Lower oil prices lead to innovation and investment to secure Bahrain's fiscal and energy needs

Although its revenues from oil and gas have fallen, the government of Bahrain is ploughing new investment into the kingdom’s energy sector in the hopes that the broader economy will reap the benefits in the years to come. This counter-cyclical spending is designed to allow a significant increase in refinery capacity and a more secure supply of fuel for the country’s aluminium smelters, petrochemical factories, power stations and desalination plants.

At the same time, the government has taken historic steps to reduce subsidies on fuel, food and utilities that have reduced its expenditure but increased the cost of living for its citizens. Bahrain, which has been a net importer of crude oil for many years, is re-shaping the unspoken social contract between monarchs and citizens that characterises the economies of its oil-exporting GCC neighbours. The country’s natural resources may help fuel industries that employ many Bahrainis, but the trickle-down effect of oil wealth will no longer manifest itself in highly subsidised petrol, groceries or utility bills.

FISCAL SQUEEZE: The result of the global slump in crude oil prices is clearly visible in the impact on government finances. The national accounts published by the Ministry of Finance show revenues from oil and gas fell from BD2.7bn ($7.6bn) in 2014 to just under BD1.6bn ($4.2bn) in 2015. Those revenues accounted for 87.1% of the government’s total revenues of BD3.1bn ($8.2bn) in 2014 and 78.4% of the BD2bn ($5.3bn) collected in 2015. Overall government revenues decreased 34.2% from 2014 to 2015, while revenue from oil and gas fell by 39.6%. Prior to the changes in prices, oil and gas revenues were relatively stable at 88% of total government revenues in 2011, 87% in 2012 and 88% in 2013.

Those dramatic revenue declines came as the price for Brent crude averaged $99 per barrel in 2014 and $52 per barrel in 2015. Most analysts believe oil prices will only edge up marginally in the short term, with the US Energy Information Association (EIA) predicting in its September 2016 “Short-Term Energy Outlook” an average Brent crude price of $43 per barrel in 2016 and $51 per barrel in 2017. These figures suggest oil and gas revenues for both 2016 and 2017 could be as modest as, or even lower than, the income Bahrain received in 2015.

ECONOMIC CONTRIBUTION: The effect of lower oil prices can also be seen in the oil and gas sector’s contribution to GDP. As stated previously, the sector generated BD1.6bn ($4.2bn) in 2015, down from BD2.7bn ($7.6bn) in 2014. This resulted in its contribution to GDP falling significantly from 23.3% to 13.4%. As energy revenues have declined, other sectors have expanded their share of GDP. Manufacturing, for example, saw its contribution grow from 14.93% in 2014 to 17.34% in 2015. Financial corporations, including financial institutions and insurance companies, also saw their collective contribution to GDP surpass oil and gas, up from 15.53% to 17.18% over the same period.

Data showed negative growth for the second consecutive year for the oil and gas sector, with a 6% fall from 2013 to 2014 followed by a 46.5% slump from 2014 to 2015. Oil and gas output dropped from BD843m ($2.2bn) in the first half of 2015 to BD620m ($1.6bn) in the same period in 2016, a further fall of 26.5% year-on-year. As a result, the oil and gas sector’s share of Bahrain’s first half GDP of BD5.9bn ($15.6bn) was 10.6%. By contrast, for the years 2011, 2012 and 2013 the sector’s contribution to full-year GDP was 26.5%, 24.9% and 25.4%, respectively.

INDUSTRY HISTORY: This is not the first fall in global oil prices that has had a detrimental effect on Bahrain’s economy in the 10 decades it has been involved in the industry. Tatweer Petroleum and the Bahrain Petroleum Company (Bapco) trace its history back to 1923, when the British-New Zealand geologist and mining engineer Major Frank Holmes – also known as “Abu Al Naft,” the father of oil – first suggested crude oil might be found beneath the sands of Bahrain. The oil concession Abu Al Naft was granted by Sheikh Hamad bin Isa Al Khalifa in 1925 was later sold, and it was not until June 1932 that Bapco, a subsidiary of Standard Oil of California – the US firm that had bought the rights for $50,000 – first struck oil in Bahrain. The Bahrain Field they discovered was 15 km long and 5 km wide, and is still pumping oil 85 years later.

However, the larger share of Bahrain’s hydrocarbons wealth was established forty years later, in 1972, when it signed a production-sharing agreement with Saudi Arabia relating to the offshore Abu Saafa field, which had been producing oil since 1966 after being discovered in 1963. In 1975 the government of Bahrain acquired a 60% stake in Bapco, subsequently taking the company into full government ownership in 1980.

Saudi Arabia’s own oil production began in 1938 with the discovery of the Dammam No. 7 well, but subsequent finds at Abqaiq in 1940, Saafaniya in 1951 and Ghawar in 1957 meant that by the time of its Abu Saafa agreement with Bahrain, more than 1bn barrels were being exported from Saudi Arabia per year. Around the same time that the production-sharing agreement with Bahrain was signed, the Saudi government began increasing its involvement in Saudi Aramco: acquiring a 25% stake in 1973, 60% in 1975 and taking full control in 1980.

The trading of oil between Saudi Arabia and Bahrain was already firmly established by the time the production-sharing agreement was implemented. The Bahrain refinery, with a capacity of 10,000 barrels per day (bpd), opened in 1936, and in 1945 the Arabia-Bahrain (AB) submarine pipeline was laid.

MARKET FORCES: Although the oil and gas industry has fuelled the modernisation and development of Bahrain, the sector has always been vulnerable to the vagaries of international oil pricing. When oil was first discovered in the Bahrain Field in 1932, oil was $0.87 per barrel, the equivalent of $14.83 in 2013. When production at the field peaked at 79,000 bpd in 1970, Bapco could fetch a price of $1.80 per barrel, $10.79 in 2013 prices.

Indeed, from 1921 to 1973, crude oil remained below the 2013 equivalent of $25 per barrel. When the government of Bahrain progressively took control of Bapco in the late 1970s, the price had jumped to the equivalent of $104 in 2013 prices, or $36.83 at the time, but within six years it had fallen back down to $14.43, $30.67 in 2013 prices.

The next big spike in prices came in 2008 when oil reached $97.26, or a 2013 price of $105.23. This coincided with the low point of production at the Bahrain Field, which was down to 32,000 bpd. Later, as production began to pick up in the onshore field, technical issues in the Abu Saafa field saw production fall from 54m barrels in 2011 to 47m barrels in 2012, just as Brent crude was fetching $111.67 per barrel, according to EIA data.

OIL PRODUCTION: In more recent times, Bahrain’s record levels of efficiency and production at both of its oil fields have coincided with slumps in prices. Data from the country’s National Oil and Gas Authority (NOGA) shows that in 2014, when the average price for Brent crude had decreased to $99 per barrel, the Abu Saafa field reached a 10-year high in production of over 56m barrels throughout the year, taking combined production from the two fields to another 10-year high of 73.9m barrels.

One year later, when the average price of Brent crude fell significantly to $52 per barrel, the Bahrain Field reached its highest output in three decades, at 18.5m barrels, contributing to a combined output from the two fields of 73.6m barrels for that year.

With the exception of the fall in production in 2012, production at the Abu Saafa field has remained reasonably constant, with an average annual output from 2005 to 2015 of just over 54m barrels. However, improved output at the Bahrain Field has seen the country’s combined output from the two fields increase by 8.2% from 68m barrels in 2005 to 73.6m barrels in 2015.

TATWEER PETROLEUM: During the summer of 2016 a number of important changes took place in the management of Bahrain’s oil industry, at both corporate and ministerial levels. The government of Bahrain assumed full control of Tatweer Petroleum, the company established in 2009 to optimise production at the mature Bahrain Field.

At inception, Tatweer Petroleum was a joint venture based on a development and production-sharing agreement with three strategic partners: nogaholding, the investment arm of NOGA; US-based Occidental Petroleum; and Mubadala Petroleum of Abu Dhabi. From December 2009 Tatweer Petroleum began increasing oil production by drilling new wells, implementing new technology and testing enhanced oil recovery methods. From those efforts, annual production rose by almost 60% from 11.6m barrels in 2010 to 18.5m in 2015. According to the company’s 2015 annual report, 65 new wells were drilled in the Bahrain Field during the year, bringing the total drilled during its company tenure to 845 and the overall well count in the field to 1730. In 2015 Tatweer produced 46,200 bpd of crude, up from 44,400 bpd in 2014, and its daily crude and condensate production averaged 50,600 bpd – a level of output not seen at the field since 1978.

However, in May 2016 plans were announced that the joint venture would be dissolved because the partners could not achieve the 70,000 bpd rate that they had targeted. Tommy McKenzie, then-CEO of Tatweer Petroleum, told OBG in late 2016 that while the venture had been successful in terms of increasing production, partners Occidental and Mubadala had not seen the return on investment they were hoping to achieve when terms were agreed to in 2009. “The terms of the agreement tended to favour the government, so that while the company was successful in increasing oil production and gas capacity by 50%, performance was not good enough to be profitable for the partners,” McKenzie told OBG.

OIL IMPORTS: In addition to the crude oil Bahrain receives from Saudi Arabia under the Abu Saafa production agreement, the country also imports substantial quantities of crude oil from its neighbour each year. Bahrain is classified as a net importer of crude oil, although the difference between domestic production and imports has narrowed in recent years, according to NOGA data. From 2005 to 2015 the average annual oil import from Saudi Arabia was 81m barrels. Imports peaked in 2010 at just under 86m barrels when combined production from the Bahrain and Abu Saafa fields was just 66m barrels, thus Bahrain needing to import 19.3m more barrels of oil than it produced. By 2014 the difference between domestic consumption and imports had shrunk to 2.1m barrels, the lowest margin in the 10 years leading to 2015. In 2015 the difference widened again to 5.2m, with 73.6m barrels produced by Bahrain and 78.8m imported from Saudi Arabia.

THE REFINING PROCESS: The crude oil produced and imported by Bahrain is subsequently fed into its refinery. The first 10,000-bpd refinery was opened in 1936, and by 1968 its capacity had been expanded to 250,000 bpd. In 1997 the government assumed 100% ownership of the private refinery, and 20 years later, in 2017, it hopes to see work start on a $5bn scheme to boost capacity to 360,000 bpd before 2020. The crude oil run to Bahrain’s refinery averaged 96m barrels per year between 2005 and 2015 and was more than 97m per year from 2012 to 2015.

From 2012 to 2015 annual refinery production averaged 1bn barrels. Local sales of refined products grew every year between 2005 and 2015, with the exception of 2011, when political uncertainty sapped demand, and in 2015 sales volumes within Bahrain reached 10.5m barrels. Exports of petroleum products were 87.2m in 2013, 87.8m in 2014 and 87.6m in 2015. These export volumes have not been achieved since 2008 when the global financial crisis impacted most economies.

The sum of local sales and exports reached 98.1m in 2015, the highest total sales of refined products since 2007. Although the refining process might be considered a manufacturing activity by those working in the upstream oil and gas industry, revenues from refining are recorded under oil revenues and combined with income from the Bahrain Field in the country’s national accounts.

GAS PRODUCTION: The Bahrain Field is also the source of natural gas and associated gas. Natural gas was first discovered in Bahrain in 1948. The Bahrain Field has 45 wells capable of producing more than 1.5bn standard cu feet (scf) of gas per day.

In 2015 the kingdom produced a combined 720bn scf of gas, including 494 scf of natural gas and 226bn scf of associated gas. This represented a 33.6% increase in total gas production compared to 2009, at the end of which Tatweer Petroleum took over operation of the Bahrain Field. In 2009 543bn scf was produced, composed of 433 scf of natural gas and 103bn scf of associated gas. In addition, data from NOGA shows combined gas production increased by 60% from 2005 when it totalled 470bn scf to the 752bn scf that was produced in 2015.

GAS CONSUMPTION: While crude oil feeds refining and so plays a key role in exports, gas is also economically critical. It is needed for sustaining water desalination, power generation and for the energy-intensive heavy industries that have developed as Bahrain has sought to pursue a policy of vertical economic diversification by using its natural resources to spawn manufacturing businesses.

In 2015 the country’s water and power plants used 31% of Bahrain’s gas; the largely state-owned aluminium smelter, Alba, used 18%; and Bapco, the Gulf Petrochemical Industries Company and other industries consumed 8%, 6% and 9%, respectively. The remaining 28% of gas production was re-injected into oil reservoirs to help support crude production. While these usage proportions may change marginally from year to year, power and water plants and Alba have collectively consumed between 50% and 60% of all the gas produced in Bahrain every year between 2005 and 2015.

SECTOR ORGANISATION: With the withdrawal of Occidental and Mubadala from the Tatweer Petroleum joint venture, nogaholding has increased its holding in the company from 51% to 100%. Through nogaholding, the state also fully owns both Bapco and its refinery in Sitra, as well as the Bahrain National Gas Expansion Company (BNGEC), which was created in 2008 and charged with managing associated gas produced by increased oil production.

BNGEC is operated and managed by Bahrain National Gas Company (Banagas), which in turn is 75% owned by the government of Bahrain, with Chevron and the Arab Petroleum Investment Corporation each holding stakes of 12.5%. Banagas processes associated gas into marketable products, with propane, butane and naphtha that is exported around the world, while methane and ethane are used domestically as feedstock by Alba, the Bapco refinery and the Riffa power station.

The government owns a 60% stake in the Bahrain Aviation Fuel Company, with the remaining equity shared by Chevron (27%) and BPME (13%). Bapco and nogaholding share 55% of the equity in Bahrain Lube Base Oil Company, with the remaining stock held by Neste Oil Company of Finland.

In addition, nogaholding has a 35% stake in Skaugen Gulf Petchem Carriers (SGPC), with the Norwegian company Skaugen holding 35% and Capital Management House owning the remaining equity. SGPC was established in 2010 to ship petrochemical gasses from the Middle East to the Far East. The company also has an equal 33.3% share in Gulf Petrochemical Industries Company together with Saudi Basic Industries Company and Petrochemical Industries Company of Kuwait.

TERMINAL: The newest company in nogaholding’s portfolio is Bahrain LNG, a consortium that was created in March 2015 to build the country’s new liquefied natural gas (LNG) import terminal. Nogaholding and Teekay LNG Partners of Canada each hold 30% of shares, while Samsung C&T of South Korea and Kuwait’s Gulf Investment Corporation each own 20% (see analysis). The project is set to be operational by early 2019, with an initial capacity of 400m scf per day. This capacity will be able to expand to 800m scf per day.

While domestic production of natural and associated gas is increasing – specifically, by 3.2% in 2015 – parties such as the International Energy Agency project that the MENA region will increasingly rely on gas imports to cover energy demands in the coming decades. Private players in the industry tend to agree. “Bahrain has a growing population, so it will be important to move ahead with the new planned LNG terminal for the kingdom’s own energy security,” Bassem Battisha, country chairman for Chevron Bahrain, told OBG.

The new import terminal will comprise a floating storage unit, offshore receiving jetty, regasification platform and an underwater pipe network linking the facility to the onshore receiving feature.

NEW MINISTERIAL PORTFOLIOS: In the month before the government of Bahrain resumed full control of Tatweer Petroleum in 2016, a new minister of oil was appointed. Sheikh Mohammed bin Khalifa bin Ahmed Al Khalifa – already a long-standing member on the board of the Central Bank of Bahrain – was appointed by royal decree on June 3, 2016. Sheikh Mohammed had also been serving as the chairman of both NOGA and Bapco. The cabinet reshuffle also saw the industry veteran, Abdul Hussain bin Ali Mirza, change portfolios from the minister of energy with responsibility over oil, gas and utilities, to become the minister of electricity and water.

Ali Mirza had previously been appointed minister of energy in December 2014 before moving to his current role in June 2016.

2020 VISION: While the division of ministerial responsibilities coincided with the government’s resumption of full control of Tatweer, it also came on pace with a series of strategic projects set to transform the kingdom’s energy sector by 2020. During his tenure as the minister of energy, Ali Mirza successfully negotiated a multi-billion-dollar raft of development plans to revitalise the sector.

In September 2015 representatives from the governments of Bahrain and Saudi Arabia signed contracts for the construction of a new $350m, 115-km AB oil pipeline, which will feed the new $5bn Bapco refinery expansion. The Saudi company Al Rabie will build the 74-km onshore pipeline, while the 41-km subsea contract went to the UAE-based National Petroleum Construction Project.

In November 2015 Bapco and Alba signed a landmark natural gas supply agreement that enabled the aluminium smelting firm to pursue its $3.5bn Line 6 expansion. Alba will become the largest single-site smelter in the world with the completion of this potline set to be concluded in 2019 (see analysis). The Line 6 expansion is forecast to raise annual output by 514,000 tonnes to reach a total of 1.45m tonnes every year at full production. Currently, approximately half of Alba’s output is absorbed by the domestic market with the rest set for export. The 2015 document was the largest gas supply agreement negotiated since the foundation of NOGA 10 years earlier.

In January 2016 a $355m contract to build a new associated gas plant for Banagas was awarded to Japan’s JGC Group. The new plant will allow Banagas to process an additional 350m scf of gas and is expected to come on-stream by September 2018.

In May 2016 a groundbreaking ceremony was held to mark the start of work on a $100m gas dehydration facility, following an agreement signed by Tatweer Petroleum and Petrofac in September 2015. In a statement, Petrofac said the plant was the first of a series of facilities being planned by Tatweer Petroleum over three to five years.

In July 2016, shortly after Sheikh Mohammed took office as the minister of oil, private firms were invited to tender engineering, procurement and construction bids for the $5bn Bapco refinery expansion project with a submission deadline of October 5, 2016. The winning bid is due to be announced by the second quarter of 2017.

POWERING UP: The power sector is expected to see a period of expanding generation, coupled with a reduction of subsidies for the utilities sector that will usher in price increases for the electricity and water used by the country’s residential and commercial customers. In 2016 the Electricity and Water Authority (EWA) received consultancy bids for the Al Dur 2 Independent Water and Power Project. According to the Bahrain Economic Development Board, the new facility is expected to include a 1500-MW, gasfired power plant and is due to come on-stream in 2019. It is estimated that this project will be costed at $1.5bn and will enable Bahrain to cope with its growing energy demands.

In 2015 EWA reported day time system generation availability of 3888 MW against a peak load on August 1 of 3335 MW, while night time system generation availability was measured as 3917 MW against a peak load on July 29 of 3128 MW.

In June 2014, according to the latest data available from EWA at time of press, Bahrain had a combined daily production of 165.3m imperial gallons of desalinated and ground water compared to demand of 163.1m imperial gallons.

In March 2016 the EDB reported that a combined $1.3bn of Gulf Development Fund investment was expected for the water and power sector. In May 2016 the prime minister of Bahrain praised the role of Kuwait, and its Kuwait Fund for Arab Development, for funding a BD280m ($742.6bn) power grid development that will provide for 400-KV electricity transmission lines to be built in Hidd, Um Al Hassam and Riffa by the end of 2017. The project is being completed by Siemens of Germany, Prysmian Group of Italy and Hyundai of South Korea.

SUBSIDIES: Many of the Gulf countries have faced sustained criticism from the IMF over their use of subsidies. It has been argued that using government funds to reduce every day costs of petrol, electricity and desalinated water is wasteful and tends to benefit the wealthiest consumers, thereby stimulating overconsumption and misuse. As a net importer of crude oil and a country with a $4bn deficit in 2016, Bahrain had fewer excuses than its larger neighbours for maintaining subsidies for its residents. As a result, subsidy cuts began taking place at the end of 2015, including for meat and petrol.

There are 1000 fils to the dinar, and in January 2016 drivers paying for 95 Octane Mumtaz fuel found themselves paying 160 fils per litre rather than 100 fils. Users of 91 Octane Jayyid saw prices rise by 56% to 125 fils per litre. Local media reported that diesel and kerosene prices also increased – to 120 fils per litre – and that kerosene prices will be bumped up by 20 fils each year until 2018, when the price will be fixed at 160 fils. Diesel will rise slightly to 180 fils per litre by 2019.

THE BARE NECESSITIES: In February 2016 EWA announced new tariffs for electricity and water consumption, effective March 1, and detailed the incremental increases that would take place through to 2019. Customers who are Bahraini citizens with a single domestic account will enjoy significantly lower prices of both water and electricity compared to other residents and business customers.

Electricity bills are banded according to usage and paid in fils. Domestic bands are for 0-3000 units, 3001-5000 units, and 5001 units and above. Charges for those bands in 2016 were 3, 9 and 16 fils, respectively, for Bahraini citizens, but 6, 13, and 19 fils for other domestic customers. The bands for commercial customers are classified into levels of 0-5000 units, 5001-250,000 units and 250, 001-500,000 units, and the 2016 charges for those bands were set at 16, 19, and 21 fils, respectively. However, by 2019 non-Bahraini residents and commercial customers will be charged 29 fils per unit regardless of usage, with commercial customers granted a discount to 16 fils for the first 5000 units.

Similar banding and fee structures apply to water usage, which is measured in cu metres, with any discount and distinction between commercial and non-Bahraini domestic customers also to be removed by 2019. In 2016 Bahraini domestic customers paid 25, 80 or 200 fil for usage of up to 60 cubic metres, 61-100 cubic metres and anything above 100 cubic metres, respectively. Other residents paid 80, 200 and 300 fils, which will rise to 750 fils per cubic metre by 2019, a rate that will also be paid by commercial customers that year. Bahraini government ministers project that these subsidy reductions or full cuts will save the country BD620m ($1.6bn) by 2019.

OUTLOOK: Bahrain’s national strategy is to diversify its sources of energy and improve its ability to process and refine crude oil and gas. The aim is to sell a greater volume and variety of petroleum, petrochemical and aluminium products in future years. If prices for those commodities increase with time, then by 2020 its investment strategy may pay off.