The financial impact of energy generation

The subject of energy generation and its financial burden on our economy has spurned PKF to organise a conference to be hosted in conjunction with Master Investor 2013, which is UK's leading investment focusing on many industries, including the oil and gas sector. This will be held next Saturday, 27 April in central London.

The agenda will bring together senior government speakers, oil and gas corporate leaders, financiers and global energy experts from around the globe to share their knowledge and experience on oil exploration possibilities. The show is now in its 11th year and attracts over 2,500 attendees as it gives investors unique insights on country-specific opportunities. PKF will be inviting interested parties, officials of MRA and  Enemalta representatives in the oil procurement division to participate and actively contribute to the development of the industry.

The battle cry is: can Malta become a potential oil and gas hub (joining Cyprus, Sicily, Tunisia, Morocco and others) and in the medium term, reap dividends from production sharing agreements once oil or gas is found in commercial quantities? During this recessionary period that is gripping most European countries, any extra tax revenue from any such windfalls can ideally be placed aside in a special fund to honour our commitment to  reduce  recurring annual financial deficits and render our budgets in surplus.

That will signal the start of a government policy to repay debt due to Maltese bond holders and mitigate the high servicing cost.  Economists will tell us that unless we accelerate our rate of growth to over 5% of GDP (last year reached 0.8%) then we can never recover a decent surplus to catch up in our race to match the standard of living enjoyed by the richer EU members. As to prospecting for hydrocarbons, this is a risky business which needs a lot of capital, and there are only a few dedicated investors which do not stop drilling after the first dry well breaks their resolve.

One remembers with nostalgia how in the 1950s - shortly after the discovery of oil in Triassic dolomites at Ragusa in southeast Sicily - interest over this discovery had caught the headlines and started our race to the bottom to try and locate the elusive gold.

It is heartwarming to hear official circles reveal that the main source rock for the oil in the Ragusa basin is expected to be rich in the organic Streppenosa oil shale unit which is designated world class in its prolific oil generating capabilities, and most likely extends into the area in our waters close to Sicily.

There is a recognisable fairway of oil discoveries and oil fields leading from onshore Sicily into its southern offshore waters. No wonder that the offshore Sicily Vega oil field, with an estimated resource of 1 billion barrels of oil in place, is only 20km away from the northern border of the latest zone in Malta's exploration efforts. Needless to say, experts predict that the proximity of similar concessions and similarity in geology to the producing basins of Tunisia and Sicily lend support to the theory that oil strikes for Malta cannot be excluded.

The 'intrabasin' ridge trend therefore offers a new and highly prospective oil strike in our waters. Unfortunately, 12 wells were drilled in 60 years, with none proving successful. But then again, one may ask: did we persevere in attracting new foreign investors to risk their capital in our waters? The answer is not easy to give and one must also recall various protests made by neighbouring countries which contested  the delineation of the boundaries in our interpretation of  territorial waters.

Admittedly, on the heels of a long-fought electoral campaign where the subject of oil drilling was considered taboo, much pessimism on the subject still persists. Perhaps the sector has been neglected over the past six years, but now it seems that due to geopolitical changes it may be an ideal time to try again.

It is encouraging to note that this year Mediterranean Oil and Gas as a licence holder intends to explore for oil and gas in Block 4, 5, 6 and 7 of Area 4. MOG has previously commissioned a specialist operator to shoot a seismic survey and succeeded to interpret an extensive long-offset 3D view over the central graben area of Area 4. The prospects look promising such that it is now apparent that this part of offshore site which is geologically analogous to the Libyan Sirte Basin, contains analogues to proven producing fields in Libya in addition to those offshore Tunisia. Logic dictates to start planning, in a more aggressive way, how to exploit our underwater riches (if indeed we have any).

Certainly, the new Labour government is keen to fully arm the Oil Exploration division within Malta Resources Authority to start one-to-one negotiations with new applicants. The government is in fact placing acreage covering an offshore range exceeding 70,000km, consisting of seven areas to be offered to suitably qualified oil companies inviting them to enter into Exploration Study Agreements (ESA) or Production Sharing Contracts (PSC). We only need one lucky strike and the good news will spread like wide fire, attracting attention from oil giants such as Shell, BP, Exxon, Chevron, Gazprom and others. Again, it is a chicken and egg situation.

When our economy is so fragile, one can be excused about being risk-averse and refrain from allocating capital to such risky ventures. Political leaders in the past PN administration were reluctant to manifest their intention to justify the huge capital investment needed to attract top oil and gas companies at a faster rate.

At this point, one can also understand the reluctance of the electorate to contemplate such a bold adventure. Yet, it is clear that more effort is needed by the new Labour government to balance the budget given its pledge to reduce by 25% the electricity tariffs within two years at the same time when running the BWSE extension on HFO and continuing the operation of the ageing Delimara complemented by the defunct Marsa power stations. 

Enemalta's electricity generation efficiency rate currently stands at a very low 31.5% (the older Marsa power station is 23% efficient). To put it in simple terms: for every €1 of oil that is burnt, the value of electricity generated rarely exceeds €0.31 which is a fact of life that is hard to believe in these days when the country is bucking under the mantle of high tariffs. Again, the latest report by rating agency Standard and Poor's was classifying Enemalta's rating at B+ after having downgraded the corporation from BB last February - it maintains that its outlook is still negative and this was recently confirmed when the 2012 audited accounts revealed a €70m loss.

Naturally, as the accumulated debt burden of the utility provider now exceeds €850 million, it is understood that S&P relied on comfort letters issued by government to provide timely and sufficient extraordinary support to the company in the event of financial distress. Recently, in what was a good move, parliament unanimously approved a Special Purpose Vehicle designed to spread the amortisation cost of its huge debt over 25 years. At this stage, the subject of energy deficit goes to show how precarious our position is - we must try to solve the economic imbalance, partly due to the big cost of fuels for energy generation.

The solution to earn more revenue on a national basis in the short term can be either more taxes, or introducing austerity measures (which are anathema given the electoral promises ushered by Labour Party) or hopefully attracting foreign oil companies of stature to invest in a multiple drilling sequence to increase our chances of a lucky strike (and make up for lost time). Still, one is mystified as to how the utility company has accumulated so much debt and for this reason, cynics retort that the current state of affairs is due to bad financial planning. They stress it is a sad reality that as a consequence of many years of under-investment, inefficiencies exist in our electricity distribution network which on its own generate high losses reaching 25%.

To conclude, prudence dictates that the island needs to restructure its energy production so perhaps the oil and gas conference will be an ideal platform to set the ball rolling on how to chart our oil exploration in the near future. Interested parties wishing to attend the London conference can register with Audrey-Ann Cassingena at email [email protected].

George M. Mangion is a partner in PKF an audit and business advisory firm

[email protected]