The Middle East is running short of energy
22 May 2008
Newton's global oil and gas analyst Charles Whall has just returned from a visit to the Middle East. His visit convinced him that, while the world's eyes are fixed on the implications of China's burgeoning demand for energy, it is growing energy shortages in the Middle East which, incredibly, are more significant for global energy prices.
Our energy supply theme has maintained consistently that global energy supply is likely to remain tight, with only a major 'demand event' (such as a global recession) likely to provide any brief respite from high energy prices. Oil and gas prices have continued to rise sharply during the first half of 2008 and increasingly it seems that the nature of demand and supply in the Middle East will be highly significant in keeping energy prices high.
Interestingly, while most Middle East commentators are focused on Saudi Arabia, it is the actions of Qatar that Charles believes will have the greatest influence on global energy prices. Qatar, which has the world's third largest gas reserves (after Russia and Iran), has turned away from low-value regional pipeline projects in order to export (higher-value) Liquefied Natural Gas (LNG) to thirsty global markets. The actions of this small country are driving up both global natural gas prices and crude oil prices for reasons outlined below.
With a small population (about 200,000 indigenous people) and strong GDP growth, Qatar has ample opportunity to play the 'long game' in relation to the volume of gas it supplies and the price at which it does so. The 'North Field', which straddles Qatari and Iranian waters, is the largest gas field in the world. However, with the Qataris trebling LNG production between 2005 and 2011, they are worried about overproducing this field and they have suspended the approval of all new projects until (probably) 2012, when they will understand more fully the impact of current developments on the reservoir's capacity.
Qatar's moratorium on new projects, together with its heightened emphasis on LNG and its demand that buyers of unsold consignments of LNG pay a price equivalent to the price of oil, are having a severe impact on energy availability in a region that has planned its future on the basis of 'cheap' gas.
Demand for natural gas is escalating dramatically in the Middle East as the region's economies plough back oil revenues into major diversification and infrastructure projects. New cities with vast complexes (and even indoor ski slopes) are rising out of the desert sands, replete with manicured lawns and fountains. Given the harsh climate, air conditioning and water desalination are required all year round. At Jebel Ali in Dubai, on the road to Abu Dhabi, a new city is being built which hoardings proclaim will be twice the size of Hong Kong; Saudi Arabia is currently building six new cities; and Doha is expanding so fast that Qatar's energy demand is likely to double over the next four years. Put simply, the Middle East's infrastructure is designed to be powered by abundant supplies of inexpensive energy.
Meanwhile, discoveries of gas are failing to keep pace with global demand. Saudi Arabia has opened up gas exploration to foreign companies to try to close its energy supply 'gap', but the kingdom's 'empty quarter' (in which such exploration has occurred) has proved to be as bereft of gas as it is of people. Supply shortages in the region are already being felt: Iran, for example, had to close some of its chemical plants last winter, despite the fact that it is in the process of building a number of new plants.
Whereas local 'pipeline' gas has been available until recently at less than $2.50/Mbtu, the oil-parity price of LNG is about $16-20/Mbtu. The dearth of gas is likely to put upward pressure not simply on the price of gas, but on the price of oil too. The extraction of oil from beneath desert sands, where reservoirs, ironically, often take a carbonate rather than sandstone form (and where recovery is achieved via the injection of gas rather than water), is restricted by the shortage of gas. Increasingly, too, generators are burning fuel oil products rather than scarce gas to meet their energy requirements.
We estimate that, by 2020, local pipeline-supplied projects will be sufficient only to meet 50% of gas demand in the Middle East (leaving a large deficit to be closed by the supply of either LNG or oil products). According to the International Energy Agency, the region's total oil demand growth is now almost as great as that of China. However, gas pricing policy in the Middle East is having a far greater impact on overall oil demand because other markets are no longer able to substitute inexpensive natural gas.
There are three key implications of changes in the Middle East:
- The region has joined the global scramble for energy security, and upward pressure on gas prices is being exacerbated therefore. Even Dubai, which benefits from a pipeline to the world's largest gas field in Qatar, has signed an import agreement (with Shell) to import LNG. Under the agreement, we estimate that Dubai is paying six times the price at what it would have expected to secure regional gas supplies just two or three years ago. Even more surprisingly, Kuwait has also signed a contract with Qatar for summer LNG to fuel seasonal air conditioning demand.
- Global energy supply is tight and the current scale of construction in the Middle East means energy supply is likely to get tighter, especially if prevailing subsidies and trade restrictions remain in place (which seems likely as regional inflation concerns mount).
- Enthusiasm for 'alternative' energy sources is likely to increase. Abu Dhabi has committed to building a new city with a population of 200,000 at Masdar that targets zero emissions. The emirate has a long-term testing site for every available solar panel on the market.
Investment implications: We are taking opportunities to invest in:
- companies with exposure to rising LNG prices (including LNG producers); and
- other global gas companies, drilling contractors and service providers.
Significant exposure to attractively-valued oil companies in general continues to be recommended.
Important Information
Past performance is not a guide to future returns. The value of investments and the income from them can fall as well as rise and investors may not get back the original amount invested.
This article is for professional investors only. The opinions expressed in this article are those of Newton Investment Management and should not be construed as investment advice. In addition the information contained in this article should not be construed as a recommendation to buy or sell a security.
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