COMING UP SHORT: ALGERIA'S GLOOMY GAS OUTLOOK

C O N F I D E N T I A L SECTION 01 OF 03 ALGIERS 001783

SIPDIS

SIPDIS

EEB/ESC/IEC/EPC FOR GLENN GRIFFIN

E.O. 12958: DECL: 12/11/2017
TAGS: ENRG EPET PGOV ECON EINV AG
SUBJECT: COMING UP SHORT: ALGERIA'S GLOOMY GAS OUTLOOK

REF: A. ALGIERS 710

B. ALGIERS 1096

C. ALGIERS 1694

ALGIERS 00001783 001.2 OF 003


Classified By: Deputy Chief of Mission Thomas F. Daughton;
reasons 1.4 (d) and (e).


1. (C) SUMMARY: Algeria will likely be unable to meet its
natural gas production goals or fulfill its contract supply
obligations in the coming years. Expansion of Algeria's gas
production has been hampered by delays in high-profile
projects like the Medgaz undersea pipeline and the Gassi
Touil LNG project, and by an inadequate distribution
infrastructure that hydrocarbon parastatal Sonatrach has no
real plan to boost. Sonatrach's attention remains focused on
gaining a greater share of downstream and value-added
markets, and on diversifying its holdings. END SUMMARY.

POOR INFRASTRUCTURE KEEPS ALGERIA FROM ITS GAS TARGETS
-------------- --------------


2. (C) The Algerians have said they intend to raise their gas
export levels from 62 billion cubic meters of gas per year to
85 billion cubic meters by 2010. But BP Algeria President
Gerry Peereboom told us on December 10 that Algeria will fall
short of its gas production targets and its contract
obligations in the coming years because it simply does not
have sufficient infrastructure in place. Peereboom echoed
comments made by Sonatrach's former Director General
Abdelmajid Attar, who told the Ambassador on October 30 that
Sonatrach has made contractual obligations based on grossly
overestimated reserves and unrealistic production timetables.
Attar said Algeria's best exploration days are behind it,
and that future fields will likely be much smaller than
current producers like Hassi R'Mel. Peereboom was not so
glum, saying BP remains optimistic that Algeria's gas sector
holds significant exploration promise, but he is not certain
that the Algerians will be able to tap it effectively. He
noted that the Medgaz project (a second undersea pipeline to
Spain) is behind schedule, as is the large Gassi Touil LNG
project. These delays alone will significantly reduce
Algeria's expected output for 2010-12.


3. (C) Peereboom noted that BP has tried to invest in
Algerian pipeline projects, not because it wants to own
pipelines but because it wants to guarantee delivery of gas
that the company will produce. BP was actually kicked out of
the Medgaz project after an initial investment so that
Sonatrach could garner a greater share of the revenue stream.
The 2005 hydrocarbons law allows private companies to own
pipelines (Sonatrach gets a 51 percent stake),and Peereboom
suspects that Algeria will use that vehicle ultimately to
build up its gas transport capacity. For example, BP is
exploring what it considers to be a promising gas field at
Ain Salah in the far south of Algeria. There is no existing
transport system between the field and the Hassi R'Mel
pipeline network, so Peereboom expects that once his company
informs Sonatrach that it has reached exploitable gas (which
may be before the end of 2007),Sonatrach will ask BP to
build a pipeline from Ain Salah to Hassi R'Mel. Peereboom
speculated that Sonatrach will have to re-negotiate many of
its long-term supply contracts to avoid penalties when it
fails to meet its contract obligations with its European
customers. Otherwise, Algeria will have to buy gas on the
international market to make up the difference.

SONATRACH GOES IT ALONE AT GASSI TOUIL
--------------


4. (C) After several major development setbacks, including a
deadly blowout, Sonatrach removed the Spanish firms Repsol
and Gas Natural from the Gassi Touil project in September,
citing major cost overruns and construction delays. BP's
Peereboom said that production at Gassi Touil is facing major
construction delays, and Attar said that the field is highly

ALGIERS 00001783 002.2 OF 003


fragmented and faces severe engineering challenges. There
was speculation at the time of the removal of the Spanish
firms that Gaz de France might join with Sonatrach at Gassi
Touil, but all indications are that Sonatrach will run this
project alone. Peereboom said there is no reason to think
Sonatrach cannot handle the project if it hires the right
subcontractors.


5. (C) Spanish Commercial Counselor Maria Delores Loureda
tried to minimize the Gassi Touil blow to Spanish interests
by telling us on December 9 that the removed companies will
not use the pending arbitration action as a means to be
reinstated in the project. Rather, they will simply attempt
to recover lost costs. Peereboom said that Sonatrach will
likely go after Repsol and Gas Natural on a breach of
contract claim similar to one it has undertaken against BP on
a small oil field BP inherited from its merger with Arco. He
said Sonatrach will likely claim that the Spanish companies
had an obligation to finish the project on time and with the
exact output of gas estimated at the outset of the project,
and that they are liable for any shortfalls in Sonatrach's
supply contracts associated with the LNG project. (Note:
Ironically, Energy Minister Khelil complained to us in May
2007 of similar tactics used by the Spanish to squeeze out
Algerian interests in Medgaz (ref A). End note.)

MEDGAZ: ALGERIA WINS COMMERCIALIZATION ACCESS
--------------


6. (C) Loureda told us that the primary issue at the heart of
the very public Medgaz fight between Algeria and Spain (refs
A and B) has been resolved. Sonatrach, which has a 36
percent share in the Medgaz natural gas pipeline project, won
the right to commercialize up to three billion cubic meters
of gas per year directly to the Spanish market when the
project comes on-line, which the consortium still projects
for 2009. Loureda opined that Sonatrach will likely form a
Spanish trading or marketing company to sell its share of the
gas. She said this will represent the first incursion into
the gas marketing monopoly in Spain. Loureda said that
Sonatrach has negotiated the same three billion square meters
per year commercialization volume in the Italian market,
where it holds the same 36 percent pipeline stake. There are
also reports that it has also done well in recent
negotiations with Portugal.


7. (C) Loureda lamented Sonatrach's serious hardball with the
Spanish this year, in which it played interests in Medgaz and
Gassi Touil off of each other. She said the Spanish were led
to believe that if they gave in on Medgaz, they would be safe
from action on Gassi Touil. Instead, according to Loureda,
once the Medgaz deal had been reached, the Algerians
unceremoniously removed the Spanish from Gassi Touil. "They
never would have done that if Medgaz hadn't been finalized,"
she said.

COMMENT: CHASING THE VALUE-ADDED
--------------


8. (C) Even as Sonatrach announced on December 10 the
discovery of two new gas fields in the far south of the
country, the company seems more concerned with diversifying
its holdings, investing internationally, and making itself
into a downstream marketer (ref B) than in ensuring
continuous gas supply from Algeria's fields. BP's Peereboom
did not believe that Sonatrach was making the conscious
choice to focus on downstream and international ventures at
the expense of developing gas fields and building more
pipelines to connect those fields, or that Sonatrach doesn't
have the talent or ability to do both simultaneously. But it
is clear that the company is pursuing value-added projects
with particular gusto. The Algerians are using today's high
oil profits to diversify Sonatrach quickly, rather than using
the profits to expand production and the capacity to
transport raw product. They seem to assume that their

ALGIERS 00001783 003.2 OF 003


partners will ensure an adequate gas supply. Ultimately, the
Algerians may simply not care if the supply is inadequate to
meet international demand, as long has they have placed
Sonatrach in a position to be a global player across upstream
and downstream endeavors, maximizing its revenues through
value-added product chains rather than through capacity
pumping of raw product. Sonatrach's ex-chief Attar echoed
what Energy Minister Khelil told us earlier in the year: it
may be better for Algeria to leave more of its gas in the
ground for future generations than to exploit it all now (ref
C). That may make sense for the Algerians if their Sonatrach
ventures pay out, but it is not a very comforting sentiment
for their European customers.
FORD