US embassy cable - 05SANAA277

C O N F I D E N T I A L SECTION 01 OF 02 SANAA 000277 
 
SIPDIS 
 
E.O. 12958: DECL: 02/02/2015 
TAGS: EPET, KCOR, ECON, YM, ECON/COM, ENERGY 
SUBJECT: DECLINING OIL AND PARLIAMENTARY INTERVENTION 
EQUALS BAD TIMES FOR OIL BUSINESSES IN YEMEN 
 
Classified By: DCM Nabeel Khoury for reasons 1.4 (b. and d.) 
 
1. (C) Summary: Yemen's oil production is steadily declining, 
and may drop below 400,000 barrels per day (bpd) in 2005. 
(Note: Production reached a high of 490,000 bpd in 2003.) 
Mismanagement of existing oil fields accelerates production 
and could serve to reduce long-term yields.  Current 
exploration is not expected to produce substantial gains. 
Hunt's Production Sharing Agreement (PSA) extension also may 
be jeopardized by corrupt side deals tacked on by ROYG 
negotiators that involve selling the ROYG's share of oil to 
other investors. In mid-February, Parliament is expected to 
review the extension and some MPs are threatening to cancel 
the deal.  Declining oil prospects and increased activism 
against traditional, albeit corrupt, business practices are 
proving unsettling for major international oil companies, 
which could negatively impact future investment. End Summary. 
 
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Minister Acknowledges Diminishing Production 
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2. (C) In a statement to the London-based daily al-Hayat, 
Yemen's Oil Minister Rasheed Saleh Ba'raba announced on 
December 30 that oil production is expected to decline by 10 
million barrels in 2005, leading to a negative impact on 
Yemen's to economic growth.  (Note: The Economist 
Intelligence Unit (and confirmed by other sources) states 
that Yemen's oil production for 2004 is about 420,000 barrels 
per day.  A ten million barrel drop would put production at 
about 390,000 bpd for 2005. End note).  Yemen's 2004 GDP 
growth is estimated to be around 2 percent (from 3.5 percent 
in 2003), a decline due largely to reduced oil production. 
Ba'raba pointed to a possible contract with French Company 
Zinco Ox to open a Zinc and Lead mine as an alternative 
source of revenue.  According to Henry Thompson, a British 
environmental scientist and Yemen expert, mineral extraction 
in Yemen is still too costly and companies interested in Zinc 
(mostly Canadian firms) were not yet comfortable investing in 
Yemen. 
 
3. (C) Yemen Hunt GM Wyndell Caviness, told Pol/Econ Deputy 
that Hunt's production was down ten percent in 2004 and 
Canadian Nexen's production dropped 40 percent the same year. 
 Caviness predicted that total ROYG production may fall below 
400,000 bpd next year.   Nexen's new PSA (near its existing 
Masila Block) is only producing 4-5000 barrels per day, 
Caviness said, and production may never rise above 20,000 
bpd.  (Note: Some ROYG oil officials have touted the new 
Nexen field as the next great find in Yemen and maintain that 
the second field alone will be able to compensate for 
diminishing returns in older fields. End note).  He observed 
that the relatively low production levels of the new Nexen 
block are indicative of future oil discoveries in Yemen. 
According to press reports as well as a World Bank study 
released in March, Nexen's Masila block produced a higher 
water to oil ratio than expected in 2004, accounting for the 
rapid production decline.  The report adds that without new 
discoveries are found, Yemen could deplete its resources by 
2012.  (Comment: While it is unlikely that there will not be 
any new oil finds, the study makes clear Yemen's near-term 
problems with oil depletion. End comment.) 
 
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Existing Resources Mismanaged 
----------------------------- 
 
4. (C) Estimates on Yemen's proven reserves range from 1.3 
billion barrels (World Bank) to 4.0 billion (Ministry of Oil) 
barrels in 2004.  Thompson believes that Yemen's Ministry of 
Oil and regulatory agencies do not manage their existing oil 
resources for sustainable production.  The Ministry of Oil, 
Thompson asserted, takes undue time and charges oil companies 
unnecessarily for activities such as drilling new wells in 
production blocks.  The Ministry's time-consuming, overly 
bureaucratic processes are a disincentive for oil companies 
to drill new wells and encourage companies to pump oil with 
as few wells as possible.  Thompson explained that fewer 
wells were inefficient and poor management can cause as much 
as 20 percent of the oil in a field to be left behind. 
(Note: Several foreign oil company executives echo similar 
complaints regarding the Ministry of Oil.  End note). 
Senior Oil Ministry officials also directly ask Oil companies 
to maintain high yields also contributing to declines in 
production.  Thompson concluded, "when it goes, it will go 
fast." 
 
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Parliament Scrutinizing Oil Deals -- Hunt's Next 
--------------------------------------------- --- 
 
5. (C) New allegations surrounding government corruption in 
the oil sector may harm Hunt's bid to extend its PSA for 
Block 14 beyond the October 31 expiration date.  Hunt 
suffered through tense negotiations with the ROYG for three 
years before reaching a Cabinet deal in 2004 to extend its 
operations from 2005-2010.  Caviness admits that in order to 
continue operating in Yemen, Hunt was forced to give up half 
of its share of oil.  Allegations have emerged (and are 
likely true) that the ROYG sold its additional share of the 
oil from Block 14 to Crest Oil -- the same company involved 
in the now infamous Block 53 scandal uncovered by Parliament 
in 2004.  According to Parliament watcher, Saad Talib, the 
sale's loss to the treasury could be as much as 5 billion USD 
and predicted that "Parliament would not ratify the 
extension." Caviness, however, is optimistic and hinted at 
serious, high-level lobbying on behalf of Hunt. 
 
6. (C) Hunt is presently in negotiation with the Petroleum 
Exploration Production Agency for an additional PSA in an 
undisclosed area.  Describing the block as "something a major 
oil company would be interested in," Caviness expressed 
frustration with the ROYG for delaying the extension and over 
difficulties in the current PSA negotiations.  Caviness also 
confided that until their PSA extension with Parliament is 
resolved, Hunt was reluctant to move forward on the new PSA. 
 
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Comment 
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7. (C) Comment: While Parliament has threatened to break the 
Hunt extension, Post believes a deal will be worked likely 
voiding the government's questionable sale of its oil share 
and allowing the largest American company in Yemen to 
continue operations.  That said, if Hunt is forced to cease 
production in 2005, the largest American investment in Yemen 
would disappear, leaving it its wake dim prospects for other 
large potential U.S. investments. 
 
8. (C) Comment continued: With Yemen's near-total reliance on 
oil for government revenue and economic growth, oil 
production declines will have a negative impact on its 
ability to expand development spending.  High-oil prices 
offset the 2004 declines, but this may not hold true in 2005. 
 Some oil watchers are hopeful that production levels may 
climb back up to the 450,000 bpd mark.  However, with Yemen's 
population rising at 3.9 percent, unemployment at 35 percent 
(conservatively) and limited alternate sources of revenue, 
the oil decline is likely the biggest economic challenge 
Yemen will face in the next five years.  End comment. 
 
Krajeski