Energy in Saudi Arabia: A Kingdom Running on Empty?

Saudi Arabia has the world's largest crude reserves, and the kingdom's natural gas reserves are the fourth largest in the world at 267 trillion cubic feet. This should provide the country with a plentiful supply of fuel for its power stations, water desalination plants and petrochemicals facilities. So why, Saudi citizens might well wonder, are power generation plants frequently forced to shut down? Last summer, in fact, the state-owned power utility, Saudi Electricity Company (SEC), was forced to withhold electricity supplies for three-hour periods to industrial users south of Jeddah and elsewhere. The reality, experts say, is that Saudi authorities are struggling to keep up with increasing demand and strained capacity.

Last year, the country's installed electricity capacity was 39,242 megawatts (MW), leaving a reserve margin of around 3%, compared to a global average of at least 10%. And because electricity generation grew only 5.7% in 2008, the country's grid could not maintain supplies through the peak summer months, when air-conditioning demand tips the energy supply balance into the red.

Oil is partly to blame for Saudi's supply/demand woes. "The very fact that Saudi Arabia dominates the world's oil markets mitigates its ability to take advantage of its gas endowment," says Justin Dargin, a research fellow at Harvard University's Dubai Initiative (a joint venture between the Dubai School of Government and the John F. Kennedy School of Government). Saudis "have always tended to view gas as a useful by-product."

The problem could get worse before it gets better. The population is burgeoning — forecasted to increase between 2009 and 2011 by nearly two million people to reach 26.7 million. As a result, the number of smaller households and industrial users is increasing rapidly. The SEC predicts power demand will grow to 59,526 MW by 2015 from 41,043 MW in 2009, and then nearly double to 75,155 MW by 2020. Saudi Arabia's Electricity and Cogeneration Regulatory Authority says an additional 35,000 MW will be needed over the next 10 years to meet projected demand. Developing a nuclear energy industry could help, some experts say. But the more immediate solution lies in finding new ways to tap into the country's vast hydrocarbon wealth.

Pushing Industrialization

"There is now a much deeper focus on natural gas in the kingdom," says David Kirsch, Washington, D.C.-based director of market and country strategies at consultancy PFC Energy. "[Saudi authorities] have really started to push industrialization as part of a broader development drive. And this means natural gas is going up the value chain, with all the new industries being very [gas-intensive]."

Yet ramping up the gas supply is proving much easier said than done, particularly with consumption growing an average 7% a year. In March last year, demand for gas outstripped supply and the government was forced to import fuel oil to use as feedstock for its key power stations.
Other industries are equally gas-centric. The kingdom's impressive array of petrochemicals units are mainly reliant on ethane feedstock, traditionally supplied at subsidized rates that give local producers a significant cost advantage over international producers dependent on more expensive naphtha feedstock.

The country certainly has the means to address the shortfall. Much of its 2010 record-high budget of SR505 billion (US$135 billion) has been earmarked for the country's power and water sectors. Meanwhile, the Ministry of Electricity and Water expects investments of US$80 billion in electricity generation over the next 10 years.

Doing its part is a three-year program involving SEC, domestic private-sector firms as well as international corporations, including Korea Electric Power and Doosan Heavy Industries & Construction, both of South Korea; Japan's Tokyo Electric Power, Sumitomo, Marubeni and Mitsubishi; France's GDF Suez Energy and Alstom; and the UK's International Power. Of the program's eight projects, which aim to bring an additional 8,000 MW on stream, five are gas-fired, two are combined-cycle and one — the Shuaiba power plant due to begin operating in 2011 — is steam-generated. (Many of the expansions planned for between 2012 and 2016 will be steam-powered and will add 17,400 MW of capacity.)

Similarly, Saudi Aramco, the state energy giant, has put natural gas development center stage in its plans. To that end, it is managing a clutch of multi-billion dollar projects designed to boost natural gas processing capacity. On the projects' completion, the processing capacity will increase from 9.3 billion cubic feet a day (cf/d) of gas to 12.5 billion cf/d.

Crude Lessons

The primary motivation for increasing gas supplies is the kingdom's long-term strategy of weaning itself off its crude oil dependence, which has left the economy exposed to a fluctuating commodity that – while delivering strong export receipts in the past 10 years – has distorted the economy.

Yet as the Dubai Initiative's Dargin notes, it is still a substantial change for Saudi Arabia to go from thinking of itself as a crude oil exporter to a more gas-intensive, diversified industrial power. "If there is ever a contest between defending the international price of oil or supplying gas to the domestic market, the latter is always going to take a back seat," he says. "They haven't made the psychological transition yet."

In stark contrast, neighboring Qatar, which until the mid-1990s was widely known as a strong oil producer, has managed to make the shift. Targeting 77 million tons a year of liquefied natural gas exports by 2011, it has in the space of 10 years emerged as the world's biggest gas exporter. "Qatar made the decision to take the bull by the horns and instituted a major gas production strategy," says Dargin. "But while Qatar had no problem changing its psychological orientation from being an oil producer to a gas exporter, Saudi Arabia has still lagged."

The reluctance to reshape its energy industry and encourage gas production is evident in the heavily subsidized rates that consumers pay for gas. For example, Saudi Aramco supplies ethane to petrochemicals producers at US$0.75 per million BTUs (British Thermal Units, or mBtus), which is substantially less than, say, the US$3.5/mBtus most U.S. producers are currently paying. Because Saudi's domestic price does not cover the gas development costs of producers, there's little incentive to focus on exploration and production.

That reluctance also seems prevalent among the international oil companies. Since 2004, Shell, Lukoil, Eni, Repsol and Sinopec, among others, have been exploring the kingdom's vast Rub al-Khali area for gas. But they are not after gas-rich deposits. Rather, they are concentrating on so-called condensate-rich deposits — gas-based liquids that are sold on the international market. According to some observers, they have overlooked promising acreage because the high costs of extracting the gas would erode the rates of return on their investments.

It's particularly problematic given that much of the kingdom's undeveloped gas endowment is likely to be in the form of what's known in the industry as "tight" or "sour" gas, which is more costly to extract than conventional reserves. Saudi Arabia is said to have more than 10 trillion cubic feet of non-associated gas of high non-hydrocarbon composition (which, unlike associated gas, is not produced as a by-product of oil production and so is unaffected by OPEC oil output restrictions).

Moreover, the slowness to adopt a more commercial domestic gas-pricing regime reflects wider issues of the traditional social contract followed by the Gulf states. Citizens of Saudi Arabia and the five other members of the Gulf Cooperation Council have long enjoyed heavily subsidized energy, water and food prices — the primary way in which the countries' hydrocarbons wealth trickles through to the wider population. Many locals view cheap electricity and natural gas as a right every citizen should enjoy. Reforming gas prices could indeed challenge Saudi Arabia's stability. But, analysts say, it must be done to avoid stunting the kingdom's industrial development, and so that the rapidly growing population can have access to stable supplies of electricity. The upshot: "People are going to have to realize that electricity is going to cost money," says Dargin.

Fuelling Ambition

With no new ethane allocations forthcoming from the Saudi government since 2006, companies cannot be guaranteed dry gas feedstock. While the search for ethane is expected to continue, the emphasis should gradually switch to extracting more liquids via oil recovery and refining, notes a report published in August by SAMBA Group, a Saudi bank. This will rationalize gas demand in the petrochemicals sector and provide a measure of relief for a country struggling to secure gas supplies.

There's another reason for optimism. Under the leadership of Khalid al-Falih, CEO of Aramco since last year and a former head of its gas division, the company has become notably more focused on developing its gas endowment. In July, it asked contractors to submit bids for the Arabiyah gas development scheme in the Eastern Province, with a view to awarding the main construction packages by mid-2010. It also recently awarded three contracts to gather seismic data to identify fresh gas reserves in the Empty Quarter and the Red Sea. And in August, Aramco and Shell announced a discovery at the Kidan structure in the Rub al-Khali with an initial flow rate of 90 million cubic feet a day. The partners are now looking at developing Kidan, left untouched for decades due to its ultra-sour gas reserves.

As Aramco increases its focus upstream gas, more such discoveries are likely. "This isn't the first time [Aramco] has been looking for non-associated gas fields," says Kirsch of PFC Energy. "But it appears to be more of a concerted effort than in the past – and I wouldn't be surprised to see other sizeable discoveries in the next couple of years."

But the supply/demand situation remains on the edge, and it is not helped by the reduction in gas production required by OPEC's quota. Saudi Arabia slashed its crude production by two million barrels a day in 2008, in line with OPEC's strategy to maintain a floor price for oil in the face of a global slump in demand. With most of the country's gas produced as a by-product of oil, this has stemmed the flow of associated gas into the master gas system.

But without imported gas – an option that is politically unpalatable to Saudi authorities – the exploitation of a largely untapped gas reserve base will ultimately enable the kingdom to get a handle on its energy needs, experts say. That will inevitably lead to a reassessment of the country's domestic pricing structure and a psychological shift to Saudi viewing itself as a diversified industrial player capable of tapping its hydrocarbon wealth. Given the expected growth in consumption of both gas and electricity, doing nothing is a luxury Saudi policy makers don't have.

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