Interview with the Undersecretary Oil and Gas in Oman, H.E. Salim Al Aufi

Can you give us a little bit of an update on the latest developments in the industry? How many players are currently involved and what are the prospects for next year – 2016?

Our industry “players” are a mix of producers and companies – we do separate them. In terms of companies that are producing today, we have counted about nine. And they’re producing from 12 separate blocks. For example, if you take CCN, they are producing from block 3 and 4, so that’s one single concession. And then, some of these companies are also exploring; they have exploration blocks like DNO (producing in block 8, but also exploring in block 36, so they will be in both counts). Occidental is the same: they’re producing from Muhaisnah and Safah but they also have an exploration in block 62 so you’ll see them in both arms. So, I’ve taken them out – I won’t count a company that is already in production mall. That gives me about six separate companies that are purely in exploration. If you add the operators who are also exploring that will give you about 11 companies that are involved in pure exploration activities, in separate blocks. In total, we have 25 or 26 separate blocks that are currently either actively producing, or actively exploring.

Can you tell us a little bit about what the main challenges are? Let’s talk about the industry on a global level and move on to the most critical challenges for the industry in Oman.

Globally, it’s no secret that we have more supply available in the market than there is demand. And the supply comes from many places. The US started reducing its dependency on imports and doing more local production. They’re not exporting yet so that meant some surplus in the market. There is also a lot of oil coming from Irak: for some time this was actually almost non-existent because of issues on the ground. Many other projects came on stream during this period, for instance from Russia, Africa, South America… Most producing companies or countries are growing in terms of production. There was a growth in production but no matching growth in demand. So the demand on average was about 900 barrels and between 7,000 to 8,000 barrels per year, in terms of growth.

Today, we have a surplus of about 1.5 million barrels (having reached 2million previously). This by far exceeds the growth in demand. It is no longer around 900; it’s more like 500-600 with the issues that are happening in Europe, and the slowdown of the Chinese economy etc. In general, growth in demand has dropping slightly. Growth and supply have been rising substantially so, in pure economy, you’ve got completely the reverse situation where demand is lower than supply. By definition, if you just drop a pin on the point at which where these two curves normally intersect, you get a reduced price. It’s no magic. If you go to any basic economy textbook, it will tell you: the perfect price for any product is when supply and demand meet. And the supply-demand today is meeting at a very low price. So that’s on the global level.

If we look forward to what’s happening globally, there is a lot of anticipation for Iranian oil to come to the market. Iran has always been saying that they have a lot of oil locked in behind pipe, which is a technical term meaning, ready to come to the market as soon as the sanctions are lifted. With a little bit of technical uplifting and some upgrades, that shouldn’t take a lot of time: the replacement of some flow lines, the revision of existing ones and it’s already in the market. It’s not something that needs to be explored and developed. It is ready to go! It may take them 3 to 6 months to get all the technical issues sorted out but, as soon as the sanctions are lifted, there will be an additional 1-2 M barrels coming to the market straight. And, of course, the Iranians are in great need of foreign currency; they would not hesitate to go to market.

Irak is growing. They are sorting out a lot of their technical issues, and now they are pumping steadily. I would say between 2 to 3 million barrels and they’re growing as well. Of course, there is growth in the OPEC countries as well. Saudi Arabia has increased their production. Our increasing production is very small here. We’re hovering at around 980,000 barrels. So we’re not having much of an impact on the market. Of course, there are plans from the UAE to also grow their production to around 3 million barrels and they are progressing in that direction. So, if I look forward there is a lot of positive outlook for supply growth and a negative outlook for demand growth, which means we’ll probably continue in this reverse supply/demand position for quite some time. How long exactly? I have no idea.

The US shell is still going strong. There was a small reduction recently. But it’s just a market correction, not a problem. And yet the thing about the US shell is that it’s a switch; it is switched off when the prices are suppressed and it’s switched on immediately after prices are favourable towards producers. It’s run primarily by private investors who are ready to come to the market at any time: there is a small margin that they can get.

The way the US market works is completely different to how we are working in this part of the world. Farmers privately own the land. And therefore, it is in the best interests of the operators to continue drilling in order to hole into the land; which means there is a lot of wealth that is currently being drilled into, but not completed (because it’s not commercial to do so). But they needed to be drilled to hole the land, and at any point in time, when the price becomes favourable, all you need is just a matter of simple pipeline, to hook them up and start producing. So, there is a lot of oil coming from the US shell. I think the exploration activities they’ve done over the last few years have led them to the sweet spot. They know where to go and drill, and that’s where they are concentrating but now they are slowing down: Wildcat exploration activities, which are taking them away from the sweet spot. At any point in time, they can go back and get into that mode. So, I’m not seeing the US shell as giving back their position: they’ve already assumed it. And so, that is where the market is going globally.

Can you elaborate a little bit more on how it will affect further exploration? You just explained in the US, how they are still exploring and investing in new fields. What about this part of the world?

The US exploration did slow down but they already know where the sweet spots are. They have a very good idea of where the oil is. They are developing their technologies further and making their operations more efficient. Their margins for producing US shell are going down on a daily basis. All that makes it more and more profitable, even at a low price, for the producers.

With this kind of oil price, it is very uneconomical to invest in expensive technologies in enhanced oil recovery. The Wildcat exploration costs a lot of money with a lot of risks associated with them. If the size of the price is not there, even if you discover at 45-50$, a lot of the projects that are running today, if they are not on stream, they wouldn’t have been constructed. The reason why they’re producing today is because the construction cost is already sunk money (and there is not much you can do with that). So now, you just recover whatever you can from continuing to produce. The operating cost is low which means it’s ok to continue producing once you have it on stream. But if it’s not on stream, then the capital required in order to develop, construct and bring the industry is quite substantial.

Not many companies have that kind of cash today to go and venture high risk and expensive projects. And technology is the same. To invest in technology, you need to have a clear understanding of what they’ve ordered it to be and at $40-60, it is tough work. So, I agree that keeping the prices down at this level will have a negative impact on the exploration program, on companies taking additional risks and on venturing further. But also on the technology development that is needed for difficult oil, tight oil, oil recovery and so on. That is unless it’s already committed, and therefore going back is more expensive than continuing, which is the case in some places.

So tell us how this is affecting the sector in Oman?

It is affecting it indeed. Oman is not immune from the rest of the world. They’re also looking for their margins; operators in Oman are trying to reduce developing costs. Either through upgrading programs or renegotiating some of their terms with contractors, working in collaboration with a lot of the contractors, internally within the companies themselves... to try and reduce waste that was inherited. When everything is good, you tend to move too fast and you don’t have enough time to look back and challenge whether everything you do adds value or not, because the time it takes to remove waste looses you more value that to just continue with it. But now that’s not the case. They’re challenging their own policies, guidelines and interfaces between the operators and the contractors to try to remove complications and wastes, and increase the level of trust between the contractors and the operators. If the contractor is doing a piece of work, the operator doesn’t necessarily need to go and double (or triple) check it on top of what they’re doing. By high-grading the programs, not everything is going to be executed as it used to be.

There is definitely a slow down in terms of the Wildcat exploration activities. Companies are thinking twice or 3 times before they venture into an area that has very little information. So, it does have an impact even though it’s a little bit lower than the rest of the world. Luckily for us, we have a lot of data available that allow us to understand where we can go and explore further. A lot of our projects have already been committed, so we are in an execution mode, terminating contractors. Stopping this project is going to cost us a lot. Not only the penalties associated with but also the cost to pick it us again, later on, is not easy. So, those programs are continuing. A lot of the enhance recovery programs executed are radio stream. We are already there to enhance our recovery; if major projects are coming in, we’ll definitely need to sit down and have a discussion. In terms of the development costs in Oman, it’s still attractive: for every barrel we produce, the margins are still healthy. Healthy for the operators, but it’s low as far as the government is concerned. The margins before were much more healthier. Now that have shrunk, it is still a profitable business. It’s probably still the most profitable business that the government can put his money in. If you compare it with any other industry, if there is a dollar that can be invested in the oil sector, I think the returns are quick, positive and assured, as opposed to a dollar invested elsewhere. But, of course, the government thinks slightly differently cause they have social obligation. Not everything invested is returning money and that’s understood.

How much of the production is currently coming from enhanced to recovers in Oman?

Last time I counted, it was in the order of 25% to 30%. So if you add it all up, I would think it’s about 30% of the black oil. Condensate is a different story. And that has high operating costs, which makes our operating budget a little bit higher than our peers’ in the region.

Do you think there will be an opportunity to somehow export that knowledge and capitalize on your experience?

Absolutely. It’s already capitalized upon and exported in some cases. We have a lot of Omanis out, but they tend to be attached to major operators like Shell, Oxy and BP, and they go as far as they can in that development program. For many years now, we have developed expertise, not only in enhanced or recovery, but also in conventional production: management, fee development, studies... There is a lot of expertise developed and that expertise can be exported. We are working now to see if we can extend further our technical know-how, to support whoever is interested in grabbing this. And we have the resources to do so; I think we can probably progress that very quickly.

Can you tell us a bit about how the role of the company has evolved over the years?

Well, it started as a company that will ultimately take a stake in most of the operating blocks, once the discovery is confirmed. They pay all their dues, but they become a partner by default once the discovery is confirmed, and we agree with the partnership percentage upfront etc. So it’s not a surprise to any of the operators or to the block shareholders.

However, recently Oman Oil also started to become an operator on its own. They started competing for open blocks like any other operator. They are producing from block 60 and exploring block 48. They’ve got block 40 and have a stake in block 53. They’re working with Occidental on block 62. They do have an interest in many places but they’ve started to operate on their own which is a major step forward for the company in order to become an internationally recognized entity with operating and development experience. They’re starting to venture outside of Oman on their own and they’re also developing associate services like wire line and so on.

So, Oman Oil is growing and I see no reason why they can’t continue to do so further. In terms of total production, Oman Oil’s contribution today it still very low. Of course the flagship is still PDO. The second one is OXY, and then CC Energy etc. Oman Oil is still low in terms of total production, but they’re starting to operate and take 100% ownership of open blocks for explorations. Which means they are heading towards being a respectable company in this area.

How would you say that all of this has impacted this economy? What do you think is the best way for the country to adapt to the new reality of over supplying production and a lower demand?

I can’t really speak about what happened in every sector and what other financers would do, but I can speak for the oil and gas sector. We are challenging the programs of the different companies continuously. Now is the best time, before we commit to 2016/2017. And wherever possible, we try to reduce the total spend so that we come to a point where we enhance the margins coming out of them. We realize that there’s only so much we can take out of the sector before it starts to negatively impact our ability to produce at this current level, and bounce back should the market return to its normal terms. We are very conscious of this and trying to play safe; not reducing our budget and activities too much, but at the same time, not continuing like business as usual, because it’s not.

Our contribution to the government revenue has dropped significantly. It was 110$, now its about 45-50$; no wonder that the government is asking us to reduce the spend as much as possible. The good thing is, with the exception of PDO, owning the other operating blocks are post recovery terms, productions sharing an agreement on recovery. Meaning the operators put their own equity money or finance it, and then, the money they spend will return on oil sales. There is a cap on how much they can return on an annual basis. Which means, as far as the government is concerned, and not putting equity money on the other operating blocks with the exception of PDO. That when we try to manage carefully, not to make the operators loose a lot of money and not being able to recover their investments fast enough, and at the same time, make him sure that they continue to invest and not to slow down.

It’s a debate we continuously have but it’s not really impacting the government so much because they’re not putting equity money. The impact comes from the fact that whatever these operators produce, the value back again to the government is still low, because of the oil prices and not because the production has dropped. And that’s a challenge they just have to face because there is not much you can do from outside, unless we start reducing the production.

Can you tell us the latest developments in the gas sector and how Oman is keeping up with the demand?

So, gas growth: first of all, we have to understand where it goes. The number one priority is the energy sector – electricity generation and it is 100% gas-driven at this moment in time. There is a momentum to try to diversify: solar, wind and even coal are on the table. But it has not really taken off yet; they’re still in discussion. At this moment, it’s all about gas. Gas is growing about 9 to 11% on an annual basis, which means we need to do a lot on the consumption side, and not only on the production side.

So, as for electricity, it goes to the committed contracts for the local industries. But that’s a small volume and we have to continue that because local industries have been set up dependent on gas. And if we don’t continue supplying them with the gas they need, they won’t grow, at least not steadily. It will have an impact on employment etc.

The third one is back again to the operators to enhance for recovery needs. They also use it for generating electricity within the concession blocks. And finally, for exports for Oman LNG. They’re steady. The oil producers are finding ways of reducing their gas demand. We are looking to generate electricity from solar power within the concession block. We release some of the gas that is currently utilized and genere electricity. We are collaborating with the Electricity Authority and the National Electricity Generation companies to try and make sure that the reserve generation capacity is reduced. If I don’t connect the two, then I don’t need to have as many contingencies available to the grid. That will create enhancement, and hopefully reduce the demand with gas. So that is happening.

The industry, with the exception of Duqm area, is steady. Of course we need to supply the Sohar refinery in order to execute their growth program. And that is happening. And then, on the supply side we are continuing to explore, although almost everything they produce is consumed on a daily basis. We hope that by 2018, the BP Khazzan Project will be on stream and that will allow for the upgrading of facilities if needs be, but will also give us a buffering case. We need to supply gas to any of our customers on a short-term basis and we have the capacity to do so. Our exploration program continues, we have not really slown down at all in that area, and there’s a very serious talk on potentially importing gas from our neighbouring countries, whether it’s for local consumption, as a gas or supply securities, or for export.

The bottom line is: you have another source of gas that can be used if needed.

What is the current production of gas?

We produce about 110 million cubic meters a day.

Can you tell us a little bit more about the progress of the BP Khazzan project?

It’s progressing quite well. I was on the field myself two weeks ago, and what I’ve seen on the ground is quite promising. I think the company is still on target to be on stream by 2017. I see no reason why we can’t. All the material they need is available, all the items have been ordered, and the workforce they need are already on the ground. They have re-designed the organization on the field so that they can focus on different activities and get them moving as fast as possible. So that is progressing quite well. By the end of 2017, I think the Khazzan Project will be on stream; that is expected to produce BCF 28 million. If you compare that to the previous numbers I gave you, that’s an additional 28 million cubic meters which then allow PDO to back off a bit.

Which is also similar to the amount you are expecting to get from the Iran-Oman gas pipeline?

Yes the Khazzan Project is well within our control. The Iranian Project requires further negotiation. We’re still not sure about the technical viability of the routes that arecurrently being surveyed and so on. But again, whilst that is progressing along it does have a different flavour. We know our activities and we can control and accelerate them; when we’re working with a third party, we need to find amicable terms between us so that we can work together, and I think it’s progressing quite well considering.

Are you making any progress in cutting down the flaring?

I don’t think we are flaring that much. It is very difficult to have a central installation for collecting the low crush in gas that otherwise would have been flared. The marginal cost today for collecting that gas, compressing it and adding it to the grid is quite high.

It is a balance: how much are we ready to invest in gas and to the molecules as opposed to accepting that there is a minimum that we just can’t do anything about?

I know technology is developing, companies are continuously challenging themselves and I know at least the 2 big projects that are happening now; one with CC Energy to catch all the gas from different bins, see if they can compress it, add it to grid or do something with it. The only challenge is: Can they assure the power operator that sustained level of production? And that is a challenge because they know their fields are not gassy. They have gas today but it is declining. But I’m not saying we don’t have a problem: we do. It’s just a question of is it commercial today to go and really catch every molecule of gas cause there is so much you can do, but this getting way too expensive for the price we can afford.

In terms of the oil and gas sector, what level of cooperation, partnership and investment do you have with US companies?

We do have US operators in the country. We have Occidental; they’ve been here for the last 30 years and they have major fields (block 9 and block 53). As an operator there, we do have small operators in the exploration block. A lot of technology provided is viable in the country. In terms of technology transfer, I think we have excellent relationships. Our market is open. We don’t look at the nationality of the company when other work is signed. We look at their technical capabilities. If we’re doing tight oil and gas, or fracking activities, we’ll always be looking at the US companies because there is a practical development involved and they are a practical example that we can go and look at. When we look at other services, the market is open for us.

If there was any specific message that you would like to convey to our audience what would it be?

The only message is that we are still open for business. We do have some open blocks: American, European companies, anyone for that matter. People who have a good track record and can improve our ability to develop in the oil and gas fields are more than welcome to knock at our doors. We are more than happy to have that dialogue. We’ve done it in the past and we’ll continue to do so. This is on the open blocks on the services.

Again, we’re developing our local content quite a lot and we’re pushing hard for that. But that doesn’t mean we’re pushing the international companies away; we want them to support the development of the local content, and partner with local providers to make their operations more efficient by being present in the country. In terms of oil & gas production, we’re going even harder at it; we‘re not slowing down but if a company is wanting to slow down then we’ll have that discussion and supplement the program; but we’re still determined that we will continue our development program of the oil and gas fields.