Abysmal Licensing Round Result in Algeria Confirms Energy Sector Malaise

Non-Confidence Vote

Algeria's ninth licensing round appears to have crowned a slew of unsuccessful rounds with an almost shockingly bad result, attracting only one winning bid from a foreign investor and seeing state-owned Sonatrach intervene to make sure that at least two projects move forward (see Algeria: 6 September 2010: New Upstream Licensing Round Launched in Algeria). Spain's Cepsa, which currently is under a takeover bid from Abu Dhabi's International Petroleum Investment Company (IPIC), secured Licence Area Rhourde Rouni II encompassing Blocks 401d, 401c and 403f, in the eastern Berkine Basin in competition with bids from Indonesia's Pertamina and Oman's Petrogas. The licence area awarded to Sonatrach was Rhourde Fares, comprising Blocks 406b and 209, also located in the Berkine Basin. Sonatrach had decided to bid "because there are interesting things in this block", its chief executive Nourredine Cherouati, told Reuters, with the company's decision sending “a strong signal that Sonatrach can compete with other companies".

There is little scope, however, for glossing over Algeria's almost complete failure to attract new foreign upstream investment, explaining why official Algerian comments were sparse and mooted in the aftermath. Algeria had hoped to see the falling upstream investment trend reversed, but has instead suffered three consecutive licensing rounds with bidding approaching ever closer to zero. In the previous late-2009 licensing round only three areas were awarded, with the late-2008 licensing round faring only marginally better, as IOCs increasingly have found Algerian fiscal terms too tight and its politically driven strong resource-nationalism sentiments unhelpful, in an environment already massively characterised by high levels of red tape and slow-moving bureaucracy. As icing on the cake, state-owned oil and gas giant Sonatrach, as well as the Energy Ministry, suffered from the consequences of a deep corruption scandal and the consecutive purge of almost all its senior leadership during 2010, with the energy establishment still only slowly emerging from a virtually complete decision making paralysis.

But No Change

The gradual slowing down of upstream investment in Algeria can be traced to the 2006 reversal of the 2005 attempt to liberalise Algeria's oil and gas sector further by former energy minister Chekib Khelil. The roll-back of liberalisation not only returned Algeria to the same situation as in the first half of the past decade, but notched up government take, as well as imposing a windfall tax on upstream profits. Sonatrach's mandatory participation in all projects was further reinforced, meaning that IOCs would have to rely on involving its slow-moving decision making systems in all project decisions, naturally adding to the project costs.

The result—the radical fall in IOC interest in investing in Algerian oil and gas projects—has meant that the project pace in Algeria gradually has fallen, a situation that the country has further worsened by existing projects being delayed by over a year in several cases, and this not even counting the almost year-long decision delays caused in the wake of the 2010 Sonatrach corruption scandal—just because of the slow pace of decision making on costs and investments on Sonatrach’s side. The company, without really receiving any larger government budget allocations, was forced to finance large equity shares in all upstream and downstream projects as a consequence of the resource-nationalist changes, as well as take full charge of a growing number of upstream and downstream projects to make up for falling foreign investor interest.

This trend has continued to deepen, resulting in Sonatrach now seeing a higher budget for upstream and downstream investment, although its ability to finance and manage enough projects to make up for the loss of IOCs, remains limited. This is demonstrated by Algeria's failure for several years to unlock development in its gas-prolific south-central and south-western Sahara desert areas, where very significant discoveries have been made and indications point to a high potential for additional discoveries remaining. Sonatrach, which has a midstream monopoly, has, however, struggled to finance and manage the construction of a trunk gas pipeline from the remote region to the coast, without which no gas can be monetized, making the IOCs with permits in the area reluctant to start serious development in order not to end up with stranded expensive production assets. In addition, much of that region's gas is found in tight reservoirs, with many of the companies losing interest in further complex and expensive exploration and development, amid high costs and low rates of return.

Outlook and Implications

While the extraordinarily weak results of the ninth licensing round should send a strong signal to Algeria's government that it is failing in its officially endorsed efforts to attract foreign upstream investment, it is unlikely that the lesson will be learned within the political elite, as long as production levels are maintained at current levels. The increasing lack of tangible upstream progress in the past five years will, however, mean that Algeria will struggle to raise its gas production substantially in the coming five years, at a time when several downstream gas export projects—both LNG and pipelines—are scheduled to come onstream. As IHS Energy has previously said, Algeria is likely to struggle filling its export capacity substantially by 2013-14 and potentially might have to renege on some export commitments. This situation might finally provide the political impetus to start contemplating a change from the staunch resource-nationalistic and investment un-friendly policies currently being pursued.

Until then, however, little is likely to happen, as the political cost to climb down from the current course is deemed too steep by those involved who are starting to see Algeria's problems. A good measure of what is deemed politically possible is the lack of calls for direct reforms on fiscal terms from the energy minister Youcef Yousfi, who instead has tried to make small structural changes within his reach—but obviously to no avail—while clearly having a good understanding of the problems Algeria is facing. A more comprehensive meltdown in Algerian strategies and oil and gas output, having a clear impact on the projected government revenue, is needed to instill an understanding for the need for change within the Algerian elite, although by then, especially in the oil production sphere, mature decline can become unmanageable to reverse, as too much time will have passed without significant investment in new production capacity coming onstream. Fluctuations in Algeria's gas output are already worrying, as well as the state of its under-financed and under-maintained midstream facilities, but raising oil and gas prices have so far made it possible to overlook such problems.

Algeria will now target a new licensing round focusing on its estimated massive unconventional gas reserves, according to Youcef Yousfi, which Algeria believes could be larger than the shale gas reserves in the United States (see Algeria: 7 March 2011: Unconventional Gas, LNG and Renewable Energy at Core of Renewed Algerian Expansion Drive). Whether foreign companies will be interested in investing in even more technically complex and demanding exploration and development without any hint of Algerian financial terms becoming more relaxed is of course dubious, risking the licensing round exercise coming away with another futile result. While Sonatrach scrambles to fill the void left by foreign upstream investors in the conventional oil and gas sectors as much as possible, it lacks the necessary experience and know-how to get unconventional gas projects off the ground.

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