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Softening oil prices will force adjustments in the Middle East

With a lower oil-price outlook, project economics will need careful consideration. Securing project finance may also become more difficult. And government spending will, no doubt, need to be curbed. James Gavin reports from Bahrain

As oil prices soften, the world’s biggest producers may need to tighten their belts – and investors to adjust their outlook. Across the Middle East and North Africa (Mena) governments now face oil prices trading below government budgeted break-even points for 2012. Even Saudi Arabia, the world’s leading exporter and the chief sponsor of the retreat in oil markets, now depends on crude fetching about $80 a barrel to keep its budget in the black. Abu Dhabi’s break-even price is greater still: at $107/b, according to United Arab Emirates’ bank Emirates NBD, it is the highest in the Gulf.

It is a growing worry. Roberto Sieber, chief economist at Hess Energy Trading, reckons Middle Eastern producers may have to reconcile themselves to a $85-95/barrel price zone, well below the previous year’s comfort level.

Production costs may be cheap. But politics aren’t. Growing dependence on high oil prices has followed Gulf governments’ unleashing of additional spending in the past year to account for social pressures associated with the Arab Spring. Capital projects and infrastructure soak up some of the cash. But handouts targeted at unemployed and low-income citizens are a new drain.

Such spending increases were comfortably absorbed by the high prices of 2011. Largesse was supported by an Opec basket price averaging $107.5/b last year, a rise of more than $30/b on the 2010 average price. The fall in prices since then has not, however, brought a shift in government spending plans. Saudi Arabia’s National Commercial Bank warned recently in a note that break-even margins are shrinking significantly.

Critically, lower prices will also affect Mena producers’ capacity to invest in oil and gas expansion programmes. This is important for consumers beyond the region, too, argues Ali Aissaoui, chief economist of Arab Petroleum Investments Corporation (Apicorp), because the International Energy Agency (IEA) says the region will be responsible for some 90% of the additional oil supplied to the market between now and 2035.

“All the different parts of the oil and gas chain depend on oil and gas prices. Debt financing, including capital markets, is based on a $90-100/b floor price,” said Aissaoui.

The region now faces much tighter credit markets and higher borrowing costs, too, with capital inflows collapsing as European banks curb their exposures to countries outside of the EU.

Equity, the dominant form of financing in the upstream sector, is generally financed internally through retained earnings and state budget allocations. Yet Aissaoui said that equity would only be secured if oil prices remained above $100/b, which is also the average break-even for Opec’s members..

For now, some deals are still going through, even in Arab Spring countries. In Egypt, the sponsors of a major greenfield refinery at Mostorod, northeast of Cairo, are close to securing a $2.35bn debt package (out of $3.6bn in capital expenditure). The refinery, which has received $400m backing from Qatar Petroleum (QP), will produce over 4m tonnes a year of light petroleum products.

Meanwhile in Bahrain, the scene of protracted demonstrations against the royal family over the past year, Bahrain Petroleum Company (Bapco) is planning the rehabilitation and expansion at its refinery complex at Sitra in the kingdom, to add 100,000 b/d of refined products. Bapco has set aside a budget of $6.5bn for the expansion programme, and has just started work to secure financing. Apicorp has been in talks with officials about providing a slug of oil and gas-related debt and equity financings in Bahrain. The multilateral lender’s chief executive, Ahmad Bin Hamad al-Nuaimi, told Petroleum Economist that the need for quality investments in oil and gas projects was continuing, even in those states most afflicted by political trouble.

With the region’s infrastructure financing landscape being reshaped following the European debt crises, al-Nuaimi says Apicorp will play an even more significant role this year in supporting Mena’s energy sector. “We work through different scenarios and we go through the worst case to mitigate against risk,” he explains.

A period of weaker oil prices would clearly inhibit the general spending of the major players in the Middle East’s hydrocarbons sector this year. But some of the recent energy financings emerging in the region at least suggest a sustained appetite from well-resourced entities like Apicorp and QP for investing for the future.

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