Frontier Players Look To Cairn's Phase II Exploration Programme

BMI View : Cairn India is about to drill a fourth well at its concession in Sri L anka . The results of exploration drilling will be followed closely as they will offer an indication of the frontier play's hydrocarbons potential and may determine interest in the country 's planned offshore licensing round. There are opportunities to be realised in th e Sri Lankan market; the country has a large consumer base that need s access to oil and the government is m aking an effort to attract upstream investment. However, it is stil l a relatively unproven play and the country could require a competitive Petroleum Resources Act that would compensate players sufficiently for the considerable risks that they would have to take.

Sri Lanka will be keeping a close eye on the results of Phase II in Cairn India 's exploration campaign. The Indian firm ( in which Cairn Energy h olds a 10% stake) announced that it will drill a well in Block SL 2007-01-001 in the Mannar Basin. Head of Corporate Affairs , Sunil Bharati , said that this should be completed within 35-40 days if operations proceed as planned.

This will be the fourth well that Cairn India will drill o n its block. It has hit gas and condensate in two out of three wells drilled to date - in Dorado-91H/1z and Barracuda-1G/1 ( see our online service, November 15 2011, 'Cairn india's Second Well Likely To Build On Mannar Basin Interest' ) . The commercial viability of these two discoveries ha s yet to be ascertained, but in conjunction with this fourth well, this could be determined by 2014.

Hydrocarbons To The Rescue

Cairn's earlier successes have proven that there is a working petroleum system in Sri Lanka - a country which currently has no proven reserves of oil or gas. Although Sri Lanka does not consume any gas, according to the US Energy Information Administration (EIA), commercial gas production could bring in much-needed income to support the country's growing oil import bill.

Petroleum Resource Minister Susil Premajayantha told the Sri Lankan parliament in November 2012 that the country spent US$3.2bn on oil imports in 2011 - or about 6% of its total GDP that year.

Premajayantha expects this bill to have doubled in 2012 due to increased demand for oil imports - after country's hydropower sector was hit by a drought - and exacerbated by high oil prices. This means the cost of oil imports will have accounted for equivalent to nearly 11% of total GDP in 2012, according to estimates provided by our Country Risk team.

Oil Stress On Market
Proportion Of Sri Lanka's Oil Import Bill To GDP (in US$bn)

Gas exports could help alleviate this burden. If Sri Lanka exports just 1bcm of gas to neighbouring India at US$11.55 per mn British Thermal Units (mnBTU) - which is the US Federal Energy Regulatory Commission (FERC)'s estimate for Indian-bound liquefied natural gas (LNG) prices for February 2013 - it could bring in income of US$0.4bn. Alternatively, domestic gas production could also incentivise a switch to gas in power generation, which would reduce the need for imported oil for such purposes.

If further exploration proves-up commercial oil reserves, this would meet growing oil demand in Sri Lanka. Demand growth has been particularly troubling over the past year, not only because of high global oil prices, but also because of the country's reliance on Iranian crude for refining. Sri Lanka's sole refinery, Sapugaskanda, only processes Iranian crude, but western sanctions on Iranian exports have placed the country in a difficult position. In October 2012, state-owned Ceylon Petroleum Corporation had to shut down Spaungaskanda temporarily due to a shortage of crude, which would have contributed to a surge in the country's imported fuel oil volumes. Crude shortages also hit the country's power sector. Consequently, domestic crude production will strengthen Sri Lanka's energy security in this respect.

Rising Oil Expectations
Sri Lanka's Oil Consumption (RHS) & % Y-o-Y Change (LHS)

Domestic hydrocarbons production could bring economic and energy security to Sri Lanka and this has led the government to actively promote the country's oil and gas prospects. Given the proven hydrocarbons potential of the Indian section of the Cauvery Basin, which holds about 700mn barrels of oil equivalent (boe) according to a 2004 estimate, Sri Lanka's Petroleum Resources Development Secretariat (PRDS) believes that its portion of the Basin holds similar promise. The two discoveries made by Cairn India in the Mannar Basin further demonstrate the country's offshore potential. PRDS concludes from these early geological studies that there is a 60% chance of 'finding hydrocarbons accumulations'.

Sri Lanka is courting partners to help it explore its offshore potential and plans to launch a licensing round that could see eight to 10 blocks in the Cauvery and Mannar Basin put out to offer. Back in July 2012, PRDS Director-General Saliya Wickramasuriya told that the regulator intended to 'close the bids by end-Q1 and award the blocks by June 2013'. At the time of writing, a licensing round has yet to be launched, most likely held back by delays to the finalisation of the Petroleum Resources Act; this is currently being fine-tuned to align with international standards and to 'introduce principles of good governance' to the nascent oil and gas industry. This is a positive development that suggests the country is committed to making its industry competitive.

Aside for a licensing round, Sri Lanka had also been active in courting possible partners in its upstream. Interestingly, most of the candidates have been state-owned firms - Russia's Gazprom, Malaysia's Petronas and Vietnam's PetroVietnam. It has also reportedly offered both China and India a block each in the Mannar Basin, and India's ONGC has made investment proposals with regard to offshore exploration. Furthermore, Wickramasuriya revealed to the BBC in a March 2012 interview that private partners had also shown interest. These are thought to include the likes of French major Total.

The Drill Ahead

Cairn India's discoveries have helped to de-risk Sri Lanka and could see it as an emerging frontier play in the global upstream segment. Its large consumer market and strategic location between energy consumption giants India and China give it good domestic and export prospects. Nonetheless, it could take time for upstream activity to pick up.

Two discoveries to date will probably be insufficient to attract large-scale interest in the country and players entering the market in the near future will most likely be Asia-focused firms and/or those with sufficiently large pockets to take the risk. Cairn India's higher-than-expected costs for Phase I of its exploration programme also adds to the operational risks; the Indian firm spent US$150mn in Phase I - US$38mn higher than i t had targeted and a possible reflection of the increased costs of activity in an understudied area where support services are limited and expensive to hire. If the country wishes to tap into its ultra-deepwater prospects as the PRDS envisions, it could also need to do more to attract experienced international oil companies (IOCs) , rather than just relying on the state-owned firms it has been talking to thus far .

India could also create hurdles . The lack of c larity over economic rights to the Mannar Basin could put Sri Lanka at loggerheads with its larger neighbour, which could prevent it from advancing commercial hydrocarbons production i n the b asin.

Results registered during the drilling of Cairn's fourth well could determine the extent of the interest in Sri Lanka's upcoming licensing round. The end of the brutal civil war has meant the security situation has stabilised, making it more positive for upstream development. Sri Lanka now needs to ensure that a revised Petroleum Resources Act will compensate players sufficiently as they undertake exploration in a still-risky frontier play.

This article is tagged to:
Sector: Oil & Gas
Geography: Sri Lanka