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Utility Week 10th January 2014

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Markets & Trading Market view Gulf mounts shale fight back As the production of shale gas in North America booms, oil and gas producers in the Gulf are having to adapt to a new global energy market, say Mike Wilkins and Karim Nassif. T he extraction of shale oil and gas in North America is proving a significant game-changer for global energy markets. As production levels have surged, the price of North American gas has collapsed and US gas and oil imports have fallen. As such, liquefied natural gas (LNG) and petrochemicals exports to US markets from major commodity producers such as member countries of the Gulf Co-operation Council (GCC) have started to decline. The Middle East Economic Digest (MEED) reports that the US is set to cut its petrochemicals imports by 50 per cent over the coming years. However, the financial performance of gas companies in the Gulf has yet to be significantly affected by the North American boom in shale gas, because GCC-based producers are diversified. Indeed, some have diverted LNG originally destined for North America to the Far East. Qatar is the most significant GCC gas exporter and was the first to respond to the price contraction. Although the state had projected an increasing supply of LNG exports to the US via its national oil company-backed facilities, these volumes are being diverted to other markets. Indeed, Qatar has not exported any LNG to the US since April 2013. While the shale boom has yet to affect the price of oil, this could happen in the medium to long term if shale oil supplies increase substantially and sufficient infrastructure is put in place to render shale oil exports competitive with GCC oil exports. Still, we consider that GCC hydrocarbon-exporting sovereigns could withstand a 15-20 per cent fall in global oil prices in an extreme scenario. Indeed, oil prices would have to drop to below $80 a barrel (Brent) before states such as Qatar and Saudi Arabia would record any financial deficits However, while diverting exports has proved effective in the short term, GCC-based oil and gas producers recognise that more substantive and innovative strategic plans are needed over the longer term. As a consequence, some national oil companies have 28 | 10th - 16th January 2014 | UTILITY WEEK acquired equity stakes in downstream refineries operating in the US. Others have established joint ventures and service partnership arrangements with North American companies that have shale know-how. Qatar Petroleum International, for instance, has bought 40 per cent of Suncor, a Canadian gas producer, while Saudi Aramco is working with US oil field services firms to gain the technological expertise to develop shale resources. In addition, GCC-based companies with mid-size exploration and production operations are beginning to allocate a share of their capital expenditures to shale activities such as horizontal drilling and fracking. One example is Abu Dhabi National Energy Company, which is looking to enhance recoveries from its Canadian fields. Meanwhile, market estimates put Saudi Arabian shale gas reserves at about 600 trillion cubic feet, and we understand that Saudi Aramco is in talks to secure 40 extra rigs to cover shale gas operations, indicating that the company expects large-scale p roduction over the medium term. In our view, Saudi Arabia is at the forefront of shale gas development in the Gulf. The government recently invited overseas companies to express their interest in a front-end engineering and design contract for shale gas that, according to MEED, was to be released in the third quarter of 2013. The technology used to extract shale gas is improving each year and this should result in cheaper costs in the Middle East. However, these costs remain expensive compared with those in the US. Aside from the aforementioned initiatives, GCC countries are creating downstream energy clusters with the aim of generating an "internal use" of oil that is, to an extent, insensitive to the market price. Saudi Arabia, for example, has developed such clusters in Jubail and Yanbu, where refineries and petrochemical plants are built side by side. In the event of a downward oil price shock in the medium to long term due to significant shale oil production, Saudi Arabia's own oil would continue to supply the refineries that fuel the operations of the petrochemical plants that produce the enriched end products. This not only guarantees a usage value for the oil at a time of potentially depressed prices, but also generates jobs and leads to greater end product diversification. We understand that several other GCC countries may emulate the Saudi model in coming years. While we believe these responses will help the GCC region retain its low-cost status over the next five years at least, shale gas-derived developments will continue to present challenges for Gulf companies. For instance, IHS, a chemical consulting firm, has highlighted the possibility of global oversupply of certain petrochemicals later this decade, when significant new capacity is slated to come online. This additional capacity is occurring as North American markets become more self-sufficient in natural gas and are in a position to increase their exports of petrochemicals such as ethylene and vinyl, and as European markets are increasingly priced out in terms of feedstock price relative to the US. According to MEED, U.S. ethylene production, which is crucial to commodity plastics production, will increase by 37 per cent by the end of the decade. Despite these headwinds, we consider Gulf downstream companies to have sufficient diversification away from European and North American markets and strong competitive positions to maintain their credit profiles. Nevertheless, we will closely monitor the degree of exposure of these companies to Europe (due to its weakening competitive position as a result of the shale boom) and to the US, and to competition from alternative export products supplied from the US over the medium to long term. It will also be crucial to observe how the potential global oversupply of certain petrochemical products affects GCC-based downstream businesses over the same time period. Karim Nassif is associate director and Michael Wilkins managing director at Standard & Poor's Infrastructure Finance Ratings

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