DECLINING OIL AND PARLIAMENTARY INTERVENTION

C O N F I D E N T I A L SECTION 01 OF 02 SANAA 000277

SIPDIS

E.O. 12958: DECL: 02/02/2015
TAGS: EPET KCOR ECON YM ECON COM ENERGY
SUBJECT: DECLINING OIL AND PARLIAMENTARY INTERVENTION
EQUALS BAD TIMES FOR OIL BUSINESSES IN YEMEN

Classified By: DCM Nabeel Khoury for reasons 1.4 (b. and d.)


1. (C) Summary: Yemen's oil production is steadily declining,
and may drop below 400,000 barrels per day (bpd) in 2005.
(Note: Production reached a high of 490,000 bpd in 2003.)
Mismanagement of existing oil fields accelerates production
and could serve to reduce long-term yields. Current
exploration is not expected to produce substantial gains.
Hunt's Production Sharing Agreement (PSA) extension also may
be jeopardized by corrupt side deals tacked on by ROYG
negotiators that involve selling the ROYG's share of oil to
other investors. In mid-February, Parliament is expected to
review the extension and some MPs are threatening to cancel
the deal. Declining oil prospects and increased activism
against traditional, albeit corrupt, business practices are
proving unsettling for major international oil companies,
which could negatively impact future investment. End Summary.

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Minister Acknowledges Diminishing Production
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2. (C) In a statement to the London-based daily al-Hayat,
Yemen's Oil Minister Rasheed Saleh Ba'raba announced on
December 30 that oil production is expected to decline by 10
million barrels in 2005, leading to a negative impact on
Yemen's to economic growth. (Note: The Economist
Intelligence Unit (and confirmed by other sources) states
that Yemen's oil production for 2004 is about 420,000 barrels
per day. A ten million barrel drop would put production at
about 390,000 bpd for 2005. End note). Yemen's 2004 GDP
growth is estimated to be around 2 percent (from 3.5 percent
in 2003),a decline due largely to reduced oil production.
Ba'raba pointed to a possible contract with French Company
Zinco Ox to open a Zinc and Lead mine as an alternative
source of revenue. According to Henry Thompson, a British
environmental scientist and Yemen expert, mineral extraction
in Yemen is still too costly and companies interested in Zinc
(mostly Canadian firms) were not yet comfortable investing in
Yemen.


3. (C) Yemen Hunt GM Wyndell Caviness, told Pol/Econ Deputy
that Hunt's production was down ten percent in 2004 and
Canadian Nexen's production dropped 40 percent the same year.
Caviness predicted that total ROYG production may fall below
400,000 bpd next year. Nexen's new PSA (near its existing
Masila Block) is only producing 4-5000 barrels per day,
Caviness said, and production may never rise above 20,000
bpd. (Note: Some ROYG oil officials have touted the new
Nexen field as the next great find in Yemen and maintain that
the second field alone will be able to compensate for
diminishing returns in older fields. End note). He observed
that the relatively low production levels of the new Nexen
block are indicative of future oil discoveries in Yemen.
According to press reports as well as a World Bank study
released in March, Nexen's Masila block produced a higher
water to oil ratio than expected in 2004, accounting for the
rapid production decline. The report adds that without new
discoveries are found, Yemen could deplete its resources by

2012. (Comment: While it is unlikely that there will not be
any new oil finds, the study makes clear Yemen's near-term
problems with oil depletion. End comment.)

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Existing Resources Mismanaged
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4. (C) Estimates on Yemen's proven reserves range from 1.3
billion barrels (World Bank) to 4.0 billion (Ministry of Oil)
barrels in 2004. Thompson believes that Yemen's Ministry of
Oil and regulatory agencies do not manage their existing oil
resources for sustainable production. The Ministry of Oil,
Thompson asserted, takes undue time and charges oil companies
unnecessarily for activities such as drilling new wells in
production blocks. The Ministry's time-consuming, overly
bureaucratic processes are a disincentive for oil companies
to drill new wells and encourage companies to pump oil with
as few wells as possible. Thompson explained that fewer
wells were inefficient and poor management can cause as much
as 20 percent of the oil in a field to be left behind.
(Note: Several foreign oil company executives echo similar
complaints regarding the Ministry of Oil. End note).
Senior Oil Ministry officials also directly ask Oil companies
to maintain high yields also contributing to declines in
production. Thompson concluded, "when it goes, it will go
fast."

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Parliament Scrutinizing Oil Deals -- Hunt's Next
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5. (C) New allegations surrounding government corruption in
the oil sector may harm Hunt's bid to extend its PSA for
Block 14 beyond the October 31 expiration date. Hunt
suffered through tense negotiations with the ROYG for three
years before reaching a Cabinet deal in 2004 to extend its
operations from 2005-2010. Caviness admits that in order to
continue operating in Yemen, Hunt was forced to give up half
of its share of oil. Allegations have emerged (and are
likely true) that the ROYG sold its additional share of the
oil from Block 14 to Crest Oil -- the same company involved
in the now infamous Block 53 scandal uncovered by Parliament
in 2004. According to Parliament watcher, Saad Talib, the
sale's loss to the treasury could be as much as 5 billion USD
and predicted that "Parliament would not ratify the
extension." Caviness, however, is optimistic and hinted at
serious, high-level lobbying on behalf of Hunt.


6. (C) Hunt is presently in negotiation with the Petroleum
Exploration Production Agency for an additional PSA in an
undisclosed area. Describing the block as "something a major
oil company would be interested in," Caviness expressed
frustration with the ROYG for delaying the extension and over
difficulties in the current PSA negotiations. Caviness also
confided that until their PSA extension with Parliament is
resolved, Hunt was reluctant to move forward on the new PSA.

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Comment
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7. (C) Comment: While Parliament has threatened to break the
Hunt extension, Post believes a deal will be worked likely
voiding the government's questionable sale of its oil share
and allowing the largest American company in Yemen to
continue operations. That said, if Hunt is forced to cease
production in 2005, the largest American investment in Yemen
would disappear, leaving it its wake dim prospects for other
large potential U.S. investments.


8. (C) Comment continued: With Yemen's near-total reliance on
oil for government revenue and economic growth, oil
production declines will have a negative impact on its
ability to expand development spending. High-oil prices
offset the 2004 declines, but this may not hold true in 2005.
Some oil watchers are hopeful that production levels may
climb back up to the 450,000 bpd mark. However, with Yemen's
population rising at 3.9 percent, unemployment at 35 percent
(conservatively) and limited alternate sources of revenue,
the oil decline is likely the biggest economic challenge
Yemen will face in the next five years. End comment.

Krajeski