Yemen draws up incentives to revive IOC upstream interest

IHS Global Insight Perspective

Significance Yemen is offering radically revised production-sharing agreement (PSA) terms and the opportunity of one-on-one bilateral negotiations with the Ministry of Oil and Minerals (MOM) in order to rekindle IOC—and especially oil-major—interest in exploration and production (E&P) investments in the country and reverse its rapidly evaporating fortunes.

Implications

Yemen's completely failed offshore licensing round late last year served as a wake-up call, bringing the realisation that term revisions, institutional and legal reform, the cutting of red tape, and depoliticisation, are all necessary to kick-start investment.

Outlook

Even with this realisation the country's deteriorating security situation—both on- and offshore—is likely to present a formidable obstacle to attracting new investment, while doubts about Yemen's continued prospectivity seem well founded.

Between a Rock and a Hard Place

Yemen—the Middle East's poorest country—is increasingly finding itself squeezed by low world market crude prices and oil output that has been in rapid mature decline for several years.

Highly dependent on its dwindling oil export revenues, and having been in no condition to save during the years of high oil prices, the government is finding itself more and more desperate for money, as the shortage—and perceived future shortage—of funds is resulting in higher levels of unrest among its fractured clan-based population.

Full and proper government control barely extends beyond the main urban population centres and in clusters around the oil and gas producing areas. As such, the country's clans have generally held a very high degree of autonomy vis-à-vis the state, often using their ability to muster force as a way to access the government's revenue stream directly or indirectly (by forcing the government to undertake development projects in their areas).

Violence has risen in line with scarcity, as clans—as well as sectarian and ethnic groupings—compete more fiercely over already-fast-diminishing resources, while the government's ability to buy support and balance groups against one other wanes rapidly.

While global oil prices have fallen by about two-thirds from their mid-2008 peak, Yemen's total production is this year expected to come in firmly below 300,000 b/d, having fallen from 380,000 b/d in 2006 and close to 450,000 b/d in 2003.

Oil exports are likely to come in at an average of only 160,000-170,000 b/d this year and provide around 70% of the government's revenue. The expected start-up of the Total-led Yemen LNG (YLNG) venture in May, exporting around 6.7 million t/y of LNG, will provide significant assistance, but will in itself not be enough to replace the state's oil income over the medium and long term.

In the immediate term, its production will hit global LNG markets as prices are falling, and as the prospect of a large-scale de facto price war looms between Qatar and Russia's Gazprom over supplies to Europe and North America, given feared large-scale Asian demand destruction and huge Qatari volumes coming onstream at the same time as those from YLNG.

Self-Awareness

Yemen's failed offshore licensing round in late 2008, together with its very real and immediate financial predicament, does appear to have finally hit home, causing the government and the Ministry of Oil and Minerals (MOM) to rethink their long-term strategies.

While the falling oil price was clearly a significant factor in the IOCs' decision to withhold their bids, Yemeni officials have begun openly to address several issues that have for some time been high on IOC wish-lists for positive change in the country.

Unsurprisingly—given the urgency with which Yemen needs to try to reverse its fortunes—timing and speed are perhaps chief among the issues MOM has attempted to reform, launching a new framework that builds on one-on-one direct negotiations over oil blocks in order to cut the time taken by the cumbersome licensing rounds and the need to conduct multiple negotiations simultaneously.

A process to depoliticise deals has also been launched. The government is understood to be moving towards ratifying oil contracts without the involvement of parliament, although this measure might backfire, reducing legitimacy and causing added political tension over the country's oil policies.

It would nevertheless be likely to make a rapid impact, as the ratification process in Yemen has tended to take an immense amount of time; for example, the ratification of blocks awarded in the 2006 licensing round did not start until the second quarter of 2008.

Yemen is also about to raise its share of project costs within the production-sharing agreements (PSAs) as its most direct way of improving financial terms for investors.

A greater overall flexibility on Yemen's terms is to be signalled before the country enters into bilateral negotiations with IOCs, meaning that further significant adjustments might be made on a contract-by-contract basis.

Aim for the Big Catch

Yemen is hoping to attract the world's majors and large mid-sized companies, a good many of whom signed up for prequalification and data packages at the latest offshore round, indicating that the country is still at least on the global upstream exploration and production (E&P) map.

The changes advertised—and the initial law revision allowing one-on-one negotiations—had already resulted in eight investment offers according to MOM in late February, three of them from majors. ExxonMobil, BP, Total, Oxy, Nippon Oil Exploration, and Nexen were named as having expressed interest to MOM in placing bids on Yemeni blocks, although there was no information yet on which blocks in particular the companies were interested in.

Absent Friends

Throughout interviews and reports published since the government and energy officials began to advertise their new terms and approaches, however, security has been conspicuously absent from their discussions.'

With government revenue melting away by the day there is naturally little it can do to reassert state authority throughout much of its territory, although clan- and al-Qaeda-related violence has crept closer and closer to urban areas, as well as to existing oil and gas installations.

For companies looking to undertake virgin exploration, this would today most likely mean venturing out into areas where government authority is completely absent and where the possibility of this being reasserted might well come down to formal military conquest of the territory in question.

Also largely avoided is the topic of piracy emanating from neighbouring Somalia, which is making all sea journeys in the Gulf of Aden, around its far-flung Socotra Island and through the Bab al-Mandab Strait into the Red Sea perilous. The upsurge in incidents over the past year has made undertaking offshore exploration with slow-moving—and extremely expensive—hi-tech seismic vessels virtually impossible, not to mention placing static drilling rigs in the waters.

In reporting the failed offshore licensing round, this was indeed one of the main overlooked reasons for its collapse, given that no IOC in the current climate would have been able to commit to work programmes in most of the country's waters.

Outlook and Implications

Yemen needs to turn its flagging oil industry around swiftly before further erosion of its oil revenues results in the complete collapse and disintegration of the state. With most of its oilfields in rapid and terminal decline, further prospectivity is limited; it is mainly its offshore areas, currently scoured by Somali pirates, that are being touted by the government as its next—and saving—frontier.

The piracy problem is a massive—if not insurmountable—obstacle, making it impossible for any IOC to deploy exploration teams or equipment in most for the country's waters, save perhaps for its Red Sea acreage, though even there some lingering maritime border tensions with Eritrea remain.

Added to that the paltry exploration work that has previously been undertaken in its maritime acreage has left legitimate grounds for doubt on the opportunities offered, although initial IOC interest for the relatively low-quality data packs in the first half of 2008 still looked solid.

If anything is to reverse the country's hydrocarbon fortunes decisively, however, it will be a clear revision of financial terms and the launch of bilateral MOM-IOC negotiations over acreage.

Better terms might still be able to kindle interest in some of its onshore acreage, and one-on-one negotiations will make it easier for IOCs to win offers based on their supreme technological expertise, without being undercut price-wise by less suitable companies who are able to run developments more cheaply but in the end achieve significantly lower production and recovery rates.

Scrapping the licensing rounds is nonetheless likely to be politically unpopular, with transparency decreasing and corruption accusations from the opposition likely to become more frequent.

This will further raise the political long-term risk, with possible retroactive revisions being launched in the future, should there be a significant change in government.

Lesser parliamentary say in the ratification process will substantially aggravate this and could cause a quicker backlash, the risk of which needs to be managed by IOCs through proactively pursuing significant transparency themselves.