Surprisingly, the Middle East, which has 40 per cent of the world's remaining gas reserves, is struggling to find enough gas to meet its own expected demands. In view of below-market pricing and muted incentives for gas sector investment, the evolution of the region's gas industry has lagged behind that of the oil sector, despite significant gas deposits. Concern over security of gas supply has become so serious that some governments in the region are looking beyond natural gas for solutions, including towards more oil-fired and coal-fired power plants in the short term (despite their less-environmentally friendly reputations) and towards nuclear and solar power over the long term.
Burgeoning gas demand in the region has been fuelled by many factors, including gas's superior efficiency for power generation, the staggering pace of industrialisation and economic diversification throughout the Cooperation Council for the Arab States of the Gulf, and Qatar's rise as a global LNG supplier. Such increased domestic gas demand, delayed supply response, limited regional pipeline cooperation, and below-market pricing are all threatening the long-term security of gas supply in the region.
Notwithstanding the myth that the entire Middle East is gas rich, the region is not homogenous. While some countries in the region (eg, Qatar, Iran, Egypt and Saudi Arabia) have significant gas reserves, others (eg, the UAE, Kuwait, Bahrain, Jordan and Syria) are relatively gas poor. Still others (eg, Oman and Yemen) have elected to export gas that could otherwise satisfy their domestic demand for years. Further, gas reserves alone do not result in available gas supply, as evidenced by Iran's inability to become an important gas exporter despite its enormous reserves. Iraq provides another example - the current limitations on successful gas development in Iraq are clear: lack of legal foundation, absence of physical security, and focus on oil infrastructure to achieve immediate cashflow. Lastly, given that much of the region's gas supply is associated gas rather than non-associated gas, reserves are often not available to supply domestic markets or export markets because re-injection is critical to maintain current levels of crude oil production.
Even the UAE (which owns the world's fifth-largest gas field but primarily has sour gas that is more expensive to extract and process) is suffering from a gas supply shortage, which may exceed more than one billion cubic feet per day. The UAE (especially Dubai), a real-estate and industrial powerhouse, has become increasingly dependent on natural gas to fuel new power and desalination plants and to provide feedstock for new industries. In an attempt to meet domestic demand, the UAE has expanded its gas production over the past 20 years and has been forced to turn to sour gas production for future supplies. Besides domestic production, the UAE is also dependent on the 2 billion cubic feet per day of Qatari gas it obtains through the Dolphin pipeline. In addition, in 2008, Dubai executed agreements calling for the import of LNG utilising a floating LNG terminal. Similarly, Kuwait, despite its substantial gas reserves, expects to receive LNG through the use of a floating LNG terminal. And both the UAE and Kuwait (like many other countries in the region) have attempted to secure gas supplies from Iran; however, due to pricing issues and perhaps certain political opposition, these attempts have not been successful.
Due to the current gas situation, the countries in the region that have been developing their gas reserves successfully are now experiencing development issues. In fact, even Qatar (the only Arab country not dealing with security of supply issues and the world's largest exporter of LNG) is so concerned with meeting domestic needs and ensuring that it does not damage reservoirs through over-production that it has placed (and extended) a moratorium on further development of its gas resources from the North Field until at least 2012. Likewise, in 2008, Egypt placed a similar ban on new export projects.
The region's gas shortage is also affecting the aluminium and petrochemical industries, which rely on cheap feedstock derived from gas. Several such large-scale projects, like the planned aluminium smelter of Rio Tinto in Al Ruwais near Abu Dhabi, have been put on hold due to the lack of gas, while other gas-intensive downstream projects have been shelved indefinitely. In Saudi Arabia, for example, dozens of petrochemical projects have been put on hold (or cancelled) in the past two years as a result of insufficient allocation of gas-based feedstock.
The Middle East supply shortage is not entirely due to a lack of resources, but is also a result of various other factors, including a lack of investment. Specifically, gas demand has not been met by sufficient investment in vital gas infrastructure. According to the International Energy Agency, a significant amount of capital (more than is estimated to be spent from 2008 to 2030) must be invested in resource-rich regions such as the Middle East, where unit costs are lowest. However, due to subsidised prices, gas supplied to the Middle East is extremely inexpensive and is sometimes up to 10 times cheaper than in other regions. As a result of such artificially low regional pricing, companies are less willing to invest in exploration and production for non-LNG supplies and producers have little incentive to sell their gas on the domestic market when they can secure much higher prices elsewhere. Qatar, for instance, has in the past five years given priority to supplying Europe, the United States and Asia, rather than countries in the Middle East. Such low regional prices are not sustainable in a period of high demand and low supply. In order to avoid critical shortages, gas prices must eventually rise towards global levels, which should in turn increase exploration and production activity.
The lack of gas exploration and development has been further compounded by many restrictions imposed by Middle East countries on investment by international oil and gas companies. However, some Middle Eastern countries are now beginning to encourage foreign investment. For example, Saudi Arabia, traditionally off-limits to foreign investment in its exploration activities, invited foreign investors to help explore for non-associated gas in the Empty Quarter, although no commercial discoveries have yet been made. Other countries encouraging foreign investment include Abu Dhabi, which took the first step in signing the sour gas project with ConocoPhillips, and Bahrain, which announced a licensing round for international companies interested in further developing Bahrain's onshore field.
The current economic downturn and lower oil price environment may also affect gas sector investment, although it is not yet clear whether such effect will be negative or positive. The world financial turmoil has resulted in a visible government funding and overall credit squeeze on investments such that many Middle East governments may be reconsidering additional energy infrastructure projects. Given sharply growing inherent gas demand, decisions not to invest in gas development in the Middle East due to economic uncertainty are likely eventually to result in an even greater gas deficit and hinder economic progress. Nonetheless, some argue that a slowdown in global energy investment could create an opportunity for the Middle East to take advantage of lower overall development and construction costs (compared to 2005 to 2007 levels), thereby allowing the region to make key infrastructure moves to at least partially relieve its no longer hidden tight gas supply situation. Whether this opportunity is recognised or taken advantage of, or both, remains to be seen.
With much of the Middle East short on gas, countries in the region are pursuing short-term solutions to solve these issues. As a short-term solution, for example, some countries in the region, including Kuwait and Saudi Arabia, are consuming more oil for electricity generation. In fact, Saudi Arabia, home of the fourth largest gas reserves in the world, placed a moratorium on new gas-fired power plants and announced that any future demand will be met by oil-fired power plants instead. Additionally, many Middle Eastern countries are exploring more coal-fired power projects to meet power needs in the short term. Both the UAE and Oman are conducting studies for billion-dollar coal-fired power plants in the hope of addressing predicted severe electricity shortages due to gas supply issues.
The growing energy demands of the region have also raised the prospect of nuclear or solar energy projects, or both, as long-term solutions. The UAE recently initiated preliminary negotiations with potential suppliers of nuclear technology and fuel, and the Abu Dhabi Future Energy Company, Masdar, is carrying out a design study for a major solar power plant. However, while progress is being made by countries like the UAE towards energy self-reliance, a perceptible shift in the region's fuel mix will take years to materialise and will not help address immediate shortfalls. Therefore, nuclear or solar energy, or both, are not viable replacements for gas in the foreseeable future, and increasing supplies of gas are, in reality, key to a secure energy future in the short or medium term.
To assist clients in successfully navigating the region's gas and power supply environment, Middle Eastern lawyers must have a solid understanding of the associated complexities and an expertise in a very broad range of relevant agreements across the gas chain (such as exploration contracts, joint-operating agreements, gas pipeline and LNG sales, gas processing agreements, LNG vessel contracts, and fuel supply agreements). Contemporaneously, in order to avoid additional surprise, lawyers working on energy projects outside the region would be wise to follow closely whether and how Middle Eastern gas-development requirements are actually addressed in the coming years.