Getting Libya’s oil flowing again is of crucial importance for the country’s recovery, stability, and prosperity. The proper management of the revenues derived from the petroleum sector is likely to define the government’s success or failure. Getting it right will be a technically difficult and politically sensitive task.
One of Gaddafi’s staple claims is that foreigners from the West are colonialists who want to rob the Libyans of their greatest asset, oil. In fact, if the West is after anything in Libya, it is to help the Libyans remove Gaddafi’s dictatorship and regain control over their destiny, including putting an end to the tremendous mismanagement of the petroleum sector and misallocation of the revenues derived from it under Gaddafi’s regime.
Exploration and Production Sharing Agreements
Most foreign oil companies operate in Libya’s upstream sector under contracts known as “Exploration and Production Sharing Agreements” (EPSA), a kind of service contract which has been used in the country since the late 1970s and is in wide use in many other countries around the globe. The most recent version of Libya’s EPSA is known as EPSA-IV.
EPSA contracts do not convey any ownership rights over oil and gas resources to the foreign operating companies. Rather, they are risk-based term service contracts, under which the foreign company undertakes to finance and carry out at its own risk an exploration program, and eventually develop the resources if a commercial discovery occurs. If no commercially viable oil or gas is found, the exploration cost is borne entirely by the foreign company, the acreage is released and can be offered to another party.
In case of a commercial discovery, any eventual production is split between the operator and the Libyan side in a pre-determined manner that allows cost to be recovered and some profit to be made. Making a profit is far from certain, as it depends on future oil prices, costs, and geological risks associated with the fields themselves. In EPSA-IV, the Libyan side (represented by the National Oil Company, NOC) takes 80 to 90 percent of the oil and gas production, while the foreign company must recover capital and operating cost and eventually make a profit from the remaining share in production, which is less than 20 percent.
Under these agreements, the Libyan side carries about 50 percent of the cost, but gets up to 90 percent of production revenues. The Libyan side also has complete control, via the NOC and the Ministry of Finance, over exploration and development plans and budgets (which have to be pre-approved), capital and operational expenditure (which has to be certified to become eligible for reimbursement) and oil exports (for which a quota must be approved and separate loading schedule granted for each cargo).
The National Transitional Council (NTC) has indicated that it intends to honor the terms of the agreements that have already been signed. All of this simply means that the control over the physical oil resource is and will remain in the hands of the Libyan government, that the Libyan side will determine whether to allow foreigners to serve its petroleum industry, and in case access is granted to foreigners, what the terms will be.
The real issue is not access to Libya’s oil and gas, but how the proceeds from the petroleum business in Libya are used, and who is in control of their allocation. Gaddafi’s regime has a dismal record of wasteful and injurious spending, ranging from the relatively innocuous like investing in white elephant projects, to the dangerous (supplying arms to suspect clients), the sinister (funding of the development and deployment of weapons of mass destruction), and the outright criminal (support, contracting, and direct carrying out of acts of terror). Domestically, petromoney has been used extensively as a tool of divide et impera, by whimsically granting or withdrawing funds to various groups of Libyan society. Internationally, billions upon billions of dollars have been wasted by Gaddafi to purchase the veneer of political support in Africa, the Arab world, and elsewhere. Nepotism and complete lack of transparency were hallmarks of Gaddafi’s funds allocation.
Ending the Embargo
Right now, most of the transactions in Libyan petroleum are impossible due to the blacklisting of NOC and many of its affiliates. United Nations Security Council Resolution 1973 (UNSCR 1973) requests all governments to block NOC’s assets. The United States and the Council of the European Union have accordingly adopted legislation implementing UNSCR 1973. The sanctions do not prohibit trade or introduce an embargo, but make impossible payments to Libyan government-owned counterparts for oil, bunker fuel, port services, and other transactions typically associated with petroleum. Banks refuse export financing and routing of payments.
The absence of Libyan oil has impacted mostly the European market, which traditionally takes about 90 percent of exports. Italy, France, and Germany have been most affected. Libyan oil is light and low in sulfur and yields the most valuable light products with relatively simple, low cost processing. In the Atlantic Basin, substitutes to Libyan oil exist in Nigeria, the North Sea and elsewhere, but suppliers of these grades of oil often do not have the flexibility to deliver on a short notice. The cost of transportation from Libya to European ports in the Mediterranean is lower than from other potential points of supply. In the Gulf, special blends of Saudi oil have to be made to approximate the quality of Libyan oil. Particularly exposed to loss of Libyan oil are Italy’s ENI and Austria’s OMV; others include Spain’s Repsol-YPF SA, France’s Total, and Germany’s Wintershall. ENI also produces gas which is exported to Italy via pipeline and used in Libya at power plants. BP and Royal Dutch Shell PLC have contracted large blocks in Libya, but their projects are at the stage of exploration.
The void created by the absence of Libyan oil has contributed to the unusually large divergence of the U.S. benchmark WTI from other benchmark crudes, wreaked havoc on refiners’ margins and caused weaker cash crude differentials. Also missing from markets went Libyan liquefied natural gas (1 million tons per year to European destinations) and ethylene (300,000 tons per year from the Ras Lanuf refinery). A joint project with Tunisia to develop an offshore field had to be put on hold. The overall effect on prices and markets, however, was subdued to marginal, since global and regional oil demand stayed rather flat due to weak economic growth and concerns about unemployment and financial instability.
Exports are technically possible from the rebel-controlled Arab Gulf Oil Co. (AGOC) via ports in the east, and several cargoes of oil have been exported on behalf of the NTC with the mediation of Qatari companies. Further exports are hampered both by the asset freeze and by low production, which has been falling because of damage to facilities caused by Gaddafi’s regime and the abrupt withdrawal of personnel due to fighting. NTC points out that the unfreezing of assets and the resumption of production and export are very urgent tasks.
Transitioning to Post-Gaddafi Structure
The risks associated with resuming oil production and exports from Libya are manifold. Some are purely technical: most of Libya’s production is from mature fields in the east that require reservoir pressure maintenance by injection of water and various gases. The abnormal shut-down of production from such reservoirs may have caused damage to producing wells that is difficult to mend without complete reworking. Even under the best of circumstances, a well workover program will take many months to implement. There is also a threat of continuous disruption by terrorist attacks on facilities like pipelines, power and water supply launched by pro-Gaddafi groups. However, Libya still has the potential to exceed its 2010 output level (about 1.5 million barrels per day) and add capacity in 2012, maybe as much as 250,000 barrels per day.
The greatest risks are not associated with the fields and the facilities or any fictional foreign control over Libya’s petroleum industry, but with the stances which the NTC and its partners will take regarding the issue of resource and revenue governance. Regarding the resource, there will be a temptation for many parties to position themselves early ahead of others and reconfirm existing contracts or secure new ones. A competitive rush will be corrosive to the contact group and could also exacerbate rivalry within NTC. Regarding revenues, there will be a temptation to seek rent and use proceeds to build political influence within Libya and elsewhere, a déjà vu that has to be avoided.
The successful transition from political to social role in the management and the use of the revenues from the petroleum industry could be a bellwether of NTC’s prospects as a leader of a modern civil society. How Libya’s oil is managed and used will be an acid test for NTC’s competence and credibility. An early discussion on governance and transparency in the petroleum business is a must for both the NTC and the contact group. Policies have to be developed in an environment of openness and transparency. Unwinding sanctions, resuming and expanding oil production, and defining economic development priorities should go hand-in-hand, in an inclusive dialogue with Libya’s emerging civil society. After all, the Libyans are the ultimate stakeholders in Libya’s oil.
Dr. Boyko Nitzov is Director of Programs for the Dinu Patriciu Eurasia Center at the Atlantic Council.