Kingdom's Continued Investment in Gas Gives Steady Rise in Output

by shariff mohammed | Dec 04, 2016

Whilst a steady supply of gas is expected to come online between now and 2020, it seems the greater challenge in exploiting gas will occur in the decade after. Considering the vast reserves of unconventional gas in the Kingdom, according to the report by Jadwa Research 'Natural Gas and the Vision 2030'.

Saudi Arabia holds the world’s sixth largest proven gas reserves and was the seventh largest producer of gas in 2015. Continued investment in gas has resulted in steadily rising output over the years, with a sizable ramp up in production in the last decade. Despite this, gas consumption has grown as fast as production. Competing demands, primarily from two sectors, petrochemicals and electricity generation, has meant the Kingdom has consistently consumed all its gas.

Looking ahead, the pace of growth in Saudi gas demand is not likely to ease. Total electricity consumption will be pushed up by industrial development, in line with the Vision 2030, and rising population levels. Concurrently, the petrochemical sector, identified by the Vision to help increase the Kingdom’s non-oil exports, will see further capacity expansion.

Accordingly, Saudi Arabia will need to grow gas output by an annual average rate of either 3.7 percent, in the base case scenario, or 6.6 percent, in the high case scenario, in the decade to 2030. We also calculate that the government could save $71 for every barrel of crude oil substituted by a barrel of equivalent of gas in electricity generation in 2030.

Whilst a steady supply of gas is expected to come online between now and 2020, the greater challenge in exploiting gas will occur in the decade after. Due to the complicated geology of newer gas fields, the cost of developing such resources is likely to be higher than in the past.

Nevertheless, we see the centrality of gas in the Vision 2030, and the unsustainable and costly alternative of using crude oil in electricity generation, as ensuring development is prioritized to meet demand in 2030.

Overview

Due to the prominent role that Saudi crude oil plays in both the domestic and global economy, the importance of the Kingdom’s gas sector has perhaps been overshadowed in the past. Despite this, Saudi Arabia holds the world’s sixth largest proven gas reserves and was the seventh largest producer of gas in the world in 2015. The last decade has seen sizable investment in the Saudi gas sector resulting in a 47 percent ramp up in production since 2005, reaching 11.6 billion cubic feet per day (bcf/d) in 2015.

This steep rise in gas output has not been enough to satisfy domestic demand as consumption has risen just as rapidly as production has in the last ten years. Competing demands, primarily from two sectors, petrochemicals and electricity generation, has meant the Kingdom has consistently consumed all its gas. The apparent shortfall of gas in Saudi Arabia is evidenced by the seasonally observed rise in direct crude burn for electricity generation during the sweltering summer months, which, on an energy equivalent basis, is much more expensive than using gas. Also, whilst petrochemical capacity has also increased rapidly in the last few years, ethane supply, the main source of current Saudi feedstock, naturally found in associated gas, has not.

The need to cater for increasing electricity (power) demand as well as rising petrochemical capacity in the years ahead means gas is likely to play a crucial role in the Saudi economy. This fact has not been lost to Saudi policy makers with gas development being targeted in both the National Transformation Program (NTP 2020) and the Saudi Vision 2030. Furthermore, in light of more recent comments from the Saudi Energy Minister, it seems that previous renewable energy targets are likely to be scaled back, which puts the emphasis on gas playing an even larger role in the Saudi economy.

Gas in the Kingdom

Production:

Saudi Arabia produced very little of gas prior to the 1980’s. This changed dramatically once the government invested in gas infrastructure in order to utilize previously flared associated gas from crude oil production. Continued investment saw gas output steadily rising, but the decade to 2015 has witnessed a more rapid rise in production. Between 2005 and 2015, raw gas output rose by 47 percent to 11.6 bcf/d in 2015, which, after processing, produced 8 bcf/d of consumable sales gas.

More than two thirds of the Kingdom’s sales gas is derived from the Ghawar field which yields both associated gas, a byproduct in the production of crude oil, and non-associated gas. Karan, Saudi Arabia’s first off-shore non-associated gas field, which hit peak production in 2012, is another large contributor. Due to historically higher proportion of associated gas in Saudi production, any decision to raise or lower crude oil production, in the past, would have had an impact on gas output. This relationship has now become weaker as a result of investment in the development of non-associated gas fields, especially so in the last decade. In 2005,around 42 percent of gas output in the Kingdom was associated gas.

In 2015, associated gas made up a third of total sales gas output. The Kingdom’s focus on non-associated gas was recently highlighted by two major gas field developments. The Hasbah and Arabiyah gas fields, which reached full capacity in mid-2016, have added 1.7 bcf/d of non-associated sales gas, with further non associated fields expected to follow. Despite this, associated gas in the Kingdom has been an important asset for the development of the native Saudi petrochemical sector, since it is extracted alongside crude oil, at a very low cost, and yields ethane, which is a key feed stock used in the industry. In 2015, Saudi Arabia produced 0.8 bcf/d of ethane gas but limited growth of associated gas in the recent past has resulted in flatter output of the feed stock. Ethane is one of a number of natural gas liquids (NGLs) produced in Saudi Arabia. Other more prominent NGLs include propane and butane, both of which are referred to as liquid petroleum gas’ (LPGs) and can also be used as feed stock for petrochemicals.


Rising population levels and industrial growth have also put pressure on electricity demand in the Kingdom. Energy sales of electricity have increased by 85 percent in the last decade and even with a rapid rise in gas output it has not been enough to cover the production of rising electricity demand. The apparent shortfall of gas in Saudi Arabia is evidenced by the seasonally observed rise in direct crude burn for electricity generation during the summer months. In the last decade, direct crude burn during the summer has, on average, increased by 50 percent when compared to the rest of the year. The burning of crude oil presents an obvious opportunity cost when considering the revenue lost from consuming a barrel of oil which would otherwise have been exported. Jadwa Investment calculates that the Saudi crude export price averaged $36 per barrel (pb) in H1 2016, whilst the cost of selling crude oil domestically is around $5 pb. Therefore, each barrel of oil consumed and not exported results in $31 pb loss in export revenue.

natural gas (LNG) terminals, in order to convert natural gas to liquid for exporting via ships, requires a huge amount of capital expenditure. Secondly, due to the fragmented nature of gas markets and the way gas contracts are formulated, the price of gas, on an equivalent basis, is always lower than the price of oil. For example, gas prices averaged $12 barrel of oil equivalent (boe) in the US and $29 boe in Asia versus the Saudi crude export price of $36 pb in H1 2016. Both these factors therefore make gas more attractive as a substitute for higher internationally priced crude oil in domestic Saudi consumption.

The price at which gas is sold domestically in Saudi Arabia is one of the lowest in the world. Natural gas is priced at $1.25 per million British thermal units (mmBtu), whilst ethane is fixed slightly higher, at $1.75 mmBtu. The price of both fuels was increased at the start of 2016 from $0.75 mmBtu previously. Even at these higher prices, Saudi gas is still approximately 50 percent cheaper than current US spot market prices and a significant 400 percent below spot prices in Asia. Considering gas consumption makes up around 38 percent of total domestic energy consumption in Saudi Arabia, the current pricing set-up represents a sizable discount.

Vision 2030 and natural gas

The need to cater for increasing power demand as well as rising petrochemical capacity in the years ahead means gas is likely to play a crucial role in the Saudi economy. This fact has not been lost to Saudi policy makers with gas development being targeted in both the NTP and Saudi Vision 2030. The NTP specifically refers to raw gas expansion, with production capacity targeted to rise from 12 bcf/ d currently to 17.8 bcf/d by 2020. The NTP goes on to state that this will be done through increasing ‘the volume of gas supplies through the development of exploration and reserves activities’. Whilst gas is not explicitly mentioned in the Vision 2030, it is nevertheless relevant to the other targets stated within it. Aside from fulfilling the Vision’s objective of ‘enhancing the competitiveness of the energy sector’, gas will also be a vital ingredient in helping diversify the economy through the development of industrial sectors, specifically mining and petrochemicals. Furthermore, in light of more recent comments from the Saudi Energy Minister, it seems that previous renewable energy targets are likely to be scaled back, which puts the emphasis on gas having an even larger role in the Saudi economy.

Petrochemicals:

The petrochemical industry is a key pillar of the Saudi economy, which is evident through its contribution to Saudi non-oil exports. In value terms, chemical and plastic (petrochemical) exports from Saudi Arabia amounted to $30 billion (SR115 billion) in 2015, comprising a substantial 60 percent share of total non-oil exports, similar to levels over the last 25 years. The prominent role of petrochemicals in the non-oil economy means it has been identified in both the NTP and Vision 2030 as one of the sectors to lead the continued push for diversification away from fossil fuel reliance. It is for exactly this reason that the Royal Commission for Jubail and Yanbu (RCJY), (set up in 1975 to ‘plan, promote, develop and manage petrochemicals and energy intensive industrial cities’) has the second highest cost borne by government for implemented initiatives under the NTP (SR41.6 billion). Accordingly, the RCJY has been set some major targets for 2020, which includes reaching an overall growth in revenue of 93 percent come 2020. In addition, petrochemicals is also one of the sectors identified by the Vision to help push the Kingdom’s non-oil export target up from 16 percent of GDP, currently, to 50 percent of GDP by 2030.


Outlook

Whilst a steady supply of gas is expected to come online between now and 2020, it seems the greater challenge in exploiting gas will occur in the decade after. Considering the vast reserves of unconventional gas in the Kingdom, we expect the majority of additional supply from 2020 onwards, up to 14 bcf/d according to our high case scenario, will come from shale or tight gas. Of course, Saudi Arabia's prospects in developing these sources will depend on the development of technology that allows effective and efficient fracking of unconventional gas and also addresses the challenges related to water scarcity issues. Some of these issues are currently being looked into, for example, using LPG and/or carbon dioxide rather than water in fracking. Also, a part of the $334bn 10 year investment plan, announced by Aramco in September 2016, will focus on research and development in order to specifically address such challenges, in addition to boosting exploration and development. Meanwhile, logistical challenges associated with transporting gas from the East to the West of the Kingdom will no doubt add to overall development costs. Meanwhile, an effective reform of energy prices would help facilitate a more rapid exploitation of gas resources, minimize losses in government revenue and, at the same, increase efficiency in consumption.

Overall, we believe both the centrality of gas in the Vision, and the unsustainable and costly alternative of using crude oil, will ensure that its development will continue to be prioritized in order to meet gas demand come 2030.



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