Global Energy Advisory – 19th June 2015

Politics, Geopolitics & Conflict

Elections in Turkey and Erdogan's 'Defeat'

Turkey's 7 June parliamentary elections are important not only for anyone eyeing oil and gas exploration in Turkey, but for anyone investing in the wider region because Turkey is a key player in the geopolitical dynamics of East and West-dynamics that in part dictate the future movement of oil and gas in a large part of the world.

Recep Erdogan, the leader of the Justice and Development Party (AKP) has enjoyed a great deal of power in Turkey, but this does not go unchallenged. The 7 June parliamentary elections have seen the AKP lose nearly 10% of the votes it had won in 2011 as well as its majority in parliament. Over the past couple of years, Erdogan has sought to increase his power base by turning a formidable ally into a formidable enemy-the Gulenists. He has also sought to increase his power base by resorting to tyrannical tactics that include attacking free speech and dealing harshly with protesters-none of which has scored him many points. Most recently, he decided to run for president, relinquishing the more powerful post of prime minister. The plan was to run for president and then re-write the constitution to render the presidency the more powerful position.

The loss of the majority in parliament makes this an impossible task. Plenty of Turks may want the AKP to continue in power, but would simultaneously like to ensure that the party is not hegemonic and that it does not control absolutely everything. First and foremost this is what the 7 June vote tells us. This was the AKP's first real setback in well over a decade. At the same time, this is not the end of Erdogan. The situation is not as black and white as that.

The real problem now is that the opposition to the AKP is inefficient and disorganized at best and they will likely not be able to take this momentum and run with it to any good end. As such, the 7 June elections may by a Pyrrhic victory for the opposition and, as a result, we could even see the AKP return stronger in the next elections.

Discovery & Development

Mexico's state-owned Pemex has announced a discovery of a massive group of oil fields in the shallow waters of the Gulf of Mexico. We're looking at five new fields here, off the states of Campeche and Tabasco, with total proven, probable and possible (3P) reserves as high as 350 million barrels of crude oil equivalent. Mexican authorities say the new fields could produce as much as 200,000 bpd. Pemex says the fields could begin operating as early as the third quarter of next year. Four of the fields are off the shore of the Tabasco state and could produce 100,000 bpd, while the fifth field, off the Campeche state, could produce that much on its own. Pemex officials also claimed the Tabasco fields could produce 90 million cubic feet of gas per day, while Campeche could produce 80 million cubic feet of gas per day. It is indeed a fortuitous discovery right ahead of Mexico's first open market auction to be held on 15 July. This first auction will open bidding for 14 shallow-water exploration blocks in the same area of the Gulf of Mexico. The details of the 'massive' discoveries right ahead of the July auction should be thoroughly examined by any investors, due to the timing of what is a major marketing event. Keep in mind also that the new discovery off Campeche is near two other deposits owned by Pemex. One is Ku Maloob Zaap, now the company's most productive field, and the Cantarell field, discovered accidentally by a fisherman in 1976.

Regulations & Litigation

• A Harvard University Business School (HBS) study, in conjunction with Boston Consulting Group, urges the US to lift its oil export ban, describing the embargo as a missed economic opportunity. The study refers to the export bans as "outdated restrictions on gas and oil exports," noting that "with abundant resources, restrictions on exports created in response to the 1970s' energy crises are now unwarranted and exports would boost U.S. economic and job growth and benefit friendly nations."

• The Norwegian government has failed to win parliamentary support for its original plan to expand further northward its Arctic drilling boundaries and will now have to re-evaluate the plan. How the government delineates the Arctic ice edge is a major issue of debate due to the contraction of Arctic ice. Norway's two opposition parties--the Christian Democrats and the Liberals-do not support the northward extension of the ice edge and have urged the government to withdraw as many as 15 blocks from the round because they are too close to the polar ice cap, which is a sensitive ecosystem supporting animals from polar bears to fish and birds. This is in reference to a new licensing round initiated in January 2015 for blocks that would see drilling further into the Arctic Circle. Also at stake here are unexplored areas of the eastern Barents Sea, which has been free of ice since 2004. Oil and energy minister Tord Lien said that he did not believe the development would affect the round where the Arctic blocks are included. The government said the framework for the 23rd licensing round, which includes 54 blocks in the Barents Sea, remains unchanged. The ruling coalition maintains that the edge has moved north as the ice cap melts, reducing the risk it could reach into some of the blocks the government was opening.

• Brazil's oil regulator, ANP, is planning to ease future fines for producers who fail to meet strict local-content guidelines as the country seeks to accelerate development of offshore oil and gas resources. There will now be a more flexible methodology used for fines when targets are missed. This means that instead of using the total rate of domestic purchases to calculate fines, penalties will be applied to separate equipment categories. That said, we note an increase in the amount of penalties for non-compliance in this area over the past year. BG Group has been fined $ 92 million, which represents the largest single penalty to date and as much as all penalties combined for last year. Oil majors complain that the local oil and gas supply chain is not ready to deliver what they need, making it impossible to comply. The first new changes to the policy will most likely be in effect for the next oil licensing round in October; however, the changes still need to be formally approved. This next licensing round, the 13th, is expected to bring in at least $313 million in bidding fees for the auction of 266 onshore and offshore areas.

• UK-based Hardy Oil and Gas Plc, which focuses on India, is experiencing additional difficulties with its license for the Cauvery Basin Block (CY-OS/2) off India's east coast. This is an 859 square kilometer block in which Hardy has a production-sharing contract in partnership with GAIL gas utility and state-run explorer ONGC. Hardy holds a 75% participating interest. In 2007, Hardy announced a gas discovery, Ganesha 1, in this block, which qualified as a Non-Associated Natural Gas (NANG) discovery under the terms of the PSC. In March 2009, however, the Indian government said Hardy had to relinquish the block because it had failed to declare commerciality two years from the date of the discovery. Hardy has argued that the two-year stipulation is for oil discoveries, not natural gas discoveries and won a ruling in its favor to this end in 2013 from an international tribunal. The Indian government has now appealed that ruling. Hardy Oil and Gas currently holds participating interest in three blocks in offshore India. This includes, apart from CY-OS/2, a 10% interest in NELP II block GS-O1 located in Saurashtra basin offshore Mumbai and an 18% interest in a producing block PY-3 located off the East coast, 80 kilometers south of Puducherry. Hardy, along with Reliance Industries (RIL), had recently relinquished another block KG-DWN-2003/1 (KG-D3) due to access restrictions imposed by the government. It is currently in talks to acquire RIL's entire 90% stake in the GS-O1 block.

• New European financial market rules have oil and gas industry executives crying foul, along with chocolate company Mars, because the new rules would make the raw materials markets both more expensive while also increasing volatility and reducing liquidity. Joining forces, Mars, the European Cocoa Association, BP, Royal Dutch Shell, and commodities trading giant Vitol have signed a letter to the European Commission noting a "significant unintended risk of damaging the markets" through new financial market rules that would increase the cost of trading and hedging. Presently, European authorities are doing a final review of their Markets in Financial Instruments Directive (Mifid II), which is designed to guard against systemic risks in equity, fixed income and commodity markets. This would place tougher restrictions on trading in capital markets by removing exemptions for commercial users that rely on swaps to offset their risks, forcing them to raise the amount of capital held on their balance sheets. The draft regulations will be delivered in September and, if approved, entered into force in early 2017.

Deals, Acquisitions & Mergers

• Hess Corp has agreed to sell a 50% stake in its processing and pipeline unit in the Bakken to private equity firm Global Infrastructure Partners for $2.7 billion. Hess said it will retain operational control of its Bakken midstream assets. Hess has experienced increased production but depressed gas prices have hit at profits and it announced earlier this year that it would move to reduce capital spending. The transaction is expected to be completed early in the third quarter of 2015. The two companies have also agreed to establish a midstream joint venture, Hess Infrastructure Partners, valued at $5.35 billion. The Hess midstream assets to be included in the joint venture include:

•  Natural gas processing plant in Tioga, North Dakota;
•  Rail loading terminal in Tioga and associated rail cars;
•  Crude oil truck and pipeline terminal in Williams County, North Dakota;
•  Propane storage cavern and rail and truck transloading facility in Mentor, Minnesota; and
•  Crude oil and natural gas gathering systems in North Dakota.

• Shell is pulling out of a shale gas exploration project in eastern Ukraine due to the ongoing conflict there. Shell has been unable to meet its obligations for the Yuzivska production sharing contract with its partner Nadra Yuzivska because of a force majeure that has been in effect since July 2014. Shell's deal with the Ukrainian government was signed in early 2013 to explore the Yuzivska field, which had an estimated production potential of up to 20 billion cubic meters of gas per year. While Shell has apparently informed the Ukrainian government of its plans to withdraw, partner Nadra Yuzivska has told reporters that it has not received any notice from Shell to this end. Shell still holds gas trading and downstream interests in Ukraine. Also last year, Chevron withdrew from a $10 billion shale gas agreement in the western regions of the country.