The hunt for WMDs in the oil price process

Review: Saudi Arabia: On top, but not settling for it

Is a talent shortage set to hold back the LNG industry?

Edition Seventeen – August 2013

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Issue 17 – August 2013

OilVoice Acorn House 381 Midsummer Blvd Milton Keynes MK9 3HP Tel: +44 208 123 2237 Email: press@oilvoice.com Skype: oilvoicetalk Editor James Allen Email: james@oilvoice.com Director of Sales Terry O'Donnell Email: terry@oilvoice.com Chief Executive Officer Adam Marmaras Email: adam@oilvoice.com

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Adam Marmaras

Chief Executive Officer

Welcome to the 17th edition of the

OilVoice Magazine. This month we have articles from Gail Tverberg, David Bamford, Eoin Coyne, Liz Bossley, Peter Jackson, Richie Etherington, Ilda Sedja and Andrew McKillop. In July we had a total of 13 different writers write articles for OilVoice which is our biggest selection yet. If you like what they have to say, please take a moment to visit their website or blog too. If you have a Twitter account, then have you subscribed to our feed yet? You will receive breaking oil and gas news to your smartphone or tablet as it happens. Over 5400 people already subscribed, and we invite you to too. It's completely free, and easy to set up. Simply visit Twitter.com/OilVoice to get started. Hope you're enjoying the summer. Happy reading Adam Marmaras CEO OilVoice

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Contents

Featured Authors Biographies of this months featured authors 3 Inflation, deflation, or discontinuity? by Gail Tverberg 5 Recent Company Profiles The most recent companies added to the OilVoice directory 13 Oil net long going short by Andrew McKillop 14 Oil and gas M&A in Q2 2013 reaches just $23.6 billion by Eoin Coyne 19 The hunt for WMDs in the oil price process by Liz Bossley 22 Is a talent shortage set to hold back the LNG industry? by Peter Jackson 25 Review: Saudi Arabia: On top, but not settling for it by Richie Ethrington 28 Middle Eastern tailwinds for the oil risk premium by Andrew McKillop 31 Insight: Better seismic data by David Bamford 39 Insight: Beyond exploration! by David Bamford 40 Implications of the Arab Spring on the MENA Oil Market by Ilda Sedja 41

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Featured Authors

Andrew McKillop

AMK CONSULT

Andrew MacKillop is an energy and natural resource sector professional with over 30 years’ experience in more than 12 countries.

Gail Tverberg

Our Finite World

Gail the Actuary’s real name is Gail Tverberg. She has an M. S. from the University of Illinois, Chicago in Mathematics, and is a Fellow of the Casualty Actuarial Society and a Member of the American Academy of Actuaries.

Eoin Coyne

Evaluate Energy

Eoin Coyne is an analyst at Evaluate Energy.

David Bamford

Finding Petroleum

David Bamford is 63. He is a non-executive director at Tullow Oil plc and has various roles with Parkmead Group plc, PARAS Ltd and New Eyes Exploration Ltd, and runs his own consultancy.

Liz Bossley

The Consilience Energy Advisory Group Ltd.

Liz has a 30 year career in international energy markets, spanning trading and marketing, management of marketing departments and extensive experience of negotiating transportation, lifting and joint venture agreements.

Richie Ethrington

Finding Petroleum

Richard Etherington, 24, works as a freelance journalist. Richard, a BA Hons Political Science graduate, is also a fully trained sub-editor and reporter.

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Peter Jackson

Lockton

Peter started working at Lockton in November 2012 and has 9 years’ experience in the insurance industry with Aon, Bupa and RSA, having worked for KPMG previously. He is responsible for revenue growth for Lockton in Singapore and development of multinational clients in Asia region.

Ilda Sedja

Evaluate Energy

Ilda Sedja is an Energy Analyst at Evaluate Energy.

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Inflation, deflation, or discontinuity?

Written by Gail Tverberg from Our Finite World

A question that seems to come up quite often is, “Are we going to have inflation or deflation?” People want to figure out how to invest. Because of this, they want to know whether to expect a rise in prices, or a fall in prices, either in general, or in commodities, in the future. The traditional “peak oil” response to this question has been that oil prices will tend to rise over time. There will not be enough oil available, so demand will outstrip supply. As a result, prices will rise both for oil and for food which depends on oil. I see things differently. I think the issue ahead is deflation for commodities as well as for other types of assets. At some point, deflation may “morph” into discontinuity. It is the fact that price falls too low that will ultimately cut off oil production, not the lack of oil in the ground. Even with little oil, there will still be some goods and services produced. These goods and services will not necessarily be available to holders of assets of the kind we have today. Instead, they will tend to go to those who produced them, and to those who win them by fighting over them. Up and Down Escalator Economies It seems to me that economies operate on two kinds of escalators–an up escalator, and a down escalator. The up escalator is driven by a favorable feedback cycle; the down escalator is driven by an unfavorable feedback cycle. For a long time, the US economy has been on an up escalator, fueled by growth in the use of cheap energy. This growth in cheap energy led to rising wages, as humans learned to use external energy to leverage their own meager ability to “perform work”–dig ditches, transport goods, perform computations, and do many other tasks that machines (powered by electricity or oil) could do much better, and more cheaply, than humans. Debt helped lever this growth up even faster than it would otherwise ramp up. Continued growth in debt made sense, because growth seemed likely for as far in the future as anyone could see. We could borrow from the future, and have more now. Unfortunately, there is also a down escalator for economies, and we seem to be headed in that direction now. Such down escalators have hit local economies before, but never a networked global economy. From this point of view, we are in uncharted

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territory. Many economies have grown for many years, hit a period of stagflation, and ultimately collapsed. According to research of Turchin and Mefedov documented in the book Secular Cycles, such economies have typically gotten their start by learning to exploit a new resource, such as using land cleared for farming, or learning to use irrigation, or in our case more recently, learning to use fossil fuels. These economies typically start out by growing for many years, thanks to the opportunity for more population and more goods and services from the new resource. After a while, a period of stagflation is reached. Population catches up to the new resource, and job opportunities for young people become less plentiful. Wage disparity grows, with wages of the common worker lagging behind. The cost of government rises. Because of the low wages of workers, it becomes increasingly difficult to collect enough taxes from workers to pay for rising government costs. To work around these problems, use of debt grows. Needless to say, this scenario tends to end very badly. Our situation today sounds a great deal like the down escalator situation. As I have discussed previously, wages stagnate as oil prices rise. In fact, most increases in wages have taken place when the real price of oil was less than $30 barrel, in today’s dollars.

As oil prices rise, wage-earners hit a second problem–higher outgo for fuel and food, since fuel is used in growing and transporting food. Thus, wage-earners are hit on two sides–flat income and higher outgo for necessities, leading to less discretionary income. Governments find that they need more taxes to pay for increased benefits for the many who no longer have jobs. These higher taxes place another burden on those who are still working. Businesses find their profits pinched by higher oil prices, and respond by outsourcing to a low wage country, or automating processes to cut costs, lowering the amount local citizens earn in wages further. Furthermore, even apart from oil issues, globalization tends to pull US wages down. All of these issues tend to add to the down-escalator phenomenon for the US economy. In past years, governments and businesses have made promises of many types, such as bank account balances, pensions, Social Security, Medicare, insurance policies, stock certificates, and bonds. The question becomes: what happens to these promises, as we step off the up escalator, and onto the down escalator? All of these promises could be paid when we were on the up escalator. The amount that

Figure 1. High oil prices are associated with depressed wages. Oil price through 2011 from BP’s 2012 Statistical Review of World Energy, updated to 2012 using EIA data and CPI-Urban from BLS. Average wages calculated by dividing Private Industry wages from US BEA Table 2.1 by US population, and bringing to 2012 cost level using CPI-Urban.

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gets paid is much less clear, if we are on the down escalator. In this post, I would like to examine what happens. The General Price Trend: Downward, with Discontinuities Each year, an economy produces various kinds of goods and services. It grows crops, and extracts minerals. It uses energy products to process the crops and minerals into finished goods, and to transport them to their final destination. The amount produced depends on the amount of goods and services potential buyers can afford. If wages are stagnant, and the government’s share keeps rising, the amount wage-earners can afford (in inflation adjusted dollars) keeps falling. Since the early 2000s, the cost of extracting oil products has been rising, because the oil that was cheapest to extract was extracted first, and the “easy oil” is now gone. There tends to be a relatively small amount of a resource available cheaply, and increasing amounts available at higher and higher prices (Figure 2, below).

In fact, minerals of all types tend to follow the same pattern as oil for two reasons: (1) Mineral extraction follows the same pattern–cheapest to extract first, moving to the more expensive to extract, and (2) Oil is generally used in extraction. If the cost of oil is rising, its cost tends to get passed on. Of course, in some instances, technological improvements can offset rising prices, but for most of the time since the year 2000, cost of commodity extraction has tended to rise. There has been a lot of publicity recently about more oil being available, and more natural gas being available. This additional availability is because of high price. It doesn’t bring the cost of extraction down. In fact, if price drops, extraction is likely to drop. This drop will not occur immediately, because much of the cost has already been paid on wells that have already been drilled, so extraction from these wells tends to continue. But future investment is likely to drop off quickly if prices drop, bringing supply down, with a lag. Because of the downward escalator the economy is on, wage-earners don’t really have enough money to pay the higher prices that are needed for increasingly costly extraction of oil and other minerals. Instead, prices tend to be volatile. The general

Figure 2. Resource triangle, with dotted line indicating uncertain financial cut-off.

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trend can be expected to be downward, because even if oil prices rise when the economy is functioning fairly well, at some point, the higher price leads to adverse feedbacks, such as consumers defaulting on debt and cutting back on discretionary purchases. The result can be expected to be recession, and again lower oil prices. The big danger is that lower oil prices will lead to lower oil production, and this lower oil production will become a problem for business and commerce around the world. The United States is likely to be one of the countries whose oil production will be affected most by lower oil prices, for three reasons: (1) We tend to have most tight oil production, and tight oil production tends to be high-priced production. It also drops off quite quickly, if drilling stops. (2) Shale gas drillers tend to use a lot of debt. Shale drillers will especially be hit if interest rates rise because of debt problems. (3) Taxes and fees related to oil production in the US (unlike many countries) do not vary with the price of oil. The US government will continue to get most of its revenue (estimated to average $33.29 per barrel on a $80 barrel of US tight oil by Barry Rogers, Oil & Gas Journal, May 2013), even as companies find themselves short of funds for new drilling. If oil production is down, US oil consumption to be lower as well. The reason for low oil price is likely to be recession and greater job loss. With fewer jobs, less oil is needed for making and shipping goods. Furthermore, the many unemployed cannot afford cars. The pattern of declining demand in the European Union, and Japan is likely to continue, and get worse. (See my post, Peak Oil Demand is Already a Huge Problem.)

In 2008-2009, the economy was able to somewhat recover, so commodity prices increased again. This recovery was not based on US economy fundamentals–a large part of it seems to be related to artificially low interest rates and deficit spending. As interest rates rise, and as deficit spending is eliminated through higher taxes/lower benefits, the US economy seems likely to head back into recession, with more job loss, probably worse than last time. Countries with low wages to begin with may be spared of some of the down-escalator economy dynamics for a few years, because their low wage levels will continue to make them competitive in a world economy. These countries will attract a disproportionate share of new jobs, allowing them to continue grow for a time, even

Figure 3. Oil consumption based on BP’s 2013 Statistical Review of World Energy.

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as the US, the European Union, and Japan continue to lose jobs. Thus, world oil prices may be able to bounce back, but probably not to as high a level as in the recent past. Eventually, these countries will tend to follow the rest of the world into stagflation and collapse, because of the interconnectedness of the global economy, and the similar dynamics that all countries are subject to. Chance of Discontinuity In order for the models to work in the expected way, business as usual must continue. A few obvious problems come into play: (1) “Demand,” as defined by economists, is what consumers can afford to pay. Therefore, a jobless individual without any type of government compensation, would have no demand for food, clothing or shelter–at least using the term in the way economists use the word. All of us know that in the real world, lack of a job and lack of government benefits causes problems. At some point, marginalized people will riot and overthrow governments. Civil war may take place, or war against another country. (2) Part of Business as usual is continuing availability of debt. At some point, it will start to become clear that the economy has gotten off the up escalator, and moved to the down escalator. On the down escalator, much less debt makes sense. It probably still makes sense to use debt on a short-term basis to cover goods in transit, and it may make sense to use debt to finance investments with a high expected rate of return. But in general, debt is likely to become much less common, greatly worsening the down escalator problem. (3) As long as the economy was on an up escalator, increasing economies of scale were part of what caused a positive feedbacks. When the economy is on a down elevator, we have the reverse effect–higher fixed costs relative to production. This is even an issue when reduction in sales are intentional–for example, increased water conservation tends to lead to higher fixed costs, per unit of water sold, and greater use of high-efficiency light bulbs leads to greater electricity fixed costs (such as grid costs) per kWh sold. These higher fixed costs tend to push up prices for services further, increasing the down escalator effect. (4) Investment in a capitalistic system does not work on a down economic escalator. Who wants to invest, if it is probable that the economy will shrink, leading to increasing diseconomies of scale? What Happens to Government and Business Promises? There are many kinds of promises currently outstanding: 1. Government promises

Social Security Medicare Unemployment insurance Continued maintenance of roads

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Free education for all through high school Government debt (Federal, state, and local) Financial help after hurricane damage Guarantees of bank accounts and pension plans

2. Insurance and bank promises

Life insurance policies Annuities Long term care policies Pension plans Auto and homeowners policies, etc. Bank account balances

3. Promises by companies of all types

Stock – implied promise it will be worth more in the future Loans borrowed will be paid back (to banks or on bonds) Pension plans Implied guarantee of future 24/7 electricity availability; grid maintenance

What happens to these promises? Over time, it is clear that pretty much all of them will disappear. They are up-escalator benefits that work when there are plenty of fossil fuels and the economy is expanding. They don’t work for very long on a down escalator. Promises to Individuals At the level of the individual, one of the implied promises has been is that an individual who gets a good education will be able to get a good paying job. This is one of the promises that is already disappearing. There is also a second implied promise–people who actually perform the work, will be compensated for it. This promise is falling by the wayside, as wages fall (partly due to globalization, and partly due to other down escalator effects). At the same time, governments need higher tax rates, to pay for all the promises made to those who are retired, unemployed, or have wages that are too low to support a family. Goods and Services Produced in a Given Year In any year, there will be a mixture of people buying goods and services:

People who are currently in the work force Retirees People who own assets and want to sell them

One thing that may not be obvious without thinking about it, is that all of the people wanting goods and services have to compete for the same set of goods and services that are available at that time.

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For example, we grow a certain amount of corn and rice, and we extract a certain amount of oil and coal and copper, and we make a certain amount of electricity in electric power plants. Because of inventories, there is a little flexibility in these amounts, but basically, the amount that is available is determined by market prices and availability of supply lines. If the amount of goods and services produced is decreasing, because we are on a down escalator economy, this smaller quantity of goods and services needs to be shared by the entire population. If there is relatively little available in total, and those who produced it don’t want to part with it, a person trying to trade accumulated “assets” for current production will not receive very much scarce production in return for his accumulated wealth, no matter what form it may take. In the case of most assets (stocks, bond, gold, silver, etc,) this means that the value of the asset tends toward $0. If currency is viewed as another asset, its value may go to close to zero as well. In fact, if there has been a government change, its value of the currency may be exactly zero. How about Quantitative Easing? Quantitative Easing (QE) represents an attempt to reinflate the economy by making more credit available to the economy, at lower interest rates. It also has the effect of reducing the interest rate the government pays on its own long-term debt, thus holding down that taxes the government needs to collect. In terms of inflation/deflation effects QE has, its primary effect seems to be to artificially inflate asset prices–stocks, bonds, home prices, and agricultural land prices. The announced goal of the Japanese QE attempt was to try to raise the inflation rate (generally) in Japan to 2%, but it has not had that effect. In fact, the same link shows that in general, QE has not led to inflation. In my view, the primary effect of QE is to create asset price bubbles. The price of bonds is raised, because of the artificially low interest rates. The price of stocks is raised, because people switch from bonds to stocks, to try to get yield (or capital gains). To get better yield, businesses find it worthwhile investing in homes, with the idea of renting then out on a long-term basis. Very little of QE actually gets through to wages, which is where the major shortfall is. QE will at some point stop, and the asset price bubble will deflate. (Crunch Time: Fiscal Crises and the Role of Monetary Policy by David Greenlaw, James Hamilton, Peter Hooper, and Frederic Mishkin points out that QE is not viable as a long-term strategy.) This is likely to add to deflation woes. The higher interest rates and the need for higher taxes to cover the higher interest the government needs to pay will add to the down escalator effects, making the trends noted previously even worse.

View more quality content from Our Finite World

Exploiting deep water fields ....it's not as easy as explorers think! London, 19 Sep 2013 Exploring internationally for unconventional oil and gas .......finding the "sweet spots" London, 02 Oct 2013 Applied Deepwater Exploration One day training course London, 09 Oct 2013 Finding petroleum in the South Atlantic ...if there's any left to find! London, 05 Nov 2013 New technologies for describing and monitoring reservoirs get to know your reservoir better! London, 26 Nov 2013

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Recent Company Profiles

The OilVoice database has a diverse selection of company profiles, covering new start-up companies through to multi-national groups. Each of these profiles feature key data that allows users to focus on specific information or a full company report that can be accessed online or printed and reviewed later. Start your search today!

Artisan Energy Oil & Gas

Artisan is a junior oil and gas company positioned for significant per share growth via focused, low-risk development and exploration drilling in Alberta.

Artisan Energy's OilVoice profile

Adamantine Energy Technical Exploration

Adamantine Energy is a technically focussed frontier exploration company applying specialist exploration technologies to explore specific and neglected exploration opportunities in East Africa with its regional operations base in Nairobi, Kenya. East Africa region remains lightly explored despite the presence of robust and regional source rock systems that have resulted in the massive oil accumulations of Sudan, Uganda, Madagascar and recently Kenya (Ngamia #1) and the multiple TCF gas accumulations located along the Indian Ocean Hinge Line and the numerous other oil and occurrences throughout the region.

Adamantine Energy's OilVoice profile

Triple Energy Oil & Gas

Triple Energy Limited is an oil gas company listed on the Australian Securities Exchange (ASX). The Company strategy is to invest in oil and gas projects in both the conventional and unconventional (coal seam gas and shale oil and gas) sectors, along with power generation where and if appropriate. The Company has recently acquired an 80% interest in an coal mine gas project in the Hielongjiang province of the People’s Republic of China.

Triple Energy's OilVoice profile

Caracal Energy Oil

Caracal Energy Inc., a Canadian based international oil exploration and development company active in the Republic of Chad. In 2011 the Company signed three production sharing contracts with the government of the Republic of Chad providing exclusive rights to explore and develop reserves and resources in southern Chad.

Caracal Energy's OilVoice profile

Ceylan Energy Oil & Gas

Ceylan Energy is Sri Lanka's first and only indigenous oil and gas exploration and production company. Bringing together some of the country's leading oil and gas professionals, Ceylan Energy is committed to long term investment in Sri Lanka. Ceylan Energy's strengths lie in its in-depth local knowledge, its strong network of contacts and homegrown team who are dedicated to maximising the island's oil and gas potential.

Ceylan Energy’s OilVoice profile

NordAq Energy Oil & Gas

NordAq Energy Inc. (NordAq) is an independent oil and gas company based in Anchorage, Alaska. The company was established by the present Board and management team in 2008 to explore, appraise and develop hydrocarbon reserves in the State of Alaska. Its portfolio includes prospects and resources in the Kenai Peninsula on the Cook Inlet and Smith Bay on the North Slope.

NordAq Energy’s OilVoice profile

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Oil net long going short

Written by Andrew McKillop from AMK CONSULT

A WILD RIDE Oil had shot higher until recent days, gaining about $11 a barrel in two weeks, fed by a mix of physical and market sentiment pressures. US market and oil industry news and trends have had an undue influence on the process - underlining one major cause of rising oil prices - the US focus for major changes of market perception, symbolized by the near total disappearance of the Brent oil premium against US WTI grade oil. As recently as February this year, Brent grade oil was priced at $22 a barrel above WTI, supposedly reflecting major supply-demand differences between WTI, the western hemisphere benchmark, and Brent oil, the eastern hemisphere benchmark. Like the premium, which disappeared almost without trace in a few weeks' trading, speculators are now pulling back from their bullish bets on oil of any grade or type. Data from the US CFTC commodities trading watchdog agency (below from Bullandbearmash) shows the huge recent rise in 'net long' positions - speculators betting on continued rising prices - in the US market. This trend is now reversing.

NO FUNDAMENTALS In an interesting and overdue symmetric process, net short positions on gold - speculators betting for a continued fall of gold prices - have dramatically shrunk in recent days. As Bloomberg reported 21 July 'Gold surged 6.7 percent… Speculators increased their net-long position by 56 percent to 55,535 futures and options contracts by July 16, the highest since June 4, U.S. CFTC data show'. In both cases - speculating against gold and for oil - this was 'fundamentals free' betting with a necessarily short shelf life and early best-by date.

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The physical gold supply-demand picture basically only concerns a small market - world annual fresh mine output gives about 0.3 grams a year for each person on the planet - but the world oil market handling about 51 million barrel a day (Mbd), and total production of about 89.75 Mbd make for a world average of about 630 kilograms a year consumed for each person on the planet. For gold, this makes it much easier to arrive at a situation similar to the one we have today - physical demand for gold can easily and totally outstrip supply. This is bullish for prices. For oil, the potential for oversupply, or insufficient demand and therefore falling prices is much higher. Over months, rather than weeks oil outlook reports from all sources, including the US IEA, the IEA, the OPEC Secretariat, the Economist Intelligence Unit, major banks and brokers all come in bearish for oil. "There is little evidence that the stronger U.S. economy is leading to a recovery in US oil demand," the Economist Intelligence Unit concluded last week. As noted by myself (Egyptian and Syrian geopolitical risk) Middle Eastern and North African political instability is one of the very few outright-positive tailwinds for oil prices. When or if this often exaggerated risk fades, there will be very few support pillars for the oil market in Q2 2013, the second half of this year. Here we have another reason for the rush to talk up oil - making hay while the sun shines. Without a serious net aggravation of Middle Eastern instability, $80 a barrel for both Brent and WTI is generous. REAL WORLD FUNDAMENTALS Most analysts look only at the large and continuing growth of US oil production and ever-diminishing net oil imports. This ignores the rest of the world, both the supply side and demand side. The Paris-based IEA has on several occasions said that its expectations and forecasts for 2014 should give the oil bulls "some cause for alarm'. Conservatively estimated, the surge in non-OPEC non-US oil output may exceed 1.3 Mbd in 2014, but other estimates go above an addition of 1.5 Mbd. The more optimistic demand forecasts for world oil demand growth - coming from the IEA, as well as OPEC - suggest growth in demand of 1.2 Mbd in 2013-2014 is about as high as can be expected. Staying with the IEA which uses IMF forecasts for world economic growth - and we know what happens to IMF growth forecasts on a regular basis - the latest monthly oil market report from the IEA claims that by Q3 this year, world economic growth will start picking up, also lifting world oil demand. This is not a rational forecast, at present. Pushing the pick-up in economic growth to early 2014, or later, is more rational or less fanciful, which makes the IEA's present forecast of world oil demand growth in 2013-2014 of 1.2 Mbd highly optimistic. In the US and Europe, as well as Japan, South Korea, Australia - in fact OECD wide - 'peak oil' now means peak demand - a rearview picture of previous peak demand. The European Union, to be sure in major part due to recession and deindustrialization, has entered its seventh straight year of oil demand decline. In the US, due to an equal balance of oil saving and recession, as well as delocalization and industrial change, oil demand has for optimists 'only flat lined'. It has not

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recovered 2007 demand levels using EIA data http://www.eia.gov/dnav/pet/hist/LeafHandler.ashx?n=pet&s=mttupus2&f=m Major oil industry players (below BP) have for a mix of reasons including their own financial strategies, as well as projections and forecasts for alternate energy development, and forecasts of changed economic structures, increasingly published outlooks for sharp continuing decline of oil in the energy mix, and the energy intensity of the economy. In this case, the decline is about 70% by 2035.

Chart of Gail Tverberg based on BP Statistical Review of World Energy, 2012 THE MAJOR ROLE OF IMPORTS World oil import demand is a key driver of prices and price sentiment. It is often treated as a dummy for national consumption but this ignores world refinery trade. Specific countries for example Singapore, a refining hub for Asia Pacific, imported around 2.8 Mbd in 2011 but only consumed about 1.15 Mbd. The rest was re-exported. The world's 10 major importers - defined as taking 3% or more of world imports - are shown below using ENI data. These importers take about 63% of imports, and the biggest 5 take 45% of world total imports. Of these top importers, six are reducing their draw on world export supply, led by the US whose net imports for domestic consumption (after refining trade re-exports), by value on a seasonally adjusted basis, fell to its lowest level since 2011 in April, according to US Commerce Department data. In terms of gross volume of imported oil however, this was the lowest level of imports since 1995. In July, Clarkson Plc, the leading tanker shipbroker forecast that US seaborne imports will decline 11% on the year to a year-average of 5.4 Mbd in 2013, the largest slide since 1991. For the world oil shipping industry this is somber news. It is

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only in the very short-term buffered by purely speculative-driven stockage of unsold crude in tankers, marginally raising ship rates for Suezmaxes, the hardest-hit, smallest category among large-sized tankers able to haul cargoes of 1-million-barrels or more. Recent and impressive growth of US refining capacity and re-exports of refined products has considerably slowed for several key export markets since 2011 or before, making it unlikely this US-source world import demand can hold up. Other major refiners including Singapore, the Netherlands and Japan will also tend to decline, or continue their existing trend of decline, for oil imports.

World Top 10 Importers Source ENI World Oil and Gas Review 2012 Unexpected to some, and completely unthinkable before 2009, July trade data from China showed its crude imports contracted in the first-half of 2013 compared with one year previous. Apart from underlining the pace of China's economic rebalancing - when added to the sharp decline of India's oil import growth to small single digit annual percentage rates - this raises the prospect that the world's major oil importer nations have all, sometimes for different reasons, entered into decline. The paradigm is firstly slow growth, then zero growth, then net decline in volume. Expecting oil prices to grow, in the face of these supply-demand fundamentals, is an excellent example of pure speculative faith. How long the faith holds together is uncertain - but it is not eternal.

View more quality content from AMK CONSULT

19 OilVoice Magazine | AUGUST 2013

Oil and gas M&A in Q2 2013 reaches just $23.6 billion

Written by Eoin Coyne from Evaluate Energy

As we embark upon a new quarter, Evaluate Energy has taken the time to reflect on the key trends that emerged during the second quarter of 2013 in the oil & gas M&A market, including the impact of NOCs and the transition of substantial gas discoveries during 2012 into multi-billion dollar deals. The most significant statistic to emerge from the data is that the total deal value in the upstream sector during Q2 2013 came to just $23.6 billion, lower than any other quarter since Q3 2009. Q3 2009 had its own strong reasons for being sluggish; during the quarter the credit crisis had claimed its first major victim with the collapse of Lehman Brothers, the US Henry Hub gas benchmark fell below $2 and oil prices were still recovering after plummeting to $30 at the end of 2008. The explanation behind the latest quarter’s lacklustre performance, however, lacks the same drama; oil and gas prices have shown stability during the quarter at $90 per barrel of oil and $4 per mcf of gas in the US. Economic uncertainty still lingers though especially within the austerity-hit European market and many CEOs are erring to the side of caution when it comes to expanding beyond their company’s reach.

Due to these reasons, perhaps it’s no surprise that the largest deals during the quarter involved national oil companies, who are less influenced by short and medium term economic fluctuations. The largest deal of the quarter involved ONGC and Oil India, who acquired a 10% stake in the 100+ tcf gas discovery offshore Mozambique in the Rovuma basin for $2.5 billion from Videocon Industries. The $0.50 cost per recoverable mcf of gas reserves would usually represent good value but commercialisation of the asset is at least 5 years away and will require large upfront payments to develop the field and construct the necessary LNG exporting

Evaluate Energy – Global Oil Deals by Quarter

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terminal which would have made this field fall short of many public company’s investment appraisals. The deal follows the acquisition of Cove Energy at the end of 2012 when another national oil company, PTT, keen to gain control of the company’s flagship asset of an 8.5% interest in the Rovuma Offshore Area 1, paid $2.2 billion. The next largest deal involved Lukoil acquiring the Russian assets of Hess Corp for $2.05 billion. The deal was initially expected to raise little over $1 billion so the price negotiated can be seen as a coup for Hess. With Russia’s steep production and corporate taxes, typical per proven barrel of reserve metrics seldom exceed $5 per boe (Rosneft acquired TNK-BP for $5.13 per boe of proven reserves in 2012), yet the Hess deal equates to approximately $25 per proven boe for the oil rich assets. Chinese companies were uncharacteristically quiet in terms of new deals during the quarter with only one notable transaction taking place; Sinopec acquired a 10% interest in Block 31 offshore Angola. In the past couple of years, Chinese-based companies averaged $8.4 billion of new global E&P deals per quarter, yet in Q2 2013, this deal between Sinopec and Marathon made the total just $1.5 billion. Despite the lack of traditional M&A, China did grab the world’s attention when it agreed a crude oil marketing deal with Rosneft worth $270 billion over 25 years to import 300,000 b/d including a $70 billion upfront cash payment. The third largest deal also came from Africa with Petrobras divesting a 50% stake in all of its African operations for $1.525 billion to Banco BTG Pactual S.A.. The divestment is part of Petrobras’ $9.9 billion divestment plan to partly fund development of its huge pre-salt oil reserves off the coast of Brazil, which will require $107 billion investment over the next 5 years. The deal involves 73.9 million boe of proven reserves which are 95% oil and 57% developed, along with a considerable portfolio of exploration assets. Given the amount of exploration upside in the deal the price paid per proven reserve of $20.63 represents an impressive deal for the buyer. In the UK, the budding onshore shale sector received a boost with its first major deal when Centrica farmed into a 25% stake in Cuadrilla Resources’ Bowland License for $152 million. All the recent hyperbole surrounding this sector has been worth its collective weight in hot air so far, but now the industry is set to have a six well drilling programme that will go a long way to discovering if the the impressive reserve estimations can be converted into commercial operations. So far, there has not been a true shale success story outside of North America, as Poland has yet to fulfil its early promise and any progress in France was quickly halted by environmental lobbyists. Despite potential environmental concerns the UK may also face, the sector will benefit from its strong indigenous demand, thereby foregoing the need for any LNG capabilities, and having a government who are keen to maximise tax revenues in the face of enforced austerity measures and the threat of Scottish devolution, which would take a large portion of the North Sea tax Revenues away from the UK Treasury. In terms of deals that closed during the quarter, there was one major deal completed as Freeport McMoRan Copper & Gold, Inc. finalised its $18.9 billion purchase ($9 billion excluding debt) of Plains Exploration & Production and McMoRan Exploration. The closures came amidst pressure from the Plains shareholders for the purchase price to be increased after there was a significant oil discovery in the company’s 50%

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owned Phobos asset in the Gulf of Mexico. Evaluation work is still underway at the discovery, so the full extent and value of the find is still yet to be determined, but Freeport relented to the demands and paid a special dividend upon closing worth an extra $1 billion to the Plains shareholders. Following a vast deal value and count in Q4 2012, 2013 was touted by some as being a year with a large amount of potential for oil and gas deals due to stable commodity prices and an improving (albeit languidly) global economy. This has not proven to be the case so far in the first half of the year with the total deal value of $51.5 billion, which falls far short of the deal value in 2012 at the same point ($84.8 billion) and 2011 ($70.2 billion). There are still enough companies however requiring large capital injections (shale acreage holders, potential LNG assets, Brazil’s pre-salt sector) and enough money in Chinese and Russian hands to potentially bring the deal values back into line with recent years before the year is done.

Acquirer Seller Brief Description

Total

Acquisition

Cost ($

million)

ONGC &

Oil India Videocon

ONGC Videsh Limited and Oil India acquires

Videocon Mozambique Rovuma 1 Limited, a

company holding a 10% participating interest in

the Rovuma Area 1 Offshore Block in

Mozambique

2,475

Lukoil Hess Corp OAO LUKOIL acquires Samara-Nafta, a

Russian subsidiary of Hess Corp. 2,050

Banco BTG

Pactual

S.A.

Petrobras

Banco BTG Pactual S.A. acquires a 50% interest

in Petrobras’ African operations via the

formation of a 50/50 joint venture

1,525

Sinopec Marathon Oil

SSI Thirty-One Limited, a subsidiary of Sinopec

acquires a 10% working interest in the

Production Sharing Contract and Joint Operating

Agreement in Block 31 offshore Angola from

Marathon International Oil Angola Block 31

Limited

1,500

Breitburn

Energy

Partners

Whiting Oil

and Gas

Corporation

Breitburn Energy Partners acquires Whiting’s

interests in the Postle and North East Hardesty

oil fields, along with associated midstream

assets, located primarily in the Oklahoma

Panhandle

860

Petronas OGX Petroleo

e Gas S.A

Petronas acquires 40% of OGX’s interest in

Blocks BM-C-39 and BM-C-40 located in

Brazil’s Campos Basin

850

Kodiak Oil

& Gas

Corp.

Liberty

Resources

Limited

660

This report was created using Evaluate Energy’s M&A database which tracks all

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global E&P, Refining and Oil Service deals on a daily basis and provides a comprehensive set of financial and operating deal metrics.

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The hunt for WMDs in the oil price process

Written by Liz Bossley from CEAG

The EC raid on the offices of BP, Shell and Statoil on May 14th seeking evidence of oil price manipulation has created a level of consternation not seen since the hunt for weapons of mass destruction (WMDs) in Iraq. If the WMDs had been there they would probably have been found. The difference with the search for evidence of oil price fixing is that, if it is there, it will be very difficult to recognise. If the evidence does not actually exist, it would be easy to mistake the actions of traders going about their lawful, if complex, business for market abuse. Looking Through the Window The spotlight is currently on the Platts' window. Platts is a price reporting agency (PRA). The prices it publishes are used throughout the industry -from the physical market to the regulated futures markets to the opaque over-the-counter (OTC) derivatives market - to solve the price formulae included in a huge number of contracts. Most physical oil contracts do not stipulate a fixed and flat price such as $X/bbl. Instead the contract price clause refers to the average of the price published on a specified number of days by a named PRA. The Platts half-hour window is a price discovery process, not a market. The actual market trades round the clock in different geographical regions. The Platts' window exists to provide a snapshot of a wide range of benchmark prices at certain key points during the day in a variety of locations. To inform that process with consistent and comparable data Platts determines who can input data to its price discovery process and what form its contracts must take in order to be included in the Platts database.

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The confusing aspect of the window process is that deals can actually be executed on the Platts electronic platform- the so-called e-window- to aid the price discovery process. Oil companies wanting to ensure that Platts has sufficient data to go on, because the numbers that gets published have a significant impact on a large number of their deals, need only trade in small quantities during a very short time period each day to have their say in the benchmark number that is published by Platts. Trades in non-benchmark grades throughout the day are considered in the assessment of the price differentials to the snapshot of benchmarks that get published. A buyer or seller wanting to offer a transaction to the widest possible pool of counterparties will typically place its bid or offer in the highly liquid futures market or through a broker to the OTC market at any time during the trading day and in any form the two parties to the deal want the contract to take. But dealing in the Platts window is more restricted. Deals that qualify for inclusion in the Platts' database can only be done in the Platts way, at the Platts time and with counterparties permitted by Platts. It will be very difficult for the EC's 'weapons inspectors' to distinguish between deals done to populate the Platts price database with reliable numbers and deals done to skew the Platts price that is reported in one direction or another. Even though there is a smaller pool of players in the Platts' window than there is in the wider market the quantity of data the inspectors will have to plough through will be vast. If there is evidence of manipulation to be found, and I am not pre-judging the outcome of the EC search, that evidence will not necessarily lie in the trades reported to Platts in its window or traded on its e-window platform. It is most likely to be found in offsetting private and confidential deals done elsewhere that do not get reported1. That is why the inspectors' job will be so difficult. Cui bono? Much of the press reporting of the search for evidence of oil price manipulation appears to assume that if oil prices are being manipulated then they must be artificially inflated to the detriment of the consumer. That may make a good story, but it is not necessarily so. In the case of crude oil, companies are taxed at a much higher rate upstream at the wellhead than they are downstream in the market for refined oil products, such as for gasoline or for diesel. So, arguably, integrated oil companies, that both produce crude oil and sell refined products, would benefit from low crude prices and high product prices. Offsetting, or supplementing, the actions of oil companies, there are the commodity trading houses that actively buy and sell both crude oil and refined products on any given day in the wholesale cargo market. On some days their trading books will benefit from higher prices and on others they will benefit from lower prices, depending on whether they are 'long or short'2 at any point in time. Many of these

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companies also input their trading data to the Platts price discovery process and also to that of the other PRAs. Private trading houses are no slouches when it comes to defending their own positions against any attempt to load the dice against them. So the assumption, that if prices are being manipulated then they must be manipulated up, is highly questionable. Beware of What You Wish For... The US Federal Trade Commission (FTC), at the behest of the Department of Justice, upped the stakes on the EC investigation by launching its own oil price probe at the end of June. A class action suit, reported on 28th May in Courthouse News Service, was brought by a Chicago trader in the District Court of the Southern District of New York against a range of oil companies and un-named co-conspirators for reporting inaccurate information to Platts. It was in the District Court of the Southern District of New York that the late Judge William C. Conner ruled in 1990 that 15-Day Brent contracts, the ancestor of today's 25-Day BFOE oil market, were illegal off-exchange futures contracts. This was swiftly followed by 'The Brent Interpretation', which clarified that '15-day Brent system crude oil contracts were forward contracts that were excluded from the CEA [Commodity Exchange Act] definition of 'future delivery,'' and thus were not futures contracts.3' This put them within the scope of the forward contract exclusion from regulation by the Commodity Futures Trading Commission (CFTC). The majority of the benchmark contracts reported by Platts and the other PRAs are either unregulated physical contracts, or they fall within regulatory exclusion zones, or they are subject to light-touch codes of conduct. Appropriate Regulation Irrespective of the outcome of the various investigations mentioned above, some sensible regulation of the oil market is over-due. As we pointed out in our book, published in May 2013, 'Trading Crude Oil: the Consilience Guide' http://tradingcrudeoil.co.uk/ , there is no forum where oil market actors can sit down together to agree simple housekeeping issues, such as the form and content of benchmark contracts, without fear of accusations of collusion. Love it or hate it, the Platts window process evolved in this regulatory vacuum to fill a perceived industry need. In my opinion this regulatory vacuum needs to be filled. As we suggested in the book referred to above 'an expert panel, subject to regulatory oversight, might be convened to deal with contractual trading housekeeping issues …. The terms of reference of such a panel might be to host regular industry meetings at which issues of relevance to oil trading contracts might be discussed. These issues might include declining volumes of key benchmarks, quality issues, logistical problems etc. that might require a concerted contractual amendment by

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stakeholders or a change in reporting methodologies of the PRAs.' If, however, the EC and/or FTC investigations do find evidence of criminal collusion to distort prices then all bets are off and the culprits can take what is coming to them. But, we would suggest, what has to be avoided is the smashing of a vibrant and necessary market with sledgehammer to crack the walnut of what may turn out to be a random minority of manipulative wrong-doers. But first we have to wait and see what evidence is uncovered, if any. 1. For example Exchange for Physicals (EFP) transactions on regulated exchanges. The volume of EFP transactions is reported, but the price is not. This is because the deal is agreed 'off-exchange' by two willing counterparties and is then transferred onto the exchange for clearing and settlement. The deal has not been shown to the futures market participants and the price is therefore irrelevant to that market. 2. A company that is long has oil for which it has no use and which it needs to sell. A company that is short has a commitment to supply oil that it does not possess and which it must buy before the delivery date. 3. http://www.cftc.gov/LawRegulation/FederalRegister/FinalRules/2012-18003

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Is a talent shortage set to hold back the LNG industry?

Written by Peter Jackson from Lockton

Employers in the wider oil and gas sector bemoan the lack of skilled workers in key roles, how much they cost, and their apparent mercenary approach to contracts. Additionally there does not seem to be a ready solution to these manpower issues. An ageing workforce, a big increase in global LNG project numbers (indeed, in projects across the energy sector), and a workforce culture of mobility have combined into a perfect storm for many oil and gas sector employers. So how does an employer remain, or become, competitive in this environment? One of the first things a company should look at are the 'non-salary' tools they have

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at their disposal. We believe the two key, and interrelated, non-salary drivers are employment brand, and how success is rewarded. Most workers of all types would rather work somewhere where they are valued and looked after. How often have you heard 'the moneys great but it's a lousy place to work?' This is a damning reputation to have - one that will attract people for the wrong reasons. Making an employee's working experience at your company a positive one comprises many factors, not least the employee benefits package you provide. If they are taken sick, how good is the service from the benefits provider? Their service, or to be a little more blunt, the service of an external provider, reflects on your working environment. If this external provider's service is good and they go the extra mile your staff member or contractor will tell their friends. If not…well, research shows people tell twice as many people about a negative experience than a positive one. Choosing the right healthcare provider is not just about cost but the service you want to provide staff who have a choice where to work. Likewise, maybe you need to be innovative in finding ways to retain good contractors. Some of them are as highly paid as anyone else in the business. Why not look at long term or loyalty bonus structures you use to retain key staff and apply the same principles to key contractors you want to use repeatedly (e.g. loyalty/retention bonus or incentive scheme for key contractors who you repeatedly use). At Lockton we have found that oil and gas companies spend more than average on healthcare but often only to keep up with what they perceive to be what everyone else is offering. Also, there is little thinking that goes into the scheme design outside of what is available as standard in the insurance market. More advanced H.R. teams are now looking at alternative structures, particularly Flexible Benefits where employees have choice about how they structure their individual benefits. For contractors this is more difficult to set up, but certainly possible. Other innovative thinking that we are starting to see is in working with Healthcare providers to add more services, some of which have little or no additional cost. Where we see room for improvement is in making sure that a company's investment in healthcare is paying off. Employee and contractor surveys are easy to set up, but often not conducted. Likewise, user service isn't monitored systematically outside of contentious claims. Despite spending more than most on healthcare it's not certain that the O&G sector is getting as good a return on that investment as they could.

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Health, Safety, Environment and Risk Management

RPS Energy is a global multi-disciplinary consultancy, providing integrated technical, commercial and project management support services in the fields of geoscience, engineering and HS&E.

ContactJames Blanchard T +44 (0) 20 7280 3200 E BlanchardJ@rpsgroup.com

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Review: Saudi Arabia: On top, but not settling for it

Written by Richie Ethrington from Finding Petroleum

There is no arguing with the facts, Saudi Arabia is the jewel in the crown of the oil industry world. The Kingdom of Saudi Arabia is home has the world's largest proven conventional oil reserves (around 18% of global supply), boasts production capacity in excess of 10 million barrels per day (bpd) - the world's highest, and is the world's leading exporter. It is also the leading player in, and de facto leader of the powerful Organisation of Petroleum Exporting Countries (OPEC). Within the grouping and in the industry as a whole, Saudi Arabia remains the only producer to hold significant so-called 'swing' capacity. Alike all of its oil producing peers across the region, Saudi Arabia is a nation heavily dependent upon oil. The Kingdom's oil revenues accounted for around 90% of total Saudi Arabian export earnings, up to 80% of state revenues, and just over 44% of the country's GDP. This goes to show that despite its best attempts to diversify, Saudi Arabia's economy remains heavily dependent on its main cash crop, the black gold. Away from petroleum, the Kingdom's other natural resources include natural gas, iron ore, gold, and copper. Despite its 'heaviest of the heavyweights' status in the industry, Saudi Arabia is far from a unilateral actor. Being the world's leading producer nation and the unofficial leader of the OPEC group, the Kingdom has a major role to play in global energy relations that stretch far beyond its borders. Closer to home, Saudi Arabia also maintains close ties with some of its neighbours and key trading partners. It works bilaterally with both Bahrain and Kuwait over the distribution and exportation of shared old resources. Although it may enjoy a lofty status within the industry, the nation is far from resting on its laurels. The success of these working relationships with strategic partners such as Bahrain and Kuwait should provide a solid blueprint from which Saudi Arabia can build on in the future. As it expands its downstream involvement in other countries, it is almost certain that bilateral relations are set to play a more important role in the nation's Energy relations - most notably with the likes of emerging market BRIC giants China and India. In terms of how the industry is run, it is very much a case of 'keeping it in the family' with Saudi Arabia. Overseas oil firms are restricted by law to service contract roles only, which allows domestic players - and in particular Saudi Aramco - to dominate proceedings. The state-run firm, which can proudly claim the crown as being the

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world's largest oil company in terms of proven oil reserves and production, is not content with its position, however. Rather it has ambitious plans to increase capacity from where it stands today at 11.6 million bpd to 12.5 million bpd by early in the next decade. So as we have established already, Saudi Arabia is and the leader amongst its OPEC equals. But does biggest always mean best? In the case of Saudi Arabia's oil industry, it would seem so. It is the envy of its neighbours, its OPEC peers, and its global competitors. But even the world's largest producer is not without its problems. For one, global demand sentiment is looking increasingly bearish this year. But also, Saudi Arabia is coming under pressure from rising production in other nations, such as in OPEC peer Iraq for example. This all translates into a likely fall in demand year-on-year in 2013. Taking all this, and the constant challenge of balancing supply and demand together with prices high enough to support the Kingdom's fiscal expenditure into account, it has its work cut out. Indeed, while Saudi Arabia may enjoy the benefits of the being the world's leading player in the global oil industry, nobody ever said it would be easy to maintain its status. Add growing pressure within the OPEC group to scale back production in an attempt to keep prices inflated (and above the USS$100 a barrel mark) into the equation and things become complicated further still. In fact, moves by Saudi Arabia to raise its production output have been repeatedly stifled in the past. Consistent and often restrained output levels have not prevented the Kingdom from pushing ahead with its own oil industry goals, however. At the time of writing, Saudi Arabia already has a large investment programme in place. In October of 2012, Khalid A. Al-Falih, President and Chief Executive Officer (CEO) of state-backed Saudi Aramco announced the outline for a US$35bn capital expenditure programme over the next five years to the end of 2017. The target of the investment initiative will be oil exploration and production (or as it is more commonly known, E&P), which comes as part of a bid for the nation to maintain its status at the top producer and exporter of oil. The US$35bn high cash mountain ring-fenced for investment marks a sharp increase on the US$20-30bn investment initiative last launched over five years ago by Saudi Aramco in an attempt to offset declining volumes from the explorers more mature fields. Interestingly, however, it is a direct consequence of the falling output from these very field that has spurred the next round of internal investment. It seems that out of need Aramco is getting increasingly aggressive in its strategy. The focus of E&P this time around will be to enhance existing projects and to further new upstream exploration initiatives. Despite already being at the top, Saudi Arabia has a very good chance of staying there for a long time to come too. Indeed even after years of successful exploration and petroleum production, the Kingdom remains underexplored, leaving potential for further rewards. According to the Oil and Gas Journal, Saudi Arabia contains approximately 265 billion barrels of proven oil reserves (plus 2.5 billion barrels in the Saudi-Kuwaiti shared Neutral Zone) as of January 1, 2013, amounting to slightly less than one-fifth of proven, conventional oil reserves worldwide.

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But in the oil industry, it is more than just a numbers game. Although Saudi Arabia has around 100 major oil and gas fields in total, over 50% of its total oil reserves are contained in just eight of its fields. The giant Ghawar field, the world's largest oil field with estimated remaining reserves of around 70 billion barrels, has a higher volume of proven oil reserves than all but seven other countries across the globe. Pertinently for the future of the Saudi Arabian oil industry, several of these key fields are in decline, meaning that just to maintain its stats - and not even improve it - the Kingdom needs to work hard and invest big. The burden for this, of course, lies with Aramco Decline estimates for Saudi Arabian oil fields vary wildly, however. Back in 2006 Platts Oilgram projected that the declines rates for existing fields could range from 6-8% per annum, meaning that the Kingdom would need to both explore and produce around 700,000 bpd in additional capacity each year just to compensate for the natural decline rate. Meanwhile, the Ministry of Petroleum and Mineral Resources in Saudi Arabia maintains that decline rates are far lower, and actually closer to 2-3% per year. In terms of ongoing projects, Saudi Arabia has seven refineries. Together this septet have a combined crude distillation capacity of around 2.1 million bpd as of the end of 2011 - according to data from the US Energy Information Administration. Of the seven refineries, Saudi Aramco owns four outright - Ras Tanura, Jeddah, Riyadh and Yanbu - and also owns equity shares in a further three - Rabigh, Sasref and Samref. Two new joint venture refineries are currently under construction at Jubail (SATORP) and Yanbu, and are predicted to come onstream during 2013 and 2014, respectively. According to reports, Saudi Arabia also has approximately 2 million barrels of refining capacity overseas through the medium of joint and equity ventures in facilities in the United States, Japan, China, the Philippines, and China. Plans call for up to 2.14 million bpd of extra capacity by 2014 through the construction of three new refineries and the expansion of one more. In April 2010, plans to expand were put on hold after US oil major ConocoPhillips announced that it was exiting a joint venture agreement with Saudi Aramco that was initially created with the intention of seeing the firm play its part in the construction of a new 400,000 bpd refinery at the Red Sea port of Yanbu. Things got back on track in May 2011, however, when Conoco was replaced at the project by state-run Chinese refining behemoth Sinopec. It seems that while self-sufficiency is a luxury that Saudi Arabia and very few other in the oil industry can afford, maintaining strong relations with overseas players remains vital to the Kingdom's both near and long-term energy future.

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31 OilVoice Magazine | AUGUST 2013

Middle Eastern tailwinds for the oil risk premium

Written by Andrew McKillop from AMK CONSULT

GOODBYE BRENT PREMIUM, HELLO SYRIAN OIL RISK The role of Syria's disastrous civil war and Egypt's increasingly strange political mutation are providing generous 'tailwinds' to oil price speculators who no longer need the Brent-WTI 'arb trade', or the once-was-massive artificial premium on Brent grade against US WTI grade, which peaked at $22.71/b on February 8, 2013. On July 19 it had completely disappeared. WTI traded, at times, at a couple of cents a barrel more than Brent, and hitting its highest price since for 16 months. One thing is sure, the political risk premium on WTI under no possible hypothesis could exceed the risk premium on Brent, due to this grade being the benchmark oil for Europe, Asia and the Far East while WTI benchmarks oil prices in the western hemisphere. Since the two major benchmark grades of oil are now essentially identical in price, Middle Eastern risk premiums added to Brent will almost instantly and magically provide tailwind to speculators upping the price of WTI. Starting with Syria, claims by oil analysts that this civil war 'will spillover and deflagrate the entire Middle East' are the major price mover. The same argument is applied to Egypt, the Arab world's biggest country now potentially facing the risk of civil war but the risk or fear premium on Arab oil is both uncertain and of low credibility. Drilling down to strict net export surplus fundamentals - production versus national oil demand - we find that any claim that Syria, Egypt, the Yemen or other countries, except Libya, Algeria, Iraq and the Gulf states, are more than tiny exporters probably moving towards net oil importer status, are very hard to defend. This is a purely political risk premium. Syria's 'glory days' as a small net exporter are already well in the past.

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The typical newsfeed driving oil prices up, until the Moursi government fell in Egypt, featured only 'the Syrian concern' of traders that 'potential region-wide supply disruption' could ensue if violence in Syria jumps its borders. This is linked with often exaggerated reports from Iraq and Lebanon saying that Qatar-financed Al Qaeda djihadists from Iraq (and elsewhere), on the Sunni side, and Iraqi Shia as well as Iran-financed Hezbollah fighters, on the Shia side, are 'flocking to fight in Syria'. The picture painted is of massive sustained armed conflict but in recent weeks, in fact, the fighting has diminished, and the Syrian massacre of unarmed civilians is hard to call warfare. Whatever oil supply disruption we might fear, this will not concern Syria's own oil export supply because output has been falling for years and will go on falling, now followed by falling demand. Looking at Egypt, this country adds 'tailwind' to oil prices which really don't need extra help at this time, through the specter of Suez canal closure - carefully omitting the fact that oil shipments through the canal are declining at an impressive rate - for numerous reasons. Some are for the least unexpected, and concern Iran sanctions busting and the satellite positioning tags for oil tankers, tracked by Inmarsat. As Peter Blackhurst, head of maritime security at Inmarsat said in a December 7, 2012 interview with Reuters, 'a ship can get its Global Positioning System (GPS) to give false data, including pretending to be another vessel'. Routing phantom tankers from Iran, but flagged Tanzanian, through the Suez canal, and paying transit fees for them, when the same ships are in fact steaming through the South China Sea to the Chinese port of Ningbo, is now a well known sanctions busting trick. Real tanker movement through the Suez canal is also falling for the simplest-possible technical reason of what maximum size of tanker the canal can accept. The Moursi government long pondered canal fee hikes or surcharges, adding this revenue item to its other play-for-time strategies, never followed by concrete decisions, in its long and mostly stymied IMF loan talks. Concerning the canal, Lloyds List on 28 June reported that canal transits are continuing to decline, just like tourist receipts. In first quarter 2013 there was a 10% year-on-year fall, especially marked for larger-sized vessels. Maximum sized vessels able to use the canal (Suezmax, about 160 000 tons deadweight) are charged around $1.2 million per return trip. Larger tankers, sometimes two times that size which ply around the Cape to reach Europe, pay no canal transit fees but use more fuel. Egypt's short-lived and small scale status as a net oil exporter, already sharply declining in the last years of Mubarak, is shown on the next page.

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TAILWIND TALK Bloomberg News always goes that extra mile. In a May 28 article, its journalists tell us: 'The civil war tearing Syria apart is threatening to erase century-old borders across the Middle East as what began as a peaceful rebellion against President Bashr al-Assad escalates into a regional religious and ethnic battle'. Bloomberg added spice to the tale by saying that previous Anglo-French posturing and wrangling over oil concessions in the Arabian Peninsula, which ended with the Sykes-Picot secret accord of 1916 - at a time when the Turkish Ottoman empire was not yet beaten - took no account of the region's seething rivalries. The article said : 'The Middle East's entrenched ethnic, political and religious rivalries weren't a major consideration when a well-heeled British diplomat, Sir Mark Sykes, and his French counterpart, Francois Georges-Picot, secretly redrew the region's borders in their agreement concluded on May 16, 1916'. Syria was however soon found to be 'low prospect' for oil relative to then-independent Kurdistan, which included a sizeable part of today's eastern Syria, and British Iraq including its Kuwait province, as well as American-reserved and dominated Saudi Arabia. Syria, French-dominated in the post-Ottoman carve up, became a small oil producer mainly in its eastern Kurdish region, at most able to attain oil self-sufficiency. Sizeable output growth (see above chart) only occurred in the 1990s, long after its independence from France in 1946. In the 1990s, Syria's export cpacity, like that of Egypt a little later, occasionally came near 400 000 barrels per day (0.4 Mbd) - at a time when prices rarely topped $15 per barrel. World traded oil shipped across at least one border totals about 51 Mbd. With the collapse of the Ottoman Empire in 1917, the two European powers, France and Britain divided Greater Syria into modern-day Lebanon, Syria and Iraq, a part of Turkey, Israel, and Jordan. The two latter were then later on split out of British Palestine. The 'logic' of the frontiers, to be sure, can be radically criticized by Bloomberg journalists, and anybody else as totally absent - but comparison with the

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famous Balkans and their frontiers is worthwhile. Today's African frontiers south of the Sahara can also be checked for their 'logicality' or lack of it. South America's frontiers can then also be compared for their 'naturality', relative to Mid East and North African frontiers. There was nothing inherent or natural about the post-Ottoman frontiers in the Arabian peninsula and eastern Mediterranean. The Sykes-Picot agreement only intensified an unnatural divide-and-rule patchwork set as far back as the Crusaders, Mongols and then Ottomans. Today, these 'unnatural frontiers' supply copy for excited journalists who can say the house of cards 'could fall apart in an eyeblink'. More likely, the latest unraveling that started with Arab Spring in 2011 will continue. THE REAL PRESSURE POINTS - TO THE EAST Apart from the 'traditional regional flashpoint' of Israel-Palestine, the almost certain pressure point for change is Syria, Iraq and Kurdistan. The region's layered and longstanding historical disputes carry a certain amount of.bad news for oil importers, but only because oil production and even oil reserves are far from the only issues in these old but still very active conflicts. The bottom line is that rather than deliberate sabotage or military attack on oil installations, the domestic, regional and sectarian political conflict will or may cause 'collateral damage' to oil production and export infrastructures. Turkey's relations with its own Kurds, and the Kurdish diaspora are complex and very long-dated. On occasions, Turkey will at least tacitly support Sunni Arab djihadists if they are fighting Kurdish militants in Turkish frontier regions. At the same time, Turkey is currently extending a pipeline with a capacity of 1 Mbd right up to the Kurdistan frontier - but not beyond. Turkey also runs a huge road fleet of tanker trucks, day and night importing about 0.4 Mbd of oil from Kurdistan. The Baghdad Federal Iraqi government of Nouri al-Maliki actively disapproves of this but to no avail. Iraqi Kurds support efforts by their Syrian counterparts to extend the present de facto, and they intend de judere Kurdish writ in their northern Iraqi bastion into Syria. Today's Kurdistan in the northeast of Iraq is already de judere for Kurds and any oil companies wanting to work in Kurdistan. Iraq however still claims Kurdistan is only a de facto entity, and Baghdad weakly claims it still has legitimate power over this 'province', in what it calls 'northern Federal Iraq'. The likelihood or even the potential of Federal Iraq using military force to destroy independent Kurdistan must be reckoned as almost zero. If Kurds succeed in expanding their territory out from oil-rich Iraqi Kurdistan, to Syrian Kurdistan, this will certainly set an increased challenge to the integrity of Iraq as well as Syria. Relations between the Kurd leaders Massoud Barzani, and Jalal Talabani symbolize Kurdish domestic political divides. Both are Kurd but the second is the official president of the Governing Council of Federal Iraq since April 2005. Their relations are so complex we can summarize them by saying that both, or either, are able to have a meeting with whatever US president is presently in office, whenever they want.

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More simply, both aim for Kurdish independence. How they obtain it, how Syria and Iraq are 'carved up' to create an enlarged Kurdistan is however only one minor factor among the several factors driving the 'car bomb war of Iraq', that has reached deadly intensity since early 2013. Massoud Barzani can be called relatively Iran-friendly and Jalal Talabani relatively Saudi-friendly. Kurds can be called generally and relatively pragmatic and patient, but their patience since the 1923 'de-recognition' of Kurdistan during the Versailles Treaty conference series, by the Allied victors, in deference to Turkey, is now very limited and can become a war motive. Kurdish action in the region can be qualified as much more political, than sectarian. The political context across the whole Arab region is tending to move away from 'pure sectarian lines', since about 2003, but this in no way prevents - for example - Iraq's present car bomb war. The Middle East patchwork, today, is responding less to theological distinctions sealed in Sunni-Shia sectarian conflict, and has moved more towards concrete political and economic strategic interests. The case of Kurdistan is a major example, but even the mass street protests against Mohamed Moursi's failed government in Egypt can be taken as another example of this trend. Sectarian Sunni-Shia conflict is not a major part of the Egyptian political conflict, either at present or in the future. The probable or possible death throes of the Assad regime in Syria are now focused on Alawite security concerns - notably securing a corridor from Damascus through Homs to the Mediterranean coast enabling the home area of Assad's Alawites to feel it is in security. This area includes the port city of Tartus, home to Russia's only naval base in the region but Russia's real interests in Syria are however hard to fathom, and could or may be related to its own domestic struggle against Sunni extremists, for example in Daghestan and Chechnya who use the 'Al Qaeda' brand name. Several alternate options are available, for describing Russian Middle East policy. US AND WESTERN POSTURING Until very recently, in fact until 2011, Western posturing about regional geopolitics was fixated by and rooted in the 1948 creation of Israel and non-creation of Palestine. Israel-Palestine relations were the almost sole interest, outside of oil. John Kerry expresses ritual concern on the Syrian crisis, treated as if it were a spinoff from Israel-Palestine issues, most recently on May 22. He said that he feared that Syrian fighting 'would lead ultimately potentially to the splitting apart of Syria itself'. Added to this, the Obama administration has also publicly worried about the territorial integrity of Lebanon and the stability of Jordan. As Kerry knows full well, Syria's border with Lebanon is open for Hezbollah fighters who cross into Syria to guard Shia villages and fight for the Assad regime. Also including Iranian volunteers, Iranian-backed Hezbollah and Iraqi Shia are in Syria battling Sunni djidhadists affiliated with the Iraqi branch of al-Qaeda supported by the Sunni ruled petromonarchies of the Persian Gulf. Rarely if ever noted or admitted by Western diplomats and analysts, the ultra weak Lebanese state is probably the 'best-fit model' for the region. Lebanon's national integrity is so flimsy that national census data is a state secret. The population, for years, is officially given as 'about 4 million' to not incite domestic political and

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sectarian animosities and claims. Its frontiers are porous. Different communities inside the loose federal national entity are organized differently, exactly as they were organized across the region under the 300-year hegemony of the Ottomans. Both Iraq and Iran, as well as the Gulf states are feeling the shock waves. Exactly 10 years after the probably illegal war of George Bush and Tony Blair to topple Sunni dictator Saddam Hussein, Iraq not only faces the de facto secession of Kurdistan, but also 'the car bomb war'. Attacks from Baghdad to Basra killed more than 700 people in June according to the United Nations, the highest monthly death toll since 2007. Sunni mosques have been attacked, and Shia neighborhoods have been ripped apart by car bombs. Both sides in this heavily sectarian conflict are well armed and financed, but the 'novelty' in this sombre killing is that the car bomb war is now also political, as well as sectarian. The usual argument given by Western political deciders and their listened-to analysts is that 'Syria is contaminating Iraq'. The claim is that what is happening inside Syria is having a major impact inside Iraq, pushing Iraqi Sunnis to 'try taking back Iraq' from the Shia majority of the oil-rich east of Iraq, and from the Sunni but non-fundamentalist Kurds. As already noted, Kurdish political action has been operated with diplomatic skill, as well as military force to push the agenda for total independence. For many observers and even some Iraqis, both Sunni and Shia, the only solution for Iraq is 'the Lebanon solution' of a loose, weak central government enabling large regional and sectarian autonomy - but this is exactly not the type of Iraq that the US and UK wanted in 2003. The same Western dreaming applies to Syria. This is despite its de facto move towards a 'patchwork state' being almost admitted by al-Assad's attempt at creating the Alawaite 'secure zone' in the Damascus-Homs-Tartus corridor. Eastern Syria is already de facto Syrian Kurdistan, although opposed by Sunni terrorists backed by the Gulf state Sunni autocrat regimes. These 'Al Qaeda factions' hold relatively large parts of the southern desert of Syria, without oil, and could be compared with the fundamentalist Muslim separatist communities in Egypt's Sinai desert, or the early kibbutzim of Israel. Western handwringing on Arab Spring degenerating into Sunni-Shia civil war is sure to rest vain without the right decisions being taken - but the weight of historical action and repeated inaction, and the current playacting as performed by John Kerry, make it unlikely that constructive change will occur. Sectarianism has been deepening across the Middle East and North Africa since 2000. Sunni autocracy Saudi Arabia and the Qatari petro principality have flexed their petromoney and propaganda muscles - and almost inevitably have chosen to back Sunni fundamentalist fighters, but to date have only been able to viciously crush majority Shia dissent in one tiny Sunni ruled state - Bahrain. Across the Gulf to the east the real 'elephant in the closet', the vastly bigger state of Iran has reinforced its Shia sectarian bridges to eastern Iraq, eastern Saudi Arabia and other Gulf states. At the same time, as in Turkey and Egypt, Iran is in no way exempt from street protest but to date, the massive protests that unseated Libya's Muammar Khadafi, Tunisia's Ben Ali, and Egypt's Hosni Mubarak followed by his Sunni Muslim Brotherhood successor Mohamed Morsi, were all successful mass

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protests against Sunni leaders. THE OIL BARGAINING CHIP Presently, US State department analysts cited by the media tend to back the concept of 'continued Balkanization of Syria', rather than outright collapse. As already noted, Syrian onshore oil is concentrated in Syrian Kurdistan, and offshore shale gas and oil potential is for the moment only that - potential. Several commentators also see Syria fragmenting like Lebanon, ending as a central government with tenuous control over some cities and some enclaves, with a patchwork of regions having more or less autonomy. Iraq is almost certainly going down the same 'slope of least resistance', and similar loose federalization would be a likely break-up model for Saudi Arabia, when or if domestic conflict developed. The role of Syria and Iraq as models for this process are called 'regional contagion' and 'soft partition', but one of the main dangers is the Western-willed concept of strong, united, national states in a region where there is no real tradition of this model. For both Europeans and Americans, with either de facto federal European administration, or de judere American federalism, the imposition of highly traditional national and even monarchic or autorcratic government models in the Middle East is very easy to criticize as an anachronism. Oil has certainly dogged and distorted the pace of change in the Middle East and North Africa. The earliest Western geopolitical and economic strategic concept for Israel, we can note, was to provide a Mediterranean pipeline terminal point and refining hub for Arabian oil, enabling the Suez canal to be avoided. Only a few relics of that era, such as rusted remains of 10-inch diameter pipelines, still exist to mark that failed concept. Both technology, time and politics relegated this Strategic Israel concept to the wastebin. Strategic Iraq is now rapidly changing, like Syria and possibly soon Egypt. As previously noted in this article, oil is not the be-all and end-all for domestic change in the region. For outsiders it is. Mixing the two, in an increasing number of cases is like mixing oil and water, making for even less predictable and faster change. To be sure, the region's huge dependence on food imports - Syria for some while being treated as a potential 'Arab breadbasket' by Saudi strategists - makes it certain it will have to go on producing and exporting oil. The likelihood, therefore, of anything other than collateral damage to oil production and export infrastructures, during regional political change, can be considered relatively low.

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Insight: Better seismic data

Written by David Bamford from Finding Petroleum

Seismic technology thunders on apace... Where are the important innovations? Although progress in the processing and analysis of seismic data is important, for example the contribution of depth imaging to exploring for sub- or pre-salt plays in the Gulf of Mexico, Brazil and now Angola, the main innovations in seismic technology arise from step changes in our ability to acquire data. Thus, we should pay attention to focus what's happening in: Deep Water where: - Targets are deeper than ever, more subtle or complex (including salt-related) whilst there is still an emphasis on low cost, 'regional' or exploration 3D. And as a result we see bigger, wider, boats, towing more cables and also nodes becoming increasingly normal; this is all putting pressure on 'boutique' towed-streamer companies. Onshore where: - There is a need for 'regional' or exploration 3Ds at reasonable costs. And as a result we see Simultaneous Sweep sources, wireless recording and an interesting growth in multi-client surveys. And Fibre Optics: - Which has a range of uses, onshore and offshore, for down-hole acquisition, permanent reservoir monitoring. We must beware of the risk that we can generate so much data, of such variety, that we cannot keep up with the volumes - we may feel as though we are standing at the base of Niagara Falls with a tin cup!

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Insight: Beyond exploration!

Written by David Bamford from Finding Petroleum

Despite recent exploration failures, we know how to keep the North Sea going for decades! 2012 was an extremely poor year for North Sea explorers, especially in the UKCS, with very few discoveries at an extremely low success rate. I might add that even this was better than onshore Europe where there were no successes from nearly thirty wells. Once again, I recall the old adage that runs "The best place to find oil is in an oil field!" As European exploration gets more difficult, there remains a major prize to be gained by increasing flow rates and improving recovery factors in existing fields. Wherever serious studies have been undertaken, truly astonishing volumes of oil can be contemplated from increasing recovery factors using technologies that are known today. Certainly, it seems reasonable to believe that the current ~10% of all existing (global) discovery volumes that has actually made it to production is very much a lower limit. And that there is no reason for our North Sea industry to 'settle' for recovery factors around 40%. In many instances, a rising oil price will ensure that primary/secondary/tertiary recovery projects are economic although in some instances it may be necessary for governments to give tax incentives to help improved recovery projects, for example those based on CO2-EOR, to bring them into existence. Increasing recovery factors depends on a range of technologies - reservoir description, surveillance, reservoir monitoring, 'smart' wells….not just IOR/EOR schemes. Nevertheless, worldwide, just a 1% increase in the global recovery factor represents almost 90 billion barrels of oil, equivalent to replacing roughly 3 years of production at current levels. As an example, Gluyas has estimated, by comparing the UKCS with West Texas, that an additional 2.7 - 8 billion barrels of technical reserves could result from CO2 injection, corresponding to an increase of recovery factor in the range of 4 to 12%. In addition there are long term, indeed historic, estimates that improved reservoir modelling - and monitoring - could add 10% or more to recovery factors.

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I'm for a bit of 'boldness' where we push the recovery factor for every UKCS oil field up to 70%! We know how to do these things!

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Implications of the Arab Spring on the MENA Oil Market

Written by Ilda Sedja from Evaluate Energy

Over three years have passed since popular revolts started throughout MENA (Middle East North Africa) countries – branded as the Arab Spring – that posed economic and political dilemmas for the struggling regimes in the region. Currently, Egypt has seen a resurgence of protests whilst Tunisia, Libya and Yemen are in the process of political challenges of a new pluralism established with the election of new bodies. Algeria managed to survive the Arab Spring to a large extent smoothly compared to its neighbours, despite the attack on the In Amenas gas field in January raising some alarm. In Syria, the civil war has deepened with a growing death toll, and relationships between Syria and its neighbours are deteriorating further, especially Lebanon. Using Evaluate Energy’s Global database, we can observe how production levels have changed in the region since the crisis began.

Source: Evaluate Energy – Global Database

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Libya’s oil production tripled during 2012 from 478,000 barrels/day in 2011 to 1,509,000 barrels/day. In Yemen, the oil production declined by 21% in both years 2011 and 2012. In Syria, crude/NGL production fell initially by 15% in 2011 and then plummeted by a further 50% in 2012 showing the extent the current political instability and the international sanctions have affected the country. Oil production in Algeria slightly decreased by 1.02% in 2012 and in Tunisia it decreased by 4.70% in 2012. In Egypt, the crude/NGL production increased by 0.17% from 2011 to 2012 whereas during the crisis it fell by 0.73%. The below graph details the percentage share of the total oil production consumed domestically in each country of our peer group from 2005 to 2012; which provides us with an insight into export capabilities.

Total oil consumption within the peer group was 1,765,000 barrels/day in 2012. The share of total oil production consumed domestically has remained relatively steady for 2005-2010 with the only exception of Tunisia, which shows some degree of fluctuation in 2007. Algeria is the only country that shows consistency throughout 2005-2012, aided by a less volatile environment. Syria shows the most volatile conditions, shifting to a crude/NGL importer in 2012, which can be explained by the high political instability and strict EU sanctions that the country is still facing. Yemen’s figures display a sharp increase (35% more crude/NGL production consumed domestically) from 2011 to 2012 for similar reasons. Syria and Yemen’s escalating problems will no doubt concern Egypt, who may fear a similar impact following the reemergence of protests and unrest in recent days from opponents to the Islamist government. Also, the resurgence of Egyptian’s unrest raises concern of a domino effect in other MENA countries. On a more positive note, the share of total oil production consumed domestically in Libya has recovered well in 2012, falling to 11.28%, thus improving its export capability levels to even better than pre-Arab Spring levels. The presence of major

Source: Evaluate Energy – Global Database

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oil and gas companies (ENI, BP, ConocoPhillips; etc.) in Libya will no doubt have played an important role, due to large vested interests in the quick recovery of oil production. However, concerns do remain about local militias following sporadic attacks at oil installations, especially in the East. The MENA region has experienced large levels of domestic consumption of oil and gas. This is closely associated to the generous subsidy regimes they have in place. The IEA advocates the inefficiency of the subsidies as it causes overall market distortion, encourages waste and undermines the competitiveness of renewable energy alternatives. However, reforming subsidy regimes in the MENA region is easier said than done; countries (Egypt, Jordan, Morocco) that have introduced reforms in order to bring the energy prices closer to real market prices have been faced with mass protests. However, the Arab Spring may have served as the catalyst for economic and political reforms that are, in the IEA’s opinion, long overdue within the region. These reforms and settling political instability are both vital not only on a regional level but also on a global scale. The EU is the most important trading partner for almost all the countries in our peer group (Algeria 49%, Libya 72%, Syria 75% (pre-war levels), Egypt 25%, and Tunisia 75%). Additionally, oil exports from Yemen are sent to Asian markets led mainly by China and India. Despite a few countries showing signs of recovery and will to reform, political and social uncertainties remaining in the region are ultimately feeding across and affecting the global oil market. To read more on the MENA region, please see Hannah Mumby’s analysis on the potential impacts of the recent Iranian elections here. Further impacts of the Arab Spring can be determined using the data compiled from the BP Statistical Review 2013 and the EIA in Evaluate Energy‘s Global Database, which provides a country by country breakdown of oil & gas performance since 1965.

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