Exploration and diversification create opportunities in Kuwait's energy sector

With about 6% of the world’s proven crude oil reserves and 1.34m citizens, Kuwait is a nation with a relatively small population that plays a major role in global energy markets. However, its reliance on a single commodity which is prone to significant fluctuations in value also presents challenges for the economy as a whole, and the energy sector in particular. According to estimates from the US Energy Information Administration (EIA), Kuwait’s total export revenues in 2015 were $40bn, compared to $119bn in 2012. Although the country has accumulated significant savings over the years, giving it fiscal buffers to weather lower oil prices in the short term, falling income has given greater impetus to long-term plans to boost production, increase upstream efficiency and diversify downstream industry, so that Kuwait can optimise the value of its natural resource endowment and pass on the benefits to its citizens. In 2017 it also played a significant role in the collective attempt to reduce global inventories of crude oil by cutting output and exports as part of an initiative led by the Organisation of the Petroleum Exporting Countries (OPEC).

OPEC Stalwart

Kuwait was one of the five founding member countries of OPEC, which was formed at a meeting in Baghdad in September 1960. Along with Iran, Iraq, Saudi Arabia and Venezuela, the newly formed inter-governmental group’s aim was to secure fair and stable prices for producers in a global market dominated by a small group of international oil corporations (IOCs), collectively dubbed the Seven Sisters. Nine months after OPEC was founded Kuwait was declared independent in June 1961. From 1899 until that point the country had been a British protectorate with the UK recognising the Al Sabah family as hereditary rulers.

First Oil

Sheikh Ahmad Al Jaber Al Saber had been the ruler in 1934 when the first concession agreement for oil drilling was signed with the Kuwait Oil Company (KOC), a joint venture that was formed by the Gulf Oil Company, now known as Chevron, and the Anglo-Persian Oil Company, now known as BP. The newly formed firm made its first significant discovery in the Burgan field in February 1938. However, disruption caused by the Second World War meant that the country’s first crude oil exports did not come until 1946. By 1972 the privately owned KOC had reached output of 3.27m barrels per day (bpd), and on some days it was producing as much as 3.7m bpd, a production rate which has not been achieved since then. In the same year the government of Kuwait acquired a 25% stake in KOC and gradually increased its share until it fully nationalised the company in December 1975.

Nationalisation Programme

Prior to the nationalisation of KOC, the Kuwaiti government had formed the Supreme Petroleum Council in 1974 in order to devise policy while the sector as a whole was overseen by the Ministry of Oil. The council remains one of the highest-ranking bodies in the industry today. With KOC in government ownership, the Kuwait National Petroleum Company (KNPC), which managed downstream refining and marketing, and the Petrochemical Industries Company were also nationalised in 1975 and 1976, respectively.

Onshore oil production in the Partitioned Neutral Zone (PNZ) between Kuwait and Saudi Arabia had been developed by the American Independent Oil Company, which was nationalised in 1977, along with the Mina Abdullah Oil refinery. In 1979 the Kuwait Oil Tanker Company was also taken over by the government. In 1980 the Kuwait Petroleum Corporation (KPC) was formed as the umbrella business for all nationalised assets in the country’s oil industry. Unlike some of its GCC neighbours, Kuwait’s constitution does not allow foreign firms to own concessions in oil and gas, with the country preferring instead to work with IOCs through service contracts.

Shifting Axis

While the 1970s saw gradual nationalisation of Kuwait’s hydrocarbon assets, it was also a pivotal decade in the history of the world’s oil industry. The axis of power was shifting east from the US, which had been the world’s swing producer, to OPEC countries, and the Gulf states in particular. For the next 40 years, Kuwait, Saudi Arabia and the UAE were able to work through OPEC to influence global oil prices by trimming or boosting their output to ensure that supply reflected demand globally.

The rapid growth of China’s economy in the first decade of the 21st century saw oil prices rise significantly as demand outpaced supply. Even after the global financial crisis in 2008, OPEC data shows Kuwait’s crude oil export revenues rose from $61.67bn in 2010 to $96.7bn in 2011, peaking at $112.9bn in 2012 and only dipping slightly to $108.5bn in 2013. China’s economic growth remained strong, but was slowly waning, and high oil prices had enabled the development of more expensive plays, such as Canada’s tar sands. On the demand side, new advances in fuel efficiency in petrol engines, coupled with breakthroughs in electronic vehicle technology, suggested the world’s appetite for petroleum might ebb, just as countries around the world were making pledges to reduce carbon emissions to slow global warming.

Shale Revolution

However, arguably the most significant factor for change from within the energy sector was what has been so-called shale revolution in the US. According to a comparative study of energy industry forecasts by Duke University, the rapid development of technology enabling natural gas extraction from shale and other tight formations in Texas, Louisiana, Pennsylvania and other states caught most energy companies and industry forecasters by surprise. Although daily extraction costs for unconventional oil and gas per unit were higher than for conventional fields in Kuwait or Saudi Arabia, the development of these new fields was much cheaper and quicker.

Through a combination of hydraulic fracturing and horizontal drilling, the US and Canada have been able to increase their output of oil and natural gas, with tight oil formations now accounting for 36% of US crude oil production, according to figures from the US Council on Foreign Relations.

Falling Prices

When the global crude oil price collapsed in the summer of 2014, OPEC countries decided to maintain or increase production and exports to seize market share while also driving shale producers out of business. It was a period of volatility that saw the price of Brent crude fall to $27.67 in mid-January 2016, its lowest level since 2003. If the goal was to drive shale producers out of business, the plan worked. However, it also showed shale’s ability to bounce back. Data from the Baker Hughes rig count shows shale reached its peak in the week of November 21, 2014, when there were 1372 horizontal wells that used shale formations in North America. A decade earlier, in November 2004, there had been just 123 of these horizontal rigs. As the price of crude oil fell in 2015 and 2016, so too did the number of horizontal rigs, falling to a low point of only 314 on May 20, 2016.

However, as prices gradually picked up thereafter, so too did the rig count. By March 2017 the number of horizontal rigs in North America had risen to 756. The Baker Hughes data also shows horizontal drilling is growing in influence. In 2004 just 9.8% of North American rigs were horizontal, while at their peak in November 2014 they represented 71.1% of the total. In March 2017, 83.7% of rigs in North America were horizontal, their highest share in history. The data suggests that the speed with which these horizontal rigs can be deployed demonstrates a new elasticity in the energy sector’s ability to react to changes in supply and demand, as well as price. For Kuwait and other oil-producing countries reliant on profiting from high prices during the traditional production cycle, where supply might lag demand by several years as new conventional fields were developed, this new elasticity characteristic of the shale revolution could create a price ceiling, which would, in turn, have a long-term impact on fiscal revenues.

Importing LNG

In a boom year for the US energy industry, BP figures show the US became the world’s leading producer of both oil and natural gas in 2015, and at the end of that year the US government lifted a 40-year ban on exporting oil and gas. A few months later, in May 2016 the Creole Spirit, an m-type electronically controlled gas injection liquefied natural gas (LNG) carrier, set sail from Cheniere Energy’s newly constructed LNG export terminal at Sabine Pass in Louisiana. Its destination was Kuwait, and the shipment of LNG produced from US shale gas was followed by a second in September of that year. Although the 3.6m standard cu feet (scf) of LNG Creole Spirit was carrying might not have been significant, it was symbolic given the recent history of global energy trade, drawing comparisons with the old UK idiom of carrying coal to Newcastle.

In June 2016 BP published its annual “Statistical Review of World Energy”, with data showing how from 2005 to 2015 proven reserves of US crude oil and gas grew from 29.9bn to 55bn barrels and from 5.8trn cu metres to 10.4trn cu metres, respectively, largely as a result of the technological breakthroughs in unconventional extraction.

Over the same period, production of oil and gas in the US grew from 6.9m bpd to 12.7m bpd, and from 511.1bn cu metres to 767.3bn cu metres daily, respectively. In contrast, Kuwait’s proved reserves remained static for oil from 2005 to 2015, and saw the volume of gas reserves rise marginally from 1.6trn cu metres to 1.8trn cu metres. Over the same period Kuwait’s oil production grew from 2.67m bpd to 3.1m bpd, and gas increased from 12.2bn cu metres to 15bn cu metres daily. From 2005 to 2015 consumption of gas in Kuwait grew from 12bn cu metres to 19.4bn cu metres. This disparity between production and consumption resulted in Kuwait making its first LNG imports in 2009, initially to cover peak demand for water and power.

OPEC Cuts

It was 18 months after the 2014 oil price slump that Kuwait and other OPEC countries decided to reduce crude oil output in the hope that their collective action would cut supplies and push oil prices up to $60 or more per barrel. In November 2016 OPEC members agreed to reduce production by 1.2m bpd and a few days later a group of 11 non-OPEC countries led by Russia agreed to cut output by a further 558,000 bpd. The Declaration of Cooperation, dubbed OPEC/NOPEC, between 24 countries was the first agreement of its sort in 15 years. The output reductions were introduced on January 1, 2017 for an initial six-month period, with the option to extend for an additional six months.

A Ministerial Monitoring Committee was formed, chaired by Kuwait and with members from Algeria, Venezuela, Oman and Russia, to report back to OPEC on the extent to which members were adhering to the agreed reductions. Kuwait’s own reduction, based on a production baseline of 2.84m for October 2016 was for 131,000 bpd, bringing output levels down to 2.7m bpd from January 2017. OPEC members Libya and Nigeria were exempted from the cuts and Indonesia, a net oil importer, suspended its membership a year after re-joining.

Wait & See

Although the agreements saw the price of Brent crude rise from $46.38 in November 2016 to $55.47 at the start of January 2017, oil traders remained cautious, waiting to see if countries participating in the reduction strategy adhered to their targets and if there was a reduction in inventories as a result. On February 22, 2017 the Kuwaiti chairman of the joint Ministerial Monitoring Committee (JMMC) announced that 86% of the promised cuts had been made by OPEC and non-OPEC countries party to the deal. The JMMC said there was room for improvement in order to reach 100% conformity, a condition some countries insisted upon across the group if they were to participate in the output reduction for a subsequent six-month period.

Short Cut

In late May 2017 OPEC decided to extend the cuts by nine months, rather than the original six-month option, until March 2018. Speaking to international press, Khalid Al Falih, Saudi Arabia’s minister of energy, said, “There have been suggestions [of deeper cuts]. Many member countries have indicated flexibility but ... that won’t be necessary.” He added that Nigeria and Libya would still be excluded from the cutbacks in production.

An additional factor affecting compliance with the reduction agreement for the remainder of 2017 may be the extent to which other countries simply step in and fill the gap in supply. According to EIA data, the US’ average production in October 2016 – the month taken as the benchmark for OPEC cuts – was 8.5m bpd. By March 2017 US oilfields had increased production to 9.1m bpd, representing an increase in output of 603,000 bpd, thereby exceeding and cancelling out the 558,000-bpd reduction collectively pledged by the 11 non-OPEC countries. These figures coincided with a report from the Paris-based International Energy Agency predicting non-OPEC production would increase by 400,000 bpd in 2017 after falling by 800,000 bpd in 2016.

“It is a new reality that OPEC needs to come to terms with as firmer oil prices, thanks to OPEC’s supply cuts, are incentivising US shale production, thereby creating a vicious cycle, which ultimately undermines oil prices,” Omar Al Nakib, NBK Bank’s senior economist, told OBG.

The OPEC production cut faced its first serious test in mid-March 2017, when the benchmark US oil West Texas Instrument plunged 9.1% in a week, closing below $50 for the first time in the year. International media reported that this price fall came as global energy industry leaders were meeting at a convention, CERAW eek 2017, in Houston, Texas, where a number of global corporations from ExxonMobil to Total were reporting reduced breakeven prices for oil production in light of efficiencies and savings made since mid-2014. A report by the Norwegian analysis firm Rystad Energy told the conference that US shale oil well-head breakeven prices had fallen by 46% between 2014 and 2016.

Breaking Even

When it comes to breaking even in a time of lower oil prices, Kuwait’s government is in a much healthier position than any of its GCC neighbours. According to estimates and projections from the IMF, in order to achieve a fiscal balance of zero, Kuwait required an average oil price of $42.5 in 2013, $55.8 in 2014 and $49.2 in 2015, rising to $52.1 and $52.8 in 2016 and 2017, respectively. The oil price in IMF estimates uses an average of the price for Brent crude, Dubai and West Texas Instrument.

Of Kuwait’s GCC neighbours, only Qatar had a lower fiscal breakeven oil price, according to the IMF, and then only in 2014. When the oil price at which the current account balance is zero is considered, the IMF calculations once again show Kuwait able to tolerate the lowest prices of any Gulf state with $38, $44, $37.9, $36.7 and $38.1, representing the external breakeven oil price in consecutive years from 2013 to 2017. At the conclusion of its Article IV consultation with Kuwait in January 2017, the IMF calculated that in 2013 oil had accounted for 82% of government revenues and 93.7% of export income, or $60.3bn and $108.6bn, respectively, in nominal terms. Its estimates for 2016 were that oil accounted for 67.5% of government revenues ($36.7bn) and 86.7% of export revenues ($45bn), while its projection for 2017 was for oil revenues of $39.2bn, or 70% of government revenues, while it expected oil exports to generate $51.9bn, or 96% of all export income. The projections for 2017 were based on average daily oil production of 3.03m barrels, rather than the 2.7m barrels agreed on by OPEC.

Strategic Objectives

Although Kuwait, as well as its fellow OPEC members, can endeavour to re-balance global oil supplies, and hence boost prices through reduced production, there is no guarantee that this approach will succeed in meeting its goals. However, the state upstream company KOC does measure its success against eight strategic objectives, which include maximising the long-term value of oil, realising the potential of gas, and growing reserves of both oil and gas through exploration and development of new fields.

Crude Oil Production

In its FY 2015/16 annual report KOC stated it had achieved crude oil production capacity of 3.02m bpd, against a target of 3m bpd. The report, published before the OPEC output production agreement, stated KOC was on track to reach capacity of 3.15m bpd by March 2017, and looking further ahead, attaining a target capacity of 3.65m bpd by 2020, sustaining that output until 2030. In FY 2015/16 it achieved actual average crude oil production of 2.88m bpd, reaching a peak in January 2016 of 3.01m bpd.

In the North Kuwait asset, a reduction in maintenance shutdown days from 51 to 23 and other changes to drilling practices allowed the field to achieve a capacity of 709m bpd, with actual production of 705m bpd. During the FY 2015/16, KOC’s biggest single construction project commenced in North Kuwait on the KD1.3bn ($4.3bn) Lower Fars Heavy Oil Programme, one of the largest projects in the Middle East. The asset has reserves of approximately 13bn barrels of heavy oil. In addition, the asset saw the drilling of the shallowest horizontal well in the Middle East using a conventional rig, which required careful geomechanics studies, as well as the testing of six additional wells.

Production was also re-activated at the South Ratqa field, which had closed in 1980. In the KOC’s most significant assets in the south and east of the country, crude production capacity reached 1.71m bpd and actual crude production reached 1.69m bpd. Booster bumps were installed to deal with associated water. Furthermore, in the West Kuwait asset, capacity reached 534m bpd with actual production of 490m bpd. Improvements to the 61-cm and 51-cm pipe networks ensured the smooth supply of heavy oil to KNPC. Across all the assets in Kuwait, 398 crude oil wells were drilled in 2015-16 against the original target of 362. The result was that an additional 770m bpd of oil gain was achieved through drilling and workover operations.

Gas Production

During the FY 2015/16, KOC’s gas production reached 1.74m scf per day (scfd), 9% higher than the 1.6m scfd combined total of associated and non-associated gas produced in the previous financial year. The average amount of gas supplied to the liquefied petroleum gas unit in KNPC had reached 1.63m scfd by March 2016. During the year, 18 wells were drilled for non-associated gas, 10 of which were exploratory wells, and 179m scfd of non-associated gas was produced. That represented a 41% increase in production of non-associated gas compared to the FY 2014/15.

Increasing Reserves

The KOC has been experimenting with alternative technologies while also conducting detailed surveys of its existing reservoirs. In 2015-16 the company launched its first pilot project in miscible gas injection in West Kuwait, while five wells were also drilled as part of an enhanced oil recovery (EOR) project in the Mauddud field in the North Kuwait asset. The KOC has also been conducting a 3D seismic survey of the Greater Burgan, the second-largest producing field in the world, and expects to complete the project by September 2017. During the FY 2015/16, a number of new discoveries were made as part of exploratory drilling operations. A new find in the Middle Marrat Reservoir in West Kuwait has the potential to produce 1053 bpd, along with average gas production of 810,000 scfd. Two additional discoveries in the Middle Marrat and Middle Mauddud reservoirs should produce 2400 bpd and 800 bpd, respectively, while a new well in the Upper Burgan reservoir resulted in 1200 bpd.

The KOC’s strategic objectives for FY 2016/17 included increasing crude oil production, development of non-associated gas fields in the North Kuwait Jurassic field to achieve a target of 1m scfd of gas by 2022-23, as well as achieving production capacity of 60m bpd of heavy oil from Ratqa Field in Lower Fars by 2018-19. It also aims to bring on stream 30m bpd at the Um Niqa Field in Lower Fars by the fourth quarter of FY 2016/17. The KOC plans to implement its off-shore drilling project to increase the production capacity of non-associated gas there by 1bn scfd by 2030. With ambitious targets to meet for both oil and gas production, Kuwait’s national oil businesses, the so-called K Companies, are faced with significant technological challenges, and industry experts believe foreign businesses can provide some of the solutions. “As the complexities in extraction increase, the Kuwaitis are having to discover new solutions, and this means there are many opportunities for international oilfield service providers,” Jeremiah Josey, director of oil, gas and energy at Abdul Kareem Abdullah Al-Mutawa and Sons, told OBG.

Neutral Zone

While the KOC is striving to pump 3.65m bpd by 2020, if the Kuwait government is to meet its stated target of producing 4m bpd, production must resume in the PNZ it shares with Saudi Arabia. By March 2017 there were no confirmed reports that production would resume imminently. A dispute between Saudi Arabia and Kuwait means both the offshore Khafji field and the Wafra onshore operations were idle throughout 2015 and 2016. The Kuwait Gulf Oil Company (KGOC) manages all of KPC’s operations onshore, with Chevron running the Saudi part of the field as a concession, while the offshore field is run as a joint venture called Al Khafji Joint Operations Company, with ownership shared by KGOC and Saudi Aramco. According to the US EIA, the PNZ has 5bn barrels of proven reserves. The Kuwait government hopes KGOC can contribute 350,000 bpd from these assets by 2020.

Downstream Developments

Kuwait operates three refineries with a combined capacity of 936,000 bpd that are owned and operated by KNPC. Kuwait Petroleum International manages overseas refining interests in Italy and Vietnam, as well as 4400 retail petrol stations in Europe. Kuwait’s refining capacity is due to increase to 1.42m bpd by 2020 through the Clean Fuels and Al Zour projects. The result will be a reduction in capacity at Mina Al Ahmadi refinery from 466 to 346,000 bpd, and an increase at Mina Abdullah from 270 to 454,000 bpd. Shuaiba refinery is to be closed down, while the new Al Zour refinery is being built with a planned capacity of 650,000 bpd by 2020. In 2015 Kuwait exported 1.96m bpd of crude oil, according to OPEC, with 88,200 bpd going to Africa, 118,000 bpd to Europe and 196,500 bpd to North America. Most of this went to the Asia-Pacific region, with 1.56m bpd. Asia-Pacific also took 440,300 bpd in petroleum products from a total of 739,400 bpd, with Europe accounting for 291,700 and North America 7400 bpd. Kuwait itself had a demand of 388,200 bpd of petroleum products in 2015, creating a surplus of nearly all products.

Powering Up

The country has experienced significant shortages in electricity generation capacity in recent years and is planning to increase baseload capacity from 15.7 GW to 25 GW by 2020. Kuwait’s power stations rely on a mixture of natural gas, heavy oil and crude oil. World Bank data shows Kuwait was the world’s sixth-largest per capita consumer of electricity in 2013, using 14,911 KWh per person. The height of demand for domestic electricity is in the summer months, when air conditioning systems are used around the clock.

Outlook

The signs are that 2017 could be a pivotal year in global oil markets and one which may have deep implications for the sector in Kuwait. The 24 nations that agreed to a cut in their crude oil output will see if their plan will produce higher prices. If North American suppliers simply respond by jump-starting and re-engineering temporarily dormant horizontal wells to fill the gap, OPEC members such as Kuwait will be forced to re-appraise their power to swing the market and face up to a longer period of lower prices. The challenge for Kuwait in these uncertain times is to ensure it makes optimal use of its natural hydrocarbons endowment through efficiency and innovation. “We have significant resources of oil, but we must not waste the value in these resources,” Ahmed Alarbeed, CEO of Seven Sisters Company, told OBG. “There is a lot of waste in our oil industry when you examine how we develop it. We should be leading the way in new innovations and developments in the sector globally.”