The natural gas substitution: The Middle East's opportunity to replace Russian gas to the EU

Q4 2022 Al-Monitor PRO Trend Report

4070 words

Introduction

 

The European Union's attempts to hastily find alternatives to what it called the Kremlin’s “weaponization of supply” following Russia’s invasion of Ukraine, roll out the red carpet to Middle Eastern gas exporters to deepen their position in the world's largest trading bloc.

On Sept. 24-25, German Chancellor Olaf Scholz visited Saudi Arabia, the United Arab Emirates (UAE) and Qatar. An agreement was made to deliver 137,000 cubic meters of Emirati LNG to Germany in December 2022. But that is a drop in the ocean compared to what Germany received each day via the Nord Stream 1 pipeline — an undersea pipeline stretching from the Russian coast to north-east Germany — before the outbreak of the Ukraine war.

Europe is also turning to North Africa and the East Mediterranean to replace part of the large quantities of Russian gas it imported before the Russian gas tap was closed.

The region is relatively well positioned to take on at least part of the monumental task. In addition to their geographic proximity, the countries of North Africa as well as Israel have close commercial ties with Europe, significant gas reserves, and export infrastructure in place. They have also been eager to seize the opportunity to boost exports, which provide much-needed financial relief and could translate into long-awaited investments. But their spare capacity is limited, and how far they will be able to step in still remains to be seen.

 

1. MENA gas: state of play

 

North Africa’s leading player in the gas industry is Algeria, which holds around 2% of the world’s gas reserves. During the first half of 2022, the country’s gas production hit 52 billion cubic meters (bcm), according to the Joint Organizations Data Initiative (JODI). These volumes put Algeria on track to keep the record highs reached last year, when it exceeded for the first time the 100bcm, accounting for 2.5% of the global share, according to British oil and gas multinational BP’s last annual statistical review.

Gaining importance in the regional gas scheme, Egypt’s output reached 67.8bcm in 2021, according to BP, representing 1.7% of the world’s share and its best figure in a decade, pushed by the giant Zohr field. However, production has trended downward since August 2021, and during the first half of 2022 it fell by 3.5% to 33.5bcm, JODI data shows. To tackle its shrinking gas surplus, Cairo approved in August a raft of measures to cut domestic gas consumption, which last year exceeded 60bcm for the first time in 10 years.

In Israel, the region’s leading emerging player, overall gas production from the Tamar field and the giant Leviathan rose by 22% to 10.8bcm in the first six months of this year, according to the Ministry of Energy. Although this is a lower output than that of Algeria and Egypt, domestic gas consumption in Israel stood at 11.7bcm in 2021. The imminent start-up of the Karish field, in disputed waters with Lebanon, should ensure higher production.

The bad news in the region is the case of Libya. Although its gas reserves stand at 1,500 bcm, according to OPEC, the country’s political instability hinders the development of the sector, which is now barely able to meet its growing local demand.

The UAE’s output reached 57bcm in 2021, according to BP, representing 1.4% of the world’s share. The country holds the world’s seventh-largest proven reserves of natural gas at over 215 trillion cubic feet (Tcf), the US Energy Information Agency reports. However, in order to meet local demand, the UAE imports a third of its gas consumption from Qatar via an undersea pipeline. Much of the industry’s focus is now on starting production by 2025 of 80 Tcf of gas resources straddling the emirate of Abu Dhabi and Dubai and announced in 2020. In 2023, The Abu Dhabi National Oil Company plans to award a contract for a new LNG plant in Fujairah aimed at starting liquefaction for export by 2027.

Oman’s output reached 41,8 bcm in 2021, according to BP, representing 1% of the world’s share. Oman’s crude gas reserves stands at around 24 Tcf, the Ministry of Energy and Minerals (MEM) announced in June 2022. Its LNG exports, which started in the early 2000s, now account for about a quarter of government revenues. Following the death of its former Sultan, Qaboos bin Said Al Said in 2020, the country’s gas strategy has seen “a lot of continuity” under the new rule, said Robin Mills, CEO of Dubai-based energy consultancy Qamar Energy. “It is all very much along the trend of what was set.” In 2023, Oman state energy company OQ, together with Shell and TotalEnergies, will start developing Block 10 of the country’s Saih Rawl gas field which is expected to reach production of 0.5 billion standard cubic feet of gas per day.

Saudi Arabia is a sleepy gas giant. The Arab world’s largest economy does not export gas. In 2021, it consumed the totality of the 117.3 bcm it produced, including in oil and gas operations to enhance oil recovery. Gas output might have to rise by as much as 6.6% on average each year in the decade to 2030 to catch up with Saudi Arabia’s industrial development plans, and also because the country aims to reduce burning crude oil to generate electricity. Yet, the kingdom has the ambition to export gas for the first time in 2030.

In 2021, Kuwait imported 7.7bcm of gas on top of its local production of 17,4bcm to match its 25,1bcm demand. The emirate plans to increase gas output by 54% to one billion cubic feet per day. No timeframe was specified. “Kuwait has struggled to develop its gas resources while demand has grown very rapidly. They are getting increasingly short of gas,” Mills said.

Bahrain, which produced 17.2bcm of gas in 2021, plans to turn to natural gas imports from 2024 to meet rising local energy demand.

Home to the second largest gas reserves in the world, Iran is by far the biggest producer in the MENA region and ranks third globally after the US and Russia. According to BP data, Iran produced 257 bcm in 2021, of which 241.1 bcm were consumed locally. The largest part of its gas output is derived from the country’s South Pars field which is shares with Qatar spanning a surface area of 9,700 square kilometers in the Persian Sea (of which 3,700 square kilometers are in Iranian territorial waters). Despite its evident potential, Iran’s gas sector has been hindered by external sanctions and lingering talks over a nuclear deal to cap the country’s production capacity, depriving it of much-needed investment and know-how to support the industry’s growth. In July, the National Iranian Oil Company signed a Memorandum of Understanding worth $40 billion with Russia’s Gazprom to promote cooperation on a number of fronts including technological support, LNG development and pipeline construction. However, in an Al-Monitor PRO memo about the Iranian-Russian deal, Bijan Khajehpour, Managing Partner at Eurasian Nexus Partners, wrote that the aforementioned agreement “is not going to lead to massive Russian investments in the Iranian gas sector, but it has the potential to create paths of cooperation” between the two sanctioned governments.

2. MENA gas flows in 2022

 

Qatar, the world’s biggest LNG exporter in 2021, is “the only GCC country that has increased LNG shipments to Europe since the start of the year,” said Leo Kabouche, LNG Markets Analyst at Energy Aspects, a British energy market research firm.

Nevertheless, the majority of GCC gas still flows to Asia — 72% of Qatari cargoes in 2021 — where Qatar, the UAE and Oman can capture a “higher netback” due to lower freight costs, Kabouche told Al-Monitor, and because, unlike European countries, Asian importers agree on long-term contracts [about ten years+ commitments, Qatar aims at 15-20 years].

“GCC states are in a strong position,” summarized Mills. GCC states may not have significantly expanded their footprint in Europe; still, Qatar has cashed in on high gas prices when selling some cargoes in the spot market. 10-15% of Qatar's production can be diverted, the energy minister said in February.

Iran’s focus in terms of gas supply has continued to be on its domestic market and its traditional export partners, Turkey and Iraq, which absorb around 16 bcm of Iranian gas yearly. According to the National Iranian Gas Company, the country’s natural gas exports increased by 22% in the first half of 2022, though this increase is likely to be a reflection of higher gas prices as opposed to larger export volumes.

As for North Africa and East Mediterranean gas producers, European officials and representatives of gas giants have visited the region several times since the onset of the war in Ukraine to explore ways to boost exports. In mid-June, Israel and Egypt signed a three-year agreement with the EU to secure gas supplies. And Italy’s ENI, which is well placed to capitalize on North Africa’s untapped potential given its stronghold in the region, has signed agreements with Algeria and Egypt to maximize production and increase exports.

Since February, the most pronounced change has come from Egypt, which exports LNG. In 2021, the country exported 9bcm (1.7% of the world’s LNG), and over 70% headed to Asia, according to energy analysis firm MEES. During the first half of 2022, however, 65% of its exports, which have increased by 5% to 4.9bcm thanks to higher gas imports from Israel for re-export, went to Europe, MEES reported.

The country that has benefited the most from this general thirst for gas has nevertheless been Israel, whose exports –mainly to Egypt and to a lesser extent to Jordan– hit 4.6bcm during the first half of 2022, up 35% from the previous year. This significant increase is mainly the result of the reopening in March of a second gas pipeline to Egypt via Jordan.

Algeria has also seen a remarkable turnaround. In 2021, its gas exports hit 55bcm, an 11-year high, and 87.5% of its pipelined gas (38.9bcm) went to Spain and Italy, while 95% of its LNG (15.4bcm) headed to Europe, BP data shows. However, the renewed diplomatic spat with Morocco and Spain over Western Sahara has resulted in a drop of almost 40% in its gas exports to Spain between January and May, according to Energy Intelligence firm. And in this scenario, Italy is the best placed to increase its imports.

3. MENA gas: 2023 outlook

 

GCC states’ LNG exports in 2023 — expected to come in around 23-25% of the global LNG market — will be “close to 2022 levels,” Kabouche said, in line with other gas market analysts. “Export patterns will be very much of the same; there is no new capacity coming online,” said Mills, expecting greater capacities only by 2026-2027.

The key upstream story to follow in 2023 is European majors rushing in to expand production capacities. In September 2022, Italian major Eni held high-level talks with ADNOC to speed up gas projects and unlock UAE gas reserves, including at the world's largest offshore sour gas development. At the same time, French major TotalEnergies struck a deal in Oman to “unlock additional potential to meet domestic and export gas demand."

Economic headwinds will weigh on demand in 2023. The fight against inflation is likely to result in a global recession, which would have a knock-on effect on China and other Asian industrial powerhouses — the biggest buyers of GCC gas. Asia’s demand for gas, which doubled since 2005, is going to be “weaker” in the first half of 2023, said Rory Green, Chief China Economist and Head of Asia Research at TS Lombard, a macroeconomic forecasting consultancy. “Looking into 2024, the story is a bit more positive. We expect the worst of the recession to be behind us and gas demand to return to basically normal levels as growth returns to trend,” Green told Al-Monitor.

Long-term Iranian gas prospects linked to fate of nuclear talks. Either way, Iran has little to offer in the way of gas exports in the immediate-term compared to other regional piers, given that it consumes most of what it produces. Of the 257 bcm produced in 2021, 241.1 bcm were consumed locally. What’s more, Iran lacks the necessary infrastructure to be able to export gas to Europe in the near future. Considering the limitations faced by Iran, “one should not view Iranian gas as a likely replacement for Russian gas exports to the European Union in the immediate term,” wrote Khajehpour in a separate Al-Monitor PRO memo published in July.

No major increase expected in North African and Israeli gas supply. Most experts agree that in the short-term it will be hard for North Africa and Israel to substantially increase gas supplies for two main reasons. The region’s exports to the EU in 2021, of just over 55bcm, were the highest since 2014, according to MEES, and there is no significant spare capacity. Also, rising local consumption, especially in Egypt, Algeria and Libya, limits their capacity to boost exports, as do continued political instability in Libya and a general lack of investment.

Gina Cohen, a consultant in Israel and Palestine’s gas markets, said that Israel will be able to keep its export volumes during the second half of 2022, up to at least 7bcm by the end of the year. She said that in 2023 the figure could rise to 10bcm considering the infrastructure in place.

Peter Stevenson, the Eastern Mediterranean editor at MEES, said that Egypt will most likely continue to send most of its LNG cargoes to Europe in the short-term. “The majority of Egypt’s LNG cargoes are sold on the spot market. So, as long as European countries are willing to outbid those from other regions, mainly Asia, then that’s where the majority will head to.”

Algeria signed an agreement with ENI in April to increase exports to Italy through the TransMed pipeline up to 9bcm in 2023-2014. But Tom Pepper, Energy Intelligence’s North African and East Mediterranean expert, said the country will probably be able to increase its supply to Italy by just about 2-3bcm or 3-4bcm in the short-term, while it holds volume and pricing talks with Spain. “There is a commitment to send more gas to Italy. Italy has prioritized Algeria a lot over the last few months, and ENI’s position there is strong,” he said.

 

4. Case Study: Qatar expansion project

 

Qatar's LNG business is already massive by any GCC standards — 7,5 times more than the GCC's second largest exporter, Oman. But the country plans a mammoth expansion to further leverage its expertise in gas markets and existing infrastructure and capitalize on its low production costs and location between Europe and Asia. By 2027, Qatar plans to pump out 126 million tons of LNG yearly, about two-thirds more gas than current levels, which have barely risen since 2013. The expansion’s first phase, called North Field East, will take the country’s production to 110 million tons of LNG yearly, before the second phase, called North Field South, takes it to 126.

To that end, European majors are stepping in to boost LNG production. On Sept. 24, 2022, French energy firm, TotalEnergies, took a 9,4% stake in the North Field South project. Earlier this year, it acquired a minority 6.25% stake in North Field East, a separate $29 billion gas project. QatarEnergy said more partnerships would be announced later. “Our view is that approximately after we finish all of our gas investments, we will have about half of our markets in Asia and half in Europe. This is what we aspire to in the future,” QatarEnergy CEO Saad al-Kaabi told ratings agency S&P Global in June 2022.

“When Qatar floated the idea some years ago of a massive expansion of their capacity, there was some debate about whether there would be enough demand for such volumes. I think that question is no longer an issue,” said Tilak Doshi, an independent energy analyst with previous work experience at Saudi Aramco and Saudi energy think tank King Abdullah Petroleum Studies and Research Center (KAPSARC). Following Russia’s military invasion of Ukraine and sanctions on Moscow, Qatar is “in the driver seat,” Doshi told Al-Monitor.

Besides investments at home to boost production, QatarEnergy executives are looking to ink new long-term contracts — the cornerstone of Qatar’s LNG strategy. Qatar locks in future demand by encouraging the deployment of LNG infrastructure, like in cash-strapped Pakistan — Asia’s sixth largest gas consumer — where it is in talks to invest in a $500 million LNG terminal near Karachi.

Qatar's expansion project is likely to heighten competition between Gulf states to strike long-term LNG deals with Asian nations. Ian Nathan is Head of LNG research at Energy Intelligence, a US-based provider of energy analysis. He told Al-Monitor that projected long-term demand for LNG in Asia suggests that the market will be “large enough for all sellers to have an opportunity to conclude long-term deals for either existing volumes or capacity under development.” He added, however: “that does not mean that sellers will not need to compete to provide attractive pricing and delivery terms.” GCC’s maturing gas markets would also see greater competition at home. For example, the Omani port of Sohar plans to compete on selling LNG as a marine fuel with the Emirati port of Fujairah, the world’s third largest bunkering hub.

“Qatar can assist China in diversifying long-term supply and thereby mitigate the geopolitical risks associated with overreliance on US-origin and Australia-origin cargoes,” John Calabrese, a professor of US foreign policy at the American University in Washington, wrote in an August 2022 report. Qatar and other Gulf states have been the United States’ closest allies in the Arab world for decades, but times are changing. More assertive GCC governments forge increasingly visible ties with Russia and China in a push to position the energy-rich region as a chess master of a multipolar world. The implications for LNG? A risk of seeing politics meddle with GCC-China growing LNG ties. Chinese state-owned majors China National Petroleum Corp. and Sinopec are reportedly in talks to invest in the North Field East project and procure LNG under long-term contracts.

5. Key takeaways

 

⮕The share of Middle Eastern gas in the European energy mix is likely to be capped as European nations might look to avoid repeating the same strategic error. On Sept. 25, German Chancellor Olaf Scholz said getting hooked too tight to a sole energy producer “will certainly not happen again.”

⮕Europe gas security would be greater with “closer coordination” of purchase from global LNG markets, S&P Global Ratings believes. But unlike Asia, the bloc is reluctant to commit to signing long-term contracts as it looks to transition to a power generation mix dominated by renewables and nuclear.

⮕The deployment of renewables, including grid-scale batteries, locks in the risk of a shift away from gas, particularly if awareness rises on the climate cost of methane. The greenhouse gas is natural gas’ largest component and shares a 30% responsibility in the rise of global temperatures since the Industrial Revolution. Gas producers pledged to reduce methane leaking in their operation and to ship net-zero gas cargoes.

⮕Still, demand remains on an upward trend. Gas analysts at US-based brokerage firm Sanford C. Bernstein & Co forecasted global LNG demand to increase by 55% from current levels by 2030. Mills believes GCC LNG has “decades worth of opportunity” in Asia. As the global race to net zero hastens, gas is likely to displace coal — a climate killer — in most Asian economies.

⮕Looking beyond 2024, Green from TS Lombard said the growth rate of Asia’s main locomotive, China, is in “terminal decline,” led by the “collapse” of the property sector. “Long-term, we will start revising down China's commodity consumption forecast,” he added. Furthermore, discounted Russian gas could start to flow eastward and take over GCC gas in China — Moscow looks to Beijing to replace Europe as its major gas customer.

⮕Population and economic growth increased gas demand in GCC countries by 290% between 1990 and 2019, but production surged nearly twice as much. Going forward, maintaining gas exports at current levels would require production to play perpetual catch-up with surging local demand — Saudi capital Riyadh aims to more than double its population by 2030 and boost economic growth — or to free up more gas for export.

⮕Despite boasting some of the world’s largest reserves, Iran is unlikely to play a key role in the gas export landscape in the short-term, as it chronically lacks the required infrastructure and know-how to do so. Iran has no pipeline connecting it to Europe nor any established LNG capacity that would enable it to ship LNG cargoes to the bloc and other parts of the world. According to Khajehpour, the sector requires some $80 billion in investment over the next decade which is likely to prove challenging under current circumstances. Even if and once sanctions are lifted, Iran may continue to be perceived as risky territory for Western oil and gas majors to venture into. An immediate post-sanctions boom is unlikely. It is also worth noting that any attempt to increase gas export will require an increase in output, as Iran currently consumes around 90% of what it produces. Alternatively, Iran could opt to reduce domestic consumption by distributing liquids to the local industry, for example, which could free up some gas for export. Finally, markets where it would make sense for Iran to penetrate in the aftermath of sanctions include gas-based industries such as petrochemicals, steel and aluminum. “In these areas, Iran has the capacity to export,” said Khajehpour.

⮕Long-term prospects in North Africa and Israel remain contingent on new discoveries and investment. Considering the current situation in the region, most experts agree that, in the long term, any significant increase in production and exports will require stability, new discoveries, investments in infrastructure, and reductions in local consumption.

⮕Israel has large gas reserves waiting to be exploited, such as the Phase-2 expansion of the giant Leviathan, which could double its production at the field. But Cohen said that Israel is still tied by a limited export infrastructure. “In order to bring bigger quantities, one needs to build infrastructure. And this takes time, costs money, needs security, and [needs] the security of a buyer,” she said. And added, “We have to move from the stage of talking, ongoing for some years, and try and make something happen. If not, we risk wasting the window.”

The options to boost Israeli exports in the long term are either to increase capacity at one of Egypt’s LNG plants and link it to an Israeli field through a pipeline, or to use a floating liquefied natural gas (FLNG) facility. Stevenson said that Leviathan’s field operator Chevron is still hesitating and has to make a decision. Other options seem to be ruled out for now.

⮕Without any new discoveries it will be hard for Egypt to keep its production and reverse its downward trend. Hopes are pinned on new explorations, but Stevenson believes that in any case it will be a while before Egypt’s overall gas output rises above 7bcf/d as it did in September 2021. “Unless some drillings find some big, Zohr-style fields, Egypt’s gas production is set to deplete,” Pepper warned.

⮕Algeria to struggle without E&P partners. Question marks over its supply-demand balance also loom over Algeria in the long term unless the situation is reversed, Pepper said. Among the country’s options are the development of renewables to reduce domestic gas consumption, and above all improvements in its dense bureaucracy, slow decision making, and uncompetitive fiscal terms to favor investments in exploration and infrastructure. “The geology is known to Europeans, and Sonatrach has more discoveries. But it doesn’t have enough funds to develop them; it cannot develop alone all the future and current discoveries [and the] recoveries it may want to pursue,” he noted.

⮕Lebanon could benefit long-term if it reaches a final agreement with Israel on their disputed maritime border in the eastern Mediterranean. A US-mediated draft agreement surfaced last week that would give Lebanon the entirety of the disputed zone in exchange for paying royalties to Israel on any gas extracted. However, the deal hit another roadblock Oct. 6 when Israel reportedly rejected Lebanon’s amendments to the US proposal. Even if Lebanon were to make a deal with Israel, it would take the country several years to start pumping gas. Israel made its first significant discovery in the Tamar field in 2009, and began producing gas from there in 2013. Unlike Israel, Lebanon is contending with an economic crisis, widespread corruption, poor infrastructure and political paralysis. It could be some time before Lebanon benefits from the natural gas off its coast.