Natural Gas in East Africa

Although natural gas prices are trading at record lows, many within the industry are taking the opportunity to explore for potential reserves prior to what many feel could be a significant market rally.

Earlier this year, Norwegian oil and gas firm Statoil ASA (NYSE:STO) announced that it had discovered natural gas offshore of Tanzania, marking the latest discovery to highlight the region as a key natural gas hub on the doorstep of Asia’s rapidly expanding markets.

A region of opportunity

The Norwegian major and its partner Exxon Mobil Corp. (NYSE:XOM) discovered the Zafarani field, which both companies hope will prove to be larger than initial estimates suggest. It is close to the region off the coast of Mozambique where even larger-scale deposits are being developed by Anadarko Petroleum Corp. (NYSE:APC) and Eni (NYSE:E). In February, Eni confirmed that its deposit has a potential capacity of 212.5 billion cubic meters (bcm).

“This is the biggest discovery made outside Norway by Statoil ever,” Statoil Vice President Tim Dodson told the BBC.

Healthy competition is also emerging in the form of international companies vying to enter East Africa’s energy sector. African-focused Ophir Energy plc (LSE:OPHR) and BG Group plc (LSE:BG), the largest supplier of liquefied natural gas (LNG) to the United States, recently made significant finds off Tanzania. Meshack Kagya, a geologist with state-run Tanzania Petroleum Development Corp., confirmed that the country’s reserves now stand at ten trillion cubic feet (tcf) and are expected to grow.

Further down the coast, Mozambique, the fastest growing energy player in the region, has estimated that energy firms are likely to spend $50 billion over the next decade in developing the country’s LNG industry.

“A major gas hub”

Magnus Smistad, an analyst at Fondsfinans, underlined this potential by stating, “East Africa will soon become a major gas hub if you look at all the big discoveries made in Mozambique, and the demand side also looks great considering how close India with its rapidly growing demand is.”

Hoping to cash in on this interest, Kenya has marked out new offshore exploration blocks that it feels will attract the interest of global players. The country currently has 16 open oil and gas blocks and has already received expressions of interest for nine vacant blocks from companies including Camac Energy Inc. (AMEX:CAK) and Total (NYSE:TOT).

East Africa’s market potential was brought to the fore when Royal Dutch Shell plc (LSE:RDSA) recently lodged a $1.6 billion bid for Cove Energy plc (LSE:COV), the owner of an 8.5 percent stake in the Rovuma Area 1 offshore block that is operated by Anadarko and estimated to hold as much as 30 tcf of gas.

“East Africa is a major prospective hydrocarbon province, which has seen a significant increase in exploration activity in recent years,” read the press release in which Shell formalized its bid.

Despite critics labelling the area as high risk on the back of tax rates, piracy, unpredictable political regimes, and company nationalization, the appeal of a region that has yielded a series of large-scale discoveries over a relatively short period of time cannot be ignored.

“With gas exploration you have to find an elephant field to make it worthwhile,” said Simon Ashby-Rudd, an investment banker at Standard Bank. “They didn’t just find one elephant – they found a herd.”

Despite proven reserves, industry professionals feel that it is the potential the area holds that is drawing in the majors. According to UK explorer Afren plc (LSE:AFR), fewer than 500 wells have been drilled in East Africa so far, compared with some 20,000 in the north and nearly 15,000 in the west of the continent.

Future demand

Analysts at Bernstein Research have suggested that underpinning the current appeal for East African deposits is the increasing demand for LNG in the Asia-Pacific region, which it forecasts is growing at 20 percent year-on-year. The firm also stated that demand for LNG will nearly double over the next decade.

Further, despite the dwindling market price, LNG’s fortunes are being driven by three major factors: the Fukushima disaster, which has encouraged Japan to switch from nuclear to gas, a long-term increase in European demand as North Sea supplies decline, and the emergence of buyers in China, India, the Middle East, and Latin America.

Frank Harris, an LNG analyst at Wood Mackenzie commented, “[w]hen you put all that together, we certainly think there’s room for significant volumes from Africa.”

Despite impressive reserve potential, investors should be aware that East Africa still poses unique challenges, including restricted availability of refining capacity, adequate logistical infrastructure, and transportation. However, with surging interest from notable gas majors coupled with increasing capital investment, it is hoped that some of these challenges might be overcome.

The mood across the sector can perhaps best be summed up by a quote in the Financial Times in early 2011 that noted, “East Africa used to be regarded as an oil industry backwater, a poorer relative to the continent’s resource-rich north and west. That’s changed over the past 12 months as majors and independents invest hundreds of millions of dollars in exploration and compete to snap up licenses on the continent’s last hydrocarbon frontier.”

Securities Disclosure: I, Adam Currie, hold no direct investment interest in any company mentioned in this article.