Onshore Gas Stagnates As Shell Divests

BMI View : Shell's exit from the Kidan gas development JV highlights the effects of unattractive state-set gas prices on Saudi's gas sector. In the absence of adequate pricing reform, we predict slow progress towards exploration and development of onshore non-associated gas fields, and the increased diversion of crude oil towards domestic consumption, in compensation for limited gas production growth.

Royal Dutch Shell is ending its joint venture (JV) with Saudi Aramco for the Kidan gas development project in the Empty Quarter. This continues a string of disappointments following the opening of Saudi Arabia's upstream to foreign participation in a bid to boost domestic gas exploration and production. Now, with Shell's looming exit, Aramco's ambitious efforts to draw foreign players into development of the Kingdom's gas reserves seem set to fail.

Shell's exit comes at a time of intense pressure on Saudi Arabia's domestic gas sector. Saudi Aramco has accelerated development of a number of gas projects, both conventional and unconventional, to answer to both rapidly rising consumption and poorer-than-expected progress on the exploration side. Developing these resources will help the country meet rising electricity demand and provide feedstock for Aramco's ballooning downstream segment, while conserving crude oil output for the lucrative export market ( see 'Gas Drive Crucial Move For Aramco', April 25 2014).

Strong Consumption Growth Soaking Up Production
Saudi Arabia Electricity Generation By Source (TWh), 2013-2023

Onshore Gas Stagnates As Shell Divests

BMI View : Shell's exit from the Kidan gas development JV highlights the effects of unattractive state-set gas prices on Saudi's gas sector. In the absence of adequate pricing reform, we predict slow progress towards exploration and development of onshore non-associated gas fields, and the increased diversion of crude oil towards domestic consumption, in compensation for limited gas production growth.

Royal Dutch Shell is ending its joint venture (JV) with Saudi Aramco for the Kidan gas development project in the Empty Quarter. This continues a string of disappointments following the opening of Saudi Arabia's upstream to foreign participation in a bid to boost domestic gas exploration and production. Now, with Shell's looming exit, Aramco's ambitious efforts to draw foreign players into development of the Kingdom's gas reserves seem set to fail.

Shell's exit comes at a time of intense pressure on Saudi Arabia's domestic gas sector. Saudi Aramco has accelerated development of a number of gas projects, both conventional and unconventional, to answer to both rapidly rising consumption and poorer-than-expected progress on the exploration side. Developing these resources will help the country meet rising electricity demand and provide feedstock for Aramco's ballooning downstream segment, while conserving crude oil output for the lucrative export market ( see 'Gas Drive Crucial Move For Aramco', April 25 2014).

Strong Consumption Growth Soaking Up Production
Saudi Arabia Electricity Generation By Source (TWh), 2013-2023

In recognition of the Kingdom's need for increased gas production, Saudi Aramco entered into four JVs with international companies to explore for gas in the Empty Quarter, in the southeast of the kingdom between 2003 and 2004:

  • EniRepSa (with Eni and Repsol);

  • Luksar (with Lukoil),

  • S outh Robh Al Khali Company (SRAK, with Royal Dutch Shell);

  • Sinopec-Aramco (with Sinopec).

However, foreign companies have one by one withdrawn from their respective JVs. Amongst several issues prompting a departure of foreign companies, the poor fiscal terms, and notably the unattractive state-set gas prices, stands out as the determining factor. Gas prices of USD0.75 per million British thermal units (mnBTU) means that several gas discoveries are not commercially viable to develop. This is a significant challenge to the Kingdom's ambitious gas plans:

  • Lukoil: In 2010, Lukoil relinquished 90% of its rights to an exploration block and two discoveries. Press reports indicated that the state-set gas prices meant that the discoveries would only be commercial if development included the recovery of sizable condensate volumes alongside gas.

  • Eni and Repsol: In 2012, Eni and Repsol also ended their hunt for gas. Due to the poor quality of gas, they also needed to discover condensate to make development economical. However, a ban on potential exports suggested limited commerciality.

  • Sinopec: In 2012, Sinopec also announced a halt to exploration, citing the 'uncertain economics' of the current joint venture.

Shell's withdrawal from its JV is due to similar concerns, and follows the exit of its former partner Total, in 2008. The Shell-Aramco SRAK venture was initially encouraging; a promising discovery was made at the Kidan block and there were reports that development tenders would be launched in mid-2013.

However, Kidan is rich in sour gas, which means it is more difficult to develop and produce than sweet gas reserves. The relatively high cost of developing the field in a context whereby gas sales prices are fixed at a fraction of probable production costs is a likely reason for Shell's decision to withdraw. Previous Reuters' reports have highlighted that failure to reach an agreement with Aramco over project developments has pushed the company towards a long-proposed exit.

The timing of the withdrawal is particularly important, given that Saudi Arabia has been floating the possibility of pushing through the long-delayed but oft-talked of plans to raise gas prices in the country. Shell's withdrawal highlights that the proposed increased from USD0.75/mnBTU to USD1.75/mnBTU, even if it does go through, is unlikely to dramatically increase the attractiveness of gas exploration.

In the absence of adequate pricing reform, we predict slow progress towards exploring and developing onshore non-associated gas fields. The unfavourable pricing environment, alongside technical challenges, will be even more dissuasive for unconventional developments ( see, 'Unconventional Projects To See Slow Progress,' June 5). As such, we see deepwater projects, alongside associated gas production as the main drivers of output growth over the next decade.

Falling Short Of Expectations
Saudi Arabia Gas Consumption (bcm and % change y-o-y), 2013-2023

However, given the early stage of offshore exploration and the rate of energy demand growth, we do not see gas output increase sufficiently to displace the bulk of oil used in energy generation. In addition, we do not forecast natural gas output to have increased substantially by 2017, when then bulk of Saudi Arabia's major refinery and petrochemical projects are due to come online. As such, we expect increasing quantities of crude oil to be diverted towards domestic consumption.

Limited Room For Export Growth
Saudi Arabia Non-Refined Net Exports (000b/d and % y-o-y), 2003-2023
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