CAUTIOUS GREEN LIGHT FOR CONOCOPHILLIPS REFINERY

C O N F I D E N T I A L SECTION 01 OF 03 RIYADH 000893 SIPDIS NEA FOR DAS GGRAY DEPT OF ENERGY PASS DAS AHEGBURG, MWILLIAMSON, GPERSON, AND JHART CIA PASS TO TCOYNE E.O. 12958: DECL: 06/08/2018 TAGS: EPET ENERG SA SUBJECT: CAUTIOUS GREEN LIGHT FOR CONOCOPHILLIPS REFINERY REF: A. RIYADH 868 ¶B. RIYADH 867 Classified By: CDA Michael Gfoeller for reasons 1.4 (b) (c) and (d). -------------- Summary -------------- ¶1. (C) In a May 27 meeting with ConocoPhillips (COP) Abu Dhabi-based Regional President Nick Spencer (strictly protect) confidentially confirmed the planned 400,000 barrel per day (bpd) joint-venture Saudi Aramco/COP refinery is likely to move forward. While emphasizing that COP had not made a formal final investment decision (FID),he summarized, "in effect, it's approved." Press stories confirming a FID are not accurate. COP has found financial workarounds to compensate for the government's decision to date not to allocate natural gas to the project. COP continues to hope a gas allocation will be forthcoming, which would make the project substantially more financially attractive. -------------- COP's Yanbu Refinery: The FID that Almost Is -------------- ¶2. (C) After recent press announcements that Total's 400,000 bpd joint venture (JV) refinery with Saudi Aramco at Juabail would move forward, Spencer confirmed that COP has been under significant pressure to make an announcement regarding its refinery at Yanbu. COP was clearly feeling the pressure to "keep up with the Jones," and make a similar announcement regarding its refinery. Unfortunately, COP's front end engineering design (FEED) is not yet complete, and so its internal procedures do not allow it to make a formal FID. In the absence of a clear FID, on 16 May, COP and Saudi Aramco announced they had "approved continued funding for the Yanbu Export Refinery." ¶3. (C) The public announcement appeared to satisfy the press, many of whom jumped on the bandwagon to promptly (and inaccurately) announce that COP and Saudi Aramco had reached FID. In particular, the Middle East Economic Digest (MEED) led with the story, the most recent in a string of inaccurate reports regarding the Yanbu refinery. COP's press release was accurate and precisely worded; it did not mention anything about FID. However, Spencer admitted COP did not wade in to correct journalists who read more into the press release than was there. COP has been under pressure to correct factually inaccurate reports from April and May MEED issues detailing the delay or outright cancellation of the Yanbu refinery. In reality, Spencer anticipates all bids for the engineering work will be received by January 2009, and FID will be made in Q1 2009. -------------- Gas Allocation Not Secured, but "Overcome" -------------- ¶4. (C) Gas allocation has been a major sticking point for the project. Spencer indicated the project still had not obtained a gas allocation, the key to generating more attractive returns on investment for COP. However, he believed the gas issue largely has been surmounted through other financial workarounds. Spencer cautioned that if COP agrees to the project without the allocation, he doubted they could obtain one in the future. He questioned why, in a period of intense competition for gas, MinPet would allocate gas for a project which they believed was likely to move forward regardless. Nonetheless, Spencer believes the Saudis will not let COP walk away from the project if gas remains the sole sticking point. He noted that on top of Total's recent withdrawal from the South Rub' Al Khali (SRAK) gas RIYADH 00000893 002 OF 003 exploration consortium (ref B),any withdrawal by COP based on gas allocation issues would be very damaging to the Saudis' international credibility. -------------- Financial "Safety Net" In Place of Gas Allocation -------------- ¶5. (C) While we do not know the exact terms of the agreement between COP and Saudi Aramco to move the Yanbu refinery forward, it appears Saudi Aramco has put in place a financial "safety net" to ensure COP will not walk away from Saudi Arabia with single-digit returns. COP told us earlier this year it was fighting to keep the double-digit returns it needed to stay in the project. With no gas allocation, and skyrocketing construction costs in the energy industry, returns for the project were hovering in the 6-7 percent range. COP's board would not countenance moving ahead with Yanbu with returns in this range, instead looking for a minimum of a 13 to 15 percent return. At the time, COP viewed a gas allocation, in effect a subsidized feedstock arrangement, as the only means making the project sufficiently profitable. COP appears to have turned a corner and is now willing to move ahead with this project, despite the lack of a gas allocation. In the interim, Saudi Aramco has introduced an additional financial sweetener, although we do not know its precise nature. -------------- CEO Visit Helps to Clinch Deal -------------- ¶6. (C) As part of COP's drive to demonstrate continued commitment to the project, in February 2008, COP CEO Jim Mulva visited Riyadh to meet with Minister of Petroleum Naimi and senior Saudi Aramco officials. The meetings appear to have gone some way to showing the firm's seriousness of purpose. Spencer and other senior COP officials have engaged in sustained shuttle diplomacy over the last year to keep up the project's momentum. Spencer anticipates COP will open an office in Riyadh within a month or two, as well as a project office in Al-Khobar. They hope to open an office in Yanbu within a year to oversee construction of the plant. -------------- Aramco Stretched -------------- ¶7. (C) Spencer also has commented on the state of affairs at Saudi Aramco, telling us that Saudi Aramco project personnel seconded into the Yanbu refinery project to date are far less experienced than they might have anticipated. COP has had to compensate by placing very senior personnel on the Yanbu project. He assesses that the Saudi Aramco joint venture project office is over-committed. Contacts from Saudi investment bank Jadwa Investments concur (ref A). Jadwa recently purchased ExxonMobil's stake in Luberef, a lubricating oil firm. As the only Saudi firm to operate a JV with Saudi Aramco, Jadwa has a front row seat to better understand Aramco's competencies. Brad Bourland, Jadwa's Economist and Proprietary Investment Manager, independently also has told us that the JV development department at Saudi Aramco is "very stretched." -------------- Comment -------------- ¶8. (C) In clinching the financial deal needed to move the Yanbu refinery forward, COP is reaping the rewards of its disciplined behavior in the early 2000's non-associated gas ("core ventures") negotiations (ref B). Both Conoco and Phillips Petroleum, then separate firms, took part in these contentious negotiations. Along with the other U.S. majors RIYADH 00000893 003 OF 003 Chevron and ExxonMobil, they walked away from the Saudi offer of low guaranteed returns. Even today, executives from these firms have no regret with their decisions. When these discussions failed, Saudi Aramco and the Ministry of Petroleum turned to Shell, as well as Chinese, Russian, and Spanish firms (ref B). After several years of exploration, even the flagship Shell-led SRAK consortium has come up with a series of dry wells. Industry watchers say that MinPet and Saudi Aramco remain very dissatisfied with the level of technology the Chinese and Russian firms in particular have been able to share. Saudi Aramco and MinPet may finally have determined that if they want access to the latest technology - in whatever segment of the petroleum sector - they will have to pay for it. COP and other American firms proved to Saudi Aramco several years ago they will walk away from commercially unattractive projects. ConocoPhillips, five years later and now a merged firm, may finally have its time in the Saudi sun. GFOELLER