BG Pricing Agreement Could Unlock Difficult Gas in Oman

Breakthrough

In a report this week by industry newsletter Middle East Economic Survey (MEES), Oman is said to have reached an understanding—in principle, at least—with BG over the price for gas produced at its potential Block 60 gas project. The talks are reported to have targeted several issues with the original 2006 contract, which were deemed as standing in the way for commercial development of the tight gas reserves, with particularly the price paid by the Omani government for the gas having been raised. An agreement is also understood by MEES to have been reached over the use of existing Omani gas processing facilities at the BG project's early stages, in order to speed up an eventual development decision and keep project costs down.

The Omani gas purchase price from BG was previously set at US$1/mmBtu, a level that would probably have made it very hard, if not impossible, to monetise the tight gas reserves at Block 60, which contain a part of Oman's very large tight gas reserves and could change the country's domestic and external energy balance significantly. The BG contract was reached in 2006, at a time when Oman had tasted the effects of increasing gas shortage, but had still not been prodded to ponder such deep changes in its approach to domestic energy. The prolonged and continuing shortage situation has evidently made the sultanate think again.

Shortage-Fuelled Rethink

Gas shortages in Oman have proven endemic, not only keeping its LNG exports lower than the ideal (and at times forcing it to renegotiate cargoes away from its domestic peak demand period to its lower demand periods, at a certain cost), but also hurting its economy and stymieing its industrialisation drive, due to a lack of feedstock and electricity. In fact, the period most upsetting for Oman in this regard—and the one likely to see a major change in mentality on the issue of domestic energy prices—was around the peak of oil prices in 2006–08, when significant funds were ready to be ploughed into domestic industrial projects and commercial developments to diversify the economy and create jobs for a relatively young population, but the domestic energy scarcity proved to be a formidable obstacle.

Indeed, over the past few years, Oman has not only taken several steps in preparation for more expensive gas production in the future, but has also started studying the use of other fuels in its power generation. Taking a realistic view on its financial, organisational, and technical constraints—but remaining optimistic on its long-term gas potential—it has refrained from jumping on the nuclear power bandwagon so in vogue throughout the Gulf region, rather veering towards the use of coal in some future power projects, perhaps through the exploitation of possible domestic deposits.

BP and BG

The timing of the Omani rethink is evident by the fact that BP—the other company undertaking vast tight gas exploration and appraisal in the sultanate—has felt much less of a need to renegotiate prices with the government, having signed its own contract in early 2007. While it may well be that BP will press for yet higher prices as it moves closer to a commercialisation decision and has a firmer grasp of the project's costs sometime in the future, it shows the relatively rapid progression of change in Oman's readiness to contemplate more expensive gas during 2006 and into 2007.

BP earlier this year moved its own target for its Block 61 tight gas reservoir commerciality evaluation forward from early 2013 to 2012, also drastically upgrading the block's vast reserves from initially thought in-place reserves of 20–30 tcf up to 30–40 tcf—and in recent communication putting them even higher to a possible 30-60 tcf (see Oman: 24 July 2009: BP Expects 2012 Completion Date for Evaluation of Oman's Tight Gas Reserves). "There is a big range because there is still a lot of uncertainty", BP Oman's general manager Jonathan Evans told MEES. Nevertheless, the prospect of production ultimately reaching 1–2 bcf/d just from BP's project—Oman's current total gas output is about 2.9 bcf/d— clearly remains game-changing for the sultanate.

Costs will naturally be high for the project, where BP still has to overcome significant technical challenges to make its hydraulic fracturing (fracking) of the reservoirs commercial on a large scale. Up to 300 wells might have to be drilled at full development, making the project highly expensive. Flow rates of between 6 mmcf/d and 40 mmcf/d achieved at the four exploration and appraisal wells so far have proven grossly disappointing in the first instance and highly positive in the second, indicating nonetheless that the jury is out on the project as a whole.

For BG the exploration and appraisal progress seems to have yielded similar results on the whole, although it is closer to a final decision with some significant optimism, as otherwise price negotiations would have seemed superfluous. "Some wells were awful, some were good, so they are testing, and have gone back to the ministry, but they would need a material hike in the gas price to go into full development", a local source told MEES with regard to the BG programme. BG has completed seven wells on Block 60 and is officially targeting development, with commissioning reported to be aimed for the latter part of 2012.

Outlook and Implications

Price Leader

As IHS Global Insight has written before (see link above), Oman's government has demonstrated the clearest understanding about the need to accept higher gas purchase prices out of its regional peers. Traditionally—alongside Bahrain—the least wealthy petro-economy in the Gulf Cooperation Council (GCC; Kuwait, Bahrain, Qatar, Saudi Arabia, Oman, and the United Arab Emirates), it perhaps has to make less adjustments to its preconceptions, never really having seen itself as having the same comfortable energy and financial position as its neighbours. With such vast tight gas reserves it is also naturally attracted to the idea of making them commercial, as its easy oil and gas has always looked much more finite than in neighbouring states such as Abu Dhabi, Saudi Arabia, Kuwait, and Qatar.

Still, there is scope for the realisation to spread through the Gulf, with Abu Dhabi by now preparing to test the ground through its acceptance of the Shah sour gas project developed by ConocoPhillips, where production costs in the vicinity of US$5/mmBtu do not look impossible. Kuwait and Dubai have, due to domestic scarcities, had to turn to LNG imports, at least during peak demand seasons. Even Saudi Arabia, where the attachment to the notion that cheap oil and gas will last generations still seems to have been the strongest, recently said that exploration of deep gas reservoirs in its offshore Gulf acreage—by necessity expensive to develop—would be a future priority after the disappointments in the Rub' al-Khali (Empty Quarter) desert (see Saudi Arabia: 9 November 2009: Saudi Aramco Advances with Gas Projects, Sees Greater Oil Use in Petrochemical Plants).