Recent high-level U.S. diplomatic activity seems aimed at addressing a sense of grievance Gulf capitals harbor.
The Gulf region is known for oil and gas resources that are easier and cheaper to develop than those in the rest of the world, which makes the success of Oman’s Khazzan gas field noteworthy. It is the largest hydraulic fracturing, or fracking, project outside of the United States, and has used U.S. methods of developing unconventional gas resources that have paid dividends for the sultanate. While most of the gas coming from Khazzan is consumed domestically, successful increases in production throughout the country have enabled Oman to export excess product in the form of liquefied natural gas. While the success of this project has very strong implications for the continuity of the shale revolution outside of the United States, a surge in gas production to the point of surplus has presented Oman with a unique puzzle. The country is now producing more gas than it ever expected to, but it must still ensure that its exports are marketed in a way that guarantees long-term profit against high production costs and an increasingly globalized gas market. To add to this challenge, the sultanate’s domestic gas demand has grown steeply for several years.
At 700 billion cubic meters, Oman’s reserves are among the smallest in the region. Despite its limited reserves, Oman still manages to export more LNG than the neighboring United Arab Emirates. And Oman, the UAE, and Qatar are the only Gulf states that export LNG. With 70% of its annual gas production allocated for domestic consumption, Oman was still able to export a record 10.4 million tons of LNG in 2018, a 21% increase from 2017. This process is managed by the majority government-owned Oman LNG, which operates three liquefaction and purification facilities, known as trains, near the coastal city of Sur. The Omani government owns 51% of the company, Shell Gas holds a 30% stake, and the remaining stakes are held by Total, Korea LNG, and several other Japanese firms including the Mitsubishi Corporation. Oman LNG also manages Qalhat LNG, which operates one of the three liquefaction trains at the facility near Sur.
Once exported, the vast majority of Oman’s LNG is destined for either South Korea or Japan. The largest purchaser of LNG from Oman is South Korea’s Korea Gas Corporation, or KOGAS, which has a 25-year contract with Oman LNG for 4 million tons per year. The expiration date of this contract may in part be because when Oman’s first LNG train was constructed, it was built with a 25-year lifespan based on the assumption that Omani gas supplies would be insufficient for LNG exports by then. Now that its gas industry has defied expectations, questions persist as to how this trajectory can be maintained.
Signed in 1996 and taking effect in 2000, Oman’s contract with KOGAS is set to expire in just over five years, with little clarity about prospects for renewal. Qalhat LNG’s three long-term contracts, which account for slightly more than 31% of gas exports, are all due to expire in 2024 or 2025. Overall, contracts for about 76% of Oman’s liquefaction capacity are all due to expire within the next five years. For now, it is still early to expect renewals, and Oman has managed some of its excess supply by selling LNG cargoes in the spot market (an agreement in which a buyer pays for immediate delivery, rather than through a long-term supply contract). Samer Mosis, a senior LNG analyst at S&P Global Platts, said that the sultanate should not rely solely or too heavily on spot trading, stating that “Oman has indicated that it is comfortable with spot trading, but in the long-term it will need to minimize spot market exposure if it wants to protect against the weak gas prices likely to hit markets in 2025.” He added that Oman’s fiscal position argues against a method of trading that is exceptionally vulnerable to periods of low prices. Although economic growth in the sultanate improved somewhat in 2018, government debt and spending levels remain high, highlighting the importance of a reliable stream of revenue from LNG imports.
In the near term, this may not be much cause for concern. Analysts expect existing customers to renew their contracts with Oman LNG, which may itself be holding out for better terms on renewals since the Asia-Pacific LNG market is currently oversupplied and prices are significantly reduced. If the LNG market starts to tighten in 2022-23, as Mosis expects, this may be a more opportune time for Oman to begin seeking long-term renewals or new customers. However, if this is the strategy Oman pursues, it may be affected by local competition from massive Qatari LNG expansion projects, as well as other new LNG projects elsewhere in the world.
With respect to South Korea and Japan, Oman’s two largest LNG customers, domestic developments are beginning to affect their demand for gas imports. In South Korea, two 1,400 megawatt nuclear reactors were added to the grid this year, which may place downward pressure on gas demand. KOGAS imported significantly reduced volumes of LNG between January and September. However, a more recent announcement concerning the shutdown of coal-fired power plants will create an energy supply gap that will more than likely be filled by gas imports if coal plants remain offline. Japan’s need for LNG surged when it took its own nuclear plants offline in the aftermath of the Fukushima disaster, but if plants receive safety upgrades and return to service, this may also temper the need for LNG imports. In Taiwan, which is another Omani LNG importer, the opposite dynamic may increase the need for gas as Taipei moves to phase out its nuclear power plants by 2025. While a tighter LNG market in this region may be highly competitive, Oman has well-established and positive trade relations with its more established customers and is generally seen as a reliable and cost competitive supplier.
Although Japan and South Korea are two of the top three LNG importers worldwide (the third is China), there are other areas of demand growth set to emerge in the near future. South Asia’s LNG demand is set to have higher short-term growth than China’s and presents Oman with a very plausible means of diversifying its customer base. Its exports have already penetrated the region, with more than 10% of Omani LNG exported to India and a modest amount exported to Pakistan. India is a mature market that currently meets half of its gas demand through LNG imports, and the market looks set to grow in the coming years. Consulting firm Wood Mackenzie expects India’s gas demand to reach 75 billion cubic meters by 2030, half of which will likely be represented by LNG. Pakistan recently withdrew a 10-year tender for LNG imports, but this development may have been the exception to the rule. Its oil consumption has decreased over the last several years, while natural gas consumption has only risen at a time when its domestic production has dropped.
While India’s and Pakistan’s demand for LNG may present more questions than answers in the short term, Bangladesh is a surefire opportunity for greater Omani penetration of the South Asian LNG market. The state-owned Petrobangla already has a long-term contract with Oman. Petrobangla also sources its LNG imports from Qatar, but with Bangladeshi demand projected to increase to 10 million tons within the next four years, its rapidly growing market may just be big enough for both Gulf exporters. Bangladesh currently uses two floating storage and regassification units and recently signed a memorandum of understanding with Saudi-based ACWA Power for a 3.6 gigawatt LNG-fueled power plant.
With a cautiously optimistic outlook for its gas exports, managing domestic gas consumption will also be an essential task. The Oman Power and Water Procurement Company plans to drastically increase its power generation capacity from 7.77 gigawatts to 11.7 gigawatts by 2023 to satisfy its projected peak demand growth of 6% each year until 2024. Almost all of Oman’s electricity is generated by natural gas, with a modest amount coming from recently developed renewable sources. As a result, domestic gas consumption will continue to grow at a steady pace. While gas shortfalls have previously been satisfied with imports from the Dolphin pipeline that originates in Qatar and runs through the UAE, this level of demand growth can potentially threaten Oman’s ability to sustain its current levels of LNG exports. As a result, the Omani government has a series of efforts underway to help offset rising gas demand. Surprisingly, this may include the use of coal for power generation in the Duqm special economic zone. Oman’s stated intent of boosting oil production to 1.1 million barrels per day by 2022 will likely result in increased associated gas production. Further development of the Khazzan field by BP is also expected to increase the field’s production by one-third. An ongoing debottleneckingroject by Oman LNG at its export facilities is also planned for completion by 2021, and the company claims this will boost its output by 10% to 11.5 million tons per year.
In the longer term, Oman plans to commercialize its gas surplus by other means. A gas-to-liquids plant, to be located in Duqm, is currently under development by Shell. The facility will be the third of its kind in the Gulf region, using a series of processes to convert natural gas to higher value products like gasoline, jet fuel, and diesel. To the north in Sohar, Total is working to develop a bunkering project that will allow Oman to capitalize on increases in demand for LNG as a marine fuel that may come as a result of International Maritime Organization regulations in 2020. Competition may emerge between Sohar and the UAE’s Fujairah, one of the most well-established bunker fuel hubs in the world. Oman’s gas surplus and nearby location may allow Sohar to emerge as a player in the LNG bunker fuel market when this form of gas demand increases.
These projects may provide alternate sources of revenue for Omani gas products, but the sultanate’s ability to continue to capitalize on its gas resources will ultimately still come from LNG export contracts. BP, which is heavily invested in Omani gas development, signed a 7-year contract with Oman LNG in 2018 for 1.1 million tons per year to its Singapore-based trading arm. Signing contracts with favorable pricing will be crucial for Oman, as the development and production of unconventional gas resources is expensive and the country does not have any domestic gas storage capacity.
In the future, Mosis suggested that Oman may be able to market its products to supermajors that will be able to profit from Omani LNG supply through their ability to optimize midstream processes, which is a strategy that Oman itself cannot copy since it does not ship LNG. In selling to portfolio players, like Shell, Oman would not bear the risk of finding an end user for its supplies. Mosis contends that this may not be the most profitable approach, but that it would be less risky than trying to sell volumes to end users on its own, especially if it wants to do so in spot markets.
Looking ahead, when and with whom Oman chooses to sign new supply contracts will be an item of great interest for market watchers. So long as the sultanate is able to manage its domestic gas consumption and sign favorable long-term supply contracts, it will continue to benefit from its modest levels of LNG exports. Yet in its current position, the Omani gas industry must accept a set of circumstances that require it to get up and run while it is still finding its feet.
Qatar’s emir has made a flurry of diplomatic visits to Iran, Turkey, the UAE, and Europe to bolster regional relations, energy cooperation, and the Iran nuclear deal.
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