Abu Dhabi's sour gas project is the latest casualty of globally spiralling construction costs, with the technically challenging Shah field's estimated production costs causing authorities and contractors to hesitate, writes Middle East energy analyst Samuel Ciszuk.

Sources close to the Abu Dhabi National Oil Company (ADNOC)'s evaluation of the bids submitted to develop the emirate's Shah sour gas field, cited by the Middle East Economic Survey (MEES), have said that the estimated production prices for the gas, to cover the development and production costs, have come in at around US$5 per million British thermal units (/mmBtu) in the bidders' calculations.

With other gas fields in Abu Dhabi generally producing gas at prices of around US$1-1.5/mmBtu, the calculations have caused serious consternation among the ADNOC leadership and the Abu Dhabi government, especially since Abu Dhabi recently begun importing substantial quantities of gas from Qatar through the Dolphin pipeline venture, at a price of around US$1.3/mmBtu.

The cost of developing both the Shah and Bab fields at the same time was originally envisioned to be around US$10 billion, although the global project cost escalations within the oil and gas business since the tender documents were first released in December 2006 would have sharply altered the initial calculations.

Upon the split of the original Shah and Bab development tender in two by mid-2007, US$10 billion was frequently aired as a possible sum for the development of just the Shah field. The cost increases within the industry since then are evidenced by the recently revealed cost developments in Saudi Arabia's ambitious refinery construction programme, or the problems encountered by the Kuwait National Petroleum Co. (KNPC) in awarding its large al-Zour refinery project during last year, as well as problems for Iran to agree with contracted IOCs over development costs and remunerations. Escalating cost will also continue to add budget and future-production-cost uncertainties to the project over the coming years, as the construction and development phase has not yet commenced.

The technologically very complex development of the sour gas fields was always going to be a challenge for the IOCs, but one with a potentially huge prize.

The successful bidder could become the world leader in unlocking large sour gas deposits, most of them hitherto untouched due to the complexities involved in monetising them.

The high sulphur and natural gas liquids (NGL) content of the Shah and Bab fields (around 30-50 per cent) has made it necessary to use specialist non-corrosive materials in the production, transportation, and processing of the gas. In addition, due to its toxicity, a completely sealed production chain needs to be created.

How to monetise and/or dispose of the vast amounts of sulphur produced has also been a massive associated challenge. The Bab field — whose gas is dry and thereby does not yield NGL during production — provides yet more security challenges in that it is located close to residential areas. It is thought that the production of 1 bcf/d of Shah gas will yield only around 500 mmcf/d of marketable gas after it has been stripped of sulphur and NGL, making the economy behind the development of the field even more questionable at levels far higher than what Abu Dhabi has to pay for Qatari imports.

Abu Dhabi is currently experiencing spiralling gas demand due to its rapid industrial, tourism, and financial growth, which also leads to an increase in the number of people demanding gas. The whole federation, including Abu Dhabi's ambitious neighbour Dubai, needs to increase its gas output—or secure imports—of around 15 per cent per year in the coming decade.

Within this staggering demand growth also lies the expected need for Abu Dhabi to increase its oilfield gas injection schemes in order to keep crude production levels at increasingly mature oilfields high.

Gas will have to be secured, but with a moratorium on further developments in Qatar's North Field, while the current production level's impact on the reservoir is studied, and future projects looking uncertain, there are few other possible large-scale suppliers in the region at the moment.

The exception would naturally be Iran, although too much reliance on Iran would be seen as uncomfortable security-wise in Abu Dhabi, especially given Iran's inclination to politicise gas export prices and call for price renegotiations. Besides, due to international isolation and red tape, Iran's gas industry has failed to take off as promised, leaving the prospect of supplies some way off in the future yet.

With the economic fundamentals of the development programme in question, Abu Dhabi — and the whole of the United Arab Emirates—will find themselves in a problematic situation. With domestic gas demand escalating, and being completely necessary for the ambitious development plans of the federation, the costs will probably have to be accepted at some point, although the emirate might choose to shelve the project for now, in the hope of the overheated market cooling down somewhat over the coming one to three years.

Nevertheless, this signals that the United Arab Emirates in general and Abu Dhabi in particular might be moving away from an environment where it can rely fully on extremely cheap energy, and it serves to explain the emirate's full-on recent move to secure civil nuclear power capacity.

Costs of US$5/mmBtu are in themselves not unbearable, but they are much closer to what Western markets are paying for long-distance gas imports by pipeline of LNG, than to what Persian Gulf customers have traditionally been used to. They will not leave much space for profit margins, but as domestic supplies in the region are generally subsidised, this might not initially be a problem for anything other than the state coffers. Also, the final construction price has not been established yet, as raw material, know-how, and technology costs keep escalating and the project still has failed to move out of the tendering phase.

The MEES revelations point to the large problems increasingly faced by producer nations in the sector, and might result in several projects being abandoned during the coming year due to development costs pushing up production costs to far too high levels, hurting profitability.

The sour gas project might be one of these, although Abu Dhabi's spiralling domestic demand is likely to make sure that the project goes ahead sometime in the coming few years, if not now. For the hopeful IOCs it will nevertheless also be a blow, as the extraordinary high development costs will serve to discourage other potential projects around the world, rather than serving as a positive example and leading many projects to follow suit.

ConocoPhillips was recently reported to be the new frontrunner to secure the Shah development project, something MEES' sources confirm.

Global Insight