Expat community: Foreign players may figure prominently in upcoming plans

Kuwait’s oil and gas sector has been a difficult market to enter for foreign investors since the industry was nationalised, but two factors suggest that it may become easier in the future. The first is the scale of government investment that has been earmarked for it over the coming years. Nearly two-thirds of the investment spending outlined in the nation’s five-year development plan, some KD20bn ($71.4bn), has been earmarked for the oil sector. The majority of this funding is to be expended on meeting a new production capacity target from the present capacity of around 2.9m barrels per day (bpd) to 3.5m bpd by 2015 and 4m bpd by 2020.

BOOSTING EFFICIENCY: With 6.1% of global crude reserves at end-2011, according to the BP “Statistical Review of World Energy 2012”, the economic case for maximising the output of this resource is obvious; the question faced by the Kuwait Oil Company (KOC) is how to achieve this most efficiently. It is a question that is made more complicated by the changing nature of the oil fields, which represents the second factor from which foreign investors might draw some encouragement: the Greater Burgan field, on which the wealth of the nation has largely been built, has been worked for over 60 years, and production levels there have been in decline since hitting a high of 2.4m bpd in 1972.

FIELDING THE QUESTION: New fields, particularly those in the north, offer more opportunity to raise the national production total, but the depth and complexity of the subsurface structures bring new challenges in terms of extraction. Expanding capacity, therefore, will require the overhaul of ageing fields already in operation, as well as the adoption of new technologies to exploit the less accessible oil of fields more recently discovered. Both scenarios present opportunities for international oil companies (IOCs), and establishing the model by which they might operate within the country has become one of the more pressing concerns facing the sector. Kuwait nationalised its energy industry in 1975 and maintains a high level of control over it to this day. Article 21 of the Kuwaiti constitution states that no natural resources can be leased, sold, or otherwise given to outside interests. The exception to this constitutional precept is the Partitioned Neutral Zone, an area jointly developed by Kuwait and Saudi Arabia, where Chevron Texaco operates under a production-sharing agreement (PSA).

Establishing a means by which to utilise the expertise of IOCs whilst satisfying the prescriptions of the constitution has represented a significant challenge to the industry for some years. In 2001 the National Assembly passed the Foreign Direct Capital Investment Law (No. 8/2001), which attempted to boost levels of foreign direct investment (FDI) in the country by allowing international entities to undertake economic activities in a number of areas. Interpretation of this law has caused some controversy, but on the fundamental matters of exploration and production it has brought no significant change to the regime as defined by the constitution: direct involvement of IOCs in exploration and production is still forbidden, and outside companies interested in providing technical services to the domestic industry are not allowed to carry out pre-contract subsurface studies – a prohibition which is frequently cited as a major inhibitor to inward investment.

NEW INVESTMENT MODELS: The constitutional barrier to IOC activity has encouraged the government to seek innovative ways to harness international expertise. The history of its efforts in this regard extends back some years. Project Kuwait, an effort to establish proper incentives to attract foreign investment in the energy sector, was first conceived of in 1998, primarily as a means to bring foreign expertise to the complex northern oil fields of Raudhatain, Sabriya, Al Ratqa and Abdali. As the constitution prevents the formation of PSAs that have met with success in other markets, Project Kuwait sought to provide an alternative structure in the form of an incentivised buy-back contract (IBBC) which neatly sidestepped problematic production sharing or concession structures. Under an IBBC contract, the government of Kuwait retains full ownership of oil reserves, control over oil production levels and the strategic management of projects. In turn, IOCs are paid a per-barrel fee and capital recovery costs, and offered financial incentives for increasing reserves.

CHALLENGES AHEAD: While Project Kuwait remains a key strategy to raise the nation’s production capacity, the performance of the model over the last decade suggests that its future deployment will face considerable challenges. The contract structure was challenged as unconstitutional in the National Assembly soon after its creation, and subsequent challenges in that chamber have impeded the ability to deploy the new investment model. In May 2007 the Kuwaiti ruling family handed over full responsibility for IBBC approvals under the Project Kuwait scheme to parliament – a decision which, although allowing for a greater level of scrutiny over project management, has resulted in further delays in implementation.

The limitations on Project Kuwait compelled the government to seek other ways in which to attract IOC investment to its increasingly complex oil fields. In 2010 it revealed a new framework of performance-based incentives, known as the enhanced technical service agreement (ETSA) structure. Under such an agreement an IOC offers technical advice for a set fee, plus tiered incentives for additional increases in production. In February 2010 Royal Dutch Shell signed an $800m, five-year ETSA with KOC in connection with services rendered at the Jurassic gas reservoirs discovered in 2006 in northern Kuwait. The deal was reached as part of efforts to increase gas production from the present level of less than 1.5bn cu feet per day to 4.3bn cu feet per day by 2030, which have been made difficult by the complex nature of its recent non-associated gas finds. The Jurassic gas fields are estimated to hold around 35trn cu feet of reserves, but their development has been delayed by unexpectedly challenging conditions: depths of between 5000 and 6000 metres, high levels of carbon dioxide in the reservoirs and a number of well control issues have all helped to cause production delays and raise development costs.

LEGISLATIVE HOLD-UPS: However, the significance of the ETSA reached with Shell lies as much in its ability to serve as a model for future investment from IOCs as its ability to provide technical solutions to the gas segment. Here, again, much depends on how the ETSA principle will stand up to Kuwait’s open yet sometimes fractious legislative process. Parliament has already launched a probe into the agreement after some lawmakers accused it of having contravened Kuwaiti law – an assertion that both parties to the accord deny. The outcome of the legislative probe is of great interest to industry observers, and the future of Kuwait’s hydrocarbons resources depends on its ability to apply new technology. “As you get into secondary or tertiary recovery, it really does help if you can work with a second entity, it could be a Schlumberger, a BP, a Shell, which faces similar challenges elsewhere,” Nader Sultan, the chairman of Ikarus Petroleum Holdings, told OBG. “To secure technology and technical competency is probably one of the biggest challenges facing Kuwait.”

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The Report: Kuwait 2013

Energy chapter from The Report: Kuwait 2013

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