Major Setback for Lebanon’s Oil and Gas

For many years, 2020 will be remembered as the year that brought the world economy on its knees and oil markets with it. The COVID-19 pandemic has caused unprecedented challenges to countries over the world. Economies, which until recently were considered robust, have been hit hard and their recovery pattern looks patchy. For a country like Lebanon, with its economic structures already dissolving and engulfed by a self-inflected major domestic crisis, the impact is much more severe.

The negative results from the exploration activity that oil giant Total and its partners carried out in Block 4 in Lebanese waters add another strong blow. It is true such an outcome is common in the industry particularly in hardly explored provinces. However, under the current gloomy oil market conditions, exploration spending will be significantly curtailed, further delaying Lebanon’s eagerly and long-awaited dream of joining the busy club of oil and gas producers. Even when, and if, that materializes, it will not be an easy ride for Lebanon in an already highly competitive market.

The government cannot and should not pin its hope on the oil and gas sector to salvage its failing economy and should immediately tackle the root causes of the domestic turmoil irrespective of the state of the oil and gas industry.

Market Turmoil

The oil market has been thrown into turmoil—first by a dispute among key producers, then by the historic collapse in demand caused by the lockdown of global economic activity because of the pandemic. The outcome? An unparalleled collapse in oil prices. This cannot be good news for Lebanon, where exploration activity has barely started and, worse still, where the first exploration well has not resulted in a discovery.

Under normal market conditions, this would not have been a major issue as dry holes are more common than technical and, even more so, commercial discoveries. But when the industry is facing “a crisis like no other” to quote the IMF, then such a combination significantly downgrades Lebanon’s attractiveness for international capital.

To understand the scale of the challenge the industry is facing, it is worth looking at the rapid unprecedented developments that hit oil markets over the last few months.

Race to the Bottom

In early March, OPEC+, an alliance of major oil producing countries, failed to reach an agreement when Russia refused to take part in production cuts recommended by OPEC. Saudi Arabia immediately announced that it was going to put an additional 2.6 million barrels per day (mb/d) into the market—that is nearly as much as the combined production of the UK and Norway. The kingdom also drastically cut its export prices. Saudi Arabia’s announcement has often been labeled a price war launched against Russia, or by Saudi Arabia and Russia to take market shares from the US, the world’s big producer, or simply a miscalculation with OPEC+ players surprising each other and overlooking the consequences of their actions. Whatever the true motive, the move was surely badly timed.

Just at the time when Saudi Arabia made its announcement and Russia immediately hit back saying it would increase production as well, the severity of the coronavirus crisis started to become obvious. Economic forecasts soon started to point downward. In its latest World Economic Outlook, the IMF projects global economic growth in 2020 to decline by 3%, a downgrade of 6.3% from its last forecast in January, and a major revision over a very short period. If it comes true, it would turn the “Great Lockdown”, as the IMF calls it, into the worst economic decline since the Great Depression, far worse than the 2008 global financial crisis.

A cash machine vandalised in Beirut amid protests.

Global oil demand, which is largely a function of economic activity, was revised downward as well. International agencies and financial institutions soon seemed engaged in a race to the bottom with their oil demand forecasts. The worst forecast to date comes from the International Energy Agency (IEA) which, in April, put demand destruction at a staggering 9.3 mb/d, or 10% of global demand. Only two months ago the agency expected demand to grow by 825,000 b/d.

The massive adjustment of forecasts only confirms that no one has foreseen the real scale of the crisis. The world’s greatest minds are still unable to understand its extent. The IMF warns that its forecasts depend “on the epidemiology of the virus, the effectiveness of containment measures, and the development of therapeutics and vaccines, all of which are hard to predict.”

As a result of the overwhelming, negative demand outlook, in addition to plentiful supplies, oil prices have been in free fall and briefly turned negative. This is a scenario hardly any oil producer ever envisioned. Operators around the world have started to shut-in production—a trend that will only accelerate at current prices. Oil companies, including Total and Eni which along with Novatek jointly hold blocks 4 and 9 in Lebanon, announced spending cuts by at least 20% for this year.

Spending Cuts

In the oil industry, when prices collapse, the axe typically falls on pre-development spending. An oil and gas project goes through several phases: First exploration is carried out, then, if a discovery is made, it needs to be appraised for the investor to determine its commercial viability and thereby to decide on whether to commit substantial capital for its development. Companies need to ensure the money is worth spending before giving the green light to proceed with building the massive infrastructure to get the oil and gas out of the ground. When oil prices are low, such decisions are closely scrutinized. The capital expenditures of companies become much more cautious, selective and disciplined; this is the case even more so in today’s highly uncertain environment.

The negative results from the first exploration in Block 4 do not mean game over for Lebanon. It means however that unless the situation in global oil markets changes drastically, investing in exploration activity in the country will become more precarious.

Of course, one can argue that when the current crisis is over, everything will go back to normal, including prices. But the question is when. With economic forecasts continuing to worsen and the history of oil prices suggesting that recovery will take a very long time, it may take a while indeed until oil markets recover their pre-crisis glory.

Triple Whammy

In the current low price environment and a market where supply is chasing demand, host governments also start to chase international capital, which will go to where investors can achieve the best risk-reward balance.

Lebanon will therefore be competing with other countries, many of which have lower geological and political risks. To improve its chances, the country may need to revisit its fiscal terms: What used to be competitive when oil prices were hovering above $60 per barrel, suddenly may become uncompetitive after prices collapsed by more than half.

Despite the challenges, many in Lebanon continue to anticipate an oil and gas bonanza that would open a new prosperous chapter for the country. Hope always dies last.

Under normal circumstances, however, good practice suggests a cautious attitude to avoid falling prey to the illusion resource wealth often creates: After first creating a false sense of security, often even an illusion of political and economic invulnerability, the hope for resource revenues can lead governments to lose sight of the need for good and growth-friendly economic management. In times of crisis, the stakes are much higher.

Lebanon has been hit by a triple whammy: The country is suffering from a self-inflicted, domestic economic and financial crisis, and it has been hit by a global disaster; both are still ongoing. No oil and gas discovery, no matter how large it is, can salvage the country from its current depression. Only strong and genuine commitment to badly needed economic reforms can.

The article was first published by the Lebanese Center for Policy Studies (in English) and republished by L’Orient Le Jour (in French)



Related Analysis

The oil market crunch”, Dr Carole Nakhle, May 2020

The Resource Curse Hits Lebanon Without the Resource”, Dr Carole Nakhle, Feb 2020

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