PDO SIGNS DEAL, BUT CAN IT DELIVER?

C O N F I D E N T I A L SECTION 01 OF 02 MUSCAT 000027

SIPDIS

STATE FOR NEA/RA, NEA/ARPI, AND EB/ESC
USDOC FOR 4520/ITA/MAC/AMESA/OME/MTALAAT
DOE FOR INTERNATIONAL AFFAIRS

E.O. 12958: DECL: 01/05/2015
TAGS: EPET PGOV MU ESTH
SUBJECT: PDO SIGNS DEAL, BUT CAN IT DELIVER?

REF: 03 MUSCAT 2417

Classified By: Ambassador Richard L. Baltimore, III.
Reasons: 1.4 (b) and (d).


1. (C) Summary: Petroleum Development Oman (PDO) signed a
40-year extension to its concession agreement with the Omani
government on December 19. The agreement was touted in the
local press as symbolic of Oman's commitment to PDO as well
as indicative of the Sultanate's capability to continue oil
production for at least four more decades. Meanwhile, the
Omani government continues to revise its long-term production
projections in an apparent effort to lower expectations while
allowing PDO to restore its reputation. American oil
companies remain skeptical that PDO can deliver on its
increasingly dubious promises, despite the lofty rhetoric.
End Summary.

--------------
Fill 'er Up
--------------


2. (U) All major news outlets in Oman covered the December 19
signing of a 40-year extension to the concession agreement
between the government of Oman (represented by the Ministry
of Oil and Gas) and PDO, the dominant oil firm in Oman.
(Note: the government owns 60 percent of the shares in PDO,
Shell owns 34 percent, Total four percent, and Partex two
percent. End Note.) PDO's original concession agreement was
scheduled to expire in 2012, so the signing comes a full
eight years in advance. Sultan Qaboos ratified the
concession extension in a royal decree issued January 1.


3. (C) For all intents and purposes, PDO is run by Shell.
This has created significant tensions between the expatriate
technicians and engineers and the Omani professional staff,
according to numerous observers and contacts. Moreover,
Shell's battered reputation from an extended crisis regarding
overestimated reserves and declining production means that
the Omani Ministry of Oil and Gas is keeping a wary eye on
PDO. Throughout 2004, PDO's Managing Director and other
officials made public pronouncements about containing costs,
making critical investments to stem the production decline
and enhance oil recovery, and embarked upon strategic
restructuring within the company to restore public
confidence. While PDO officials and analysts expect
production to bottom out in 2005, the company's ability to
restore full production levels remains in question.

--------------
Shifting Baselines
--------------


4. (C) While laudable for its straightforward approach, PDO
may be playing with numbers. A noticeable trend in PDO
accounting is to revise production estimates and projections
downward in an effort to lower expectations. Early in 2004,
published reports indicated that PDO sought to restore
production to nearly 900,000 barrels per day (bbl/d) by 2007.
By the end of the year, the figures had been revised to
indicate a target production of close to 800,000 bbl/d by

2009. Moreover, PDO is also toying with its short-term
estimates. During a recent conference for chief executives
in Muscat, PDO's director of procurement and contracting
stated that July 2004 was the first time in nearly four years
that PDO had achieved its target production. Econoff noticed
on the same graphic display that July 2004 coincided with a
dramatic decrease in projected monthly oil production,
thereby explaining the company's "recovery" without an
increase in actual oil output. Such shifting baselines call
PDO's methodologies into question and cast doubts over its
ability to deliver on lofty promises.

--------------
Developments in the Field
--------------


5. (C) While PDO is by far the largest player in the Omani
oil patch, accounting for over 90 percent of Oman's crude oil
production, other companies are chomping at the bit to gain
additional ground in Oman. Several American firms (Hunt Oil
and Occidental) seek to expand their operations in the
Sultanate, and Chinese and Thai firms are becoming
increasingly aggressive in seeking (and winning) concessions
on the margins of Block 6 (PDO's crown jewel, the largest and
most prospective block in central Oman). Meanwhile, PDO's
only attempt at opening Block 6 itself consists of bringing
in small-to-mid size international firms on a contract basis
to rehabilitate marginal fields. (Note: According to an
executive from one such American firm, PDO's expertise
appears to be in drilling wells, not in managing long-term
production. End Note.) Oilfield equipment suppliers told
Econoff in late December that PDO's production costs range
from $9-11 per barrel -- somewhat less in northern Oman, more
in the south with its difficult terrain and heavy, viscous
crude. The suppliers went on to say that PDO is earmarking
over $6 billion for the development of the Mukhaizna
oilfields in southern Oman, which is also the target of
Occidental's expansion plans (reftel). These high lift costs
and massive investment plans underscore the challenge facing
PDO.

--------------
Budgets and Bottom Lines
--------------


6. (C) In announcing the state budget for 2005, Omani
Minister of National Economy Ahmed bin Abdulnabi Macki
January 2 revealed that the government used a revenue figure
of $23 per barrel and an estimated average daily production
of 753,000 bbl/d in its accounting. Both figures deviate
significantly from the Sixth Five Year Plan endorsed by the
government, wherein oil production was estimated at 909,000
bbl/d at an average price of $18 per barrel. The chairman of
the State Council's Economic Committee (a close Embassy
contact) claimed that if oil prices were to collapse to
levels last seen as late as 1998-99 ($10-15 per barrel),the
government could not even meet its payroll. In light of
recent global price increases and oil revenue windfalls, such
a warning falls on largely deaf ears in the government. The
official budgeted price of oil remains conservative, but it
is definitely trending upward along with public spending.

--------------
Comment
--------------


7. (C) This signing represents perhaps the only good news for
Shell in Oman all year. Given its global and local
difficulties with overstated reserves estimates and PDO's
continuing production woes, this long-term concession
salvaged an otherwise gloomy year for the Sultanate's oil
giant. Sultan Qaboos remains loyal to Shell, but this
sentiment reportedly does not extend universally throughout
the government. PDO faces an uphill climb to restore
production and the public's confidence, and sooner or later
the shifting statistical baselines won't be enough to stop
the leaks. Huge investments in enhanced oil recovery (EOR)
technologies are expensive, and PDO's reluctance to allow
full foreign partners into Block 6 could prove even more
costly in the long run. While PDO is holding its head high
following the recent signing of its concession agreement
extension, the prevailing mood in the oil sector is far from
celebratory in Oman.
BALTIMORE