Submitted by Martin Katusa of Casey Research
Forgotten Treasure: Unconventional Oil in the Middle East
As the conventional and cheap oil and gas start to dry up in the
Middle East… a bigger, even better opportunity seeks to replace it.
For many who aren’t familiar with the region, the Middle East comes
across as an updated version of Lawrence’s Arabia, only with lots of
oil. But this mosaic of cultures isn’t made up of only Arabs or Muslims,
and most Middle East countries are neither awash with heavily armed,
rather excitable citizenry… nor with black gold, which is what we’re
interested in. Twenty-three countries comprise the Arab League, but
only Saudi Arabia, Iraq, Kuwait, the United Arab Emirates (UAE), and
Iran are major oil producers.
No matter; with the exception of Kurdistan in northern Iraq, none of
the oil heavies are currently open to us investors anyway. We’re
digging for other finds, with three basic criteria. We’re looking for
countries in the Middle East that:
- Have potential for unconventional production, such as oil shales
- Have incentive to develop it, and
- Are either net importers of oil or soon will be.
Why? In short, conventional production is in decline, but demand for
oil isn’t. That means the state-owned oil companies and large companies
operating in the region either need to find new fields and basins or
apply new technology to get more out of established ones. Or both, of
course. Nowhere is this reality more critical than in the Middle East,
the world’s most important oil region, where oil production is the
lifeblood of governments.
Our analysis, gleaned from data and on-the-ground experience alike,
points to investment opportunities in new, unconventional technology and
resources. Exploration costs will likely be lower, as companies aren’t
starting from scratch. And in what we see as early days in the
national drives for energy security, it makes sense to look close
around your own turf.
We believe that blue-sky potential lurks in companies operating in the
Middle East with expertise in unconventional production, access to good
source rock, and management that can marry the two.
The Proving Grounds
It’s still early in the game, which can mean both good (high returns)
and bad (high uncertainty) for investors. We believe the potential
upside of unconventional development in the Middle East is just too big
to ignore, however. So what we’ve done, is track down and lay out the
most likely go-to countries for those explorers with the right stuff.
The following chart will narrow further the countries that meet the
three criteria we outlined above. That is, who’s “in the red” when it
comes to oil?
We see here that six countries currently rely on imports for their crude oil: Egypt, Cyprus, Lebanon, Jordan, Israel, Turkey.
In addition, two countries appear on their way to becoming net importers of oil: Syria and Yemen.
Outlook: The oil and gas industry are an essential
sector in Egypt's economy, and the country’s reserves convey its
potential to become a significant producer. In 2009, Egypt produced
678,300 of barrels of oil per day, while consuming 683,000 barrels per
day. Egypt has traditionally been a net producer, but production peaked
in 1993 and has been in decline. Combine that with its increase in
domestic consumption, and Egypt is now a net oil importer.
Consequently, the Egyptian government has reversed its previously much
harsher fiscal regimes and now actively encourages the exploration of
domestic oil, which has resulted in an industry dominated by foreign
Natural gas, on the other hand, has tripled in production in recent
years due to some major discoveries. Thus Egypt is a net producer here,
and more important in the broad picture, a source for European natural
gas. European countries are usually eager to decrease their reliance on
Gazprom, the state-controlled gas giant from Russia.
Egypt has a developed network of pipelines to export its natural gas to
Southern European and eastern Mediterranean countries. It also sends
liquefied natural gas (LNG) to Europe, Asia, and the Americas.
However, as natural gas represents over 80% of Egypt's source of
electricity, the government has slowed plans for export expansion to
ensure all domestic demands will be met before any further moves.
Outlook: Cyprus has no oil or gas production currently,
and so must import all it needs. However, an oil deposit has been found
recently in the seabed between Cyprus and Egypt. An oil licensing
round took place in 2007, when 11 blocks were offered to potential
This first round took place against a backdrop of opposition from the
Turkish government. As a result of this territorial dispute, companies
chose not to bid, and as of now, only Noble Corporation has a
production-sharing agreement (PSA) with the Cyprian government.
In May 2010, Cyprus announced it was close to commencing a second oil
licensing round for several offshore blocks. It’s again under Turkish
protest. Turkey has even warned Lebanon and Egypt against working out a
deal with Cyprus for oil exploration.
Outlook: Lebanon also has neither oil or gas production
at this time. However, Cyprus has signed lineation agreements with
Lebanon and Egypt to exploit large hydrocarbon reserves that cross
borders offshore, as we mentioned above, and hope to begin exploration
And according to Lebanon’s parliament speaker, Nabih Berri, gas
reserves found off the coast of Israel are located in Lebanon's
territorial waters as well. These fields, however, may run into
developmental difficulties as Israel and Lebanon to this day still
dispute their maritime borders, leaving large fields such as Leviathan
and Tamar in a state of limbo.
Outlook: Large corporations have been eyeing the
unconventional potential in Jordan for quite some time, but were put
off due to both political as well as economic reasons. However, with
advancements in oil shale technology and a gradual shift towards
liberalization by the Jordanian government, which has long been envious
of the hydrocarbon wealth of its neighbors, Jordan’s government has
established plans to liberate the oil market in the next five years. If
that happens, it will be a first for investors since 1958. Under the
National Energy Strategy’s initial phase, four companies will be
offered 25% of the kingdom's reserves. The remaining 75% will remain
under the control of the state-owned Petroleum Refinery Company (JPRC)
until full liberalization.
This development will pave the way to exploit Jordan’s oil shale
resources. Oil shale deposits underlie more than 60% of the Kingdom of
Jordan and have enormous potential. The World Energy Council estimates
Jordan's oil shale reserves at approximately 40 to 60 billion tons,
making it the second richest state after Canada in rock oil reserves.
Furthermore, the oil shale quality is very high compared with the oil
shale in the United States. Jordan has recently signed a deal with
Shell Oil to extract oil shale in the central part of the country. First
commercial quantities are expected by 2020, with an estimated amount
of 50,000 barrels of oil per day.
Modest natural gas reserves were discovered in 1987, and the Risha
field near the Iraq border produces approximately 30 million cubic feet
of gas per day. However, production is pretty flat and looks to stay
that way. That means imports.
Outlook: Israel relies on importing resources to meet
the majority of its energy needs. It boasts no major reserves, and thus
oil production is minimal. However, as we said above, Israel has found
substantial natural gas reserves located in Mediterranean deep water.
This discovery has prompted increased exploration off Israel's
coastline, not to mention increased territorial disputes.
The U.S. Geological Survey reports that Israel's offshore reserves
could hold 122 trillion cubic feet of recoverable gas. That makes it
one of the world's richest deposits.
As a result of this discovery, Lebanon has rushed through approval of a
law that outlines the guidelines of surveying, exploring, and
producing of gas. The legislation also calls for a sovereign wealth fund
to manage the potential revenues.
Nevertheless, Lebanon is still three to four years behind the Israelis,
as it still must secure investors, select bidders, and begin
exploration work. Israel is already well on its way.
Outlook: Although Turkey has both oil and natural gas
reserves, the country is a net importer for both resources. It may
become energy independent as new oil and natural gas reserves have been
discovered off the coast of the Black Sea, Eastern Thrace, the Gulf of
Iskenderun, and in the regions near the borders of Syria and Iraq.
Due to its location, Turkey is vital in energy transportation between
major oil-producing areas, in the Middle East and the Caspian Sea, and
consumer markets in Europe. In 2009, the pipeline network in Turkey
covered over 3,636 kilometers for crude oil and 10,630 kilometers for
One of the pipelines, the Baku-Tbilisi-Ceyhan, is the second largest
oil pipeline in the world. It’s responsible for delivering crude oil
from the Caspian Sea to the port of Ceyhan on Turkey's coast. From
Ceyhan, the crude oil is distributed to oil tankers, which will further
transport it to the world's markets.
Another pipeline, Nabucco, is in the planning stages. It is expected to
provide European markets with natural gas from the Caspian Sea basin.
Outlook: Compared with some of its neighbors, Syria's
oil and gas production is fairly unassuming. On the other hand, Syria
is the only significant producing country in the Eastern Mediterranean
region. Oil production had declined, then flattened out for several
years before new fields were discovered. They’re expected to bump up
Syria's known oil reserves are located mainly near the Iraq border and
along the Euphrates River, while some smaller fields are located in the
central part of the country. Upstream production is controlled by the
state-owned Syrian Petroleum Company (SPC). The main foreign consortium
which is currently producing is Al-Furate Petroleum, a joint venture
made up of SOC (50%), Shell Oil (32%), and a collection of other
Contracts have been awarded to Shell, in 2008, and TOTAL, earlier this
year, for exploration at greater depths in existing oil fields in the
Euphrates and central areas. Offshore exploration came up dry in 2007,
but recently there’s been renewed interest. The SPC has commenced plans
to issue tenders for the offshore blocks in the future.
Syria is also strategically important as a transit hub and will provide
a larger role with the ongoing plans for pipeline network expansions
in the area.
As for gas, new fields are expected to ensure that Syria's domestic
demands are met after several years of decline in production. About 35%
of natural gas production is reinjected into oilfields for enhanced oil
recovery techniques, with the remainder going mostly to generate
electricity and for domestic use. By the end of 2010, Syria expects to
double its natural gas production.
Outlook: Like Egypt, Yemen is a strategic hub for oil
shipping. More than 3.7 million barrels of oil pass daily through
shipping lanes off its coast. The alternative is a very costly trip
around the southern tip of Africa, so governments and oil companies are
anxious to avoid any disruptions.
Hydrocarbons currently account for approximately 25% of Yemen's GDP and
over 70% of government revenues. Accordingly, the government is
actively seeking to increase foreign capital in this sector.
Barring significant change, however, its harsh fiscal regime is
strangling exploration. Yemen is currently a net producer of oil, but it
won’t be for much longer at this rate. Production is currently limited
to two major sedimentary basins, but another 10 basins are believed to
hold oil reserves.
A number of companies are interested in the area of Yemen’s border with
Saudi Arabia, though activity has been very limited due to a
combination of limited infrastructure and continued security concerns.
An initial licensing round in 2007 for offshore exploration also
stirred interest, but the rise of Somali pirate activity in the Gulf of
Aden has more or less put the kibosh on that. A fourth round of
bidding was postponed in August 2009 because of the pirates and the
exorbitant insurance rates that companies would need to pay to operate
in the region.
Up until 2009, all natural gas produced was reinjected to provide
enhanced oil recovery. Natural gas export only became viable when a
milestone agreement was signed in 2005 with Korea Gas Corp. Yemen also
signed an agreement Swiss GDF Suez Company and TOTAL. All three
contracts run for 20 years.
Yemen's first liquefied natural gas (LNG) plant, located on the port of
Balhaf on the Gulf of Aden, went online in October 2009. Yemen has the
ability to export over 200 million cubic feet of LNG per year, and much
of the future investment into Yemen is expected to be used in the
natural gas infrastructure.
What It All Means
So the question is, what do we have and, more importantly, how can we make money?
When investing in the Middle East, there’s evaluating infrastructure,
fiscal policies, and, perhaps most important of all, Middle East
Much of the Middle East is well developed, particularly around urban
centers. But many places where a company would be looking for
unconventional oil are a ways off the beaten track, and that means
additional infrastructure. A prominent example is Kurdistan, where
billions of dollars’ worth of infrastructure upgrades are needed to
turn the region into prolific oil-producing center. A junior company
alone could not possibly have the connections to build such
infrastructure. Countries such as Yemen and Oman have similar stumbling
blocks to investment and development. The Catch-22 is that these
places are precisely where the remaining “elephant deposits” could be
Behind the scenes in the Middle East is always politics, much of it
nuanced and layered by generations of history and family ties.
It takes a management team that has been in the arena before and knows
the intricacies of the particular area of interest. A good security
detail may be a must in some places as well.
Lastly, the fiscal systems in the Middle East are relatively tough
compared with the rest of the world, and in some countries, such as
Saudi Arabia, there are very few, if any, opportunities for foreign
companies to even come in and share the wealth.
Countries with the highest petroleum shortfalls tend to have the lowest
government take. But that’s relative. Any company that operates in the
area needs to remember the Middle East holds the dubious record of the
highest number of “two-stars” (80-90% government take) and “one-stars”
(90%+ government take) in the world, leaving contractors with very
little with which to recuperate their costs and justify their
investments. Southern Iraq and Kuwait can even reach 95%+.
Who’s Got It
Nevertheless, opportunities are definitely available for those looking
for them. Some are conventional, but the big upside that we see in the
Middle East is in its unconventional potential. Reconnaissance and
seismic data for the region are readily available due to decades of
exploration in the area, saving companies millions, if not billions of
dollars that would have been needed to do the same work. There are also
a good number of pipelines here that, where geography and geology
meet, can convey a premium to any unconventional oil production. As
several countries begin to look for the oil shale opportunities, the
unconventional story has the potential to be the biggest boom in the
energy market in decades.