary skills to provide the necessary support industries?

Does it have a desire to develop new capabilities (e.g. heavy engineering)?

Does it see the need for promoting the sector to support social projects?

The upstream industry is typically not a particularly labour intensive industry per se; however the businesses which it can support can provide considerable employment and value creation opportunities.

However, the scale of the multiplier effects is largely dictated by the level of activity within the industry. If exploration and development activity is maintained at a relatively high level, as would be the case with a combined domestic/export strategy, then support industries can be developed to support this. But with a strategy focussed only on domestic demand the level of activity is likely to be sporadic and subsequent development of support and associated industries will be limited.

2.4 Developing a sustainable gas export industry

If Israel is to consider the development of gas exports then it faces certain challenges in making this a successful and sustainable business that realises the full potential of the country’s resources. In many respects the decision to export is relatively simple, while the question of how to achieve it is much more difficult. While natural gas has become increasingly global in the last 20 years, gas is not a commodity and requires consideration of the full value chain when considering monetisation and maximisation of value. In establishing an export business there are some key questions for Israel to consider:

How much gas is needed to develop a gas export business?

The amount of gas required to support export really depends on the nature of the monetisation option and the export markets being targeted. If the export involves a short pipeline to a neighbouring country then relatively small volumes can be considered (e.g. as has been the case with the EMG line from Egypt to Israel) since the capital costs may be relatively small. However, since it is unlikely that Israel would seek to export significant volumes of gas to its immediate neighbours (other than perhaps small volumes to Jordan and the Palestinian authority), then the most likely scenario for exports from Israel is as Liquefied Natural Gas (LNG).

One of the key features of the LNG business is the level of capital which is required throughout the value chain. A typical world scale project could have capital costs of over US$20 billion and there are many projects in development and proposed where the costs will be considerably higher. The cost of liquefaction is a significant proportion of this and as such adds significantly to the landed cost of the gas (possibly US$3-4/mmbtu). As a result it is extremely important that the development of liquefaction capacity is optimised to ensure this cost is kept as low as reasonably possible. As such developers typically look for projects where economies of scale can achieved and the value maximised.

Over the last few years a number of developers have taken Final Investment Decision (FID) on new Greenfield LNG projects. Bar a couple exceptions, most of these have followed a relatively consistent template of a two train facility with total capacity of around 7-10 mmtpa. Indeed in the last three years, 7 onshore projects have taken FID, 5 of which were two train facilities with total capacities of 7-10 mmtpa. The primary reason for this has been the desire to balance maximum cost efficiencies in liquefaction (and upstream) along with the ability to find buyers for the bulk of the LNG in the global marketplace.

The cost of storage and loading infrastructure has traditionally been the reason that many small-scale LNG export projects (i.e. less than 2.5 mmtpa) have struggled to demonstrate commercial viability and LNG buyers and financiers remain reluctant to back these proposals for fear of cost over-runs and risks to delivery. Since these costs are relatively



fixed irrespective of the project size, the larger the project the better the economies of scale. This also applies, albeit to a lesser extent, to the gas treatment and fractionation costs (Figure 10). The smaller-scale Donggi Senoro LNG facility (1 train, 2 mmtpa) in Indonesia is an example of this principle. At US$1,400/tonne for the LNG plant, it is at the higher-cost end for LNG facilities currently in the construction phase.

Utilities20%

Liquefaction14%

Refrigeration28%

Offsites (storage,

loading, flare)27%

Fractionation1%

Gas Treatment7%

Site preparation3%

Figure 10: Typical breakdown of LNG plant capex (source: KBR)

If Israel is to export gas then it is likely that the most flexible and lowest risk option will be to convert the gas to LNG and ship it to markets in Europe and/or Asia. While small scale projects (



Firstly, the supply project needs to have all the required gas committed to the project (and potentially more than enough) for 15-20 years. If there is a question that the gas might not be available to the buyer under the contractual agreement then this will present a significant concern

Secondly, the project needs to be commercially robust under a variety of economic conditions. If the project is marginal then there is a danger that the developers may not deliver on their commitments if the project economics become challenged. In this respect, buyers will likely feel more comfortable buying LNG from a larger two train facility which potentially has better economics and provides a degree of flexibility in the event of a disruption at one train

Thirdly, the project developers must be perceived to be capable of delivering the project. The Asian buyers place a great deal of store in their relationships with the major LNG players and as such are more comfortable if those players are backing a project. While new companies have been able to develop relationships with some of the buyers there is always a preference for the “tried and tested” relationships

And fourthly, the supplier will be perceived favourably if he can provide the buyer with offtake flexibility e.g. destination flexibility, delivery timing, interim supplies, etc. In markets such as Japan and Korea, the buyers have increasing levels of uncertainty around future requirements for LNG and as such need future contracts to reflect this uncertainty with flexibility provisions

While there are other factors which concern a potential buyer (e.g. political risk of supply country, technical challenges, etc.), the four main qualitative elements defined are balanced with pricing to secure new long term contracts. If a supplier can offer all of the above then he is likely to be able to secure premium pricing, if not then it is likely he will face pressure for price reductions (if he is considered by the buyer at all).

From an Israeli perspective, the securing of premium pricing and thus the maximisation of project value will involve presenting the most credible project possible for the potential buyers. That means offering a project which can address their concerns over security of supply as well as their need for ongoing flexibility. While the export of gas can help Israel realise the full potential of its resources, it should be noted that the global gas (and in particular LNG) market is still highly competitive and securing long term export contracts is neither simple nor easy. Based on the expected global demand for LNG and possible supplies it is clear that there is indeed a window of opportunity for new suppliers: prior to 2017/18 the level of competition is relatively low. However from 2018 onwards the number of potential suppliers increases significantly and as such the competitive dynamic for selling long term volumes increases (see Appendix).

3. Conclusions and Implications for Israel

Israel is clearly in a very fortunate position with regards to its existing and potential gas resources which lie offshore. Within the world of natural gas there are few frontier basins which show the kind of untapped potential that is presented by the Levantine basin and as such there is the potential for significant investment by the international energy industry. Discoveries on the scale of Tamar and Leviathan are extremely rare in the current global E&P business and represent some of the largest discoveries (of either oil or gas) in recent years anywhere around the world.

Israel’s current (and potential future) reserves are so significant that the country has come to an important crossroads: to keep the gas for the domestic market or to follow a tandem strategy of domestic supply and exports. Both options present significant benefits and potential issues but it is the weighting and balancing of these factors which will provide Israel with the most appropriate way forward.

In a “Domestic Only” scenario, the country will be presented with the opportunity to provide security of gas supply for generations to come assuming that domestic pricing is sufficient to support their commercial development. However, there will be a number of potential downsides for the overall development of the industry:

It is likely that, with no near term market supply opportunity, exploration will effectively cease and development activity will focus only on one or two specific fields

As a result, competition in the upstream industry will be very limited, development activity will be dominated by a small number of players and Israel natural gas infrastructure will be sub-optimal

With relatively slow incremental growth in demand (due to the size and maturity of the Israeli energy market), the development of Leviathan will likely need to be postponed until sufficient demand will allow a commercial development to proceed and as a result the local demand will face periods of shortfall



The income to government through direct taxation will be significantly less than would be possible. In addition, it is unlikely that a material support industry could be developed

The development of a robust pipeline system is unlikely to be commercially viable. The most likely outcome will be a scaling up of the existing system presenting considerable supply security risk.

In a scenario where exports are developed in tandem with meeting the domestic requirement for natural gas, considerable benefits can accrue to Israel:

Access to export markets and netback pricing providing considerable incentives for further exploration and for the development of existing discoveries

The stimulation of competition in the natural gas sector ensuring that the most efficient approaches are adopted to develop the country’s reserves

The establishment of large and robust natural gas infrastructure facilities that would minimize the risk of shortfalls to the Israeli market and create stability and redundancy in the system

The creation of significant government revenues that could amount to more than $100 billion and the distribution of wealth within the economy that would significantly enhance Israel strategic position

Development of an investment environment in the highly prospective Levantine Basin which is attractive to international E&P players and competitive with other opportunities around the world

While the benefits of an integrated strategy of exports and domestic supply creates considerable advantages for the successful development of Israel’s gas sector, it is worth noting that the gas export business (and in particular the global LNG business) is highly competitive. Many new LNG projects are being brought to market each year and the longer that Israel takes to come to market the higher the potential level of competition from other countries.

Appendix – Global LNG Market Summary

In order to help the committee address the geopolitical aspect of exporting natural gas, we hereby add some additional global and Middle Eastern information. This information might help the committee assess the global LNG market dynamics by addressing the demand for LNG which is not yet covered by some form of LNG contract. This is effectively the portion of demand which is still contestable and which potential suppliers are competing to supply with long term contracts. In the chart below (Figure 11) we highlight the global uncontracted demand by country.

Asia-Pacific region will clearly drive the global LNG demand growth story in the coming decade. Key countries which will contribute to this growth include the traditional LNG buyers i.e. Japan, Korea Taiwan, China and India.

The Fukushima crisis has undoubtedly led to a significant increase in LNG demand in Japan. Wood Mackenzie estimates uncontracted LNG demand in Japan at 61 mmtpa by 2025, which is approximately 30% of the global uncontracted LNG demand

LNG demand in India has been showing a substantial growth, post reservoir performance issues and production problems at one of their major gas producing fields, Dhirubhai in KG basin. However, the price sensitive behaviour of buyers has led to increased dependency on spot/short-term imports. Long-term import volumes into the country have not increased in tandem with demand, resulting in uncontracted LNG demand of 30 mmtpa by 2025

China is the engine of global economic growth today and LNG demand in the country has been soaring over the past few years. Though China has already tied-up 35 mmtpa volumes on long-term basis, Wood Mackenzie estimates further uncontracted LNG demand at 23 mmtpa in 2025



-100

-50

0

50

100

150

200

250

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

mm

tpa

Japan India China South KoreaOthers - Asia Pacif ic France UK Others - EuropeMiddle East South America Afirca North America

Figure 11: Uncontracted LNG demand by Key Countries

In addition to the traditional LNG importers, new emerging buyers (including Singapore, Thailand, Pakistan, Indonesia, and Peninsular Malaysia) will also contribute to the growing uncontracted LNG demand in Asia Pacific.

European countries have currently over-contracted LNG and will require additional volumes only towards the end of this decade. Overall uncontracted LNG demand in Europe is estimated at 63 mmtpa in 2025, which is equivalent to the uncontracted LNG demand of Japan alone. France and UK will account for more than 55% of this uncontracted LNG demand.

The Middle-Eastern, South American and African countries will continue to import small volumes of LNG. Wood Mackenzie does not envisage these regions to play a bigger role in LNG imports.

0

50

100

150

200

250

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025

mm

tpa

Japan India China South KoreaOthers - Asia Pacif ic France UK Others - EuropeMiddle East South America Afirca

Figure 12: Uncontracted LNG supplies relative to demand



In terms of new supply which has not yet been contracted, it is clear that the global market is relatively balanced out to 2017/18, i.e. most of the global LNG demand has been contracted. After that the level of competition increases significantly with a range of potential projects vying to supply the uncontracted market. As the levels of demand increase post 2018, the level of competition increases from potential projects from a wide range of countries. By 2020, there is estimated to be twice as much potential supply as there is uncontracted demand implying that more than half of these supplies will have to be deferred (since supply will always meet demand).

From a competition perspective, the most significant challenge to Israeli LNG from a volumetric perspective is the next wave of new LNG supply which can come from Australia. In addition to conventional LNG developments (e.g. Gorgon, Gorgon Expansion, Wheatstone, Ichthys), uncontracted volumes in Australia will also come from CSG to LNG projects (QCLNG expansion, APLNG) and floating LNG projects. Wood Mackenzie estimates Australia could contribute more than 75 mmtpa uncontracted LNG supply in 2025, which represents over 40% of global uncontracted demand.

As well as the established supplier countries such as Australia and Nigeria, there are a number of new players which are vying to access the market. Countries such as Tanzania, Mozambique and indeed exports from the US present potential competitive threats to Israel. Indeed, while Israel’s neighbours Cyprus and Lebanon may be behind in the process of exploration and appraisal, if they have future discoveries in the Levant basin it is highly likely that they will look towards LNG exports if the reserves are significant enough.

Without doubt, there is a window of opportunity for Israel from around 2017/18. The longer Israeli LNG takes to come to market the greater the likely competition from other countries.

Reference

Hans Zayed (2011), Natural gas in the Mena region, RBS, www.rasmala.com/equity_report/Mena_Strategy_14Oct11.pdf

Paul Bloxham (2011), Does Australia have a resources curse?, HSBC Global Research

Giles Farrer, Andrew Pearson (2011), Smaller scale liquefaction – Still a lot to prove, Wood Mackenzie LNG Service

Western Australia DomGas Alliance (2010), Domestic Gas Action Plan: Submission to the State Energy Initiative

Western Australia DomGas Alliance (2011), Meeting Domestic Gas Obligations

Theresa O. Okenabirhie (2010), The Domestic Gas Supply Obligation: Is this the final solution to power failure in Nigeria? How can the Government make the obligation work?, University of Dundee

Chemical Intelligence (2009), Middle East Petrochemical Development, Oil and Gas Journal

Robin Wigglesworth (2011), Bullish Saudi petrochemicals eye M&A, Financial Times

John Richardson (2011), Saudi Ethane Prices Set To Rise To $2/mBTU, ICIS, http://www.icis.com/blogs/asian-chemical-connections/2011/02/saudi-ethane-prices-set-to-ris.html

Wood Mackenzie Disclaimer

The information upon which this report is based has either been supplied to us by Delek or comes from our own experience, knowledge and databases. The opinions expressed in this report are those of Wood Mackenzie. They have been arrived at following careful consideration and enquiry but we do not guarantee their fairness, completeness or accuracy. The opinions, as of this date, are subject to change. We do not accept any liability for your reliance upon them.

120112 perspectives on gas exports final · 2019. 8. 26. · perspectives on gas exports from...

Documents