Global Energy Advisory – 21st November 2014

Politics, Geopolitics and Conflict

Under fire from the Islamic State (IS), Baghdad has cut a deal with the Iraqi Kurds, ending a long-running and intensifying dispute over unilateral Kurdish oil exports. This news has not only resulted in a jump in share prices for companies operating in Iraqi Kurdistan, but will also lead to another run on investment in Iraqi Kurd oil plays. Under the agreement between Baghdad and Erbil, the Kurdistan Regional Government (KRG) will give 150,000 barrels per day of oil exports to Iraq's federal budget, and in return Baghdad will release $500 million in budget funds for the KRG. Since January, Baghdad has been withholding the Iraqi Kurds' share of state revenue in retaliation over the KRG's unilateral shipments of oil to Turkey, where it is being sold on to the international market.

It's a great deal for the Kurds-if it holds. While the 150,000 bpd represents about half of what the Iraqi Kurds are exporting to Turkey, exports are expected to rise to 500,000 barrels per day in the first quarter of next year. The bottom line here is that the KRG is now exporting enough to pay off Baghdad, pay off its producers to whom it is indebted, and still turn a nice profit. The Kurds are essentially now able to afford their independence, and at 500,000 barrels per day, they will account for 17% of all Iraqi oil exports. Their influence is also growing due to Baghdad's need for the Kurdish Peshmerga security forces to help fight back the Islamic State in parts of northern Iraq that lie in the "disputed territories" between Iraq and the KRG.

Furthering developments, Genel Energy Plc, the largest producer in Iraqi Kurdistan, has signed a deal with the KRG to develop two gas fields, Miran and Bina Bawi. It will also acquire OMV AG's 36% stake in Bina Bawi for $150 million. According to the deal, Genel will pay $20 million up front and the remainder once the field starts producing gas in 2018. The fields contain a combined 11 trillion cubic feet of gas, according to Genel estimates, and it will take $1 billion in investment over three years to get them to production of around 4 billion cubic meters annually.

We have been promoting Iraqi Kurdistan as THE place to be in the Middle East for some time, while most eyes were on central and southern Iraq despite the clear signs of instability. It has already turned into a highly competitive environment, and the window of opportunity here is closing fast-for anything but large-scale deals.

While we believe that IS will have a much more difficult time infiltrating territory officially controlled by the KRG-or the Iraqi Kurd capital of Erbil-security will remain a concern for the immediate future. On 19 November, a suicide car bomber attacked Erbil, killing at least four people near a government compound. This was the worst attack in Erbil since a bombing in September 2013, while such attacks are common in central and southern Iraq. IS does not, at this time, have the capability to surge across the KRG borders and take over large swathes of land as it has done in Northern Iraq and Syria. Instead, it will be reduced to sporadic suicide bombings of this nature, and we could expect more attacks in the near future as the Peshmerga fight back IS in the disputed territories.

Tenders & Licenses

• The United Arab Emirates will announce the results of a tender to build an LNG import facility at the port of Fujairah by the end of this year or early next. The facility will have a capacity of 9 million tons annually. Approval for the joint venture Emirates LNG project between state-controlled International Petroleum Investment Co. (IPIC) and Mubadala was won a year ago. Front-end engineering design has been conducted by France's Technip.

• The Trans-Adriatic Pipeline AG (TAP) has issued its first major tender invitation for the construction of the onshore section of the pipeline. TAP will transport natural gas from Azerbaijan's giant Shah Deniz II field to Europe. The tender contract will be for engineering, procurement and construction. This is the largest contract TAP will award. The prequalification process was launched in May this year. The contract will cover some 760 kilometers onshore in Greece and Albania. Construction should begin in 2016, with the contract scheduled to be awarded in the third quarter of 2015. TAP's shareholders include BP (20%), Azerbaijan's SOCAR (20%), Statoil (20%), Fluxys (19%), Enagás (16%) and Axpo (5%).

• Azerbaijan's state-run SOCAR has opened bidding for engineering, procurement, construction and serving contracts for a new industrial waste water treatment plant at a time when waste water management is becoming a significant issue for the oil and gas industry due to environmental concerns.

Regulatory Alerts

• The head of Brazil's state-run Petrobras has pledged to reform the company's management structures and create a compliance division. Petrobras has been involved in a large-scale corruption scandal for diverting money to political parties, which recently led to 23 arrests. This has become a particularly sensitive issue with the re-election of President Rousseff, who was the company's chairman during these scandals. His longevity will in part depend on repairing reputational damage, and as such he is expected to focus heavily on transparency measures. At the same time, earlier this month, the president of the Audit Tribunal revealed that audits relating to Petrobras investments uncovered evidence of overpricing by around $12 billion, in one of the largest financial frauds ever discovered by the tribunal, according to our partners at Southern Pulse. The total includes a $624 million court-authorized allocation to buy a Pasadena Texas refinery and $117 million in overpricing for investments in the Petrochemical Complex of Rio de Janeiro (Comperi). The tribunal has requested that the Federal Supreme Court process an injunction against Petrobras, which does not have to comply with the Public Procurement Law, making it easier to find loopholes and commit fraud.

• While the US House passed legislation approving the construction of the US leg of the Keystone XL pipeline, the bill has narrowly failed in the Senate, failing to secure the 60 votes it needed to pass this week. The bill saw 59 senators vote for it and 41 against.

• Germany has reiterated its ban on hydraulic fracturing under public pressure from a media report suggesting it was considering relaxing the ban, which now allows fracking only below a depth of 3,000 meters in order to protect groundwater supplies.

• China's Sinopec Group has pledged to spend $4.6 billion over three years to improve safety at its oil pipelines. The pledge comes after the government ordered a temporary shutdown of two pipelines after safety inspections led to causes for concern. The inspections in turn were prompted by a deadly explosion in November 2013 caused by an oil leak. The explosion killed 62 people and authorities blamed lack of maintenance and design flaws. The Sinopec pipelines temporarily shut down include the 179-kilometer Linyi-Cangzhou pipeline and the 40-kilometer Tanguu to Dagang pipeline.

LNG Updates

• The US Department of Energy has granted final approval to the Freeport LNG project (Qintana Island, Texas) to ship LNG to non-free trade agreement countries. The final authorizations included those for the expansion of the Freeport LNG project and for the FLNG liquefaction.

• India is preparing to receive its largest shipment to date of LNG next month from North America. India's state-run Gail India Ltd. has agreed to purchase 3.5 million tons of LNG annually for two decades from Houston-based Cheniere Energy's Sabine Pass terminal in Louisiana. The Indian company has also booked 2.3 million tons of annual capacity at the Cove Point LNG liquefaction terminal in Maryland. Shipments should begin in 2017 or 2018.

• Finland and Estonia have reached an agreement to build two LNG terminals connected by a pipeline running through the Gulf of Finland by 2019. The larger terminal will be in Finland. The plan is to reduce dependence on Russian gas. Financing for the projects remains an uncertainty, while the expectation is that the EU will cover 75% of the pipeline costs of 200 million euros. The two terminals will cost an estimated 300 million euros. In a related deal, earlier this month the Finnish government took control of the country's only gas utility, Gasum, for 510 million euros.

Discovery & Development

• NET Mexico Pipeline Partners, a unit of NET Midstream, has announced the early completion of a new pipeline to transport Eagle Ford Shale natural gas into Mexico. The 120-mile pipeline begins in the Agua Dulce hub in Nueces County to a point about 6 miles east of Rio Grande City in Starr County, and was originally slated for completion on December 1. The pipeline is now operational.

• Pakistan's United Energy Pakistan (UEP) has announced what it is calling a major gas discovery in the Mirpurkhas Khipro (MKK) lease. UEP says that total production from the field will increase to 400 million cubic feet per day in different phases, while the field will start pumping an additional 150 mmcfd into the Sui Southern Gas Company's (SSGC) pipeline by June next year. UEP is owned by Hong Kong-based United Energy Group (UEG), which is already producing 250 mmcfd from the Naimat and Kausar fields on the MKK lease. UEP is also working on bringing online two gas processing plants with a total 160 mmcfd capacity. The plants should be operational in March and June next year.

• Centrica Energy has announced the discovery of a "massive" new gas field-Pegasus--off the Tees Valley coast in the United Kingdom. The discovery is said to be in the same area as the Cygnus development which could produce enough gas to supply 1.5 million UK homes. There are as of yet no indications on how large the Pegasus field could be, though media describe it as "massive." Initial testing shows a sustained flow rate of more than 90 million standard cubic feet of gas per day (equivalent to 15,000 barrels of oil). Centrica Energy has a 55% operated interest in Pegasus, which includes the Pegasus North well drilled in 2011, along with partners Third Energy which has a 35% interest and Atlantic Petroleum with a 10% interest.

• ConocoPhillips has announced a second oil discovery at its two-well offshore program in Senegal. The discovery was made at the SNE-1 well located approximately 60 miles off Senegal's shore in the Sangomar Deep block formation. ConocoPhillips holds a 35% interest in the well while Cairn Energy PLC has a 40% interest. FAR Limited owns 15% and Petrosen has 10%. Cairn is the operator and will continue to drill the well to a depth of 10,000 feet.

Deals, Mergers & Acquisitions

• By far the biggest oil and gas merger story this month is Halliburton Co's move to acquire Baker Hughes Inc for $35 billion in cash and stock. This will create a massive oilfield services company that will pose a major challenge to market leader Schlumberger NV. There is a great deal of speculation about the strategic nature of this deal, with many holding that consolidation of this nature is a reflection of the slump in oil prices and could lead to much larger consolidations in the oil and gas sector.

• Italy's Eni SpA has signed an agreement with Algerian state-run Sonangol on joint oil and gas projects. (Details to follow at a later date).

• French utility GDF Suez is preparing to sell its Hungarian power trading business to Hungarian MET Group, which is 40% owned by state-run oil and gas company MOL.