Will shale shake the Middle East?

The debate over shale’s impact on the GCC continues. Will this be the end of low-hanging fruits and high margins?
By Lionel Mok
Tue 14 Jan 2014 03:55 PM

Innumerable articles have been published around the world on the US shale boom. In addition, its immediate consequences for GCC countries such as reductions in LNG exports from the GCC to the US have frequently been discussed in the Middle East. Yet there is always a need to consider the less obvious interdependencies between the US shale boom, the GCC’s oil and gas businesses, and the implications on chemical sites in the GCC including an assessment of possible risk factors.

Does the US shale boom threaten the business of chemical players in the GCC?

Attendants at recent oil and gas conferences in the GCC countries were generally well aware of developments in the US, but diverse opinions on this rather new phenomenon from the US were voiced. Some experts tended to be rather relaxed, seeing their business affected but not seriously threatened. Others were more alert to the topic and mentioned various risk factors that could have considerable negative effects on GCC countries’ oil, gas and chemical businesses. But Stratley AG, a specialised consultancy focused on the refiing, petrochemicals and chemicals industriesm, believes that there is no need to panic. Taking interdependencies between the US shale boom and other risk factors into account does, however, reveal possible consequences such as growth obstacles and margin squeezes in GCC countries.

Risk factor: LNG exports

Ethane is commonly a by-product in many gas fields and is consequently extracted at a higher rate if methane production is high. As an example, the ethane feedstock used in the Ras Laffan cracker (Qatar) with a capacity of 1.3 million tons of ethylene per year is extracted from the North Field, one of the world’s largest conventional gas fields. Only five fields. Only five to ten years ago, Qatar had planned to export large amounts of LNG to the US and to eastern Asia, and constructed LNG export terminals as well as large vessels to do so.

Then the US shale gas boom started, and the forecasted US methane self-sufficiency by 2020 forced Qatar to change export plans. Qatar’s new plan is to increase export volumes to Asia accordingly, mainly to China and Japan, where demand increases are considered high enough to absorb the additional LNG supplies.

While China’s and Japan’s demand extrapolations based on 2013 economic figures might sustain this plan, risk factors remain.

China featured impressive economic growth – until recently, when first signs of a fading dynamic hit the headlines. This effect might be temporary and does not allow conclusions for future development, because China is large, complex and features a unique political and economic system that is difficult to predict.

One risk factor is that mid- to long-term economic development may turn out to be below expectations. Another risk factor is that political decisions limit LNG imports from Qatar – for instance, by import supplier diversification (gas from Far Eastern Russia, LNG from Australia or US), by domestic shale gas production and by driving or even subsidising other forms of energy production.

Post-Fukushima Japan has presumably left an energy gap that Qatar might fill by supplying additional LNG. One of the main risk factors concerning Japan is that Japan might operate its nuclear power plants longer than planned.

Furthermore, Japan is actively evaluating methane hydrate extraction off its shores. As yet, commercial production is a distant prospect, but it could become one option of hydrocarbon supply in the future.

Risk factor: oil production

Large amounts of gas, especially in Saudi Arabia, are produced as associated gas in oil production.

As by-products, ethane and other gases are produced in volumes tightly correlated to the oil volumes produced. This also means that constraints in oil production limit the ethane gas supply.

The shale/tight oil boom in the US has reduced, and will further reduce, the demand for light oil imports. Upstream companies in the GCC are well aware of this and argue that, firstly, they can still supply heavy crude to the US (shale/tight oil is mainly light oil) and that, secondly, East Asian demand will grow fast enough to more than compensate the US demand reduction.

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The degree of the first argument is uncertain, because Canada has abundant heavy crude resources and can, under favourable oil price conditions, at least partly supply the US with cost-competitive heavy crude. Similar to the LNG scenario described above, the second point appears reasonable, but bears risks.

For the oil, however, the risks are currently more on the supply than on the demand side.

In addition to the revolutionary shale/tight oil production increase in the US, Iraq has increased its oil production from 110 MMtons/year (2.2 MMBbl/day) in 2009 to around 170 MMtons/year (3.3 MMBbl/day) in 2013.

The 2013 Iraqi production value is >4% of total global oil production. Forecasts for 2015 range from 200 MMtons/year to 300 MMtons/year.

Furthermore, potential political changes in the wake of the recent elections in Iran might lead to mid- and long-term sanction deregulations and enable Iran to push much larger oil volumes into global markets. Such large additional volumes, which are not balanced with demand dynamics and OPEC guidelines, either drive global oil prices down or require OPEC countries including Saudi Arabia to further limit their production.

Implications for chemical companies

GCC countries, and most notably Qatar and Saudi Arabia, are differently affected by the gas and oil risk factors described above. These risks have the capability of accelerating the regional ethane shortage, which might lead to or worsen underutilisation of production assets. Underutilisation has already been observed, for example, in 2010 at around 80% for ethane crackers in Saudi Arabia. It is not surprising that there is a tendency in the region to base new crackers on naphtha.

In the light of cheap ethane in the US as well as more naphtha-based ethylene in GCC countries, the cost advantage of these countries’ derivatives will shrink significantly compared to the US. US shale developments have triggered new technology developments (e.g. on-purpose dehydrogenation of propane) as well as investments in additives and co-monomers capacities, which further strengthen the US ethylene downstream position compared to GCC countries.

As of today, GCC downstream players hardly felt any serious effects from the shale boom, while Europe has started to bear the heavy burden and will continue to do so; a closure of approximately 10% of total European ethylene capacity is forecasted by industry experts.

In the longer term, GCC countries will most likely keep their position as the lowest cost producer – despite a new shale-age market equilibrium, albeit with much less margin differential to the US.

One must not forget that in the foreseeable future, GCC downstream players will still have favourable raw material conditions and will most likely be able to manoeuvre their businesses reasonably around shale gas-induced market changes in the US and elsewhere.

However, the times of abundant low-hanging fruits and extraordinarily high margins in GCC countries is set to end.

Source:Index Mundi, Qatargas, Reuters, Saudi Gazette, Shale gas conferences in China, Europe, GCC countries, USA.

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