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Global Energy Advisory – 7th November 2014

Politics, Geopolitics & Conflict

We are closely monitoring oil developments in Somaliland, which threaten to cause instability in northern Somalia. Somaliland’s separatist administration is proposing an Oil Protection Unit (OPU), which could trigger all-out armed confrontation between Puntland and Somaliland over the disputed territory of Sool. A UN monitoring group is calling for the cessation of all commercial activity in the oil sector due to looming threats. The brewing conflict stems from Somaliland’s granting of oil exploration licenses to foreign companies—including Genel Energy, Rakgas, DNO and Ansan Wikfs—which is being challenged by the Somalia Federal Government and Puntland. Somaliland is planning to provide armed protection for oil workers here, and there is the risk that the unrecognized Somaliland will violate an arms embargo to do so and spark an armed conflict with Somalia and Puntland. These oil companies have jumped the gun on Somaliland oil, and our assessment is that this will most likely end in conflict in an area already wracked with violent instability. The flashpoint, Sool, is extremely tense. Somaliland troops seized a village in Sool in April, taking control of strategic oil-rich targets. In August, clan militia attacked foreign oil workers working for DNO near Sool. The battle for the control of Sool and Sanaag in northern Somalia has continued on and off since 2000.

In Ukraine, separatist elections indicate what was already becoming a foregone conclusion: The central government in Kiev has lost control of the region. On Sunday, 2 November, votes were held by pro-Russian insurgents, installing rebel militia leaders as prime minister of two self-declared republics in the east, Donetsk and Lugansk. These two areas plus the already lost Crimea represent about 15% of Ukraine’s population (counting those who fled).

Development Focus: Kenya

Tullow Oil has encountered oil shows in its Kodos-1 exploration well in the Kerio Basin, but there are mixed sentiments on this, while a planned pipeline with Uganda—which will be a game-changer for explorers when production goes commercial—has received a boost with World Bank funding.

For Tullow, which made the first major discovery in Kenya in 2012, blessings have since been mixed. In late October, the company said it had drilled Kodos-1 to a depth of 2,500 meters, encountering oil showings of mixed quality alluvial sands. Tullow then announced it would plug and abandon the well, moving on to a second well, Epir-1, 25 kilometers north of Kodos-1. The company says the Kerio Basin remains highly prospective. At the same time, Tullow’s major find in the Ngamia-4 well in Block 10BB has moved forward with the successful appraisal of the Ngamia oil field in the most promising South Lokichar Basin. The well encountered up to 120 meters of net hydrocarbon pay, with 80 meters of oil. Testing of Tullow’s Twiga 2A well produced a maximum rate of 3,270 barrels of oil per day, which represents the highest rate of production in Kenya so far. The Ekosowan-1 well has also encountered oil shows, but because it is in tight sands it cannot be commercially extracted and will be abandoned. We caution against interpreting this as a reason to have less optimism over Tullow in Kenya. Much of the negative sentiment is largely due to the fact that Tullow is highly exposed because it made such a significant discovery with Ngamia and put Kenya on the East African oil map. Recall that Tullow has struck commercially viable deposits of oil in the Lokichar basin in Turkana, where it has discovered resources of about 600 million barrels.

October has also seen Tullow challenged with worker unrest at a number of its drilling sites in northern Kenya. Earlier in October this had led to the evacuation of some workers. Tullow was facing industrial actions by sub-contractors from one of its suppliers; however, the situation appears to have been resolved for now. It is the second time such unrest has manifested at Tullow drilling sites in as many years. At the same time last year, Tullow suspended drilling operations on two blocks in Turkana due to security concerns after local residents held protests demanding more jobs at the sites.

Key infrastructure, in the meantime, is moving forward, with a $600-million pledge from the World Bank for the Uganda-Kenya oil pipeline. This 1,300-kilometer pipeline will link oil fields to Uganda, South Sudan and Kenya. The project will cost an estimated $5 billion.

The situation with Kenya’s only oil refinery in the port of Mombasa remains up in the air. In November 2013, Kenya bought the remaining 50% stake in the country’s only oil refinery from India’s Essar for $5 million. Now the government is deciding whether to turn this into an oil storage facility or foot the bill for an extensive refinery upgrade. The refinery produces low-quality products and fuel distributors largely choose importing less expensive and better quality products. Essar had been planning $1.2 million in upgrades before it pulled out after determining the plan was not economically viable. The refinery’s capacity is now around 1.6 million tons of crude annually, which Essar was hoping to boost to 4 million tons.

In September, Kenya accounted it was planning a new capital gains tax on foreign companies, which could be as high as 37.5%. The law is tentatively scheduled for 1 January implementation, but remains a debated issue.

Africa Oil, Tullow’s partner in Kenya, is seeking to reduce its stake here by around half by early 2016. Right now it has a 50% interest in the Kenyan fields, with Tullow the operator. Tentatively, Africa Oil would like to keep around 25% and use a “farm down” deal to recoup exploration costs and fund further development.

(Next week, a deeper look at oil rows and development problems in emerging gas giant Tanzania)

Deals, Mergers & Acquisitions

• Hong Kong-based Brightoil Petroleum Holdings Ltd. is bidding on Newfield Exploration Co.’s (NFX) China offshore assets in Bohai Bay worth around $800 million. Brightoil already has assets in Bohai Bay and the Newfield acquisition would be of a block that is scheduled to begin production by the end of November. Brightoil has said it is planning to spend $1 billion annually over the next 3-4 years in China to transform itself into an oil and gas asset owner, from a largely marine fuel trading business.

• Peru is tentatively planning to sell up to 49% of its stake in state-run Petroperu in the second quarter of 2015.

• Italy’s Eni is exploring options for the sale of its stake in Saipem oil services company, which has been dogged by corruption scandals emanating in Africa.

Oil & Gas Legislation Alerts

• Canada has tabled a new law that would require oil, gas and mining companies to publicly disclose payments they make to foreign governments, much like the US Dodd Frank Act. The new law was introduced on 23 October.

• Argentina has won congressional approval for a reform designed to rebuild oil and natural gas production and attract new investment. The reform cuts some oil sector taxes, provides fiscal incentives and makes it easier for companies to bid on tenders and licenses. It also extends licenses to 35 years for unconventional projects (up from 25 years) and 30 years for offshore projects. Production royalties will be capped at 12% for the initial concession and then 18% for extensions. Developers will be allowed to export up to 20% of their dollar profits without restrictions.

• The government of the Bahamas is expected to table long-awaited oil exploration legislation in November in a package that will include a framework for a sovereign wealth fund. There have been no commercial oil discoveries as of yet in the Bahamas.

• Mexico's Supreme Court has rejected petitions submitted by two leftist parties to hold a national referendum on reversing major energy reform which have opened the country's energy sector to foreign and private participation for the first time in nearly eight decades. Justices ruled that a referendum on the energy overhaul would be unconstitutional. Oil and related taxes account for about a third of federal budget revenue. The reform was passed last December, and the legislation which governs the implementation of the reform was passed in August. Mexico's left had vigorously opposed the reform and asked for a national referendum to ascertain citizens' opinions on its contents. The leftist Party of the Democratic Revolution, and the recently formed Morena party, had each collected several million signatures needed to request the referendum, which still required approval of the Supreme Court.

• Voters in the city of Denton, Texas (Barnett Shale), on 5 November said “yes” in a referendum to ban fracking within in the city limits. Now we are in for a prolonged legal battle as the Texas Oil and Gas Association and the state’s General Land Office have filed lawsuits to keep the ban from being implemented.

Discovery

• Chevron and BP have announced an oil discovery in one of the deepest regions of the Gulf of Mexico in the Keathley Canyon Block 10. The block—in the Guadalupe prospect--is situated some 180 miles from the coast of Louisiana. Estimates have not yet been provided, while tests are ongoing. The discovery well was drilled in 4,000 feet of water to a depth of 30,000 feet. Chevron is the operator with a 42.5% stake. BP has a 42.5% stake, and Venari Resources has a 15% stake. Drilling started in June.

• Spain’s Repsol (in partnership with Colombia’s Ecopetrol) has also announced a Gulf of Mexico discovery off the coast of Louisiana in the Keathley Canyon region. The Leon discovery was made in 6,100 feet of water and drilled to a depth of 31,000 feet. Again, no estimates have been given.

• Total E&P Norge AS has announced a discovery at its appraisal well (34/6-3S) in the Cook formation in the Norwegian North Sea. The company encountered a 120-meter column of gross oil, describing its quality as “very good.” The appraisal well was drilling to 4,462 meters in 381 meters of water. The test showed good flow properties with stable flow pressure and low pressure decline, and consistent pressure build-up. The well produced oil with a gas-oil ratio of 19:1 cu m.

• Italy’s Eni has announced the discovery of up to 1 million barrels of oil in the Congo, in the Minsala Marine exploration prospect, 35 kilometers offshore in the Marine XII Block. The Minsala Marine-1 well was drilled in 75 meters of water to a depth of 3,700 meters. The find was in line with the four billion barrels of oil already discovered between the Congo and Gaon. Eni is the operator of Marine XII with a 65% stake.

Tender Update

• Croatia has received six bids in an international tender for oil and gas exploration areas in the Adriatic Sea and will choose the top bids by the end of this year. The tender closed on 2 November after running for seven months. It comprises 29 block areas for exploration and future exploitation, eight in the north and 21 in central and southern Adriatic. The size of one block ranges from 1,000 to 1,600 square kilometers. According to the preliminary data, gas reserves are more likely to be found in the north while crude deposits are expected in the southern part of Croatia's Adriatic, where the seabed is deeper.




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