Global Energy Advisory - 5th December 2014

Politics, Geopolitics & Conflict

Any and every oil and gas investor operating in Europe and Eurasia should be concerned about the very dangerous and very misguided Cold War geopolitics currently being bred. The US/NATO strategy against Russia threatens to destroy Europe entirely, and the next US president will likely take this to the point of no return, after the stage has been set by the current. The only way out of this predicament is to redraw borders in Eastern Europe-arbitrary borders that were put in place by the Soviets and, as we have seen in Ukraine, are not tenable. NATO's misguided mission to start a Cold War threatens World War III, and NATO will not be on the winning side, eager as the organization is to regain some glory. This is the Number One medium-term threat to oil and gas investments in the region, and we recommend that investors start some serious strategic planning-now.

Ukraine should be considered no-go territory for investors. They are about to nominate a new Energy Minister, and this will be someone fully controlled by the oligarchs (sorry, business elite) with no mind for bringing in foreign investment and increasing Ukraine's energy independence. Independent energy players in Ukraine will withdraw. They have had enough and the appointment of a new Energy Minister will only justify this sentiment further. The IMF is largely going to control the shots in most areas, but not in energy-even if they think they will be getting a minister they can control. The Ukrainian president has been saying all the right things, but he is smart rather than genuine.

Amid the crisis in Ukraine, panic and division across Europe and sanctions against Russia, Russian state-run gas giant Gazprom has said it will scrap the $50 billion South Stream gas pipeline that would transport gas through the Black Sea to Europe, which has some Eastern European countries wondering where their future gas is going to come from and how much it's going to cost. South Stream is being replaced-at least according to a public announcement--by a smaller, more manageable pipeline project running to Turkey. There is a great amount of speculation as to why the project is being scrapped, with Western media keen to call it a victory of sanctions that rendered the massive project too expensive to cope with. Others suggest it might not be scrapped at all, but the threat of its cancellation could pressure countries like Bulgaria, Serbia and Hungary to more vociferously support Russia to this end. Indeed, Italian oil and gas services company Saipem-one of the biggest immediate losers in this game ($1.55-$2 billion in lost revenues)-says it has not received any official notice of termination of the project. If it's a bluff, it will probably work. The European Commission is pretending the project hasn't been scrapped and says planned 9 December talks on South Stream will take place as usual. To our mind, Turkey-which manages to straddle the middle in every major conflict from Europe to the Middle East-will gain the most from the varied fallout emanating from the European gas crisis and the conflict in Ukraine. The new pipeline envisioned with Turkey would be able to handle 63 billion cubic meters per year, and earlier this week Gazprom CEO Alexei Miller and Turkey's state-run BOTAS CEO Mehmet Konuk signed an MOU outlining the deal and giving Turkey a large discount on gas. While South Stream may now be out of the picture, the new pipeline clearly is meant to directly compete with the planned EU-backed Trans-Adriatic Pipeline (TANAP).

This week in Vienna, Iran's Oil Minister Bijan Zanganeh said that despite the sanctions, the country was still planning to increase exports in the short and medium term and to continue to build on gains it made in 2014 of 200,000 barrels per day, year-on-year. To do this Iran is exploiting a loophole and exporting condensates that are not affected by US sanctions. If a deal with Iran is reached before the next American presidential elections, we expect this market to open up. If not, the game is up and it will be back to the status quo with Iran.

Discovery & Development

Kenya-Forwards And Backwards

We are encouraged by recent forward movements on major infrastructure projects in Kenya and wider East Africa.

Earlier this week, the World Bank said it would provide $1.2 billion for infrastructure development and improving competitiveness among the East African Community (EAC). This money will contribute to planned EAC investments over the next 3-7 years and complements individual country lending by the World Bank. Specifically, the World Bank will invest in transport links that will connect up landlocked countries such as Burundi, Rwanda, Uganda and South Sudan and improve their access to the Indian Ocean ports of Mombasa (in Kenya) and Dar-es-Salaam (in Tanzania).

Making Kenya-and East Africa in general-a more attractive investment in the ongoing market integration of the EAC countries mentioned above.

In Kenya, Japanese firm Toyota Tsusho has won the contract for the feasibility study and preliminary design of the much-awaited oil export pipeline from Uganda to Kenya. This is a key infrastructure project that must be in place when commercial production launches.

At the same time, there are growing security concerns in Kenya. Two major attacks in 10 days led this week to the sacking of two top Kenyan security officials. On Tuesday, an attack in northeastern Kenya left 36 people dead. Ten days prior to that, 28 people were killed when militants hijacked a bus in the same region. The Tuesday attack saw militants execute quarry workers in Mandera County near the border with Somalia as they slept in their tents. Somalia's al-Shabaab claimed responsibility for the attack, and are thought to have perpetrated the earlier attack as well. Witnesses claimed that the militants separated non-Muslims from both groups and executed them. The failure to provide security has led to protests in the capital, Nairobi.

Other Developments

• Exxon Mobil Corp. (XOM) and Russian Rosneft (ROSN) have terminated contracts for five Norwegian-operated service vessels due to sanctions that get in the way of exploring the Russian Arctic.

• Chevron Corp this week launched production of oil and gas at a massive, deepwater field in the Gulf of Mexico at the Jack and St. Malo fields. The two fields-25 miles apart--will feed a single semi-submersible floating production platform. The wells are in 7,000 feet of water in an area beneath the Gulf known as the Walker Ridge, approximately 280 miles south of New Orleans. Daily production is expected to reach 94,000 bpd of crude and 21 million cubic feet of natural gas per day.

Discoveries

• French Total SA says it has struck oil near the Iraqi Kurdish capital, Erbil, in its second discovery in the Harir block in as many years. The Jisik-1 well was tested with flow rates of 6,100 barrels per day. Total has a 35% interest in the Harir Block, while Marathon Oil has a 45% interest and the Kurdistan Regional Government (KRG) holds 20%--as it does with all deals. Total also has a 20% interest in the Taza Block, and an 80% operated interest in the Safen and Baranan Blocks in the Kurdistan Region of Iraq.

• Brazil's state-run Petrobras has seen its shares jump 3.61% to $9.32 on the announcement this week of a discovery of natural gas in an exploratory well off the Colombian coast. This is the first deep-water discovery in Colombia's Caribbean waters. Petrobras is the operator of the area, the Bloco Tayrona, with a 40% stake, while Colombia's state-run Ecopetrol SA and Spain's Repsol each hold 30%. Gas volumes have still not been announced.

Regulations, Compliance And Labor

• Oil workers in Gabon earlier this week began an open-ended, industry-wide strike after talks with the government collapsed. Long lines have formed at gas stations as fears spread that the strikes will lead to massive shortages. The trade union had been in negotiations with authorities for several weeks, demanding the reinstatement of some workers who had been fired by oil companies, among other issues. ONEP, the umbrella union for the oil trade, is also calling for the manager of STSI Boccard, which is subcontracted by French Total, to be expelled from the country, as well as the departure of the director general of Libya Oil Gabon.

• Puerto Rico's House of Representatives has approved a $2.9 billion borrowing plan intended to boost cash flow for the Government Development Bank and help fund public transportation. The bill raises the petroleum tax to $15.50 per barrel, from $9.25, with the additional revenue going to back a sale of as much as $2.9 billion of bonds. The legislation must now be approved by the Senate. The House added amendments to the bill that would delay implementation of the oil-tax increase until lawmakers approve an anticipated tax overhaul next quarter.

• Turkey's natural gas law, which is slated for liberalization and as such is currently being revised, was the point of discussion this week at the 7th International Energy Congress and Fair. Experts called for a more liberal and flexible law to facilitate imports. Right now, the existing law makes it necessary for companies to obtain separate licenses for each type of gas they import, including pipeline gas, LNG and compressed gas. The new natural gas law is yet to be approved in the Turkish assembly. Turkey's gas market is largely controlled evenly by Turkey's state-run pipeline company, BOTAS, and Russia's Gazprom, which is the main supplier.

Deals, Acquisitions & Mergers

• We are edging closer to a new oil and gas bidding round in Egypt before the end of the year, as the country announces it may pay up to $3 billion in debts to foreign producers. The auction will, for the first time, include shale acreage, and contractual terms are being amended to make unconventional production commercially viable.