sharing in governance of extractive industries

Lebanon's new gas contract: everyone just take a breath!

The news that Lebanon had finally signed a contract for gas exploration in its offshore has set off a flurry of speculation in national and international media. A leading bank in the country produced a report suggesting the government could earn up to $200 billion in revenues from the deal, turn the public deficit into a surplus within five years, and all but eliminate the country’s debt in the long term.

Meanwhile the Gulf News carried a report including quotes from a consultant that domestic consumption of gas could cut fuel bills by $1.5 to $2 billion a year.

While it is not impossible that gas finds could prove transformative, there are so many large uncertainties – in scale, timeline, and even if there is any exploitable resource at all – that there is a serious risk of unrealistic expectations, which could in turn lead to misjudged policy.

OpenOil will publish a full financial model of the deal signed by the Lebanese government with Total, Eni and the Russian firm Novatek in Blocks 4 and 9 in April, as part of our ongoing commitment to create a library of full financial models of oil and mining projects. In the meantime, here are some preliminary observations, based on commercial analysis and an early draft of the model, on some of the predictions made so far.

As far as the Bank Audi predictions – of $400 billion in revenues, of which the government would see half.

·       It seems to be based on a misunderstanding of technical standards for evaluating oil and gas assets. The report speaks in terms of “reserves” of 865 million barrels of oil, and 96 trillion cubic feet of gas. Lebanon currently has no reserves under industry definition, since these need to be confirmed by first drilling, and then a detailed investment plan showing commerciality. Pre-drilling, putative amounts of oil and gas are normally classified as “prospective resources” and considered highly speculative by industry. To put this in context, the ratio between prospective resources and actually produced oil is frequently greater than 10 to 1. So this could be an overestimate of as much as 1,000 percent – assuming any gas is found at all.

·       The agreement is only for two of Lebanon’s ten blocks, whereas the report states the estimates for all Lebanese waters.

·       The chance of drilling converting preliminary estimates from seismic studies into producible oil and gas is known as the “chance of success” (CoS). Industry typically uses a CoS of 10% to 20%, though there may be some reason to place the confidence somewhat higher in this case. So it is far from certain that there is anything producible at all.

·       Bank Audi states that the assumption of turnover is based on current prices. First, this is unstable as the markets are continuously volatile. Second, gas in particular has no global market price so valuation depends on which market it is assumed Lebanese gas would supply.

·       In terms of debt servicing any reasonable time frame for development of the field would not see sizeable production, and therefore revenues, until the late 2020s. The level of discounting then required on future revenue predictions is going to be considerable to assess what the deal is worth in today’s money – “Net Present Value”. Meanwhile, presumably existing debt accumulates compounded interest.

In terms of general economic knock-on – cheaper fuel available to the domestic economy – it requires an entire chain of optimistic assumptions to reach the level of savings discussed, in the $1.5 billion a year range. Production would need to reach nearly a trillion feet a year, all of it allocated domestically, prices the same as now in European markets, and the use of gas to be 50% more efficient in generating power.

To put this in perspective, Eni describes the Zohr field in the Egyptian Mediterranean as a “super giant”, with 25 trillion cubic feet.

Separate to the question of what level of resource may be found, and what extraction costs would be, two other key factors have yet to be addressed, transport infrastructure and sales agreements. Whether pipeline or LNG, for domestic or international use, infrastructure to bring the gas to market will clearly cost billions of dollars, and if there are discoveries there will be a complex series of calculations around what level of production can support what kind of infrastructure. Also, for gas companies typically need to secure baseline sales agreements – “term contracts” – before they begin development, to reduce risk from future volatility and assure a minimum return on capital.

More detailed results will come with the model. But it is essential that a sober view is maintained. Lebanon is several large leaps away from any gas discoveries – which have yet to be made – solving the issue of its public debt, or even providing a “soft landing” for its economy, and no public policy should be made on that basis.

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