Foreign direct investment (FDI) in regional energy companies is still limited but further opportunities could emerge with potential future oil and gas listings and changes to capital market legislation, says a Morgan Stanley report released yesterday.
The study, called "Middle East: Short Gas, Long Demand – A New Role for IOCs", says the extent and range of exposure to oil and gas in the region is set to increase.
The study adds that moves such as the proposed part-listing of the Total/Aramco Jubail refinery may eventually open up new opportunities.
Saudi Aramco and Total have formed a joint venture to build a 400,000-barrel-per-day (bpd) grassroots refinery in Jubail, due to start operating in 2013. The intention is for 25 per cent of the refinery to be listed on the local exchange at some stage.
Prior to the regional market correction there were plans to privatise and list the Kuwait Foreign Petroleum Exploration Company (Kufpec) – the international E&P arm of KPC – on the Kuwaiti stock market as part of the government's privatisation programme.
This is now on hold, given current market volatility, but should plans be revived it would present investors with an opportunity to gain exposure to Kufpec's upstream oil and gas operations, says Morgan Stanley.
Recent changes to capital markets legislation are intended to encourage foreign investment in the region. In August, the Saudi Capital Markets Authority approved the use of swap agreements between non-resident foreign investors and authorised persons to allow international investors to buy Saudi stocks through intermediaries, while local investors retain legal ownership of the shares.
"As countries such as the UAE and Qatar continue to establish themselves as significant international financial centres, the need to attract foreign investment is likely to continue, and foreign ownership limits may be reviewed," adds the report.
According to Morgan Stanley's estimates, the oil and gas sector accounts for 84 per cent of government revenues in Saudi Arabia and just under 80 per cent in Kuwait and the UAE. However, availability and access to listed oil and gas equities in the region is extremely limited as most companies are state-owned.
Those energy stocks that are listed typically have limited liquidity and foreign ownership restrictions, with the result that less than one per cent of the region's total market cap of $800bn (Dh2.9 trillion) – $3bn – is theoretically available to international investors.
"When screening for oil and gas opportunities in the Middle East, investors should therefore also consider ancillary sectors that are heavily exposed to oil and gas and which currently carry higher weightings in regional indices.
"Petrochemicals and power generation are two key sectors in this respect."
Since a sharp correction in 2006 regional equity markets have generated only modest returns after seeing much lower levels of speculative activity. Until recently the consensus view was that the large budget surpluses and petrodollars generated by higher crude prices would insulate regional equity markets from the liquidity concerns elsewhere in the world.
However, as market conditions have deteriorated, negative sentiment has weighed on shares and GCC markets are down more than 40 per cent since July. The recent sharp falls in equity prices, on the other hand, may also present attractive opportunities to state finance-backed investment vehicles like Taqa, Mubadala and Kufpec.
"Strategic investments remain a priority, which may influence required returns and possibly mean that diversified exploration and production; and energy portfolios are more attractive than a high quality single asset," the report adds.
Similarly, there are also limited opportunities for the international oil companies (IOCs) in conventional oil but the exploration and production operations which are becoming ever more complex – such as offshore, deepwater, high temperature high pressure, heavy oil, tight/sour gas operations – would provide more opportunities for the oil majors.
"It is obvious that, for long-term growth, the IOCs need to establish more material positions in regions like the Middle East. What is less obvious – and what surprised us during our trip to the region – is the growing recognition there is a meaningful role for the majors and service companies to play in the region."
While the national oil companies (NOCs) have decades of experience in developing their countries' reservoirs and have built strong relationships with buyers in established export markets, the IOCs can bring cutting-edge technology, human capital, access to emerging and newly developing export markets, sharing some of the project risk and the project management.
However, there will be a shift in the agreements. Morgan Stanley says existing contracts will be renegotiated and reserves are unlikely to be booked as IOCs adopt a service-oriented model.
Negotiations between NOCs and IOCs are likely to be more centred on cash flows rather than ownership or shares of physical barrels.
From the 1940s until recently the IOCs have been driven largely by a philosophy of finding and then developing oil and gas, at first in the resource-holding nations, and then, after the creation of Opec, in other areas of the world.
As reserve gathering was the mission the reserve levels of the majors came to be seen as the measure of their success, and finding and development costs the measure of efficiency. In a more evolved world of energy Morgan Stanley expects a more service-oriented model – the development and marketing of hydrocarbons on behalf of resource-holding nations.
"As service providers, oil companies may well not 'book' reserves, and in many cases there may be no need to 'find' them. Relationships and behaviour could therefore change very dramatically over the next 10 years."
The renegotiation of BP's contracts with Abu Dhabi for the Adco onshore and Adma offshore concessions, which are due to expire in 2014 and 2018 respectively, will be something of a watershed.
These concessions were initially awarded as far back as 1939 for Adco, which contains some of Abu Dhabi's largest oilfields, including Bab and Bu Hasa, and 1958 for Adma, which contains the large offshore Zakum field.
Production from these concessions is significant for BP, with net production of 130,000 barrels of oil equivalent per day (boepd) from Adco and 80,000 boepd from Adma. "We understand BP is currently renegotiating these fixed margin contracts. We suspect it is unlikely that BP will benefit from reserve booking but that there will a proxy economic benefit reflected on its books."
According to the Baker Institute for Public Policy, the hydrocarbon power has now shifted to the NOCs.
The seven major Western oil companies currently have only 10 per cent of the world's oil and gas resource base.
About 77 per cent of the world proven oil reserves (1,148 billion barrels) are owned and controlled by NOCs and that is without equity participation by big international oil companies. The remaining 13 per cent of the reserves are the subject of joint exploitation by IOCs and NOCs.
Moreover, 14 NOCs or newly privatised NOCs comprise the world's top 20 oil producers in terms of reserves, production and sales volumes. Five of those are from the exporting countries of the Middle East and North Africa.
Price correlation
Investment in oil and gas is likely to go ahead despite lower oil prices and the global economic downturn, says Morgan Stanley.
"Some of the more significant strategic investment projects will be funded directly from government treasuries, and are thus not constrained by domestic or international banking liquidity concerns," the report says.
"Ongoing investment projects were undertaken when crude prices were at much lower levels, and indeed, with current prices still above break-even budget levels for the majority of Middle East oil and gas producers, it is unlikely that we see any significant slowdown in investment spending in the region."
Some projects, however, may go through a re-evaluation phase to reassess the impact of current market conditions.