Analysis: When Royal Dutch Shell was awarded a concession to explore for natural gas in the Rub al-Khali desert of Saudi Arabia last week, it added one more twist to the ongoing soap opera involving the kingdom's $20 billion Natural Gas Initiative (NGI).
The NGI has been an on-again, off-again, on-again, off-again affair that appears about to be on again.
All in just the last 60 days.
The Shell deal represents the first significant re-opening of the kingdom's upstream hydrocarbon sector to foreign investment since the kingdom nationalized the oil industry in the 1970s.
For five years, Saudi Arabia had conducted a beauty contest to attract foreign investment in its domestic economic growth and jobs package. The process appeared to collapse last month when Saudi oil minister Ali al-Naimi formally announced that negotiations with foreign oil companies had been terminated.
Indeed, on July 13, the kingdom pronounced the whole project dead. Then--just four days later--Shell was awarded its bid. And now the kingdom has issued invitations to 50 oil companies, including the eight who had been involved in the various consortia in the original initiative.
Those companies are expected to meet with Saudi officials this week in London to take a look at the new proposal, which involves exploration for natural gas only.
Don't feel bad if you're confused. Apparently so is everyone else, including the parties involved, the trade media, and, judging by actions over the last 60 days, the kingdom of Saudi Arabia as well.
The story is long and convoluted. It sheds light on the current gestalt of the Saudi government, which must modernize in a changing world that involves the eventual return of Iraq to the oil production sector. Iraq is the only country that has anywhere near the oil reserves Saudi Arabia possesses and could eventually threaten the Saudi leadership role in global oil markets.
When the Natural Gas Initiative was launched five years ago, Iraq was not a concern. Instead, the Saudis were facing the realities of brutal demographics. The kingdom has one of the highest global birth rates. The number of people under the age of 25 has doubled in the last two decades. And each year, more and more young people enter a labor force that finds jobs few and far between.
According to the U.S. Department of Energy, Saudi unemployment ranges from 15 to 20 percent. The demographic challenges could destabilize the nation, particularly when coupled with the government's economic challenges.
And while the kingdom has discussed economic reform and privatization, movement has been glacial at best. No state assets have been sold or transferred to private control, though some private firms have been allowed to provide services. These steps are necessary if the Saudis are to gain admittance to the World Trade Organization, a major national goal.
In 1999, the kingdom created the Supreme Economic Council to boost investment and create jobs for Saudi nationals. The Natural Gas Initiative was one of the outcomes. It would expand primary resources like electrical power and potable water and provide natural gas as feedstock to expand petrochemical, metal smelting, and other domestic industries.
It was a grand plan, reminiscent of the 1970s when the Saudis launched a five-year program to build the Master Gas System after nationalizing the oil and gas industry. The project gathered associated gas from coast to coast, channeled it through treatment plants, and eventually directed it to power generation plants and water desalinization centers. Gas was also used to power new petrochemical complexes at Yanbu and Jubail on opposite coasts. This was responsible for the rise of the petrochemical industry, a development that enabled the Saudis to diversify their economy, creating a value-added domestic industrial base instead of serving as just an oil reservoir spigot.
The Natural Gas Initiative sought to double the capacity of the Master Gas System. The Saudis anticipate an investment up to $300 billion in petrochemicals, power plants, and water projects over the next two decades, including $50 billion in natural gas development.
While oil comprises 90 percent of Saudi export earnings, the goal for natural gas has been to create private sector growth domestically. Saudi Arabia ranks fourth in natural gas reserves behind Russia, Iran, and Qatar. Saudi reserves are estimated at 225 Tcf, about a fourth the size of Iran, and one-eighth the size of Russian reserves.
The kingdom has 78 Tcf in nonassociated gas reserves, or about one-third of the country's total. The nonassociated gas was the main target for the Natural Gas Initiative. As envisioned, the NGI would use foreign investors as integrated project partners, enabling the government to allocate tight capital resources to other programs.
Saudi Arabia lacks the large managerial resource base necessary to oversee large integrated projects involving upstream development, transmission infrastructure, and diverse plants and industries. That's why the kingdom pursued the packaged option with foreign oil firms.
The multinationals, for their part, desired involvement in Saudi Arabia's upstream sector, something which the Saudis neither need nor desire. At the same time, foreign oil companies have been less interested in managing downstream infrastructure, utilities, or industries that use gas to generate employment growth.
The Saudis and the multinationals had separate interests, which created barriers to any deals on the Natural Gas Initiative. What kept the large oil companies interested was an opportunity to gain risk-free return on capital. The companies reportedly sought internal rates of return in the 18 to 20 percent range while the Saudis offered rates in the range of 10 to 12 percent.
The Natural Gas Initiative seemed to be coming together in 2001 when the Saudis selected eight major multinational oil companies to develop three core ventures. ExxonMobil, Shell, BP, and Phillips were to develop a $20 billion program in South Ghawar as Core Venture 1. ExxonMobil, Marathon, and Occidental were to develop an area around the Red Sea as the $5 billion Core Venture 2. Finally, Shell, Total, and ConocoPhillips were to develop an area in the vast Shaybah desert in southeastern Saudi Arabia as Core Venture 3, a $5 billion initiative.
Core Venture 2 was eventually scrapped as uneconomic.
The kingdom and foreign oil companies subsequently failed to meet several deadlines. When the kingdom came up with its final framework last September, agreements had been reached with foreign firms on the power generation, water, and petrochemical portions of the two surviving projects.
But the major oil companies, possibly concerned with the nation's stability after September 11, 2001, balked. The barrier concerned the quality of upstream assets. The licenses were good for nonassociated gas only, while existing gas reserves were excluded. Finally there was disagreement over seismic interpretation in the proffered blocks.
As recently as May it still looked like a go. Saudi oil minister Ali al-Naimi was given full authority to bring the multibillion-dollar negotiations to a swift conclusion following his reappointment as national oil minister. The kingdom conducted senior level meetings with ExxonMobil and Shell early in the month and expected to have the deals finalized by June.
Then the kingdom abruptly cancelled the $15 billion Core Venture 1 natural gas project in June after the ExxonMobil coalition rejected the kingdom's final terms. It was billed as a major break between the Saudis and the U.S. oil industry. Soon thereafter, trade media were reporting that the kingdom had ended the Natural Gas Initiative.
On July 13, final word seemed to indicate that negotiations for Core Venture 3 had ended unsuccessfully.
Four days later the Saudis awarded the bid to Shell.
Then the Saudis announced they were planning to re-launch the Natural Gas Initiative with more than 50 firms invited to the London roadshow this week.
What's different this go-round is that the new tenders will involve upstream natural gas development only instead of having the integrated nature of the previous proposals. Foreign companies will still be excluded from production.
Thus, after two steps back, the modified Saudi Natural Gas Initiative appears to be alive once again. In a conservative land where economic reform comes slowly, that can be considered one step forward.
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