In Europe, the Strategic Importance of Algerian Natural Gas

Developing Algeria as a major natural gas exporter is an economic and strategic imperative for EU countries as North Sea production of the commodity enters terminal decline in the next decade. Algeria is already an important energy supplier to the Continent, but Europe will need expanded access to natural gas to offset the decline of its indigenous reserves. With large conventional and unconventional natural gas reserves and suitable export infrastructure, Algeria appears primed to succeed Norway as Europe's primary regional natural gas supplier.

Until recently, however, Algiers has been reluctant to facilitate the large-scale influxes of Western technical and financial capital necessary to boost natural gas production to the levels required to meet Europe's needs. And while the government has become more receptive to foreign involvement in recent years, security issues highlighted by the Ain Aminas hostage crisis will at least temporarily cool Western enthusiasm for investment in Algeria. But a European energy crunch is looming and other options are lacking. Continued investment in the Algerian energy sector from Europe -- as well as attempts by European countries, particularly France, to stabilize the region -- can therefore be expected.

Analysis

The United Kingdom and the Netherlands, two of the three traditional North Sea natural gas producers, are expected to halt exports of the commodity almost entirely before the end of the decade -- the United Kingdom has already become a net importer. Norway's reserves are more significant; the country is the world's third-largest natural gas exporter after Russia and Qatar, supplying nearly 19 percent of Europe's annual consumption. But Norwegian reserves likewise are expected to begin a steep decline around 2015.

The need to offset the coming terminal decline of Norway's output is a great concern for many European countries, which do not want to upset the balance in the diversification of their natural gas supplies. The Russian-Ukrainian energy crises between 2006 and 2009 made EU customers wary of relying too heavily on Russia for natural gas, prompting a string of diversification and integration efforts within Europe. Maintaining a predominant role in European energy markets is a political and economic imperative for Russia, and Moscow has taken clear and effective action to ensure the reliability of its future supplies to Europe -- most notably by building the Nord Stream and South Stream pipelines. But many Western European nations are unlikely to allow Russia to provide the majority of their natural gas imports.

Europe's Best Option

The problem for EU countries is the lack of proximate stable sources of natural gas outside of Russia. The EU-backed Southern Corridor project, which would pipe natural gas to Europe from Azerbaijan (with eventual but unlikely plans to pipe natural gas from Turkmenistan, Iran and northern Iraq), has been hampered by increasingly high costs and competition from the South Stream project. Liquefied natural gas from distant producers in the Middle East or the southern Pacific is an option, but importers would need to overcome obstacles such as high shipping costs and competition with Asian consumers.

Currently, Algeria ranks as the third-largest supplier of natural gas to the European Union, exporting some 10 percent of the bloc's consumption, primarily to Spain, Italy, France and the United Kingdom. The country's export infrastructure is highly developed and features two sub-Mediterranean pipelines and three liquefied natural gas export trains, each with spare capacity. Moreover, Algeria has been willing to commit to long-term supply contracts, which are preferred by stable European countries that typically favor locking in advantageous fares for long periods of time. In early 2013, for example, Spain and Algeria signed a supplementary 18-year contract for small volumes of natural gas.

Algeria is particularly important as a future supplier for European countries that rely heavily on North Sea natural gas reserves. For example, France receives around 45 percent of its supply from Norway and the Netherlands. In contrast, Mediterranean nations that already rely heavily on Algeria have less interest in developing the country's natural gas output since they are insulated from the impacts of the North Sea declines.

Obstacles to Investment in Algeria

Energy is the lifeline of the Algerian economy, accounting for 36 percent of its gross domestic product and around 60 percent of the country's revenues. The country mainly produces a type of high-quality crude oil that is particularly sought after for blending purposes. Its oil exports are relatively well-diversified, so production fluctuations are unlikely to have major consequences on regional or global markets. With an estimated 4.5 trillion cubic meters of conventional natural gas, Algeria's reserves are the second-largest in Africa after Nigeria and more than double the size Norwegian reserves.

The Algerian government estimates that the country also has around 17 trillion cubic meters of shale gas. However, exploratory work on Algeria's unconventional reserves is still preliminary and technical challenges remain, particularly a lack of the freshwater needed for enhanced recovery techniques and hydraulic fracturing. More problematic is the poor investment climate in Algeria, which particularly afflicts the oil and natural gas sectors. Foreign participation in Algeria has suffered in large part due to protectionist policies enforced by the highly nationalistic military government. Foreign investment slowed during the decades-long civil war, which was sparked by the military's decision to invalidate a 1992 parliamentary win by Islamist parties. Algeria's state of emergency was not lifted until 2009 and the war was not declared over until 2011.

In recent years, there have been some signs of improvement in Algeria. With internal violence quelled and the military being relied upon less to stabilize the country, Algerian President Abdel Aziz Bouteflika's government has begun to slowly ease protectionist policies and lessen the burdens of its overwhelming bureaucracy. The appointment of Abdelmalek Sellal, a technocrat, as prime minister in September 2012 signaled renewed focus on Algeria's relatively underdeveloped economy.

Already, such moves have helped boost non-energy investment in Algeria, with Algiers signing an unprecedented number of investment and partnership agreements in late 2012. The economic crisis in the European Union has encouraged the movement of capital and expertise in struggling industries to markets outside the Continent, and geographical proximity to and historical ties with Algeria make the country a natural destination -- especially for European states on the Mediterranean. In mid-December, French auto manufacturer Renault signed an agreement to build a plant in the western Algerian city of Oran. Spanish and Portuguese companies then announced the creation of a multi-billion-euro joint venture with Algerian companies to build 100,000 housing units throughout the country.

Algeria has also appeared somewhat ready to tap into its potential as a natural gas powerhouse on Europe's doorstep. In 2011, the country inaugurated the Medgaz pipeline, which can transport 8 billion cubic meters per year between the Algerian port of Beni Saf and the Spanish city of Almeria. Other efforts seek to expand Algeria's liquefied natural gas export capacity by 50 percent.

Security Risks and Future Interventions

The immediate fallout of the Ain Aminas hostage crisis will likely dampen Western enthusiasm for investment in Algeria in the near future. Western governments and companies are raising questions about the Algerian army's intervention, in which the government seemed to prioritize crushing the hostage-takers over the safe rescue of the hostages themselves. As the French intervention in Mali continues to develop, the risk of al Qaeda-linked militants in the Sahel targeting other installations remains.

A primary motive behind France's intervention is to contain al Qaeda's regional franchise, al Qaeda in the Islamic Maghreb, and other militant groups. Paris fears, among other things, that these militant groups could use Mali as a base for training, recruiting and launching destabilizing attacks on Algeria and its energy infrastructure. The sustainability of such operations will be an issue since public support for costly foreign interventions will likely decrease amid escalating financial and social crises in Europe. Already, France's opposition has decried the intervention in Mali as lacking concrete goals and international backing.

However, energy needs will shape the reactions of France and other EU members to situations like the hostage crisis in Ain Amenas. Even if appetite for involvement in Algeria dips temporarily, Europe will eventually be so dependent on the country for natural gas that EU members will have no choice but to invest further in the Algerian energy sector. The existing involvement of EU energy majors in high-risk countries like Nigeria, Libya, Yemen and Iraq indicates a healthy tolerance for instability and security problems. North African countries outside Algeria have also become increasingly important for France and Europe (France, for example, relies on Niger for nearly 70 percent of the uranium needed to fuel its nuclear energy sector). Thus, efforts by European countries, particularly France, to stabilize the Sahel will probably continue -- especially as the United States disengages from foreign interventions.

More challenging will be Algeria's reaction to the Ain Amenas events. The attack came at a delicate transition time for Algiers; should the security situation deteriorate in the country, Algeria may refocus its attention on national security and place the liberalization of its economy and energy sector on the back burner. However, early indicators such as the Jan. 21 approval to amend foreign investment laws concerning unconventional hydrocarbon resources show that after decades of intransigence, Algiers is slowly becoming more receptive of foreign investment into its critical energy sector.

Marc Lanthemann is Europe Analyst at STRATFOR P:(+1) 512 744 3911.  STRATFOR is a Natural Gas Europe Media Parter.  For more visit http://www.stratfor.com/

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