ENERGY FORUM

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Issue 73 May 2008 Oil in Africa Jean-Pierre Favennec Bassam Fattouh Walid Khadduri Africa is often referred to as the forgotten continent. It only catches Philippe Copinschi the headlines when revolutions, massacres or massive electoral Gerald Doucet and Latsoucabé Fall – page 3 fraud take place. Africa is not a poor continent however. There is both hydrocarbon and mineral wealth. Oil and gas resources are US Presidential valuable assets for the countries that possess them, and globally for Candidates and Energy an energy hungry world. In this issue of Forum five authors assess Michael Lynch – page 16 successes achieved and problems faced by some African countries Comments on Gas in the hydrocarbon and electricity fields. Demand, Contracts and Prices Jean-Pierre Favennec sets the scene to participate in the development of James T. Jensen – page 17 describing first the main features oil and gas upstream. Bassam Fat- of the energy sector in the conti- touh shows how Libya managed to Asinus Muses – page 20 nent, most remarkably the very attract a very large number of for- low level of primary commercial eign oil companies from the super energy consumption particularly in majors to newcomers from the East sub-Saharan countries (other than after the lifting of sanctions in 2004. South Africa). This reflects the state This was not done by offering cheap of under-development of the region and easy terms in production shar- and in turn may well be a contribut- ing agreements. On the contrary, ing cause. Yet oil reserves in Niger- Libya imposed tough fiscal agree- ia, Angola and Libya are substantial, ments taking advantage of a strong as are gas reserves in Algeria, Ni- bargaining position. geria and Libya. Recent discoveries Algeria began a long process of in the Gulf of Guinea, Mauritania, opening-up in 1990 having suffered Chad and Sudan have widened the economically from the lean years of set of countries with hydrocarbon the 1980s. The final stage was the potential. Disappointingly, oil adoption of the 2005 Hydrocarbon revenues have been misused almost Law which took four years of po- everywhere. Some governments fac- litical debates involving the parlia- ing rebellions, civil wars or unrest ment, trade unions, political parties purchased weapons. Others were and various interests in the civil unable to prevent the diversion of society. It succeeded in attracting funds into private purses. foreign investors both in gas and oil In North Africa, Algeria and Libya, despite an insurgency which caused albeit in different contexts, govern- security concerns. Walid Khadduri ments have invited foreign investors mentions in addition some of the OXFORD ENERGY FORUM MAY 2008 problems encountered by Algeria in realising its in favour of biofuels, but will they change their ambitions of becoming a player in the Spanish minds when the unintended consequences of this domestic gas market. preference become clear? The Democrats will want to reduce tax breaks on the industry but On certain criteria, Nigeria is the most important McCain has not expressed views on this issue. oil country in Africa. Philippe Copinschi notes Clinton and Obama may try to increase excise the dynamism of investments by oil companies taxes on petrol despite past failures of such at- since 1998, the year when the military dictator- tempts; McCain will not. And there are other dif- ship ended, and the results in offshore discoveries. ferences which Lynch defines carefully. Production capacity will increase as these new reserves are developed, but whether production Forum is a debating journal. We welcome letters will grow as a result is a different question. True, and longer comments. James Jensen is contribut- the insurgents are less able to disrupt offshore ing very significant comments to the articles activities, but complacency on the security issue published in the last issue of Forum (No. 72). is not warranted. The obstacles to progress in the His comments are on the crucial topics of gas development of the Nigerian hydrocarbon sector demand growth, contracts and prices. Two of his and indeed the whole economy are well known main messages are: first, although ‘international but deserve to be repeated and repeated. gas markets are more flexible than they used to be…the long-term contract is far from dead’; and Electricity is in many respects a superior form of secondly that nobody seems to have an answer energy. It reaches the point of application at the to the crucial question of how to place a value on end of a wire; no messing about with pipes carry- long-term gas supply. Without such an answer in- ing a toxic fuel, dirty coal to be shovelled under a vestment decisions on major gas projects become boiler, or oil products either viscous or vaporous, very difficult. unsuitable for lighting and awkward in domestic uses. Gerald Doucet and Latsoucabé Fall rightly stress the important role that electricity can Contributors to this issue play in deprived Africa: ‘it is a cornerstone for economic progress.’ Their contribution is about Philippe Copinschi teaches at l’Institut d’Etudes the Inga projects that aim at realising some of the Politiques de Paris (Sciences Po) huge hydropower potential of Africa, a ‘potential of which only 7 percent is presently exploited’. Gerald Doucet is Secretary General, World Energy Council This issue includes two other articles. Michael Lynch addresses the topical question of changes Latsoucabé Fall, is Manager Africa, World in the US energy policy that may result from the Energy Council Presidential election. What would Clinton, or Mc- Bassam Fattouh is Reader in Economics, Cain or Obama do in this complex area if elected? London University School of Oriental and The current administration was expected to adopt African Studies and Senior Research Fellow at pro US oil industry and pro Arab domestic and the OIES foreign policies. What actually happened was dif- ferent. There were few benefits to the oil industry Jean-Pierre Favennec teaches at the Institut and President Bush turned out to be more sympa- Français du Pétrole thetic to Israel than to Arab positions. James Jensen is President of Jensen Associates The three presidential hopefuls have similar inten- Walid Khadduri is a consultant to Middle East tions as regards curbing greenhouse gas emissions. Economic Survey They are all in favour of renewable energy which needs subsidies. They rightly believe that this is Michael Lynch is President and Director of good for the environment and less convincingly Global Petroleum Service at Strategic Energy that it is also good for energy security. They are and Economic Research Inc.

 OXFORD ENERGY FORUM MAY 2008 Energy in Africa

Jean-Pierre Favennec this group of significant producers, North African producing countries are and other West African countries more closely related to Middle Eastern on the importance of already produce oil (Ivory Coast, producing countries than those of Mauritania) or will do so soon (Ghana West Africa: Algeria and Libya are oil in Africa and possibly Niger or Mali). Uganda OPEC members, their oil industries is also a future producer. were nationalised in the 1970s, their Africa is unique because it has a very national companies (Sonatrach and low primary energy consumption, of Africa’s proven oil reserves amount NOC Libya respectively) still play the order of 0.4 tonnes of oil equiva- to 15 billion tonnes (Gt), i.e. ap- a very important role, and there is lent (toe) per inhabitant, compared proximately 10 percent of the world’s greater sensitivity to political tensions with 1.7 worldwide and no less than total reserves, and are fairly evenly in the Arab Muslim world. distributed between North Africa 8 in the United States. South Africa Libya produced almost 3.5 million alone consumes 40 percent of the en- and West Africa. In 2006, African production reached 10 million barrels b/d in the early 1970s. But its produc- ergy used in Africa, and North Africa, tion then dropped sharply with the mainly Algeria and Egypt, 25 percent. per day (Mb/d) – equivalent to 475 million tonnes – i.e. over 10 percent decline of investments as a result By contrast, sub-Saharan countries of the restrictive terms imposed by (West Africa, Central Africa and East of the world’s total production. Given its reserves and production, Africa is Colonel Qaddafi’s government on Africa), from Mauritania to Namibia oil companies present in the country, and Sudan to Mozambique, use very therefore no ‘new Middle East’, but its role as a supplier to the United States and the government’s wish to reduce low quantities of commercial energy. production. Having fallen to a little This low energy consumption is both and Europe makes it a key player and the setting of a battle for influence over 1 million b/d during the 1980s, the cause and the effect of the low production rose again to 1.8 million level of development in the region. between the main consumer zones. Indeed Africa uses only 30 percent of b/d in 2006. Algerian production, on Biomass (wood, plant residue, and the oil it produces, leaving consider- the other hand, has increased progres- so on) represents two-thirds of total able quantities free for export and sively and is now 2 million b/d. household energy consumption. South making the continent the third largest In Algeria and Libya production Africa uses very large quantities of oil-exporting zone, just behind the prospects are good. In Algeria the coal, and North Africa uses substan- CIS but far behind the Middle East. liberalisation of the hydrocarbons tial quantities of natural gas, but oil is sector that took place around 1990 widely used everywhere, particularly allowed foreign companies, in as- in sub-Saharan countries. Oil in North Africa sociation with Sonatrach, to seek and Algeria and Libya are substantial exploit hydrocarbons, and this has Recent Discoveries and Considerable suppliers of oil to Europe, unlike considerably increased both reserves Reserves Egypt which consumes most of its and production. But the total liber- production and where production alisation of the sector, which would In many regions of the world, oil has been falling slightly for the past have enabled foreign companies to production began in the nineteenth ten years. The oil simply has to cross operate independently, was rejected by century (the United States, Russia and the Mediterranean to reach France, the National Assembly. In a context Indonesia) or at the beginning of the Italy, Spain, Greece and Turkey, so of very high prices and abundant twentieth century (the Middle East over two-thirds of North Africa’s revenue, it did not appear advisable and South America), but the discovery oil exports are destined for Europe. – apparently – to allow a substantial of hydrocarbon deposits came much However, the share of the United share of hydrocarbon revenue to go to later in Africa where production only States is growing. foreign companies. started in the 1950s. It is concentrated in a few countries in two areas: first, the coastal area around the Gulf of Table 1: Oil in the Economy of the main North African Producers Guinea, with two major producers, Nigeria and Angola, and several Proven Production Consumption Exports % Share of oil in significant producing countries, in reserves (Mb/d) (Mb/d) (Mb/d) exports GDP State particular the Congo, Gabon and (GTonnes) resources Equatorial Guinea (a recent newcomer Libya 5.4 1.8 0.3 1.5 95 50 60 but expanding fast), and secondly Algeria 1.5 2.0 0.3 1.7 >95 30 60 North Africa, with Algeria, Libya, Egypt 0.5 0.7 0.6 0.1 40 4 10 Egypt and to a lesser extent Tunisia. Sudan and Chad have recently joined Source: BP Statistical Review of World Energy, June 2007 & www.doe.eia.gov

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In Libya the sector opened up after Niger alluvium also contains deposits have been made there recently. Sao the United States lifted its sanctions, belonging to Cameroon, Equatorial Tomé and Principe could soon leading to the return of the American Guinea and Sao Tomé. However, become an oil producer, since its terri- companies that had contributed to tensions between the local population, torial waters probably hold significant the discovery and exploitation of oil the oil company and the government quantities of oil. in the country. This return is a logical have a great impact on production. move. Installations and personnel are the Central and East Africa object of frequent attacks, forcing the operators to interrupt production for Oil production in Sudan began in Oil in West Africa varying periods of time. 1995. The production deposits are located in the centre of the country The region’s second largest producer Trends in Oil Production in West and are exported via a pipeline over is Angola. Production there started Africa, thousand barrels per day 1500 kilometres long, opened in 1999, in the enclave of Cabinda during the which takes the oil to Port Sudan on 5000 Portuguese colonisation, and is now the Red Sea. The deposits are mainly expanding fast, thanks in particular to exploited by the Chinese company 4000 the discoveries made off the enclave CNPC. Western companies involved (60 percent of the oil produced in An- 3000 in production in Sudan withdrew gola comes from this area). Significant following pressure from non-govern- 2000 production has also been developed mental organisations (NGOs). It is in the deep offshore further south, off very likely that there are other sub- 1000 the coast of Luanda. stantial deposits, but they are located 0 In neighbouring Congo Brazzaville in the zones of combat between the production is much more modest, but Khartoum government forces and the 1965 1975 1985 1995 2005 has also increased consistently since armed opposition movements. the 1970s, and recent deep offshore Source: BP Statistical Review of World Chad is a recent arrival on the oil discoveries should make it possible Energy, 2005 production scene. Its first barrels to maintain production at a high level arrived on the world market in 2003, in the coming years. In both these after the opening of the Chad–Cam- More recently, in the 1960s and countries, practically all production is eroon pipeline. Oil reserves were 1970s, the Gulf of Guinea area joined offshore, which explains in part why identified around Lake Chad in the the world oil scene. Its reserves are it has never been interrupted for any north of the country in the mid-1970s, certainly limited in global terms with length of time, despite the conflicts in but they were too limited to justify only 4 percent of reserves and 6 the area. percent of production. Nevertheless, the construction of a pipeline to the since the end of the 1980s, the Gulf Production in Equatorial Guinea Cameroon coast (over 2000 km away) of Guinea has become a favourite started off very modestly in 1992 and to export the crude oil. In addition, destination for international oil only became significant in 1997. It is the civil war meant that the Chadian investors and production here has growing fast, and the recent discover- dream of becoming an oil producer almost doubled in fifteen years. The ies make the country one of the major was delayed on several occasions. oil – although offshore – is relatively players in the region. By contrast, Continuing in the South the ex- easy to produce and is of high quality. production in Gabon, which had ploration operations that had been This region has also been the location doubled at the end of the 1980s, is in conducted in the North, the American of some of the biggest recent discover- decline and unlike its oil-producing oil companies Conoco, then Exxon, ies. Finally, the region is well situated neighbours, few offshore discoveries revealed the presence of considerable in relation to consumer markets in Europe and the United States. Exports Table 2: Oil in the Economy of the main West African Producers from the area are therefore quite well balanced between the main centres of Proven Production Consumption Exports % Share of oil in consumption: 45 percent to the United reserves (Mb/d) (Mb/d) (Mb/d) exports GDP State States, 40 percent to Asia and 15 (GTonnes) resources percent to Europe. However, there are Nigeria 4.9 2.5 0.3 2.2 95 20 80 powerful rivalries between consumers, Angola 1.2 1.4 0.1 1.3 90 85 - as we shall see. Congo 0.3 0.3 0.01 0.2 90 65 70 Gabon 0.3 0.2 / 0.2 80 51 63 The biggest oil-producing country Equ. Guinea 0.2 0.4 / 0.4 90 72 - in the region is Nigeria, which Chad 0.1 0.2 / 0.2 has substantial reserves in the area Sudan 0.9 0.4 0.1 0.3 70 around the mouth of the Niger. The basin of sediments created by the Source: BP Statistical Review of World Energy, June 2007 & www.doe.eia.gov

 OXFORD ENERGY FORUM MAY 2008 reserves in the Doba region. A ing conflict against Joseph Savimbi’s The low density of energy consump- pipeline 1300 kilometres long had UNITA (UNITA uses the profits tion makes oil particularly attractive to be constructed across Cameroon from the sale of diamonds in the because of its liquid state: it is easy to exploit them. This project was zones that it controls to supply itself both to transport and to store. De- delayed for a long time, in particular with military equipment). spite all the potential advantages of by the intervention of NGOs who In Congo Brazzaville the situation is photovoltaics (environmental factors, highlighted the environmental risks similar; a long civil war has destroyed independence), small oil-fired power of the project: the pipeline crossed part of the country’s infrastructure. A plants remain an economic source of fragile areas, and there were risks for few years ago the Congolese bishops electricity, often very competitive in local populations, particularly for proposed a break in oil production remote areas that are difficult to access the pygmy community. The project, and a national conference to con- for electrification. Oil, in the form of with a total cost of almost $4 billion sider the best way of utilising the oil fuel for vehicles or power plants, is (production installations and pipeline) revenues. therefore the main source of energy, eventually went ahead thanks to the apart from traditional sources such intervention of the World Bank which, Dependence on oil revenues is not as wood, charcoal, plant and animal after extensive studies, finally gave unique to the large producers of residue. the go-ahead and financed part of the West Africa. Many OPEC countries investment. show the same characteristics and diversifying their economies appears to be difficult. Nearly 100 years after its first oil exports, Venezuela remains “Dependence on oil largely dependent on hydrocarbon exports. Takings from the sale of oil revenues is not unique to and gas play a prominent role in the the large producers of West Russian economy. But the weakness of Bassam Fattouh Africa” African administrative structures has aggravated certain tendencies towards considers the the wasteful use of oil revenues. history of foreign oil The reserves in Chad and Sudan, which are of prime importance for the Conclusion: different uses of oil companies in Libya economic development of these coun- While the respective shares of the tries, are marginal in global terms. different energy sources in the energy The first Petroleum Law enacted in However for the past several years mix of the entire continent are close 1955 in Libya was innovative in many they have been the subject of intense to the global average, these statistics aspects compared to the concessionary international controversy, due to hide important differences in the way systems adopted in most of the Mid- the nature of the political regimes in oil is used – and the high consumption dle East Gulf. Rather than granting power in Khartoum and N’Djamena, of coal in South Africa masks the fact concessions over large areas, it limited and the political and economic situa- that in the rest of Africa oil represents the size of single concessions to 75,000 tion in the two countries. almost 60 percent of the energy sq. km which ensured that the oil consumption (excluding firewood). sector is not dominated by a few big oil companies. The law also set a Oil Rent and Development Although oil products are increasingly used worldwide exclusively in captive relinquishment requirement so firms The use of oil revenues remains sectors (basically transport), in Africa that lease blocks and do not engage confusing. The economic situation, they are still used mainly for the in exploration and development indeed the political one as well, of the generation of electricity. The conti- activity could lose their concession to large African producers is not good. nent’s transport infrastructures are other competitors willing to develop Nigeria, for example, is placed at 183 relatively underdeveloped so there is the block. The 1955 Petroleum Law out of 201 in the categorisation of a lesser need for automobile fuel. The fostered competition and succeeded in countries by Gross National Product. small size of the markets (due to low attracting the reluctant majors and a Exports of oil and gas represent income), and the fact that consumers wide range of other companies which almost the entire exports of the are widely dispersed, means it is prac- had few available upstream opportuni- country, but contribute nothing to its tically impossible, and not profitable, ties outside the country. This gave development. The share of food in to- to develop a natural gas distribution the Libyan government a powerful tal imports has doubled between 1974 network, except in the Ivory Coast bargaining position. and 2001. Dutch disease has prevailed and Nigeria, where a critical size can The tight oil market conditions of in Nigeria as in many countries. be achieved. The use of coal, which the 1970s strengthened further the In Angola the money from oil has is almost non-existent in the region bargaining position of the Libyan gov- been used by the MPLA government outside South Africa, would lead to ernment vis-à-vis the concessionaires. to purchase arms for the longstand- the same economic difficulties. In September 1970, the government

 OXFORD ENERGY FORUM MAY 2008 reached an agreement with Occidental of exploration and sharing agreements imposed on Libya which allowed for wherein this independent company (EPSA II) whose terms were even less the resumption of most commercial agreed to pay income taxes on the attractive than EPSA I. activities on the part of US companies basis of increased posted rather than In the 1980s, Libya was hit by a series including investments in the oil sector. realised prices, and to make retroac- of US sanctions which resulted in the US oil companies have thus been mak- tive payment to compensate for the departure of several US companies. ing their way back into Libya through lost revenue since 1965. Soon after, Exxon and Mobil (now ExxonMo- participating in the exploration rounds all other companies operating in bil) exited in 1982. Amerada Hess, and/or renegotiating the resumption Libya submitted to the new terms. Conoco, Grace Petroleum, Marathon, of operations they left behind. In As a result of this agreement, other and Occidental, continued their activi- 2005, Occidental returned to Zueitina oil-producing countries invoked the ties until 1986, when President Reagan Oil Company (ZOC) as a minor- most favoured nation clause and made ordered their withdrawal from the ity partner to the NOC. ZOC was it clear that they would not accept Libyan oil sector. The departure of US established to take over Occidental anything less than the terms granted companies allowed a range of non-US assets when this company exited in to Libya. Negotiations conducted in oil companies such as Italy’s Eni, 1986. Output suffered heavily as the Tehran led to a collective decision to Spain’s Repsol YPF and Petro-Canada result of Occidental’s departure and raise the posted price and increase the to fill the void. US sanctions; ZOC’s output declined tax rate. However, the Tehran agree- from 140,000 b/d in 1986 to 60,000 ment resulted in better fiscal terms Faced with a decline in oil revenues in b/d in 2006. The year 2005 also saw than those negotiated in Libya and the mid 1980s, the Libyan authorities the return of Conoco, Marathon, thus the Libyan government reopened felt the need to increase exploration and Amerada Hess to the Waha Oil negotiations with foreign oil compa- activity. In 1988, it introduced a Company (WOC) where the joint nies to bring the terms in line with the third generation of exploration and venture partners signed a deal with the Tehran agreement. production sharing agreements (EPSA Libyan government to return to fields III) which is more attractive than they abandoned in 1986 and extended During the period 1971–73, the the previous ones. For the first time, their licences to 2034. Libyan government began to revise Libya agreed to provide foreign firms existing concessions in favour of 51 with a percentage of oil production percent participation agreements with to compensate companies for explora- Exploration Rounds the state oil company, the Libyan Na- tion and development costs they had In 2004, substantial new acreage was tional Oil Corporation (NOC) created incurred. EPSA III was relatively offered under the terms of EPSA IV. in 1970. After months of negotiations, successful and allowed the entry of In the first round of bids, NOC re- many oil companies accepted the new new players into Libya. ceived 104 offers from 56 companies. participation agreement including Competition was intense as reflected BP, Agip, Occidental, Marathon, The Lifting of Sanctions in the large number of bids for some Amerada Hess and Conoco. For of the blocks (fifteen bids were made those oil companies that rejected the In 2004, the USA lifted its sanctions for the offshore area 54 and area 106 new participation deal such as Exxon, Mobil, Texaco and Chevron, the government issued a decree on 1 Sep- Table 1: Awards of the First Licensing Round tember 1973 nationalising 51 percent Basin Contract Blocks Company Available No Contractor Bonus of their concessions. This has been the Area Open of Bids Share of ($ million) most radical decision that the Libyan Acreage Gross government has ever taken against Output (%) foreign oil companies. In the same Sirte 106 4 Oxy Liwa 6520 15 12.4 25.6 year, Libya announced that any future Murzuq 131 4 Oxy, Liwa 10381 10 13.3 25.6 involvement of foreign oil companies Sirte 124 3 Oxy, Liwa 6113 4 10.8 15.3 Murzuq 163 4 Oxy, Liwa 11236 9 15.9 15.3 would be based on exploration and Cyrenaica 59 2 Oxy, Liwa 5298 1 38.9 1.1 production sharing agreements. Offshore 36 4 Woodside , Oxy, Liwa 10414 7 17.4 16 Offshore 52 4 Woodside, Oxy, Liwa 6182 6 17.9 10.05 During the period 1973–78, the Offshore 53 4 Woodside, Oxy, Liwa 8047 8 19.8 8.12 government signed exploration Offshore 35 4 Woodside, Oxy, Liwa 9070 3 10.4 5.21 and production sharing agreements Offshore 54 4 Amerada Hess 9769 15 12.4 6.18 (known as EPSA I) with foreign Murzuq 177 4 Chevron Texaco 11317 6 12.8 0.6 players. In an effort to intensify Sirte 86 4 Oil India, Indian Oil 7078 5 18.4 0 exploration activity, the government Offshore 18 4 Petrobras, Oil Search 10307 2 31.8 1 Ghadames 65 2 Sonatrach 4374 4 25.0 2 forced existing companies to relin- Ghadames 47 4 Verenex , MEDCO 10531 9 13.7 0.25 quish some of their blocks. These blocks were then offered to foreign Source: MEES; Daniel Johnston, ‘Impressive Libya Licensing Round Contained Tough companies under a second generation Terms, No Surprises’, Oil&Gas Journal 18 April 2005

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round was dominated by European Table 2: Awards of the Second Licensing Round and Asian companies with a strong Basin Contract Block Company Available Contractor Bonus entry for Japanese oil companies. Area No Open Share of ($ million) Acreage Gross In August 2006, the Libyan authorities Output (%) embarked on a third international bid- Sirte 102 4 Oil India/Indian Oil 2,750 10.5 3 ding round for 14 areas (41 blocks). Sirte 123 1,2 BG (2750, 2000) 10.9 7.5, 7.5 Seven licences were first awarded on Sirte 123 3 Pertamina 2,030 8.8 7 20 December 2006 followed by three Ghadames 81 1 ONGC Videsh 1,900 11.8 6 additional awards for areas that only Ghadames 81 2 Teikoku/Mitsubishi 2,650 7.5 6 received single bids. The oil companies Ghadames 82 3 Teikoku/Mitsubishi 2,500 7.5 6 agreed to a total work programme of Murzuq 146 1 Norsk Hydro 2,444 7 7 $951 million. The third round saw the Murzuq 147 3,4 Turkish petroleum 2,270 9.7 7.262 Murzuq 161 1 Eni 2,750 8.5 3.1 entry of the Russian firms Gazprom Murzuq 161 2,4 Eni 3,900 7.9 4 and Tafneft. Murzuq 176 3 Eni 2,750 9.8 3.3 Murzuq 176 4 Japex 2,750 6.8 3 Cyrenaica 42 1,4 Total/Inpex 3,352 27.8 1.8 Bilateral Negotiations Cyrenaica 94 1,2,3,4 Statoil 10,000 24.9 2.95 Libya also awarded some contracts Cyrenaica 40 3,4 Japex, Nippon, Mitsubishi 4,540 8 1.7 (mainly gas) to foreign companies Cyrenaica 44 1,2,3,4 ExxonMobil 10,290 28.5 1.5 Kufra 171 1,2,3,4 Statoil/BG 11,000 19.8 1 without going through competitive Kufra 186 1,2,3,4 Eni 8,400 15.4 1.1 bid rounds. One such agreement was Offshore 2 1,2 Nippon,Mitsubishi 4,650 8 2.5 concluded with Shell in 2005 which Offshore 17 3 Pertamina 2,010 11.7 8 involved commitments to spend Offshore 17 4 CNPC 2,535 28.5 6 between $105 million and $405 million Source: MEES to upgrade an LNG facility, and to invest $187 million in exploration of in the Sirte basin). The first round of with such a result as it rebalanced five blocks in the Sirte Basin. Another licensing was concluded in 2005 and the mix of companies which was agreement was reached with BP in resulted in the award of 15 areas cov- heavily dominated by European oil 2007 awarding it three offshore and ering 126,639 km2. The oil companies companies. four onshore blocks in the Ghadames agreed to a total work programme of basin. These agreements secured Encouraged by the success of the the return of Shell and BP into US$299 million which include drilling first round, the NOC announced a 24 exploratory wells and 2D and 3D Libya after their departure in 1974. A second bidding round in May 2005 similar agreement was concluded with seismic survey. The upstream licensing offering 44 blocks and 51 companies round was dominated by Occidental ExxonMobil in 2007 over four blocks participated. In the first quarter of in contract area 21. ExxonMobil com- Petroleum and Australia’s Woodside 2006, the Libyan government awarded Petroleum. Occidental (in partnership mitted a five-year work programme 40 of the 44 blocks covering an area of consisting of at least 4000 km of 2-D with UAE based Liwa) were awarded 94,080 square km. The oil companies five blocks. The consortium led by seismic and 2000 square km of 3D agreed to a total work programme of seismic, drilling one deepwater explo- Woodside Petroleum which also US$482 million which include drilling includes Occidental (35 percent) and ration well at cost of $97 million, and 36 exploratory wells and 2D and 3D payment of a signature bonus of $72 Liwa (10 percent) won an addition seismic survey. The second licensing of four areas. Amerada Hess won the million. Although the awards granted much contested licence for offshore 54. The first licensing round also saw Table 3: Awards of the Third Licensing Round the return of Chevron/Texaco which Basin Contract Blocks Company Contractor Bonus relinquished all holdings in the coun- Area Share of Gross ($ million) try in 1977. Interestingly, no European Output (%) company was able to secure a licence. Offshore 20 4 Exxon Mobil 22.30 10 Some observers claim that granting Offshore 43 4 ONGC 28 10 the bulk of licences to American firms Murzuq 113 2 Inpex 12.9 10 was politically motivated as Libya Offshore 19 4 Gazprom 10 10.1 tried to foster its relations with the US Ghadames 82 1 Tafneft 10.4 10 government. However, this is unlikely Ghadames 98 2 Tafneft 10.4 10 Sirte 69 4 Tafneft 12 10 given the nature of the competitive Sirte 137 2 PetroCanada 18 10 bids. The absence of European firms is Murzuq 162 2 CPC 7.8 5 better explained by the fact that they Kufra 201 4 Wintershall 13.5 3 have been outbid by their competitors. Source: MEES In any case, Libya was comfortable

 OXFORD ENERGY FORUM MAY 2008 were not the result of a bid round, non-negotiable conditions, selection through exploration and obtain a it is unlikely that these super majors criteria (based on contractor share, 50 percent working interest of the managed to secure more favourable exploration commitments, bonuses, venture. In return, NOC agrees to terms than obtained under a bid, given parallel investment and local content), pay 50 percent of capital expenditure. that Libya applied EPSA IV terms pre-qualification procedures and The NOC is also carried further and judging from the extra commit- minimum expenditure commitment. through the development phase where ments that these companies made. For Unlike EPSA III, awards were granted it would pay 86.3 percent of the instance, the commitment made by for companies that made the highest venture’s operating expenditures. The BP for exploration was described by bid on the share of gross produc- NOC pays 100 percent of all royalties Tony Hayward as ‘the single biggest tion going to NOC. This bidding and Libyan taxes incurred on each exploration commitment’ with an parameter is usually referred to as the discovery, including the contractor initial budget of $900 million. production factor while the remain- group share. ing share going to the contractor is referred to as ‘cost recovery’. This can Until the contractor recovers his costs, Renegotiations with Existing be considered a novelty as the share the entire 13.7 percent share of pro- Companies going to the national oil company is duction goes to the contractor. Once the contractor recovers his costs, the NOC has also been busy rene- generally pre-determined in the model contract or subject to negotiation. It difference (i.e. profit oil) is shared gotiating the outdated contracts between the contractor and NOC with foreign oil companies already is unusual for the production factor to be subject to a bidding process. In based on two sliding scales: R factor operating in Libya. ENI was the first calculated as the ratio of accumulated company to renegotiate, followed by effect, this production factor acts like a royalty since it is taken from gross receipts by the contractor to the Occidental, OMV and PetroCanada. accumulated capital expenditure and The renegotiations resulted in the revenues and is not accessible to the foreign investor. In our example, the the current year total project produc- extension of these firms’ contracts tion rate (P factor). The share of profit by 25 to 30 years. But this came at a bid yielded a production factor of 86.3 percent or a cost recovery bid of 13.7 oil accruing to the contractor in each high cost for oil companies as the new quarter is equal to: R×P×Profit Oil. contracts involved heavy investment percent .This means that the company commitments aimed at increasing has to recover its exploration, devel- As can be seen from this example, the the recovery rates of existing fields, opment and operational costs from its contractor’s take is low. Furthermore, new fiscal terms in line with EPSA 13.7 percent share of production. there are also limits on how much IV harsh terms and hefty signature the oil company can benefit from the In case of a tie on the production bonuses. The new terms meant that upside potential of its investment. In factor, the company offering the high- oil companies’ share of post-tax gross fact, the overall government take for est bonus would receive the licence. production fell dramatically. But oil EPSA IV blocks averaged around 88 Thus, the companies had to compete companies seem to have little choice. percent which is considered as one of on bonus payments. As can be seen As OMV spokesman Thomas Huemer the highest in the world. from Tables 1–3, the bonuses were puts it: ‘the oil price is much higher quite high in some cases especially in than before and therefore NOC wants the first round of bidding. That being to adjust its contracts. It is a fact of Evaluation said there is a large divergence in the life that we have to live with.’ amount of bonuses paid, varying from Oil companies’ willingness to accept zero to $25.6 million. Bonuses are such tough terms indicates how much Harsh Fiscal Terms most burdensome to the contractor as the oil scene has changed in the last they are paid regardless of whether a few years. Specifically, these hardened The high interest shown by foreign oil discovery is made. Furthermore, the terms can be explained by: companies during these three licensing contractor is not allowed to recover • Libya’s attractive geological charac- rounds may suggest that Libya has bonus payments as cost oil. been offering attractive fiscal terms. teristics where it is considered as a But on the contrary, the Libyan terms The new agreements also give the high quality oil province with low have been described as the toughest so option for NOC to participate in the cost of production and relatively far. Take for instance the EPSA signed venture if a commercial discovery is under-explored in part due to sanc- between the Libyan NOC and Veren- made. In this case, NOC is said to be tions imposed since the early 1980s ex Energy and its partner MEDCO carried through the exploration phase. • The limited opportunities available for area 47 granted under the first In other words, it has the option to for foreign oil companies to access licensing round. In appearance, the take a working interest in the venture high quality reserves elsewhere EPSA follows the conventional pro- without reimbursing the exploration duction sharing contract but there are costs incurred by the contractor but • Libya’s geographic location at the some major differences. Under EPSA it would pay its share of development doorstep of Europe IV, the government followed new costs. In the example of Verenex, the • The competitive nature of the procedures with sealed-bid rounds, NOC has the option to be carried bidding process that NOC adopted

 OXFORD ENERGY FORUM MAY 2008

• The current environment of high place against a background of a weak upstream to the downstream. Algeria oil prices; and institutional environment, inefficient was able to increase its hydrocarbon • Oil companies’ expectations that bureaucratic system, stifling customs production with the assistance of oil prices will not return to1990s procedures, and shortage of qualified IOCs in the 1990s and beyond levels. employees. Low institutional capacity at a time when it was adopting a can delay the conclusion of agree- controversial Hydrocarbon Law, Although the government feels ments and the implementation of and suppressing an Islamic militant confident that it will meet its target projects. insurgency. of capacity expansion from the current level of around 1.7–1.8 mb/d The adoption of the 2005 Hydrocar- to 3 mb/d by 2010–2013, some risks Conclusion bon Law involved a lengthy period (four years, from 2001 to 2005) and remain. First, the strict fiscal terms Despite its reliance on foreign oil a transparent process (public debates mean that making some of the projects companies, Libya has proved over about the draft with civil society, profitable is very challenging. Lower and over again its ability to impose trade unions, political parties, and in oil prices, unexpected escalation of tough fiscal terms by timing its parliament). Initially, the draft met costs, and/or failing to make big renegotiations with favourable changes strong resistance as there were fears discoveries may render many of the in oil market conditions, introducing that it would weaken Sonatrach and projects unattractive for the contrac- innovative bidding procedures, attract- ultimately lead to its privatisation. tor. In such cases, the oil company ing different types of oil companies, Later on, the Law received wider would want to renegotiate existing and using negotiation tactics that aim support when the draft was revised to contracts. These renegotiations can at obtaining maximum concessions address these and other concerns and prove costly and may cause serious from one of its partners and then ap- to define more clearly the respective delays in implementing some of the plying the new terms to the other oil roles of Sonatrach and the IOCs in marginal projects. companies. The pressures from long the oil and gas sectors. Second, there is always the risk that sanctions and the desire to re-establish harsh terms may dissuade firms from political and economic links with the The Hydrocarbon Law covered more participating in future rounds. In West do not seem to have changed than issues relating to public/private the latest gas bid round last year, 35 Libya’s approach towards dealing sector involvement in the oil and companies were pre-selected to bid with foreign oil companies. To many gas upstream sector. One of its main for 12 exploration areas (41 blocks) observers, this came as a surprise. For characteristics was to distinguish of prospective gas areas which cover Libya, it is business as usual. the roles and functions of the State, more than 700,000 km2. This round public sector corporations and private attracted big players such as Shell, companies in gas transmission and Gazprom, and Sonatrach but the distribution, and in other parts of the turnout was rather low. Only 13 hydrocarbon sector. It established a companies put in bids and so far model for the creation of independent NOC has only awarded five of the institutions which will perform su- 12 exploration rounds. This lack of pervisory and regulatory functions in interest may be due to lack of the gas sectors that hitherto had been covered potential of the blocks on offer, but Walid Khadduri looks solely by state agencies. The Law also may be related to the unattractive provides for the creation of two new fiscal terms on offer. Unattractive at Algerian petroleum agencies, Alnaft, which is responsible fiscal terms may also dissuade firms development and its for organising licensing rounds and from participating in a proposed new the award of new hydrocarbon explo- licensing round aimed at attracting imperfections ration licences, and the Hydrocarbon investment in enhanced oil recovery Regulatory Authority which oversees technical regulations, tariffs and open and improved reservoir management Algeria has been able to increase its access arrangements for pipeline and to offset the decline in production crude oil production from around storage facilities, health and safety from mature fields. 750,000 b/d in 1975 to approximately regulations, studies of transportation Finally, there is the issue of institu- 1.4 mb/d in 2007. The country also capacity, and, requests for transporta- tional capacity. NOC has been doing produced in 2007 around 330,000 tion concessions. too many things simultaneously: b/d of liquids (condensates and running bids, awarding exploration NGLs), and 168 mboe/d of natural Sonatrach has also opened the door licences, negotiating with return- gas. Furthermore, Algeria’s national for IOCs to own equity in oil and ing US companies, renegotiating oil company Sonatrach has signed an gas projects in Algeria itself. The In with existing operators, conducting increasing number of joint venture Salah Gas consortium, comprised bilateral negotiations with some super contracts with IOCs, for projects of Statoil, BP, and Sonatrach estab- majors, and trying to develop its gas both inside and outside the country, lished in 2004 (before the adoption potential. These activities are taking all along the value chain from the of the Hydrocarbon Law), was the

 OXFORD ENERGY FORUM MAY 2008 first major gas partnership between was completed in 1983 and its capac- vigilance and provided security for Sonatrach and foreign operators. The ity doubled in 1994. And in 1996, a installations and personnel, declaring consortium has development rights consortium consisting of Sonatrach, the oil and gas zones as security areas; for seven of the twelve existing fields Spain’s Enagas and Morocco’s SNPP and at one point civilians were not in the In Salah area which is located completed construction of the 1000 allowed to enter these zones without a south of the country’s main gas hub mile 820 mcf/d Maghreb–Europe Gas permit from the Ministry of Defence. Hassi R’Mel. The In Salah region is pipeline (MEG). The line connects Sonatrach’s expanding oil and gas crucial to Algeria’s plan for increasing Hassi R’Mel with Cordoba, Spain, via sales to Europe eventually gave rise to its natural gas production. The fields Morocco. differences with the European Union. controlled by the consortium contain In the downstream, Sonatrach has The EU has been seeking to eliminate proven reserves of around 6 tcf, and a started construction of a $3bn 300,000 the ‘destination clauses’ (whose aim potential of 10 tcf in total recoverable b/d refinery with an IOC partner at was to prevent gas from being sold gas. Production began in July 2004 Tiaret, located 200 km from Arzew. to third parties by specifying the from an initial capacity of 880 mcf/d. The project is part of a plan to end user of the contracted sale) from Additional gas projects with foreign double the country’s refining capac- contracts with its member countries. equity include agreements for three ity to around 1 mb/d by 2010, and This encouraged Sonatrach to consider blocks – Ohanet, In Ammenas, and to upgrade the existing refineries at other markets for its gas. Gassi Touil – in the Illizi province Algiers, Skikda, and Arzew. Sonatrach A second difference has been the of southeast Algeria. Ohanet, led by also plans to award $7bn worth of result of an understanding between a consortium of BHP-Billiton and petrochemical projects with IOCs Russia and Algeria to strengthen Sonatrach, is on the northern edge of during the second half of 2008 to bilateral relations following the visit the Sahara. Production of natural gas, increase production capacity from of Russian President Vladimir Putin NGL, and LPG in this block began 360,000 t/y to around 6 mt/y during in 2006 and his talks with Algerian in October 2003. The Ohanet project the early 2010s. Plans also include a President Abdelaziz Boutaflika. The includes a natural gas processing plant Gas-to-Liquids project. main public result of that visit was with a capacity for 30,000 b/d of Moscow’s express readiness to write condensate, and 26,000 b/d of LPG. off Algerian debt in exchange for In November 2004, Algeria awarded the purchase of Russian arms. It also to Repsol-YPF and Gas Natural a “because of long transpired later that the talks had project at Gassi Touil, a block with implementation delays expressed a desire for ‘successful’ gas around 9 tcf of proven reserves of and huge cost over-run, negotiations between Gazprom and natural gas. The $2bn integrated Sonatrach toward a joint development project consists of 52 development the relationship between of gas resources in North Africa. The wells, a 780 mcf/d natural gas process- Repsol and Sonatrach EU is worried about an increased de- ing facility, a 630 mcf/d natural gas ended up in tears” pendence on gas imports from Russia pipeline, and a 500 mcf/d natural which would increase if Gazprom and gas liquefaction terminal at Arzew. Sonatrach were to jointly supply gas Unfortunately, because of long Algeria undertook these major to Europe. The leadership provided implementation delays and huge cost hydrocarbon projects, among many by Algeria and Russia in the attempts over-run, the relationship between others, at a time when the country to establish an ‘OPEC Gas’ organisa- Repsol and Sonatrach ended up in was affected by a struggle between tion is another cause of concern. tears. The contract with Repsol was the army and Islamic militants. At Will this lead to the emergence of a cancelled and Sonatrach took over first the struggle was with the home- cartel able in the future to exercise implementation of the project. grown Islamic Salvation Front (FIS) some monopoly power in a European In July 2001, a consortium led by following the refusal of the army market increasingly dependent on gas Spain’s Cepsa (20 percent) and Sonat- to recognise the results of the 1991 for its future energy needs? The moot rach (20 percent) agreed to build a gas legislative elections and the subse- question is whether these worries are pipeline linking Algeria and Europe: quent annulment of these elections. fully justified. Medgaz. The $1.2bn 120 mile Medgaz Violent clashes continue but now A dispute erupted between Algeria will link Beni Saf, Algeria to Almeria, involve the al-Qaeda Organization in and Spain over how much gas Sonat- Spain, with an eventual extension to the Islamic Maghreb. The intensity of rach would be allowed to market in France. Initial capacity of the line is the fighting has lessened and is now at Spain. This was partly resolved in 390 mcf/d, increasing to a maximum a much lower level than it was in the July 2007 when the Spanish Ministry of 1.55 bcf/d. Algeria already has two early 1990s. While FIS did not target of Industry, Tourism and Commerce gas pipelines across the Mediterranean, oil and gas personnel, al-Qaeda on overturned the Energy Commission the 670 mile Transmed, extending the contrary put this group at the top (CNE) decision to limit Algeria’s from Hassi R’Mel via Tunisia to of its list of targets. Nevertheless, in freedom to operate in the country. Ac- Sicily and mainland Italy. This line both cases the army maintained strong cordingly, construction of the 210 km

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8 bcm/year Medgaz subsea pipeline pitched the central government against National Petroleum Corporation, began in early March 2008. However, the secessionist forces of the oil region NNPC) a partner of the foreign the issue was not totally resolved as of the Delta. From half a million companies, unlike many OPEC Sonatrach called for legal mediation barrels per day (mb/d) in 1969, members Nigeria has never completely of the Repsol operated integrated Gas production rose to 1 mb/d in 1970, 1.5 nationalised the operations of the Touil project. mb/d in 1971 and 2 mb/d in 1973. To- companies. Of course the NNPC has day Nigeria produces about 2.5 mb/d gradually become the majority partner and its reserves stand at more than in all joint ventures, but the foreign Conclusion 35 billion barrels, which is about 70 companies remain the operators (the Algeria is an example of a country percent of the reserves of sub-Saharan main joint ventures are operated by which could still go ahead and de- Africa and about 30 percent of total Shell, Chevron, Mobil, Agip and velop its hydrocarbon industry despite African reserves. Thus, Nigeria is the Total). The NNPC receives by right serious domestic challenges. That the largest producer of sub-Saharan Africa about 55 percent of output, but 98 armed forces have remained united and represents almost half the pro- percent is produced by the companies. in the struggle against the militants duction of the region. It is the sixth has certainly helped. The fact that the largest producer in OPEC, after Saudi In addition, Nigeria possesses sig- opposition remained local and did Arabia, Iran, Venezuela, the UAE and nificant reserves of natural gas (5.2 not involve mujahideen from abroad Kuwait. trillion cubic metres at end 2006, or a was also a favourable circumstance. third of the reserves in Africa). This The determination of ministers and places Nigeria sixth in the world after senior Sonatrach officials to expand Russia, Iran, Qatar, Saudi Arabia and production capacity and to undertake “unlike many OPEC the United States. Its gas production the more difficult task of promoting a members Nigeria has never is increasing fast (more than 28 billion wide debate about the Hydrocarbon completely nationalised cubic metres (bcm) in 2006 against Laws bore fruit. By making necessary 6 bcm in 1999). This huge growth compromises along the way they the operations of the can be explained by the fact that minimised opposition to the Law companies” gas, in particular associated gas, was in the country after its adoption by neglected for a long time by the oil Parliament. We have seen, however, companies who until the 1990s flared that in some instances the relation- That production and reserves are it off since they were unable either to ships with foreign companies and with continuously increasing is due to the use it in the local market or to export gas-importing countries in Europe dynamism of the investments by the it. were not without difficulties leading oil companies since the end of the In the framework of a strategy aiming to legal processes of conciliation or military dictatorship in 1998 and to to eliminate flaring completely by arbitration. the numerous discoveries in the last 2010, a large gas liquefaction plant was few years in the deep offshore (Bonga, inaugurated in 1999 on Bonny Island, Agbami, EA, Yoho, Erha and so on). operated by Shell as part of a joint The share of the offshore (about 50 venture bringing together the Nigerian percent) is relatively small by com- gas company (NLNG), Total and parison with neighbouring countries Agip. The site, large enough for six but growing fast. During the last ten liquefaction trains (about 20 bcm per years significant deposits have been year), exports its production to the discovered in the deep and very deep USA and Europe. Other gas projects offshore and are progressively coming are being developed, for example the Philippe Copinschi into production. Production capacity construction of liquefaction plants and assesses frustrated in Nigeria will therefore increase as a regional gas pipeline (the West Af- fast as the development of recent rican Gas Pipeline, 900 km in length). contested oil discoveries, even if the actual produc- This is supported by the World Bank ambitions in Nigeria tion remains theoretically limited by and intended to supply Benin, Togo, the OPEC imposed quotas. Ghana and the Ivory Coast with With the exception of BP, all the Nigerian natural gas. Finally, a gas A Country in the Middle of an Oil majors are involved in at least one pipeline project to cross the Sahara Boom project, either as operator or partner. is frequently mentioned; this would In 1956 oil was discovered in com- For although Nigeria has been an enable natural gas to be exported from mercial quantities for the first time in OPEC member since 1971 and, Nigeria to Algeria and then – by con- Nigeria, 100 km from Port Harcourt following its recommendations, has necting to the network of Algerian gas in the Niger Delta. The real take-off put in place a policy of nationalising pipelines – to Europe. However, it is of production dates from 1970 at the the oil industry, progressively making not clear whether there is an industrial end of the Biafran war which had the national oil company (Nigerian interest in this project.

11 OXFORD ENERGY FORUM MAY 2008

Perspectives and Problems economy pass them by. They preach and distorted a productive economy violent action and proclaim secession- which, at independence, was largely The management of the NNPC aims ist views, while trafficking in oil. Shell based on agriculture. to reach 40 billion barrels of oil produces 40 percent of Nigerian crude reserves and 4 mb/d of oil production but each day it loses 10 percent of its Secondly, the widespread corruption is by 2010. This ambitious objective is production through sabotage. Hostage another indicator of the dysfunction- based on the fact that all the majors, taking is also increasing, for example ing of the political, economic and American and other, have large in 2006 the Movement for the Eman- social institutions of the country and projects in the course of development cipation of the Niger Delta (MEND) is a further obstacle to the develop- in Nigeria and these should come into abducted nine expatriate workers from ment of economic activity in general production in the near future. Nev- a company sub-contracted by Shell. and oil in particular. Nearly fifty years ertheless, several major problems are after independence Nigeria has still restraining the growth of production By virtue of its seniority and pre- failed to find a model of economic in the country. eminence in Nigeria, Shell is often the development which would allow it to primary target in a conflict. Relative First, political and ethnic tensions valorise its oil wealth. Oil represents to Shell, other companies have been make it very dangerous for the oil 95 percent of its export receipts, 80 saved from attacks by the population companies to operate – particularly in percent of budget receipts and 40 for the simple reason that the main the onshore areas. The taking of oil percent of gross domestic product. part of their production – the whole company employees as hostages, acts This places Nigeria among the top six in the case of Mobil, two-thirds in the of sabotage against installations and oil-exporting countries, with revenues case of Total – comes from reserves far intimidation have become frequent in of more than 34 billion euros in 2006. from the coast whereas Shell’s activi- the Niger Delta. Several times over However, in the last United Nations ties are all onshore. the last few years the main foreign oil Development Report Nigeria was companies have had to suspend part of placed at 159 out of 177 in terms of their operations for reasons of secu- human development, a drop of nine rity. Indeed, attacks on Shell pipelines places since 2000 – despite an increase recently led to a drop in production “widespread corruption in production and in the price of oil of about 169,000 b/d for shipments in is another indicator of on the world market. This low level of April and May. As a result the com- the dysfunctioning of the development is explained above all by pany announced it would be unable the fact that with a population of 130 to honour its contractual obligations political, economic and million (the most populous country at the Bonny Terminal for those two social institutions of the in Africa), the redistribution of the months. country” oil rent takes place in a context of widespread corruption and clientelism, Although Nigeria is not officially and a large part of the political elite at war, in the Delta where the oil is have no consideration for the general extracted there is a high level of crimi- In addition to attacks, kidnapping interest and the public good. nal violence and rebellion is endemic and ransom demands, there is also within political activism and economic theft of equipment and piracy from Thirdly, the Nigerian state’s huge banditry. The people of the Delta pipelines. This technique known as economic and financial difficulties know that the oil generates enormous bunkering consists of siphoning off mean that it is regularly unable to wealth from which they do not oil in order to resell it as contraband cope with its obligations vis-à-vis benefit. This situation creates resent- and affects between 5 and 10 percent the foreign companies associated ment, not only against the enterprises of Nigerian production. It is this with the NNPC. In a joint venture that produce this wealth but equally aspect, which is proof of another each partner (NNPC and foreign against the heads of the community type of criminality, that will be the company) contributes to the financing who are accused of colluding with the most difficult to combat, for it reveals of operations in proportion to its companies. The cultural region of the undeniable complicity between participation. The overdue payments Ijaw is today among the most affected company employees and the mafias of the national company amount to by agitation against the oil companies. who resell the oil on the black market. hundreds of millions of dollars. These Confrontations between militias Oil engineers secretly help the pirates recurring problems with delayed regularly result in deaths. Groups like by informing them of the whereabouts payment of the quota of the NNPC the Niger Delta People’s Volunteer of the key points and precise layout push the companies to demand a Force (NPDVF) increase their at- of the pipelines, both underground reduction of the NNPC share in the tacks against companies such as Shell, and subsea. Within the context of an joint ventures, or even to replace them Chevron, Agip, Total and so on. This economy based on rent and extraction, by production-sharing contracts. In movement is emblematic of the root- not to mention looting, the oil boom these contracts the entire exploration lessness of Ijaw youth of low social of the 1970s destroyed the structure and development costs are initially status who are unemployed and who of Nigerian society, inflamed armed borne by the foreign company which are watching the benefits of the oil banditry, hastened the flight of capital is later compensated by a share of

12 OXFORD ENERGY FORUM MAY 2008 the production. For several years the technological development. Background to the Inga Projects and government has offered production- Development of the huge African current Issues sharing contracts for new projects in hydropower potential, of which only The Inga hydropower Projects are the Nigerian oil upstream, particularly 7 percent is presently exploited, will located on the low course of the those concerning offshore production. bring adequate electricity supply to Congo River, in the so-called Inga Finally, Nigeria is a member of OPEC Africa, and thus contribute substan- Hinterland area, about 250 km south and as such it is subject to produc- tially to the achievement of the three west of Kinshasa (Democratic Re- tion quotas. Thus its oil production WEC Millennium Energy Goals of public of Congo, DRC) and 150 km cannot increase to any great extent in accessibility, availability, and accept- from the West Atlantic Ocean. They the near future unless it succeeds in ability, which are the fundamental would offer large energy potential and renegotiating its quota. It is not clear pillars for achieving the sustainable great benefits for the DRC and other that this would be possible. In prac- supply and use of energy. African countries, if realised in a cost tice, a country like Nigeria has only In that perspective, the Inga projects effective and timely way. a marginal effect on the protection of offer a unique opportunity to provide prices. Its quota is more formal than affordable and clean electricity to real and Nigeria respects it largely more than 500 million Africans who because it corresponds more or less do not have it today, and to promote “Electricity is a bridge to to its production capacity. Before economic interdependence and peace provide sustainable access the deep offshore ‘boom’ there were and prosperity. no prospects of a significant growth to modern energy and of capacity in the country. Today it In particular, the development of contribute to sustainable seems unlikely that Nigeria will curb Inga 3 and Grand Inga, as African development” the development of the many and integrator projects, will offer a great prolific recent discoveries for having opportunity for supplying the major- failed to obtain a reevaluation of its ity of the African energy market, A hydropower potential of more than quota. including the South African Power 44,000 MW is concentrated in the site, Pool (SAPP) countries in Southern with potential annual energy produc- Africa, and also other African coun- tion estimated at more than 320 TWh. tries in the West and North and East But barely 4 percent of that potential regions, via the other African Power is currently developed at Inga 1 and 2 Pools, namely the WAPP, PEAC, power stations. These two power sta- EAPP and COMELEC. tions contained 73 percent of the total Africa’s energy needs are immense and installed capacity of the country and continue to increase substantially, due produced two-thirds of the electricity to growing population, improvement generated in the country in 2005. of living standards and economic At present, two hydropower projects development. However the energy are being considered for future devel- infrastructure is weak and the quality opment in the Inga site, namely Inga Gerald Doucet and of energy services is poor. Electric- 3 with a generating capacity of 4320 ity demand, estimated at 84 GW Latsoucabé Fall stress MW and Grand Inga with a hydro- (515 TWh) in 2005, is expected at power potential estimated at 40,000 the importance of least to triple by 2030 (reaching 260 MW. Once the Grand Inga project GW (1590 TWh) to 310 GW (1900 the Inga hydropower comes into operation it would be the TWh)); of this demand, 87.4 percent is world’s largest hydropower scheme, projects for Africa concentrated in Southern and North with about twice the generating Africa (53.2 percent and 34.2 percent, capacity of the Three Gorges in China Introduction respectively) and 8.1 percent in West (22,400 MW) and three times that of Africa. A large increase in the electric- Access to electricity is very poor Itaïpu Binacional Project between ity supply will be necessary to meet in Sub-Saharan Africa and this has Brazil and Paraguay (14,000 MW). this demand. contributed to the continued poverty and underdevelopment that ravages Therefore, the World Energy Council Inga 1 & 2 the continent. Electricity is a bridge to (WEC) intends to support the Inga provide sustainable access to modern projects and to bring the relevant The two existing power stations energy and contribute to sustainable organisations and actors to carry out located in the Nkokolo valley, namely development. It is a cornerstone for the renovation of existing installations Inga 1 & 2, totalled an installed economic progress, social develop- (Inga 1 & 2), and the development capacity of 1775 MW: 351 MW for ment and environmental sustainability, of the Inga 3 and Grand Inga hydro- Inga 1, commissioned in 1972; and and is imperative for harnessing power projects. 1424 MW for Inga 2, commissioned

13 OXFORD ENERGY FORUM MAY 2008 in 1982. SNEL (Société Nationale meanwhile the feasibility study of the the facilities. Grand Inga would be the d’Electricité), the State owned Na- transmission system will be financed most powerful hydropower scheme in tional Electricity Utility, owns and (likely by EIB) and carried out by an the world, with a very low production operates these installations. However, international consultant. cost estimated at around US cents 1.1 at the moment, they are both func- Preliminary investigations identified to 1.4/kWh (compared to an average tioning well below their nominal two main transmission routes from cost of US cents 4/kWh for coal, and generating capacity (respectively 52 Inga 3 – one to Westcor countries even more for other energy sources and 34 percent). (DRC, Angola, Namibia and South such as fuel, gas, wind, solar and Renovation works are currently being Africa) and a second to Moanda nuclear). undertaken on a few plants (plant (150 km) to supply BHP Billiton number 2 of Inga 1, funded by the aluminium smelter. World Bank; and plant number 3 of According to the DRC Government, “Once the Grand Inga Inga 2, funded by a public/private the Inga 3 Project could be envisioned partnership with Mag-Energy). How- as a public–private partnership for the project comes into ever, these works are insufficient and development, construction, opera- operation it would be the need to be reinforced by a complete tion and management of the facilities world’s largest hydropower and in-depth renovation programme, (power station and transmission which would probably last between system). The Government would hold scheme” four and five years. It is also worth a minimum share, allowing private mentioning that the work currently shareholders to be involved and to being undertaken at the Inga 1 and play an important role. It has been estimated that when it is 2 plants is experiencing a delay of at commissioned in around 2025, the least fifteen months. Grand Inga contribution to African Grand Inga electricity demand would be between Inga 3 Grand Inga will be located in a natural 26 and 30 percent. Consequently, most valley of the Inga River with a reser- of the African energy demand would The pre-feasibility study of the Inga 3 voir naturally laid as a big basin with be met through the five African power project is now completed and was pre- its own side and front walls. The area pools, and the project would improve sented to the stakeholders in Kinshasa is quasi empty in terms of habitats and the lives of over 500 million Africans in February 2008. The technical, no one resides in the valley. who are without access to electricity. environmental and financial aspects of the project have all been examined Key technical characteristics of the In order to allow the construction in the SNC-LAVALIN study. The electricity facilities are: phase to start as soon as possible, planned installed capacity of the • Potential capacity will be 40 GW and in line with the need to meet the power station is 4320 MW (sixteen (pre-feasibility study done by EDF growing and urgent energy needs plants of 270 MW power capacity & Lahmeyer International in 1997); of South Africa (Eskom) and other each, equipped with Francis turbine African countries, the feasibility study with vertical axis). • Investment cost of the hydro plants of Grand Inga should be funded is estimated at over US$40 billion; and performed as soon as possible. The power station will be constructed • Investment cost of the transmission Consequently, the search for finance in two phases: phase 1, 2009–2018 is urgent and crucial; the total financ- for an investment cost of US$1974 system is estimated at over US$40 billion; ing required is estimated at between million, and phase 2, 2014–2021 for an US$15–20 million. investment cost of US$1569 million. • Selected interconnection trans- (Thus the total construction cost is mission system (HVDC) would estimated at US$3.5 billion). include: Social & Environmental Issues – Northern Highway (Inga– In order to move from the pre-fea- The social and environmental aspects Sudan–Chad–Egypt, 5300 km), sibility study into a feasibility study, of the Inga site, emphasised by the – Southern Highway (Inga–Angola– geological and hydraulic studies official representatives of the Inga Namibia–Botswana–South (mathematical model to simulate Hinterland are related to the legacy Africa, 2734 km), and water behaviour) will need to be of the existing dams and electricity – Western Highway (Inga–Congo– undertaken. The cost of these studies facilities. A detailed study on the Gabon–Cameroon–Nigeria is estimated at US$5–6 million and environmental and social impact has (Calabar), 1400 km). could be funded by BHP Billiton been carried out by SNC-LAVALIN or the European Investment Bank. The overall project will be capital in the context of the pre-feasibility The predicted timeline for their intensive, requiring huge investments study of Inga 3. For that purpose, 365 completion is estimated at one year (probably exceeding US$80billion) as people were surveyed (including 21 from now, and this will allow the well as technical and managerial skills public hearings and interviews with construction phase to start in 2009; and expertise to operate and maintain 32 opinion leaders) and a site survey

14 OXFORD ENERGY FORUM MAY 2008 was conducted as well, to evaluate the economic interdependence and and establishing a Promotion Com- impact on several factors, including peace and prosperity ; pany (PROCOM). quality of life, quality of the water, • Promoting cooperation with Afri- Phase 2: Setting up a project frame- electricity access, supply of drink- can stakeholders and international work and establishing a Holding ing water, livelihoods, ecosystem, supporters; Company (HOLCOM). compensation, displacement, fight against diseases, and so on. In order • Involving the potential stakeholders Phase 3: Developing the project, to overcome the possible related in direct relation with the project, raising finance and preparing for problems and to minimise the impacts, namely countries crossed by the construction. the study recommended creating an transmission lines, customers, A ‘Team Inga’ open to external Environment and Social Management energy companies, civil society, companies/institutions was established Plan, which will be implemented, local communities, and so on; at the Forum to achieve Phase1 of the managed and monitored by an Envi- • Developing a commercial project WEC Inga Action Plan, under the ronmental and Social Unit to be set up under favourable conditions, for leadership of WEC. by the DRC authorities. instance by government guarantees The WEC is also planning to organise As for the Grand Inga which is to underwrite the risks; a high level workshop on the financ- more complex with the creation of • Creating a promotion company and ing of the Inga projects, in London a reservoir, the design needs to be a holding company; from 21–22 April 2008. The main carefully considered so as to achieve • Creating an Inga Zone, a sort objective will be to identify the key zero or minimal environmental financial requirements and partners for impact. Nevertheless, there are of hub for manufacturing and engineering support, in order to an accelerated and sustainable devel- positive aspects with regard to the site opment of the projects. The workshop of Grand Inga, because there are no develop local manufacturing and to facilitate job creation for Afri- will also be the opportunity to launch humans or animals, fauna or flora that the creation and financing of the would need to be relocated for the can workers; this hub should be implemented before the beginning Promotion Company and to define introduction of the infrastructure. The the bases of the Inga Infrastructure of the construction phase of Inga 3. site is naturally laid as a big basin with and Services Integrated Zone. its own side and front walls and the Moreover, changing market conditions The creation of PROCOM should machines could be installed into the in the electricity sector (liberalisa- natural walls. facilitate and accelerate the start-up of tion/privatisation), as well as demands the Inga 3 and Grand Inga projects as In a nutshell, the Environmental and from the financial sector which is well as the refurbishment and renova- Social Management Plan should make eager for high and short-term returns tion of the existing facilities (Inga 1 certain that the benefits of the Inga on investments, means that these & 2 power stations, HV transmission projects are maximised and that nega- projects must have strong political system and MV and LV distribution tive social and environmental impacts support from the DRC Government, network). are avoided, mitigated or compensated the African Union, African Develop- for. This will ensure that the Inga ment Banks and Regional Economic The Inga Infrastructure and Services projects meet the ‘Sustainability Communities, as well as international Integrated Zone would be a hub Standards’. Institutions. to support engineering, equipment Further cooperation should also be maintenance and other services and established with local and regional manufacturing, in order to develop WEC Actions and Prospects to move technology transfer and local capaci- activist groups, environmental defence ahead on the Projects and civil rights organisations, to work ties and to facilitate job creation. Its together to take into account the From 16–17 March 2007, the WEC establishment would be facilitated and social interests and needs of the local held an International Forum in supported by a consortium of suppli- population and affected communities, Gaborone, Botswana on ‘How to ers (equipment and material producers as well as to preserve the environment. make the Grand Inga hydropower and other contractors), PROCOM, project happen for Africa’. The forum DRC and other governments – the brought together high-level repre- World Energy Council and Team Inga Principles sentatives from governments, top-level will help in establishing this Zone. In order to improve the chances of executives from major energy com- success, the World Energy Council panies and related businesses, leading identify the following principles to financial institutions and the WEC move forward: Member Committees. An Action Plan • Scaling up energy access through was established, and three Phases to the development of the Inga move ahead were identified: projects, to overcome poverty Phase 1: Ensuring support by a broad in Africa, as well as to promote range of stakeholders, including G8

15 OXFORD ENERGY FORUM MAY 2008 US Presidential Candidates and Energy Michael Lynch

With one of the most contested presidential elections under decades ago, remains on the minds of all three, who argue way in the United States in decades, the impact on the energy for a combination of increased biofuel usage and Clinton and industry is a particularly relevant issue. On the one hand, McCain highlight the potential of plug-in hybrid vehicles. all three remaining contenders are likely to be much less None, admittedly, is very open about the difficulty (or im- favourably inclined to the energy industry than the current possibility) of eliminating US oil imports, or the irrelevance Administration; on the other hand, there are serious nuances of reducing oil imports from the Middle East. between them. On the other hand, taxes could be a major battle, par- And it must be admitted that the current Administration ticularly if imposing some form of carbon or energy tax has not been successful in delivering the kinds of benefits to is attempted again. The last time this was tried, in the first the oil and energy industries that many had expected when Clinton Administration, a huge political and lobbying battle it was elected, partly due to conflicts with the Democrats ended the effort very decisively. But the changed political in Congress. (The initial energy policy proposal quickly atmosphere, and the greater concern about global warming, became mired in legal difficulties over who had advised the might encourage the Democratic candidates to try again; John Vice President in its construction.) But also legal challenges McCain is almost certain to resist any such effort. have restricted some of its preferred policies, especially where Still, the three candidates remaining are actually strongly environmental regulations have been involved. similar in their views on energy and the environment, at George W. Bush and Richard Cheney had rather brief least compared to the current Administration. Both Clinton careers in the petroleum industry, but were assumed likely and Obama have released detailed policy statements, while to adopt strongly pro-industry – and pro-Arab –industrial McCain has made remarks indicating his general prefer- and foreign policies. Instead, Bush immediately embraced ences, but these conform to what is understood about their Israel’s Ariel Sharon as a ‘man of peace’ and failed to deliver inclinations. any significant benefits to the petroleum industry, which Global warming is the most important issue for at least had hoped for better access to prospective drilling areas in the Democrats, but all three candidates support cap-and- Alaska, the Rockies and the Gulf of Mexico. Only modest trade systems to reduce long-term greenhouse gas emissions benefits have accrued to the energy industries, as nearly all (Clinton and Obama 80 percent by 2050, McCain 65 percent), of the Administration’s energy policy proposals have been and all are technological optimists, pointing to other chal- blocked by the opposition in Congress. (Then, too, the lenges met and overcome (most of them not very relevant, war on terror and the war in Iraq have diverted most of the such as McCain’s noting the massive improvements in cell Administration’s attention from other policies.) phone technology). The industry did benefit from the Administration’s Still the fiscal situation for the oil industry is likely to environmental policies, which attempted to roll back the worsen, as all three candidates view it unfavourably. Both Clinton Administration’s late-hour shift in the approach to Democrats have made clear that they will reduce so-called New Source Review. That move had tightened regulations on tax breaks on the industry and redirect the funds towards existing energy facilities (especially utilities) that maintained (primarily) renewable energy, and while John McCain has or modernised their plants. They also fought attempts to not taken as strong a stance on taxing the industry, he has have carbon dioxide declared a pollutant subject to federal not been regarded as friendly to it. regulation, thus slowing environmentalists’ legal efforts to On the other hand, McCain’s focus on national security fight global warming. And they were resistant to proposals and the war on terror could see him pushing some aggressive to increase regulated automobile efficiency standards, which attempts to reduce American dependence on imported oil, were, nonetheless, passed into law last year. especially from the Middle East. This could include a new However, it appears as if the next Congress will be push to open up more US territory for drilling, including somewhat more liberal and Democratic, making it easier for ANWR in Alaska, but might also devolve into efforts to some policy changes to be enacted, depending on the identity ‘acquire’ access to non-Middle Eastern sources. Past such of the President. Most notably, all three candidates can be efforts have been relatively marginal and low-cost, with expected to take a stronger stance on curbing greenhouse gas limited success, but diplomatic pressure on oil producers emissions, and to do it fairly quickly. Much of this will take (Russia, perhaps?) to allow easier access for exploration are the form of subsidies, as all three embrace the notion that likely to ensue. renewable energy is good for both the environment and the The two Democrats can be expected to favour a demand- supposed improvement in energy security. Given the recent side approach, pushing for appliance and building efficiency move to regulate higher automobile efficiency, new steps in standards, for example, and possibly taxing large vehicles, that direction should not be expected, at least initially, but while subsidising efficient ones. Funding for mass transit Clinton has suggested raising fleet efficiency standards to and railroads will increase, but probably not enough to 55 miles per gallon by 2050, and Obama proposes doubling make a significant difference in the short or medium-term. efficiency by 2025. Clinton has proposed a $50 billion Strategic Energy Fund The fight for US energy independence, which was lost with financial assistance to low-income home owners and

16 OXFORD ENERGY FORUM MAY 2008 automakers alike, while Obama supports a ten-year $150 technologies, particularly renewables, especially where they billion Clean Energy Fund, with emphasis on both R&D appear to provide for the creation of new jobs. McCain, on and working retraining. (McCain emphasises tax breaks for the other hand, emphasises R&D and deregulation as means R&D rather than government spending.) to improve overall efficiency of energy programs. The fuel of choice for power generation is going to be Also, both Democrats can be expected to adopt much a major source of conflict, whoever the next president is. stronger etatist attitudes, attempting to ‘correct’ market Coal has many environmental problems, but much political imperfections, something the current oil price has high- support in both parties; even green Democrats listen to lighted. While it is possible that they will attempt to reign coal miners’ unions. As a result, policies to reign in emis- in ‘speculation’ such as investment in the commodity index sions from coal combustion are heavily focused on new funds, the complexity of the task should defeat them. More technologies, including those that allow economical carbon likely, an SPR drawdown such as occurred in 1996 to dampen sequestration. Only Obama seems ready to ban construction then-exorbitant crude prices, would be used to deflate the of ‘traditional coal facilities’. current oil price bubble. Nuclear power’s public perception remains schizophrenic, In the past, energy-policy making (and policy analysis) with many environmentalists still opposed to it, but growing has suffered from a boom and bust cycle largely correlat- support among the general public. A McCain administration ing with energy prices – and public attention. However, is likely to encourage new power plant construction, and this seems somewhat less likely this time, as worries about while neither Democrat will evince the same level of support, global warming, energy security, and high energy prices are either one might come to accept it. Given Barack Obama’s much less likely to fade as quickly as similar problems in more populist credentials, he is the most likely to push for the past. Thus, not only will energy policy-making for the wind and solar over nuclear, while the more pragmatic Clin- new administration be a high priority, but unlike previous ton has noted the benefits of ‘emission-free’ nuclear power. administrations, early efforts seem less likely to be abandoned And while the traditional liberal view of microeconomic when they meet resistance. regulation, such as requiring specific technologies for emis- Of course, given past policy failures, often caused by over- sion control, appears to have become discredited, nonethe- reaction to transient problems, this can hardly be considered less, the two Democrats are much quicker to emphasise a good sign. government spending programs in support of new energy

Comments on Gas Demand, Contracts and Prices James T. Jensen

The February issue of the Oxford Energy Forum contained But perhaps the biggest change has been in energy price five excellent articles on the future role of natural gas. There levels. In 2003, Brent crude averaged less than $29 per barrel. appear to be two recurring themes – strong growth in gas Last year it averaged more than $75 – up 160 percent over demand and issues of contracting and pricing. 2003. Gas prices have also risen, but their increase has been far more modest, substantially altering the earlier relationship Gas Demand Growth between gas and oil prices. Superficially, there appears to be a conflict between Michael Obviously, there has been a rather dramatic change, not Stoppard’s optimistic description of the very large increase in only in absolute energy price levels, but in the relative prices LNG capacity between now and the year 2010 and Jonathan of fuels that compete with one another in the marketplace. Stern’s more subdued recounting of the forces that are likely And it raises two interesting questions: What effect will the to constrain future gas supply. In fact, the two positions uneven energy price increases have on interregional gas trade? are not inconsistent since they focus on two different time and What determines the price of long- term gas supply? periods. With a four- to five-year lead time between the When coupled with the fact that construction costs of both initiation of a new LNG (or pipeline) project and its comple- pipelines and LNG facilities have risen substantially in the tion, Stoppard is effectively describing capital expenditure last several years, it should not be surprising that there is a lot decisions that were set in motion between 2003 and 2006. of soul-searching going on over capital investment decisions Stern is asking whether the present growth in gas supply is for new gas projects. likely to continue once the existing wave of new capacity is Both the IEA and the EIA, in their periodic forecasts, finally completed. have weighed in on the first question. Both agencies have Much has changed in world energy markets since the been progressively reducing their projected estimates of gas early part of this decade. In 2000 North America experienced demand and increasing their estimates of gas production. The its gas price shock, and revived its long-dormant interest net effect of these two price responses has been to squeeze the in LNG. Spain was in the midst of a surge in demand for expected level of interregional gas trade required to balance LNG that would make it the Atlantic Basin’s largest LNG supply and demand. importer by 2002. And by 2004 the UK had changed from a Last year, Jensen Associates undertook a study for the net exporter of North Sea gas to a net gas importer. California Energy Commission projecting world LNG trade

17 OXFORD ENERGY FORUM MAY 2008 out to the year 2020. Our estimates came in well below most spot market transactions. other public projections. They were based on two assump- He speaks from the perspective of the country that im- tions: 1) they accepted the view of the IEA and EIA that high ports more Russian gas than any other except the Ukraine, prices have depressed the long-term outlook for interregional and is thus in the centre of the controversy between Russia gas trade, and 2) they concluded that there are increasing and the European Community over supply reliability. But constraints on the potential for new supply projects. These Germany is not alone. The issue of third country transit include both those geopolitical constraints that Stern has rights has long plagued natural gas pipeline projects and has outlined in his OEF piece, but also concerns about costs often fostered less economic LNG projects as a means of and the technological and economic challenges inherent in avoiding the geographic limitations of pipelines. increasing reliance on Arctic gas supplies for new projects. The contract issue is essentially about risk sharing for While the forecast for the California Energy Commission capital-intensive gas projects. While the North American focused on LNG, it necessarily had to make assumptions gas markets have largely dispensed with long-term contracts, about the balance between LNG and pipeline trade. In this there is nothing inherently inconsistent between long-term context, it is worth noting that both North America and contractual relationships and free markets. For capital- Northeast Asia will be dependent on LNG for their inter- intensive projects, the contract provides assurance to the regional imports, while Europe, China and India have both financing agency of debt service coverage by the parties to supply options. On the supply side, the two largest long-term the agreement. It also provides a mechanism for risk-sharing future potential suppliers are the Middle East and the FSU between buyer and seller. (Not to mention rent sharing (Russia plus the Central Asian Republics). The Middle East with host governments) The old adage, ‘The buyer takes supplies are likely to be predominantly in the form of LNG the volume risk and the seller takes the price risk’ has led to while the FSU’s will be largely by pipeline. take-or-pay clauses for the buyer and price escalation clauses It is apparent that our low forecast rests on conservative for the seller in traditional contracts. assumptions, both of the future demand for gas, and of the The concern for financial risk protection remains, even willingness of suppliers to provide it. What can go wrong in fully-liberalised markets. For new pipeline investment in with these assumptions? North America, for example, the sponsor holds an ‘open sea- On the supply side, there are obviously great uncertain- son’ for potential shippers to acquire capacity. If the project is ties. Relying for future supply on countries that have not viable, the shippers then assume a ship-or-pay financial obli- previously been LNG exporters (or even gas exporters) and gation to the project sponsor. While not a long-term contract have not shown much enthusiasm for LNG is problematic at in the traditional sense, the resulting control of capacity may best. The supply estimates could be higher or lower and the also inhibit more flexible commodity competition. . results will have a significant effect on future supply/demand In traditional contracts, the pricing clause was most com- balances and on prices. monly linked to oil prices – crude oil in Northeast Asia, oil On the demand side, the 800 pound gorilla in the room products in Europe. But in the liberalised markets of North is carbon regulation, which has the potential to shift much America and the UK, where gas-to-gas competition prevails, of the stationary energy demand to gas. If the optimistic gas such clauses put the buyer in an impossible position when gas demand forecast materialises in the face of supply constraints, prices fall below oil levels. A resulting temptation to protect it would obviously threaten substantial price increases. the buyer by linking pricing clauses to gas market indicators, such as Henry Hub or the NBP, effectively shifts much of the Contracts and Pricing project risk to the seller, since the buyer can so easily cover A common assumption during the early days of gas market his risk by trading in the liquid spot market. The response liberalisation was that gas would become just another inter- of the sellers is to integrate downstream through what might nationally traded commodity. Long-term contracts would be described as self contracting. Increasingly, we are seeing become obsolete and an LNG-based international pricing project venture partners contracting with their own ventures system would develop. To date, gas has failed to follow that to sell the gas downstream in North America or the UK. The script. While international gas markets are more flexible than contract commitment is still there, but it has moved upstream they used to be, and LNG provides a degree of interregional from the earlier buyer/seller interface. price arbitrage, the long-term contract is far from dead. And Stoppard calls this group ‘aggregators’ and describes how there is no consistent international approach to gas pricing. they provide destination flexibility similar to that provided Two major differences between gas and oil are gas capital- by the spot market. As he points out, they are most common intensive, front-end-loaded investment pattern and for pipe- in the Atlantic Basin, where North America/Europe arbitrage lines, at least, geographic inflexibility. The first characteristic is active, and the Middle East, which can act as the arbitrage means that projects are usually debt-financed and someone agent between the Atlantic and Pacific Basins. has to assume the obligation to cover debt service. And the However, the flexible Atlantic Basin contracting is largely second characteristic exposes buyers to the risk that their focused on the liberalised markets in North America and the suppliers will fail to deliver. UK. Much of the Continent still retains traditional long-term Burckhard Bergmann addresses the second issue in de- contracts. The fault line between the two systems runs down scribing Germany’s need to compete for future supply and to the middle of the North Sea between the UK and the Low diversify its supply risks. He suggests that the future industry Countries and inward from the Continent’s Atlantic LNG structure will include some mix of long-term contracts and re-gasification terminals.

18 OXFORD ENERGY FORUM MAY 2008

Many long-term contracts – both LNG and pipeline Japan it was 59 percent; in Korea 73 percent. But there is – are now in a state of flux. The price caps and S- curves some evidence that the low relative prices in Northeast Asia in oil-linked contracts that were included to protect buyers have enabled some buyers to cross-subsidise spot LNG from oil price shocks are now protecting buyers from what cargoes at prices well above oil parity. suppliers argue is a new permanent level of world energy The push by producers to restore the oil link, either by prices. Japanese LNG prices averaged 101 percent of JCC contract renegotiation or international arbitration, is strong. (the Japanese crude price indicator) in 2002; but in 2006, Few would argue that oil prices any longer have the com- they averaged only 64 percent. Vigorous efforts at contract petitive meaning that they once had, but it has been difficult renegotiation and a number of international contract arbitra- to find a suitable substitute. But Tokyo Electric’s efforts to tion disputes are underway in essence to resolve the question: replace its lost nuclear generation suggests that – were Japan What determines the price of long-term gas supply? This markets fully liberalised – gas and oil prices might still be raises the issue of gas pricing, a recurrent theme in a number indirectly linked. of the articles. In Northeast Asia tight markets, suppliers’ efforts may Theorists would argue that its value should be established well meet with success. On the Continent, the competition by price competition in a free market. But a number of the from the gas-to-gas competitive supplies delivered via LNG articles point out that pricing systems differ in various parts or the pipeline links to the UK is beginning to penetrate of the world, and describe some of their departures from the some of the Continental markets. The current pressures are ideal. Thierry Bros argues that the liberalised UK market may downward, not upward. have worked well in surplus, but as the UK has become a So the question remains: How do you place a value on net importer, it provides a highly volatile pricing system with long-term gas supply? It is a question that is important in little or no price guidance for making long-term investment making major gas project investment decisions, but I am not decisions. In short, it does not provide the answer to the sure that anyone has an answer. question: What is future gas worth? And financial derivatives have lost some of their lustre as a tool to provide long-term future price certainty following the Enron debacle. Recent OIES Publications Stern discusses the common underpricing of gas practised by gas-exporting countries and describes some of the market Energy: the long view (SP 20) distortions that result, both in the Gulf and in Russia. Simon by Malcolm Keay, 2007 Pirani details Russian progress towards adopting European netback pricing as a means of correcting these distortions. The Dynamics of Crude Oil Price Differentials (WPM 36) The Unanswered Question by Bassam Fattouh, 2008 During the 1970s and 1980s, when North America and the UK restructured their gas industries, the working assump- Why do Oil Shocks no Longer Shock? (WPM 35) tion was that market competition would set gas prices and by Paul Segal, 2007 oil prices would be irrelevant. In such a formulation, the traditional long-term contract, with its linkage to oil prices, Agreements from Another Era: Production Sharing was viewed as a relic of an over regulated era. Agreements in Putin’s Russia, 2000–2007 (WPM The position of both those market structure options has 34) changed significantly since that time. North America and the by Timothy Fenton Krysiek, 2007 UK both liberalised when their domestic markets were in surplus and supplier competition cut prices below oil parity How Secure Are Middle East Oil Supplies? (WPM levels. Now the surpluses in both regions have disappeared 33) and they – like the Continent and Northeast Asia – have by Bassam Fattouh, 2007 become importers. When the North American supply surplus disappeared in Bottom-up Electricity Reform Using Industrial Cap- 2000, oil prices once again became important through inter- tive Generation: A Case Study of Gujarat, India fuel competition in boiler applications. The UK had a short (EL 07) price run-up following its transition to net import status. by Christopher Joshi Hansen, 2008. But both regional markets are now in sufficient balance that they are in gas-to-gas competition – their prices remain well Entry–Exit Transmission Pricing with Notional below oil parity levels. Hubs: Can it Deliver a Pan-European Wholesale There has also been a substantial change in the position Market in Gas? (NG 23) of the oil-linked contractual markets on the Continent and by Paul Hunt, 2008 in Asia. The use of oil-shock-limiting clauses in long-term contracts has effectively decoupled gas and oil prices in many The Dolphin Project: The Development of a Gulf Gas of these markets. In 2007, the relationship between border Initiative (NG 22) prices and Brent for the six largest Continental markets by Justin Dargin, 2008 ranged from 58 percent in Italy to 72 percent in Spain. In

19 OXFORD ENERGY FORUM MAY 2008 Asinus Muses

One hymn sheet? to the general conclusion that biofu- Fatigue els were responsible for food price When the whole world seems to be rises, announced a reconsideration (read To give an Executive summary of the singing the same song (for example, abandonment) of the whole idea and the foregoing section – experts are say- the great ode to decarbonisation at the European Commission is heading in the ing that, compared with the IPCC’s end of the Bali conference) big trouble same direction. Of course, all this was assessment, climate change avoidance cannot be far away. Momentarily it did foreseen two years ago in this column; will be a lot easier, a bit easier, more seem as if the moribund Kyoto agree- there are times when even Asinus just difficult, considerably more difficult ment might be replaced by something has to bray. or virtually impossible. This constant better. The all-seeing ones of the IPCC barrage of seemingly inconsistent sci- had produced a report Delphic enough The moving target entific advice may well produce con- to bring vague general agreement yet fusion in the fight against warming. specific enough to provide some bench- The scientists as well as the politicians Appropriately the Climate Change mark for policy making. They were are also adding a few unscored cadenzas Summit, convened by The Guardian for interpreted as saying that the future to the song of Bali and are finding major May 2008 is entitled: ‘Fighting climate might be tolerable if CO2 concentration deficiencies in the IPCC report. Since change fatigue; keeping the individual in the atmosphere was held below 450 Bali, they have made the following engaged’. One imagines a melée of ppm (it now being about nearly 390 and pronouncements: climate-change-cheerleaders, global- rising at about 2 per year), thus using its a. the IPCC seriously overestimated warming-syndrome-therapists, CO2- factoids to establish a goaloid. the continuation of ‘automatic’ de- attention-deficit-disorder-advisors, carbonising technical progress, and irritable-global-warming-syndrome-

Climate poker so the world does not possess the healers and personal-CO2-trainers. technology to combat global warm- The EU rapidly made this 450 ppm ing. Conclusion: a massive technical Strike for the planet goaloid the basis of its global warming progress programme will have to be policy with ‘20-by-20’ as a first step financed; As I go to press, almost all the above to this (carbon emissions reduced 20 b. some claim warming seems to have is rendered irrelevant by an event of percent by 2020). China and India said stopped since 1998 though others say immense significance for energy and cli- that it would be unjust for them to that this is nonsense; cautious experts mate change. Workers at an oil refinery make reductions unless the USA did argue that you can ‘cherry pick’ any in Grangemouth have gone on strike something radical (this was a ‘zero-by- one of a number of plausible but in defence of their pension scheme (for who-knows-when’ to be followed by contradictory accounts of recent younger readers I should explain that a ‘who-knows-what-by-who-knows- temperature change; a strike, until recently believed to be when’ policy). In the end even George c. Lord Stern has admitted that his extinct, is a protest in which employees W. joined the bidding, offering on behalf review had severely underestimated refuse to work). The two day strike is of the USA ‘zero-by-25’ followed by the problem, because CO2 is rising expected to stop a significant fraction another ‘who-knows-what-by-who- much faster than expected; of the UK’s production, import and use knows-when’ stage, conditional on a d. James Hansen of NASA, threw a of oil and gas during a whole month. prior offer by India and China of a bomb into the debate by saying that And that means lower CO2 emissions. ‘much-by-soon’ policy. Three months historically when the earth had a Isn’t that the answer? Combat global after Bali we are left with this insoluble CO2 concentration of 450 ppm (the warming through strikes. Carbon offset set of simultaneous equations. post-Bali consensus goaloid), it was firms, instead of paying for the planting ice-free. So, if it remained at that of trees should be financing strikes. Biofools rush in…and out level the sea level would rise by 75 After a long air trip, forget about chang- metres (i.e. submerging Buckingham ing the light bulbs, go on strike. This Europe’s first practical post-Bali initia- Palace and the New York Stock policy is backed by science: in recent tive – mandating the use of biofuels Exchange, not to mention a good decades there has been an almost exact – came a spectacular cropper. Only days part of Africa, Asia and America). (inverse) correlation between the aver- after the new rule that motor fuel sold So, actually achieving the world’s age global temperature and the number in the UK had to contain 2½ percent new climate goaloid would amount of strikes. biofuel, the Government, responding to unimaginable catastrophe.

Oxford Energy Forum. ISSN 0959-7727. Published by Oxford Institute for Energy Studies, 57 Woodstock Road, Oxford OX2 6FA, United Kingdom. Registered Charity 286084. Tel: (0)1865 311377. Fax: (0)1865 310527. E-Mail: [email protected] EDITOR: Robert Mabro. Annual Subscription (four issues) £45/$85/a65. © Oxford Institute for Energy Studies, 2008. Indexing/Abstracting: The Oxford Energy Forum is indexed and/or abstracted in PAIS International, ABI/IN- FORM, Fuel and Energy Abstracts, Environment Abstracts, ETDE and CSA Human Population and the Environment 20