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Natural gas is emerging as a strategic resource for the sultanate and the government may need to do some tightrope walking to meet future demand. Mayank Singh reports

It's 2am and a sleepy silence pervades the neighbourhood of Oman Gas Company's (OGC) headquarters in Al Khuwayr, Muscat. Inside the building Sultan Mohammed al Waily, gas controller, OGC, sits in the high security SCADA (real time pipeline management system) room looking at three 19-inch monitors oblivious to the desolation outside. His gaze is focused on the screens showing natural gas pipelines in red, blue and yellow colours crisscrossing the length and breadth of the sultanate, akin to the arteries of a human body. The comparison seems apt, as these gas pipelines are as vital for the sultanate. Natural gas is the energy source which helps power plants like Rusayl, Barka and Manah generate electricity. Desalination plants from Muscat to Salalah run on this hydrocarbon resource. Industrial units from Sohar Aluminium to Oman India Fertiliser Company (OMIFCO) will use gas as an integral livestock. And finally, Petroleum Development Oman (PDO) uses gas in its upstream operations to push up oil as part of its enhanced oil recovery (EOR) programme.

The importance of natural gas as a hydrocarbon source can hardly be overstated. Though it would be foolish to underestimate the importance of oil in the development of the country, experts believe that gas as an energy resource may henceforth be far more critical to the sultanate than its illustrious predecessor. Says Adel Abdullah al Raisi, advisor to the Ministry of National Economy for gas affairs, "Oil will continue to have a cash generating role, but gas will be the backbone of the industrial sector." Realising the importance of this energy resource, the Ministry of Finance has earmarked US$5bn for the exploration and production of natural gas during the Seventh Five Year Plan (2007-2011).

The gas table

Where does Oman stand in the league of gas producing nations? The sultanate is the fourth largest producer of gas in the Middle East after Saudi Arabia, Qatar and the UAE. At the end of 2006 its proven gas reserves stood at 35.6 tcf (trillion cubic feet). The year also saw the country's gas production increase by 27 per cent to touch 25.1bcm (billion cubic metres). If things work to plan, by 2008 gas will account for 40 per cent of the hydrocarbon production of the sultanate. Unlike oil, which has a history that dates back to the 1860s, the use of gas gained traction in the late '80s owing to a spurt in demand from Asian countries like Japan and Korea. Though a young industry, the success of gas has been nothing but meteoric. Says Brian Buckley, general manager and chief executive, Oman LNG, "The worldwide demand for gas is over twice the demand for oil." According to the estimates given by the Energy Information Administration of the US government, the worldwide consumption of natural gas will increase from 100tcf in 2004 to 163tcf in 2030. The projected increase in gas consumption over the period is second only to coal.

The energy resource has a number of factors working for it. It is seen as a green fuel compared to other fossil fuels like coal or oil due to its low pollution levels. Second, it is much more efficient and cost effective in operations. Says Kevin Donaldson, member, Ernst & Young Oil and Gas Centre, London, "Countries like Spain and Brazil which depend heavily on hydro-based power have been turning to gas as a result of changing weather patterns and large gas consuming markets of North America and the UK have become net importers." Technology breakthroughs like liquified natural gas (LNG) have enabled the transportation of gas over large distances creating new demand centres like China and India. When natural gas is cooled to minus 160 degrees, it liquifies into LNG. The process helps to compress its size by a factor of 600 making its transportation economical. At its final port, LNG can be regassified to its original size and used for industrial purposes. "Gas demand will continue to grow driven by clean fuel agendas and technology trends," says Donaldson.

LNG quadrant

Oman has been farsighted in recognising the potential of LNG as a revenue generator. It has put in place an enviable infrastructure to process and transport gas. The sultanate has three LNG trains in place. Oman LNG, the first amongst these, is a joint venture between the government of Oman, Shell, Total and Pratex. The company was established in 1998 and shipped its first cargo to Korean Gas Company in 2000. "Oman LNG was the fastest LNG project in the world," says Khalifa al Hinai, technical advisor to the minister, Ministry of Oil and Gas. The project also created a record of sorts for Oman as it exported its first gas-based cargo in just nine years since the discovery of natural gas at Saih Rawl in Central Oman in 1991.

The success of the project and increased demand from customers saw Oman LNG commissioning a second train in the same year. The two trains produce up to 6.6mmts (million metric tonnes) of LNG a year. This was followed by the third LNG train – Qalhat LNG, which was incorporated in March 2003. The company is a closed joint-stock company owned by the government of Oman, Oman LNG and Union Fenosa Gas of Spain. The plant has a capacity to produce 3.7mmts per annum of LNG. The Qalhat LNG train is located adjacent to the two identical trains of Oman LNG at Qalhat, and the two companies share certain common facilities. Oman LNG operates the third train on behalf of Qalhat LNG as an integrated plant while optimising the operation and efficiency of the complex. The three trains together give the country a combined LNG capacity of over 10mmts per annum.

Despite being a variant of natural gas, the trade in LNG is markedly different from oil. While oil is explored, produced and then marketed, contracts to sell LNG are front-ended – companies producing LNG secure long-term contracts with customers before a project goes upstream. Oman LNG has three long-term customers: Korea Gas Corporation (Kogas), Osaka Gas of Japan and Itochu, a Japanese utility company. The three of them have committed to purchase the plant's entire output for 25 years (till 2025). Similarly, Qalhat LNG has a 20-year sale and purchase agreement (SPA) with Spain's Union Fenosa Gas, a 17-year agreement with Osaka Gas and a 15-year one with Mitsubishi.

The biggest reason for this is that extraction and delivery of natural gas is far more expensive than oil. Says Buckley, "An LNG plant costs close to US$1bn. Add to this the cost of acquiring LNG vessels and the need for storage and regassification facilities at the final port. Given this, one would like to have buyers before committing investments." Oman LNG cost US$2bn while another US$700mn went into Qalhat LNG. The average cost of an LNG vessel ranges between US$300mn and US$500mn. Given such numbers, companies cannot be faulted for looking for buyers who can put cash on the table. In addition, financial institutions and banks ask for long-term contracts before giving out loans for LNG plants.

At a macro level, the market for oil is far more evolved than the market for gas. For example, the spot market for oil is more sophisticated than LNG. Crude oil is one of the world's most actively traded commodities. The New York Mercantile Exchange (NYMEX) division light sweet crude oil futures contract is the world's most liquid form of oil trading. Second, crude oil price benchmarks like West Texas Intermediate, Brent Crude and Dubai Crude have been around since mid-80s. Compared to this, the price of gas varies depending on a country's location and customer type. North America gas prices are based on Henry Hub prices, Canada uses the ACEO-C hub in southeast Alberta for pricing gas, while Europe follows the Heren Index or the Zeebruge Hub (Belgium) prices. The Far East has no hub and follows the Japanese Crude Index. Says Harib al Kitani, president and CEO, Qalhat LNG, "As oil is a traditional market there are enough players and vessels to trade in oil at any given time, the LNG community is smaller by comparison and the number of vessels available are limited." The difference in the nature of the two markets results from the fact that the history of oil industry dates back to late 1850s (the first commercial oil well drilled in North America was in Oil Springs, Ontario, Canada, in 1858). The market for LNG by comparison is a 1990s phenomenon.

Shipping benefit

For any country with global aspirations in the LNG space, a robust shipping capability remains an indispensable handmaiden. The sultanate has been quick to grasp this reality. Oman has lined up an impressive array of six vessels – Sohar, Muscat, Nizwa, Salalah, Ibri and Ibra to transport LNG. Oman Shipping Company, the nodal agency for the business, has chartered a seventh vessel, Excel, to meet the country's growing needs. Prior to 2003, Oman LNG used the services of Sohar LNG, a vessel which was jointly owned by Mitsui, Enron and the Shipping Corporation of India to transport LNG, but the sultanate realised that it needed to have global shipping capabilities. Keeping this in view, Oman Shipping Company (OSC) was established in 2003. "It was felt that there was a shipping benefit that should accrue to the sultanate," says Tariq al Junaidy, head of commercial, Oman Shipping Company. OSC earned a revenue of US$161mn in 2006 and expects to earn US$185mn in 2007.

Gas can be transported either by pipelines or by using LNG vessels. The latter has been getting increasingly popular due to a number of reasons – economy factor being the foremost. Says Junaidy, "It is economical to transport gas by pipelines up to 2,000km, beyond which it becomes uneconomical." Constructing a gas pipeline costs US$20,000 per inch per kilometre and so beyond a certain threshold it becomes uneconomical. The threat of disruption of supply due to damaged pipelines is another issue that works against supplying gas across countries. Compared to this, transportation of LNG by vessels is less prone to such threats. With customers working on tight schedules and limited storage capabilities, the reliability of supply is a critical issue. Adds Kitani, "With LNG, one can redirect vessels from one port to another at any given time ensuring flexibility and security of supply."

The efforts of the sultanate to put in place a gas ecosystem seems to be paying off in good measure. LNG exports accounted for US$2.31bn (RO888.4mn) worth of revenues in 2005. This is 12 per cent of the sultanate’s export revenue and more than the combined non-oil exports.

Domestic priorities

The sultanate's success in harnessing LNG has been nothing but spectacular. With natural gas being the feedstock for a variety of uses, the country is doing a rethink on the role of gas and how to harness its potential to maximise benefits. And it seems that LNG will be taking a backseat from now. Says Raisi, "LNG fuels the industrial development of other countries and we want to reverse this process." The sultanate has identified power and desalination plants as its biggest priority when it comes to earmarking gas, followed by providing gas for industrial projects and the government's LNG commitments. With close to 53 per cent of the sultanate's population under the age of 16, the government feels that natural gas should be used to meet critical needs like electricity and water and create job opportunities for young Omanis. It reckons that this is possible only by promoting the industrial sector and is promoting industrial enterprises in Rusayl, Sohar, Salalah and now Duqm. Industries like Sohar Aluminium, Sohar Methanol and Oman Polypropylene have been lured by promises of natural gas supplies. "When you promote core industries it generates high quality jobs. Sabic in Saudi Arabia and Reliance Industries in India are prime examples of this trend," says Raisi.

The demand for gas from OGC is expected to change in the coming years in line with the government's priorities. For example, out of the 7bn cubic metres of gas that the OGC supplied in 2006, nine per cent went to industries. Says Yousuf Mohammed al Ojaili, CEO, Oman Gas Company, "As more industries get commissioned in Sohar, the supply of gas to industries will go up in the coming years." The accelerated consumption of natural gas by domestic demands envisages the need for a robust internal delivery system connecting new areas. OGC has put in place a 2,000km pipeline in 2006 (up from 900km in 2001) for gas transportation. The government is considering putting in an additional 500km of pipelines to network upcoming utilities.
Between two stools

With the government committing gas to a number of users, sceptics feel that the sultanate may be spreading itself too thin. They point out that unlike Russia or Qatar, which have 26.3 per cent and 14 per cent of the world's global gas reserves respectively, Oman's share of the global gas reserves is a paltry 0.5 per cent. According to an Economist Intelligence Unit report, "Growing demands on its limited natural gas reserves present a challenge for Oman. In the absence of new discoveries, the government may face some difficult decisions."

The government, on its part, is aware of these challenges and has been working on a multi-pronged strategy to ensure adequate supplies. The blueprint for this is a four-fold approach. The first of these takes a stab at providing enough fuel for power generation, a non-negotiable priority. It is worth mentioning that the discovery of gas fields in the early 1990s was the catalyst for mega power plants in the sultanate. Prior to this, the country survived on power plants with low capacities. The Manah Power plant which produced 90MW of power since 1996 upgraded its generation capacity to 280 MW in 2000, based on gas. Al Kamil Power and Barka Power and Desalination plants were set up as gas-based plants in 2000 to generate 270MW and 427MW of electricity.

Energy needs absorb a lion's share of the country's gas production. In 2006, power and desalination soaked up 64 per cent of OGC's gas supplies. The government is trying to rationalise gas usage by power plants. Globally, developed countries use a mix of hydrocarbon sources like gas, oil, coal and water to run their power plants. This restricts the overuse of a single energy source. Secondly, it reduces dependence on a single source, enhancing security against any disruption. The sultanate will adopt a similar fuel-mix policy. For example, an upcoming 1,000MW power plant in Duqm will be a coal-based one. This model will be extended to other power plants helping to rationalise the use of gas.

Importing gas is part two of the matrix. The government is exploring options to import gas to increase supplies. For a start, it has inked an agreement with Dolphin Energy of Qatar to supply natural gas to Oman. Dolphin Energy will start supplying 5.5mmts of gas per day from 2008. Most of that will be used in the Sohar Industrial area. This may well be the way of the future. Says Donaldson, "Given the prevailing oil prices and the relatively clean nature of gas, Oman is likely to consume the bulk of the incremental domestic production at home and may well become a net importer over time."

Taking a leaf out of its experience in oil, the government has entered into agreements with multinational companies like British Petroleum (BP) and British Gas (BG) to explore and produce gas from its tight gas reserves. These companies are expected to bring international best practices to Oman. If the move works, Oman may be in for a windfall. BP on its part is upbeat about producing 2bcf of gas per day by 2020 in Oman. If its estimates come true this will double Oman's proven gas reserves of 35.6tcf (at the end of 2006). BP has exploration and production rights in a 2,800km stretch covering the Khazzan and Makarem gas fields. These fields were discovered in 1993 but have remained undeveloped due to their complexity. The government's investments – like the US$5bn in the Seventh Five Year Plan – for E&P activities are expected to help find new reserves.

With these measures in place, Oman is confident about meeting its domestic and foreign gas commitments. Says Hinai, "Though we are overstretched, we are studying various possibilities and are confident about meeting all our needs comfortably." A part of the confidence stems from Oman's experience in oil. The sultanate has constantly belied doomsday predictions of oil wells drying up, thanks to its ingenuity and E&P efforts. This time around it plans to do the same with gas.