Sudan-South Sudan: Watch Now as the Oil Flows

I've been skeptical about investing in either of the two Sudans without an oil and border security deal in place. That said, recent developments remove a lot of the political risk, so now might be the time.

Earlier this month, Sudan and South Sudan reached an agreement for the resumption of South Sudanese oil exports through Sudanese infrastructure. There have been oil deals before and they were dead in the water because they didn't come along with border security agreements. This time we've got the full package. The deal calls for a withdrawal of troops from both Sudan and South Sudan and the creation of a demilitarized zone to facilitate the flow of oil. Oil hasn't flowed for about a year after South Sudan blocked exports via Sudan over a tariff dispute.

It's been a bit of a tricky situation. South Sudan seceded from Sudan in July 2011. Along with this South Sudanese independence came 75% of Sudan's oil resources-minus the infrastructure (pipelines and ports) which remains in Sudan. So South Sudan is now rich in oil, but it's land-locked.

The climax came in December 2011, just a few months after South Sudan seceded, when Sudan started diverting South Sudanese oil to its own refineries and selling it illegally on international markets. South Sudan lashed back by shutting off the pumps in January 2012. Neither could maintain this absence of oil revenues for much longer. (About 98% of South Sudan's state revenue comes from the production of about 350,000 barrels of oil per day).

The stickler during negotiations was Khartoum's (Sudan) insistence on guarantees that South Sudan would cease backing rebels fighting in the South Kordofan and Blue Nile states-oil-producing regions that haven't been fully demarcated. Sudan softened its stance to allow for the creation of a buffer zone instead.

In mid-March, South Sudan ordered the resumption of crude oil production. Oil production can be resumed in a couple of weeks, but it won't be hitting international markets for about a month because of technical reasons.

There's still one spoiler, though: The two countries have still not agreed on the status of disputed areas and large areas of the oil-rich border are not yet demarcated. For now, though, the oil WILL flow, and were talking billions in revenues for South Sudan and up to $1.5 billion annually in transit and other fees for Sudan.

Sudan and South Sudan have anywhere from 4.2 to 6.7 billion barrels of proved oil reserves. The majority of reserves are located in the oil-rich Muglad and Melut Basins. Natural gas associated with oil production is mostly flared or re-injected. Despite known reserves of 3 trillion cubic feet (Tcf), gas development has taken the backseat to oil development and gas exploration has been limited.

Asia dominates here: the China National Petroleum Corporation (CNPC), India's Oil and Natural Gas Corporation (ONGC) and Malaysia's state-owned Petronas. These companies hold the largest stakes in the leading consortia operating in both countries: the Greater Nile Petroleum Operating Company (GNPOC), Petrodar, and the White Nile Petroleum Operating Company (WNPOC).

Petronas will be the big winner in this political breakthrough. The company will see production increase by about 120,000 bpd, after seeing a reduction over this past year by almost 85%.

The bulk of oil production comes from South Sudan's Blocks 3, 7 and 5A and Sudan's Block 6, as well as in Blocks 1, 2 and 4 which form the Greater Nile Project and are split between the two countries, including the disputed Abyei region. 

Our Pick-Block 14 (Sudan)

In July 2012, Khartoum auctioned off nine new exploration blocks, with 72 companies participating in the bidding. The licenses went to companies from Canada, China, Nigeria, Australia, Brazil and France, and the blocks are in territory that is not disputed, so the political risk is minimal.

But here's one of the most promising pieces of acreage: Block 14. Canada's Statesman Resources Ltd owns the license for this block through its subsidiary, Statesman Africa Limited. The company has a 75% working interest and operatorship, in partnership with Australia's Sirocco Energy, Express Petroleum and Gas Company Ltd and the Sudan National Petroleum Corporation (Sudapet). Recently, Agri Energy Limited agreed to acquire a 49.9% stake in Statesman Africa Limited. Statesman and partners will dump $12 million into development of this block over a 3-year period.

This is a 100,000 sq km block in Sudan's northwest, along the border with Egypt. In terms of exploration potential, it's believed to hold up to 1.5 billion barrels of prospective resources for which the first exploratory wells will be drilled later this year. If we had to bet on where the next big discovery will be in Africa for this year or early next, this might be it.

The geology is promising. Block 14 holds the Mourdi Basin and the southern part of the Mesaha Basin and suggests the presence of lower Silurian and Devonian Shales (some of the most prolific source rocks in northern Africa). Statesmen Resources thinks the Mesaha Basin is analogous to Northern Egypt's Komombo and Sirte Basins. It also says both the Mourdi Sub-Basin and the Mesaha Basin are extensions from prolific Libya.

Right now, according to Statesman, "Block 14 is still in the early stages of exploration. Previous exploration on Block 14 includes around 1,200 km (13 lines) of 2D seismic plus microbial, geochemical gravity and magnetic surveys. The acquired seismic suggests a good structural environment for the presence of reservoir strata with good potential for traps and seals."

In terms of infrastructure, thanks to massive Chinese investment, getting product refined and to market won't be a problem. In January, China's CNPC extended a $1.5 billion loan to the Sudanese government. Here, China is the heavyweight, holding majority stakes in the key consortiums (especially for Blocks 13 and 15) and pursuing a number of critical infrastructure projects, including the building of the Khartoum Refinery, the Khartoum Petrochemical Plant and pipelines connecting fields to Port Sudan. Historically, most production from South Sudan and Sudan has gone to Asian markets.

Oil Shutdown

Keep an Eye on the Geopolitics Going Forward

The geopolitics is complicated-if not colorful, and I would keep an eye on Khartoum's simultaneous courting of Iran and Saudi Arabia, which never works well. At the same time, the "West" has been heavily courting South Sudan and highly critical of Khartoum's negotiating manner. It's interested in helping South Sudan develop alternative pipelines to the Indian Ocean (via Ethiopia and Kenya).

In late-February, Khartoum's defense minister was in Saudi Arabia at the same time that its oil minister was in Iran. Sudanese President Omar al-Bashir also met with Iranian President Mahmoud Ahmadinejad on the sidelines of an Organization of Islamic Cooperation meeting in Cairo in January. This was followed by al-Bashir's participation in the Arab Economic Development summit in Riyadh in February.

It's either highly pragmatic, or dangerously undiplomatic. Israel will also not look kindly on Sudan's courting of Iran and will view this as a furthering of an alliance that has been viewed as a proxy against Israel (and the reason behind an Israeli air strike on a military factory in Khartoum in October 2012). Saudi Arabia is also concerned about Iran's alleged use of Sudanese territory to transfer weapons to Shi'ite rebels in Yemen. So at the same time that Sudan is hoping to repair relations with Saudi Arabia (lobbying for oil investment), it's more heavily courting Iran.        

Bottom Line: This is the most progress Sudan and South Sudan have made since 2011. Economics will eventually dictate things, especially for South Sudan, so the oil simply has to flow. However, if Sudan makes some big new discoveries in blocks that are indisputably owned by Khartoum, then it will have more negotiating power and less reliance on transit fees earned from South Sudan's oil. This could eventually result in a renewed spat if Khartoum is emboldened by petro dollars.