Opening up: The government looks to boost investment in the sector, which could provide opportunities for increased private sector participation

For many, the passage of the National Development Plan in 2010 heralded an opportunity for Kuwait’s non-energy-related industries to finally come to the fore of the country’s economic development. Indeed, desire to diversify the country’s income stream – around 90% of government revenue over the last 10 years has come from oil receipts – has led to increases in investment in alternative industries.

Yet as the price of oil reaches historic highs once again, Kuwaitis (and those who have invested in the country) are appreciating the fact that oil remains the backbone of the economy. The government has the enviable task of channelling the KD4.5bn ($16.2bn) surplus for fiscal year 2010/11 (which ended in March 2011) into effective investments that will support the country’s continued macroeconomic health. In addition, Kuwait Petroleum Corporation (KPC), the state-owned energy company, has announced $90bn worth of spending on the oil and gas industry up to 2015. Meanwhile, the government is planning to double power and water generation capacity within the next 10 years.

INVESTING IN THE FUTURE: The development of oil in Kuwait began with the formation of the Kuwait Oil Company (KOC) in 1934 by the US’s Gulf Oil and the Anglo-Persian Oil Company (now BP). The country’s largest and most productive oil field, Burgan, was discovered in 1938, and its first shipment of crude came in 1946. Production expanded rapidly, peaking in 1972 at 3.34m barrels per day (bpd). Throughout much of the 1970s, Kuwait ranked as the fourth-largest producer of oil in the world. However, production has since experienced some fluctuations, particularly in recent years.

Output had dropped to 2.5m bpd in 2010, though it had increased to 2.9m bpd by October of that year. The dip is mostly due to ageing fields, an acknowledged lack of investment and the loss of an estimated $50bn worth of infrastructure during the Iraqi invasion. OPEC quotas have also played their role. So it is understandable that Kuwait is looking to expand production, with KOC stating that it plans to increase capacity to 4m bpd by 2020 (see analysis). At least part of this expansion will likely be derived from heavy, sour, or other complex reserves whose extraction has so far not seemed economically viable. Yet with the price of Brent North Sea crude trading at nearly $120 per barrel in February 2012, the exploitation of even difficult-to-extract reserves has understandably become attractive.

Expanding capacity will require significant investment, however. In December 2010 the KPC, the state-owned energy company, announced plans to invest approximately $90bn over the subsequent five years in its oil and gas businesses. These expenditures are due to be part of a longer-term programme that may see up to $340bn in spending by 2030.

The immediate five-year investments will be used to develop and expand domestic upstream and downstream capacities, as well as to build refineries abroad and upgrade the country’s oil tanker fleet. Development of downstream operations includes an expansion of refining capacity through the construction of a new refinery and an overhaul of the country’s three existing facilities. KPC is also engaging in activities overseas, having planned the construction of a $9bn refinery in China. It is also looking into establishing additional refineries in other Asian markets.

GOVERNANCE: Policy for the oil sector is set by the Supreme Petroleum Council (SPC). The chair of the SPC is the prime minister, Sheikh Jaber Al Mubarak Al Hamad Al Sabah. Of the 12 other members, six are ministers and six are representatives from the private sector who are appointed by the Emir. All members serve three-year terms. In conjunction with the Ministry of Petroleum, the SPC supervises all aspects of hydrocarbons policy in both the upstream and downstream sectors. The SPC, founded in 1974, oversaw the nationalisation of KOC in 1975 and the eventual formation in 1980 of KPC, which acts as an umbrella company for the country’s vertically integrated oil and gas entities.

KPC’s 10 subsidiaries operate both within and outside of Kuwait. They include KOC, which manages upstream activities, including exploration and production; Kuwait National Petroleum Company (KNPC), which controls the country’s refineries and operates domestic distribution outlets; Petrochemical Industries Company (PIC), which produces chemical and nitrogen fertilisers from Kuwait’s natural gas; Kuwait Oil Tanker Company, which along with KNPC oversees export operations; Kuwait Foreign Petroleum Exploration Company and Kuwait Petroleum International (KPI), which control KPC’s international upstream and downstream operations; Kuwait Gulf Oil Company, which oversees operations in the “neutral zone”, an area containing a number of fields jointly owned with Saudi Arabia; Oil Services Company, which provides support infrastructure for the industry; Oil Development Company, which promotes collaboration with international oil companies (IOCs) and informs the public on issues related to Project Kuwait; and Kuwait Aviation Fuelling Company.

OIL PRODUCTION: The government does not allow third-party exploration and assessment but its total reserves are estimated at 104bn barrels, according to Oil and Gas Journal. Production in 2010 stood at 2.5m bpd, up 0.6% on the levels recorded in 2009 but still below the 2005-08 period, when production peaked at 2.8m bpd, according to the “BP Statistical Review of World Energy”. This output makes Kuwait the fourth-largest OPEC producer, after Saudi Arabia, Iran and the UAE.

PRODUCTION INCREASES: In October 2011 the minister of oil, Mohammad Al Busairi, announced that oil production had climbed to 2.9m bpd, as the country joined other oil exporters in expanding production to offset supply disruptions in Libya. The minister added that capacity could be sustained at this level and increased to 3.05m bpd if needed.

A little less than two-thirds of the country’s production comes from its oldest field, the Greater Burgan in south-eastern Kuwait, which is considered the second largest in the world, after Saudi Arabia’s Ghawar field. The Greater Burgan has a capacity of around 1.75m bpd but production in recent years has been closer to 1.3m bpd as the field has aged. KOC is hoping to boost production from the Wara reservoir by 270,000 bpd through water injection.

Output at Kuwait’s complex oil fields in the north of the country increased to around 800,000 bpd in 2010, according to the US Energy Information Administration (USEIA). A further 250,000 bpd come from the neutral zone, which contains 5bn barrels of reserves both on and offshore.

Ongoing exploration has produced significant finds in recent years. During the 2005-06 period, KOC reported the discovery of an estimated 20bn-25bn barrels of reserves in the Sabriya and Umm Niqa areas of northern Kuwait. Unlike much of the country’s oil, these reserves are heavy and sour, and will require enhanced oil recovery (EOR) techniques to come to market. Because EOR has been infrequently used in Kuwait to date, KPC may have to turn to IOCs that have developed EOR expertise elsewhere in the region to fully develop the fields’ potential.

While foreign participation in the hydrocarbons sector remains limited, in 2010 Kuwait signed an enhanced technical service agreement (ETSA) with Royal Dutch Shell for assistance in developing its northern gas fields. This is not the first example of an IOC participating in extraction in Kuwait, but it is the most extensive involvement of one to date and may be a harbinger of future agreements.

However, as has been demonstrated by the sidelining of Project Kuwait, a plan to allow IOC involvement in the hydrocarbons sector through an incentivised buy-back contract structure, the government looks unlikely to give major ground on its longstanding constitutional policy of limiting foreign participation in the exploitation of its reserves (see analysis).

DOWNSTREAM: At present, Kuwait has three refineries, at Mina Abdulla, Mina Al Ahmadi and Al Shuaiba, which have a combined processing capacity of 930,000 bpd. A small fraction of refined products are retained for domestic use and the rest are sold abroad, offering a valuable alternative export to crude oil. KPI markets KPC’s refined products, as well running two refineries in Europe. The 80,000-bpd refinery in the Netherlands is fully owned, while the 240,000-bpd refinery in Italy is a 50:50 joint venture with Italian energy company ENI.

Kuwait has made a strong push into emerging markets, with plans for additional refineries in China and Vietnam. A third project in Indonesia is also being considered, with a feasibility study under way as of mid-2011. In addition to providing demand for Kuwaiti crude, these refineries could pave the way for enhanced exports to emerging markets, where demand for energy remains high. Kuwait’s total exports of oil to China surged 39% in 2010, to 198,000 bpd, and are expected to increase further.

Additional refining capacity will add to Kuwait’s ability to efficiently make use of its resources. According to Saad Akashah, the chairman of Kuwait Catalyst Company, “You cannot just produce commodities, you have to produce specialised products and get the best value out of the resources.”

Kuwait also has active interests in petrochemicals. Since 1966 PIC has produced ammonia, urea, ammonium sulphate and sulphuric acid at its plant in the Shuaiba Industrial Area. Three additional ammonia plants, along with two urea plants and a polypropylene facility, have further increased the country’s petrochemical offerings.

GAS: Nearly 40% of the world’s supply of natural gas is located in the Middle East. Kuwait currently produces less than 1% of its proven reserves of natural gas, in part because much of this natural gas is associated, and therefore linked to oil production levels, which are limited by OPEC. However, there has also been little incentive to develop domestic natural gas reserves until relatively recently. Kuwait has historically used its abundant oil supplies to generate much of its electricity and desalinated water, and the low price of natural gas has made constructing the infrastructure necessary to export it uneconomical.

However, as the price of oil has increased, the opportunity cost of using oil to fire the country’s power plants has become much higher. Gas already accounts for a portion of power generation in Kuwait, but its share could be increased, either by building new facilities or converting older plants to gas-fired power. Indeed, most of the 10,000 MW of additional generating capacity that is planned for the next decade will likely be gas-fired.

According to Ahmad Atallah, the chairman and managing director of Shell Companies in Kuwait, the increased use of gas will translate into both financial and environmental benefits. “Increased gas supply helps reduce reliance on more costly liquid fuels for power generation. This is complemented with an environmental benefit as gas is the cleanest burning fossil fuel,” he told OBG.

EXPANDING OUTPUT: For these reasons, KOC has said that it is aiming to more than triple its output of natural gas, to 4bn cu ft per day, by 2030. Production has increased incrementally over the past two years, with an 8% rise to 1.17bn cu ft per day of natural gas in 2010, compared to 1.08bn cu ft per day in 2009, according to the USEIA. However, these quantities are not sufficient to meet domestic demand during the summer, when the country’s gas-fired power plants draw heavily on local natural gas production. For this reason, Kuwait imports liquefied natural gas (LNG) during the summer season.

Looking ahead, the country’s gas production could be expanded, in part through the development of the Jurassic fields in northern Kuwait, whose reserves have been estimated at 35trn cu ft. Although their reserves are sizeable, these northern fields are known for their complexity. Much of the gas is sour and difficult to access, requiring sophisticated extraction techniques. However, the size of the Jurassic fields makes them especially attractive. In addition, they are non-associated and thus do not need to comply with OPEC oil quotas. Development of these northern fields has entered into its second phase, with output levels expect to exceed more than 600m cu ft per day by 2013 (see analysis).

Assuming that oil prices remain buoyant, any additional natural gas production in Kuwait will likely be used for the generation of power. If the country is able to expand its production at the expected rate, some analysts predict that domestic gas needs could be met as early as 2016. Given the size of reserves, the country could even have potential as a natural gas exporter. Demand from emerging markets is expected to continue to grow, and gas could be added to Kuwait’s export portfolio.

POWERING UP: The Ministry of Electricity and Water (MEW) predicts that peak demand for electricity will increase at a rate of 6-8% per year, reaching 14,256 MW in 2014. Peak load in 2010 was around 11,000 MW, according to MEW, just shy of the country’s 12,500 MW of installed capacity. Peak demand usually comes in the summer months, when heavy use of cooling systems can strain the power grid. According to some estimates, air conditioners account for about 70% of Kuwait’s peak power demand.

As these figures indicate, the country must increase its power generation capacity to remain competitive, but it seems committed to rising to this challenge. “Electricity and water play a fundamental role in any society and we aim to support the development of supply and distribution in order to satisfy the growing demand, especially in light of the natural growth of population and expansion of development projects in the coming years,” Ahmad Al Jassar, the undersecretary of electricity and water, told OBG.

In June 2011 the first phase of the new Sabiya combined-cycle power and water plant came on-line, the first of a number of facilities that are in the works in an effort to keep ahead of energy demand. Most of these plants are expected to be gas-fired, although renewable options and nuclear energy are also being considered (see analysis).

While all of the country’s power and water plants are at present owned by the state, the private sector will likely play a greater role in the utilities industry going forward, in part though the establishment of independent water and power project (IWPPs).

In March 2011 the Partnership Technical Bureau (PTB), the organisation responsible for issuing and overseeing public-private partnership projects, called for proposals for the construction of the country’s first IWPP. The plant, which will be built at Al Zour North, will have a capacity of 1500 MW and produce 102m gallons of water per day. It will be the first of five plants that are planned for the complex at Al Zour North, which is expected to become the largest concentration of power and water generation plants in the Middle East (see analysis).

ALTERNATIVE POWER: As originally conceived, the power and water plants at Al Zour North were to be steam-fired, using oil as a feedstock. However, in light of the discovery of the Jurassic fields in 2006, which doubled the country’s proven reserves of natural gas, the MEW changed its plans and decided to use combined-cycle generation technology rather than build steam-fired plants.

Switching over to natural gas power generation will go a long way toward reducing the country’s carbon footprint and will provide an alternative to costly oil-fired generation freeing up oil for export. According to the KPC, Kuwait consumes on average 200,000-300,000 bpd to generate power.

MIXING IT UP: Some are also calling for further changes to the country’s energy mix. Various organisations, both public and private, are exploring renewable technologies, including solar (see analysis). At the same time, the government has also launched a concerted effort to evaluate the potential for establishing a nuclear energy programme, and in September 2010, Kuwait announced plans to build four 1000-MW nuclear reactors by 2022.

The Kuwait National Nuclear Energy Committee (KNNEC) was established in March 2009 with a mandate to develop the country’s nuclear policies, including policies for interaction with international energy and security bodies. As of mid-2011, Kuwait has signed memoranda of cooperation or understanding with the US, Japan, Russia, Jordan and France, and was discussing further agreements with South Korea and the UAE. The country has also committed to working with the International Atomic Energy Agency (IAEA) to oversee the process and ensure safety, allowing IAEA inspectors full access to future plants. As of mid-2011, KNNEC was in the final stages of approval for Stage I of IAEA regulations. The expected timeline for regulatory approval for a country like Kuwait is around eight years, according to KNNEC.

Selecting an adequate site that is distant from population centres but close enough to available cooling water may prove difficult, especially in light of the Fukushima disaster in Japan, although Kuwait is not near any volatile fault lines. However, the most daunting task may be securing approval from the country’s National Assembly.

The exigencies of increasing the country’s domestic power and water generation capacity may provide enough momentum to move the project forward. The level of success enjoyed by the UAE’s nascent nuclear programme will also likely have some influence on the progress and speed of Kuwait’s efforts.

BUDGET: Both the economy and the fiscal balance are highly dependent on the hydrocarbons sector, with oil and gas exports accounting for 93% of government revenues during 2010/11. Although the 2010/11 budget had forecast a deficit of KD6.6bn ($23.8bn), the common practice of budgeting for low oil prices – in this case, a projected oil price of $43 per barrel – ensured that the government instead enjoyed a comfortable surplus of KD4.5bn ($16.2bn). That year marked the country’s twelfth consecutive surplus, with that of 2011/12 expected to be even higher. However, translating this surplus into specific spending plans has proved an ongoing challenge, as the exact funding mechanism for many projects has yet to be finalised (see Economy chapter).

For the 2011/12 budget, the government has forecast a deficit of KD6bn ($21.6bn), based on spending of KD19.44bn ($70.1bn) and revenues of KD13.45bn ($48.5bn). While the government has increased its assumption of the oil price to $60 per barrel, this is still well below prevailing market prices, and most analysts expect the government to achieve a surplus in 2011/12.

Indeed, in October 2011 the state reported that its oil revenues for the period of April to August 2011 amounted to KD11.3bn ($40.7bn), creating a budget surplus of KD8.1bn ($29.2bn) for the five-month period. Revenues were up due to an increase in both price and output, the latter of which resulted from the country’s decision to expand production in response to a sharp decline in Libya’s exports.

UNCERTAIN DEMAND: However, setting aside a temporary jump in Kuwait’s output, it is unclear how global demand for oil will evolve over the coming months. In mid-2011, forecasts for near-term higher oil sales in much of the world were revised downwards, reflecting fears of slower growth in OECD countries, as the US and EU dealt with their respective debt crises. There was increasing concern of a slowdown in emerging markets as well, many of which have struggled with inflationary pressures.

Finally, although higher-than-budgeted oil prices have given Kuwait a healthy fiscal outlook, the authorities are well aware that a reliance on hydrocarbons-related income is unsustainable in the long term. Kuwait has moved to prepare itself for a post-oil future by investing oil revenues in the Reserve Fund for Future Generations (RFFG). Every year, 10% of government revenues are allocated to the RFFG, and the money is invested in a number of key projects both within Kuwait and abroad.

OUTLOOK: The government’s interest in involving foreign companies in projects like the Al Zour IWPP and the exploitation of the Jurassic gas fields heralds a shift in policy by the historically self-sufficient Kuwaiti energy sector. International companies and investors will be watching keenly to see whether this is in turn translated into broader openness to foreign and private sector participation within this key sector, which may well benefit from the technical expertise these players can bring to the market.

While diversification remains a key aspect of domestic policy, equally important is the full development of the hydrocarbons value chain, which will play a significant role in funding new industries and supporting key physical and social infrastructure. In conjunction with this initiative, a variety of opportunities will emerge in response to the need to vary the mix of domestic power and water generation.