Prospects For A Recovery In Libyan Oil Output Remain Uncertain

by: E.A. Lukas

Libyan crude oil export levels are most likely to return to 300,000 barrels per day (bpd) by the end of 2011, and a return to the pre-revolutionary production levels of 1.6 million bpd should not be expected until 2013 at the earliest. This outlook will see Brent front-month futures contracts maintain a level above $100 per barrel through the end of the year, while continuing to retain a strong premium over West Texas Intermediate (WTI). The absence of Libya’s valuable, high-quality crude from world markets will be a major contributor to the continued strength of Brent, while the lower price levels of WTI futures will continue to reflect domestic factors in the North American market.

Two weeks after the collapse of the Qaddafi regime, the prospects for a recovery in Libyan oil output remain uncertain. At the time the rebels moved into Tripoli, several estimates pegged Libyan oil production to return to 500,000-600,000 bpd by the end of 2011 and to the pre-revolutionary level of 1.6 million bpd by the end of 2012. Now as more information surfaces about the state of Libya’s oilfields, it is becoming increasingly likely that these estimates were overly optimistic. Estimating the recovery of Libyan production and the country’s return to global oil markets must take into account the state of the oilfields, production and exporting infrastructure, and the unstable political atmosphere.

Brent activity and Libyan uncertainty

The persistence of both a $110 price floor for Brent front-month futures contracts and a Brent premium of more than $20 over corresponding WTI contracts is largely due to concerns over Libya’s stability. Though pre-revolutionary Libyan output represented only about 2 percent of global production, Libya’s high-quality light, sweet crude retains significant influence over the market due to its sought-after position in European and emerging-market refineries. On August 22, October 2011 Brent futures fell from $108.62 per barrel to nearly $105, as the Libyan rebel advance into Tripoli appeared to bring an end to the conflict and sparked hopes of renewed Libyan oil production. But despite the collapse of the Qaddafi government, uncertainty returned to oil markets as traders began to reassess the Libyan political situation, and the October Brent prices inched back up, closing the week of August 22 at $111.36. With the exception of two brief dips earlier this week, October Brent has remained above $110 ever since. On September 6, it closed a record $26.89 over WTI; on September 9 it ended the day at $112.77 per barrel, at a spread of $25.53 over the WTI October contract.

That uncertainty was further reinforced by remarks on Monday by Nuri Berruien, the new chairman of Libya’s National Oil Company (NOC), whose outlook on the country’s oil prospects countered earlier statements by interim oil and finance minister Ali Tarhouni that Libyan oil production would be back at 500,000 to 600,000 bpd by the end of 2011 and back at pre-war levels of 1.6 million bpd by the end of 2012. Berruien, by contrast, has acknowledged that the 1.6 million bpd target may not be reached for at least 15 months, according to the Financial Times. His words support more sobering reports from analysts at PFC Energy and Wood Mackenzie, who stated two weeks ago that it could be 2013 or even 2014 before Libyan production returns to the pre-war level. This skeptical “2013 consensus” has been given further credence by estimates this week by Bank of America and the International Energy Agency.

Risk factors in Libyan production recovery

Expectations of a delay in restoring Libyan oil production are driven by security concerns and the difficulties that the NOC will face in rehabilitating oil infrastructure and several productive oilfields that were damaged in the six-month conflict. In the short term, Libya and its new government face a chicken-and-egg problem on security and production. The National Transitional Council (NTC), the country’s provisional government, desperately needs the physical receipts from oil production to not only rebuild the country but also to provide security in the fields and reconstruct and rehabilitate Libyan oil infrastructure. But bringing back oil production will require capital from foreign oil companies, which in turn will demand security before sending workers back into the desert.

The map below illustrates Libyan oilfields. Out of sight in the southwest is the Murzuq basin. The Sirte basin is in the center, with the offshore Pelagian fields off the northwest coast.
Libyan Oilfields and Pipelines

Sirte basin

Rehabilitation of some fields will prove to be a daunting task. The country’s richest oilfields are in the Sirte basin, which is estimated to hold up to 80 percent of Libya’s 46.4 billion barrels of proven reserves, according to the U.S. Energy Information Administration; the Sirte basin accounted for some two-thirds of Libyan pre-war production, or about 1.07 million bpd. The Sarir and Mislah fields, which lie in the eastern part of the basin and have long been controlled by the rebels, should be back on stream relatively soon. However, the fields in the rest of the Sirte basin, as well as pipelines leading to the export terminals at Brega and Ras Lanuf, were plugged, broken up, and heavily mined by Qaddafi forces, though the full extent of the damage is not known. However, landmine removal experts have estimated that it could take 18 months to clear the mines. Additionally, the Sirte basin contains several mature fields where production dates back to the 1960s, and mature fields require continual pumping to remain in operating condition and to prevent solidification in wells. Since most of the Sirte basin has lain idle for the past six months, these fields will take several months to restore.

Murzuq and Pelagian basins

The Murzuq basin in southwest Libya, which is capable of producing 400,000 bpd, is in better condition than most of the Sirte basin and may be restored more quickly. However, the pipeline between the basin and the Zawiya refinery was cut by the rebels, and it is uncertain how long restoring it will take. The offshore fields in the Pelagian basin, which account for about nine percent of Libyan production, suffered no damage in the conflict; they should be back on stream within weeks.


Infrastructural problems will complicate restoration efforts. Es Sider, an important pipeline terminal for the Sirte basin, was mined and badly damaged in the fighting. Ras Lanuf and Brega, the primary ports for Sirte oil, will also need to be cleared of mines and terminal infrastructure must be reconstructed. Finally, much of the infrastructural support equipment, including control facilities at pipeline terminals, has been damaged due to looting in the conflict. As these reconstruction costs add up, restoration of pre-revolutionary output appears far from assured.

Security and political barriers

Attracting foreign investment for reconstruction efforts will therefore be a high priority for the NTC and the NOC, but security considerations will loom large. The coastal town of Sirte and interior towns of Bani Walid and Sebha remain held by Qaddafi forces, and it is still unclear whether additional loyalist insurgent groups may be elsewhere in the desert interior. Additionally, the emerging NTC government structure is still precarious, resting on retaining much of the Qaddafi-era bureaucratic structure, which may provoke dissent from other branches of the rebel forces. Some Libya experts have warned that the tribal makeup of the country could make national governance a permanent and fragile balancing act. The Economist has reported the presence of protection rackets run by private rebel militias in Benghazi, which does not bode well for the nascent business climate of post-Qaddafi Libya.

Recovery estimations

With these infrastructural and security considerations in mind, Libyan oil production exports may be estimated at 300,000 bpd by the end of 2011. The eastern oilfields of Sarir and Mislah, having suffered minimal damage, look set to come back on stream during the fall, and the pipeline extended from these fields to the port of Tobruk is capable of carrying 250,000 bpd. Eni S.p.A. (NYSE: E) has signaled that it could restart production at its offshore sites in the Pelagian basin, but maximum output in these fields is relatively small at 45,000 bpd and the crude produced here is of a heavier, sour grade compared to those on the mainland, and therefore less desirable in world markets. In a best-case scenario, pipeline repairs could see Murzuq basin production begin this fall, but since the Zawiya refinery will require repairs as well, output from the Murzuq fields may be no more than 150,000 bpd by December 2011. Most of the Sirte basin will require extended repairs and restoration work, and it is not likely that any oil will be exported from this basin apart from the Sarir and Mislah fields before the end of 2011.

Even if Libyan oil production reaches 350,000 bpd or higher with the opening of the Murzuq fields, a sizable portion of that oil must be allocated to domestic Libyan consumption. Prior to the revolution, approximately 25 percent of Libyan production went towards domestic consumption. Given the pressing need for export earnings in order to rebuild the country, it is likely that a reduced proportion of domestic oil production will be consumed at home, leaving an expected oil export figure of 300,000 bpd for December 2011.

Several oil firms have been negotiating with the NTC government and the NOC to rehabilitate oil fields and infrastructure, including Eni, Total SA (NYSE: TOT), Repsol YPF SA (OTCQX:REPYY), and Wintershall Holding AG (a division of BASF SE (OTCQX:BFFAF)). The NTC has indicated that though it will honor many pre-revolutionary contracts with oil companies to reestablish production capacity, it will be re-evaluating all of them. How soon contracts can be honored or renegotiated will set the bar for the pace of foreign oil investment in Libya, and thus the recovery in production.

Strong outlook for Brent and a persistent premium

With only a very limited recovery of Libyan oil production, Brent futures contracts should remain at prices above $100 per barrel through December 2011. During Libya’s absence from the world oil market, Libya’s light, sweet crudes were replaced by increased Saudi production, but since Saudi crudes are generally heavier and sourer, Brent price levels rose above the $100 per barrel mark. Though a troubled European economy may exert downward pressure on Brent, the continued absence of Libya’s desirable crudes from most of the market will keep prices high for the remainder of the year.

With Brent price levels remaining high, the spread between Brent and WTI should also be expected to endure through the end of 2011. WTI is facing downward pressure from the market due to the continued buildup of inventory in the U.S. PADD II Midwestern region. This buildup in inventory has been a result of sustained high stocks at the Cushing, Okla. pipeline hub earlier this year and the surge in production (to nearly 400,000 bpd) and drilling at the Bakken field in North Dakota, which lacks pipeline access to Cushing. The absence of pipeline capacity to bring stocks from Cushing and the upper Midwest to the Gulf Coast reinforces the high PADD II inventories, thus pulling down WTI futures prices and contributing to the WTI-Brent spread. The Obama administration’s approval of the Keystone XL pipeline might provide that capacity needed to bring excess inventories to the Gulf, but for now Keystone’s approval is uncertain. Recent adverse outlooks on U.S. economic conditions from the Federal Reserve and the August jobs report, combined with a seasonal drawdown in refining activity, will be further contributors to high Midwestern inventories and barriers to a rise in the price of WTI futures contracts.

These strengthened inventories will combine with uncertainty over Libyan oil recovery to produce a strong outlook for Brent and weakened one for WTI, allowing the spread between the two benchmarks to persist through the end of this year.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.