Continental divides: African gas production is becoming increasingly competitive

For more than 40 years now, Egypt has been pumping natural gas, with its first discoveries coming in the still-rich Delta region, but over the past 15 years, the country’s prominence as a major producer has risen significantly. Gas reserves were equivalent to more than 77trn cu feet (tcf) by the middle of 2011, an increase of about 50% from the start of the last decade, and with more than 150 commercially feasible discoveries coming over the past decade, the expectations for future growth are sizeable.

REGIONAL TRENDS: This recent jump in output – production more than doubled from 742bn cu feet (bcf) in 2000 to 2.2 tcf in 2011 – places Egypt in the midst of a broader regional trend on the African continent, where gas is now becoming an increasingly big industry. New producers – particularly in the liquefied natural gas (LNG) segment – are coming on-line around the Gulf of Guinea, and with East Africa finding significant new deposits and shale gas surveys being conducted in South Africa, the entire continent is seeing ever more capital flowing into gas-related exploration and production.

This comparatively sudden boost in output across the continent – in line with worldwide increases – affects Egypt’s own gas segment by expanding global supply and increasing export competition; as a result, it has an effect on how the country divides its production between exports and domestic consumption. This in turn can play a key role in determining local energy policies, such as subsidies and pricing, two of Egypt’s most sensitive issues. There are a number of elements that are conspiring to loosen gas markets, but a rise in reserves of more than 106 tcf in Africa over the past decade – with scope for at least 494 tcf more – is worth examination because it is perhaps the most dramatic.

GLOBAL MARKETS: The jump in African production is a plus for all of the obvious reasons, but it has also noticeably tightened the export market, particularly as the US continues to boost domestic natural gas production (see analysis), which in turn has affected the outlook for some of the African producers. Lower pricing structures in the US, which have just hit a 10-year-low, have resulted in a rise in interest from foreign markets, particularly in Asia, where Chinese and Japanese firms are signing contracts for future supplies from American exporters.

Demand is rising significantly, thanks to higher levels of consumption in emerging markets, with the International Energy Agency estimating that it will grow by 50% by 2035. Given the potential jump in supply, whether revenues will be sustained during that period is less clear, however. Demand has already slackened during previous periods. During the height of the financial crisis, for example, demand for LNG dropped, prompting major exporters like Algeria to scale back production by 10%.

At the same time, new LNG operations in countries including Qatar, Yemen, Indonesia and Russia have added supply to the market. In late 2009 major LNG importers such as Italy, South Korea and Japan were buying less than usual, and European stocks were higher than normal. With the eurozone debt crisis continuing to dampen demand in one of the world’s largest gas consumers, and with China’s momentum slowing, the increase in demand may be more than offset by the boost in supply.

CONTINENTAL COMPETITION: Although natural gas exploration in Africa intensified noticeably during the height of the oil price spike, when sustained elevated crude prices helped justify looking in traditionally marginal producers or technically complex blocks, activity across the continent has continued even as the cost of oil has moderated. Wildcat firms and smaller explorers have been particularly aggressive, and in some cases have ended up on top of sizeable finds, such as Ghana’s Jubilee field.

As a result, while there are three major traditional LNG exporters active in Africa – Nigeria, Libya and Algeria – a number of new producers will be adding to the continent’s overall export figures. Although commodity production is not necessarily a zero-sum game amongst producers, as OPEC ably proves (see analysis), the growth in African output has significant consequences for global supply as well as for Egypt’s own export prospects.

NIGERIA: At more than 180 tcf, Nigeria has more natural gas than any other country in Africa, although a lack of processing facilities and pipelines limits the extent to which the country can process its mainly associated deposits. As a result, reinjection, venting and even flaring are commonplace. In fact, the country is one of the biggest culprits when it comes to flaring, second only to Russia.

However, the country still exported more than 17m tonnes of LNG in 2010, primarily through the world’s largest liquefaction facility on Bonny Island in the Niger Delta, and the government has unveiled aggressive goals to raise that figure. Currently, Bonny – the only LNG plant operating in Nigeria – is massive, with six trains and 22m tonnes of capacity, and accounting for roughly 66% of Nigeria’s total gas production. This brings in more than $10bn a year for the consortium running the plant, and plans are afoot to introduce a seventh train. A Gas Master Plan, alongside new facilities, including a four-train plant and a two-train plant, are both on the cards, which would significantly increase export volumes.

Once one of the world’s largest producers with 10% of production, Nigeria’s influence on LNG export markets is variable at the best of times. Export volumes dropped by nearly a third in 2009, thanks to shut-in supply and low-level violence around production areas. The country exports most of its LNG to Europe and the US, two places where demand is slackening, prompting the government to increasingly prioritise domestic use. The extent to which this can be achieved will depend in part upon the tightness of export markets. As global demand slows, the government may face a drop in opportunity costs that will in turn allow it to more ably shift gas production towards local electricity generation and industrial feedstock, which will have long-term benefits for the country’s diversification.

ALGERIA: Meanwhile, Algeria has proven reserves in excess of 159 tcf, a large portion of which is found in the Hassi R’Mel field, the country’s oldest. Algeria was the first country to supply LNG in 1964, so it has a long history as a gas producer. At present it has a total capacity of 943 bcf spread across four complexes, with an additional 9m tonnes per annum (tpa) of new capacity being built at present. Overall gas production regularly exceeds that of sales, sometimes by as much as 3.5 tcf, most of which is accounted for by reinjection or shrinkage, but the country still manages to export in the region of 1.8 tcf annually. About 1.1 tcf of this is piped out, via two European-bound pipelines to Italy and Spain, with the remaining volumes transported as LNG.

The country is targeting a rise in export levels to 3 tcf by 2015, much of which will be directed toward Europe, which already accounts for more than 95% of Algeria’s outbound gas sales. While it is unlikely that US production would divert a meaningful number of customers away from Algeria’s piped product, output increases from Russia, the EU’s single largest supplier, may make prices more elastic.

LIBYA: Long a top-ranking oil producer, following the end of sanctions Libya has in recent years also seen a significant influx of capital from the major players into its hydrocarbons sector. Although oil dominates, with the country boasting some of the largest reserves in the world, Libya also hopes to reach its potential as an LNG exporter by boosting capacity at its Marsa El Brega facility from 0.6m tpa to 3.2m tpa. Italy’s Eni and BP are planning LNG export operations in Libya, but they will not begin building liquefaction terminals until exploration programmes under way now find enough gas to justify them. However, estimates for total reserves range as high as 54 tcf and in spite of the problems engendered by the civil war, Libya’s long-term ability to maintain a strong export profile is – like Algeria – dependent in large part on its direct pipeline to European consumers.

NEWCOMERS: Angola, which has shot to the top of the tables in oil production over the past decade, alternating with Nigeria for the first continental spot, has also begun to lay plans to better leverage its roughly 10.6 tcf of proven reserves. The country has already begun aggressively exploring for new gas deposits – its current reserves are roughly five times what they were 10 years ago – and has announced plans to get started with a 5m-tpa LNG train near Soyo, and a second is in the works. Crucially, the exports were originally destined for the US but with import demand in the US declining, the new production will be sold to clients in either Asia or Europe.

Elsewhere in the region, Equatorial Guinea is one of the more recent additions to Africa’s LNG producers, having filled its first cargo ship in May 2007. With 1.3 tcf of proven reserves, this tiny country has most of its deposits offshore, not far from Bioko Island. The majority of the country’s exports come from the main LNG terminal, with virtually all of the output going to Asia and Latin America.

Korea alone accounts for roughly one-third of the country’s exports, and over the past year demand from Japan, which usually makes up one-sixth of Equatoguinean exports, spiked on account of the temporary closure of more than 50 of Japan’s nuclear power plants. With Japanese clients increasingly turning towards the US, however, Equatorial Guinea may need to begin looking elsewhere for new contracts.

The Gulf of Guinea as a whole is beginning to attract more attention. Ghana’s Jubilee field, which came on-line at the end of 2010, has substantial associated deposits, with estimates of reserves ranging as high as 2472 tcf. The country, which only discovered commercially viable quantities of hydrocarbons five years ago, has since scrambled to establish the infrastructure necessary to handle the gas. Flaring there is banned and continued reinjection risks destabilising the current oil deposits. As a result, Ghana has paired up with China to put in place preliminary infrastructure over the next 12 months to handle the gas for both local processing and for transport to the West African Gas Pipeline. Exports from the associated condensates are likely to be regionally oriented but a recent second discovery by Eni of a new deposit offers the potential for LNG exports.

THAT’S NOT ALL: While these relatively new producers have already begun to shift supply to the global market, there is more coming down the pipe. New discoveries in East and South Africa look set to have an impact on worldwide supply, particularly in the LNG segment. Formerly regions where hydrocarbons were few and far between, finds have begun to come at increasingly rapid pace, with firms pouring into the region from Kampala down to Cape Town.

Perhaps the biggest recent announcements have been in East Africa, where Tanzania and Mozambique have come across substantial new discoveries. Both Eni and US-based Anadarko have made significant finds in the waters off the shores of Mozambique that between them come up to a potential recoverable estimate of 99 tcf, vaulting the former Portuguese colony into the ranks of Africa’s top producers. Discoveries from firms like Norway’s Statoil in Tanzanian waters have helped to triple that country’s estimated reserves in recent months to roughly 2.8 tcf.

Finally, South Africa, whose forté has traditionally been in minerals and coal, has the potential to dramatically change the game. Recent studies by Shell indicate that the Rainbow nation may be sitting on as much as nearly 494 tcf of shale gas, a figure that would double the entire continent’s gas resources if proven. Whether that will actually happen is uncertain, given that the deposit sits primarily under the protected nature reserve of the Karoo, but it certainly would affect export markets around the world.

Even smaller countries such as Mauritania are conducting gas exploration. Africa’s gas reserves are estimated at above 530 tcf now, as opposed to 424 tcf in 2000, and LNG capacity is projected to increase by 44.9m tpa by 2014, according to Petroleum “Given the need for higher export revenues, Egypt should seek to export more oil and gas instead of consuming such resources domestically in an inefficient manner,” said Mohamed El Mahdi, the chairman and managing director of Siemens in Egypt.

Balancing the two is not an easy choice for any policymaker, but there is no doubt that Egypt, which exported roughly 530 bcf in 2010 (approximately two-thirds of it in LNG and the remainder piped), is seeing its export commitments increasingly pressured by the rise in domestic consumption, even as its export markets face growing competition, whether from Central Asia, Russia or its African neighbours. The problem has become so acute that in previous years, the Egyptian government actually stopped signing new contracts for natural gas. From 2008 to 2010, no new export agreements were inked.

COMPARISON PRICING: That of course brings concerns of its own for upstream gas producers in the medium to long term, given the lower prices commanded locally. Production costs also play a role, particularly as far as they influence end-user pricing. Crucially for the country, a large number of these recent finds are in the Mediterranean or in the Nile Delta, and are comparatively accessible, helping to keeping production costs low. The government has recently concluded bidding rounds for new blocks, and a massive multibillion-dollar project, led by BP, is currently under way in the Nile Delta region. However, work is moving into more technically challenging areas, including deep offshore segments, which will slow the pace of new exploration and raise the cost of extraction. For countries like Mozambique that may hold massive new deposits, the cost scale is more attractive but for more modest-size blocks, recouping those expenses is crucial.

As a result, in a bid to maintain parity with the excitement of new production elsewhere and to match some of the more attractive terms being offered in countries like Tanzania, the Egyptian Natural Gas Holding Company (EGAS) has overhauled its concessionary pricing model for the recent bidding round. In previous rounds, interested bidders would have to agree on pricing terms with EGAS, based on preliminary studies but prior to exploration. The terms have since been revised to allow for firms to negotiate prices after discovery, permitting a better representation of the true costs of production.

But this is not a simple picture, with further complications added by the fact that Egypt’s export prices have, at times, been cheaper than local prices. The recent ban on exports to Israel has prompted speculation by the press that East Mediterranean Gas, the Israeli-Egyptian joint venture that manages the pipeline between the two countries and which does not publicly release prices, sells the gas at between $1 and $2 per British thermal unit (Btu) less than what domestic firms pay. This sparked an outcry, but Egypt’s terms with Jordan were until very recently similar, at $2 per Btu as opposed to the $4 domestic price, although they have since been raised to $5.

LOOKING AHEAD: There is no doubt that the debate over how Egypt’s natural wealth is used will continue for some time, and however the balance is struck, it will be the result of myriad factors, including pricing, socioeconomic developments and power consumption. It is clear that the immediate benefits of Egypt’s current export policy, particularly in light of its recent success in renegotiating contracts, have the ability to pay short-term dividends by providing access to much-needed revenues.

In the longer run, while Egypt will likely continue to pipe or ship a portion of its gas abroad for at least a decade to come, its ability to maintain its export commitments will come under increasing pressure, not only from domestic demand, but also from global market conditions that are rendering the price of a key commodity ever more elastic. Gas production has wavered in recent years, and thanks to key clients shifting towards cheaper US production, alongside an impressive rise in African production and a more fluid export market, the ability of Egypt to ensure sustainable export revenues will likely be weakened.