Solidifying the base: Creating a suitable environment for expansion and diversification

Not far from Kuwait International Airport, signs of the nation’s growing industrial infrastructure are sprouting up; just a short drive along the coastal road are the gantries and tanks of the Shuaiba refinery, one of the three refineries in Kuwait and just part of the vast network of facilities that underpin the nation’s oil and gas industry. Not far away, rising from the adjacent desert, are the distinct skeletal outlines of a few of the nation’s most important petrochemicals plants – tangible evidence of Kuwait’s drive to capitalise on its hydrocarbons wealth and open up downstream industrial activity. “Instead of exporting the excess gas as liquefied natural gas, which is a very complex and expensive process, Kuwait has chosen to divert that gas to the petrochemicals sector, where it can create bulk materials that can be transported much more easily,” said Fuad A Akbar, the chief projects officer of Qurain Petrochemicals.

Both upstream and downstream segments are undergoing a process of expansion guided by a national five-year plan that also calls for investment in the nascent non-oil industrial sector. The result, it is hoped, will be a more diversified industrial base where value-added downstream petrochemicals processes take full advantage of the country’s supply of feedstock, while non-oil industries will benefit from greatly improved infrastructure, favourable tax regimes and access to regional markets.

OIL & GAS: Kuwait’s economy is famously based on its natural resources, which include 8.2% of the world’s oil reserves (101.5bn barrels) and around 1% of global natural gas reserves (63trn cu ft). Consequently, the oil and gas sector accounts for the vast majority of industrial activity in the country.

Over the past decade the hydrocarbons sector has contributed between 50% and 60% of nominal GDP each year, although this figure declined in 2009 (the most recent year for which official statistics are available) to approximately 45% due to the global economic crisis and the subsequent decline in oil prices.

Following the rebound in oil prices in 2010, Kuwait’s oil industry accounted for approximately 49% of the country’s GDP for 2010, according to the locally based Global Investment House. Oil thus maintained its position as the country’s single largest source of income, alone providing the government with around 95% of its annual revenue.

CREATING CAPITAL: The responsibility for converting the nation’s hydrocarbons wealth into industrial capital falls to the Kuwait Petroleum Company (KPC), a fully state-owned giant that is involved in every aspect of the local oil business, including petrochemicals, onshore and offshore upstream exploration, production and refining, marketing, retailing and marine transportation. The KPC has performed the role of supervisor and coordinator of the oil industry since its foundation in 1980 and carries out its duties today through 10 fully owned subsidiaries, often referred to collectively as the “K-Companies”, which specialise in the various elements of the oil extraction, refining and distribution process.

Kuwait Oil Company (KOC), for example, has been responsible for exploration and extraction since the first commercially viable oil deposits were discovered in the renowned Burgan field in 1938. More recently it has overseen the discovery and extraction of super-light crude at Sabriya in 2005 and, the following year, the independent gas reservoirs at Rahiya, Mutriba and Um Niga, on which the country’s future gas self-sufficiency will be based.

REFINERIES: Kuwait National Petroleum Corporation, another subsidiary, operates the nation’s three refineries for KPC – Mina Abdulla, Mina Al Ahmadi and Shuaiba – which have a total capacity of 936,000 barrels per day (bpd). The nation’s fourth refinery, a $15bn project with a 615,000-bpd capacity, is expected to be developed in the southern coastal area of Al Zour, following the successful settlement of a disagreement in the National Assembly regarding its tendering process. The refinery expansion comes at a time of planned upstream production growth, during which the government intends to boost national oil production to 3.1m bpd by 2014, up from 2.8m bpd in fourth-quarter 2011 (see Energy chapter).

PETROCHEMICALS: Kuwait’s prodigious oil and gas sector has enabled the development of a sizeable downstream petrochemicals industry, the growth of which is almost entirely attributable to another KPC subsidiary – the Petrochemical Industries Company (PIC). PIC fully owns two plants for the production of ammonia and urea, of which it produced 636 kilo-tonnes per annum (kta) and 1021 kta, respectively, in the 2010/11 financial year.

Perhaps PIC’s most valuable contribution to the local petrochemicals sector has come through a number of joint ventures with both local and international partners. PIC owns 42.5% of the polyethylene and ethylene glycol producer Equate Petrochemical Company, along with DOW Chemical Company (42.5%) and local private player Boubyan Petrochemical Company (9%), an entity which was created and successfully sold off by PIC. Al Qurain Petrochemical Industries Company owns the balance of 6%.

An identical ownership structure lies behind The Kuwait Olefins Company (TKOC), which runs a complex with an annual ethylene production capacity of 850 kta and an ethylene glycol capacity of 600 kta.

Similarly, The Kuwait Aromatics Company (TKAC), which began operations in 2009, is the result of a joint venture between PIC (40%), the Kuwait National Petroleum Company (40%) and Al Qurain (20%); while the Kuwait Styrene Company, which also began operations in 2009, is a joint venture between TKAC (57.5%) and DOW Chemical (42.5%).

INVEST & EXPAND: The ownership structure of the nation’s four major petrochemicals operations reveals the central role PIC plays in the sector – it holds a major interest in all of them. Local private sector representation comes from two companies, Boubyan and Al Qurain, which were created by PIC and sold off through initial public offerings for the purpose of forming a joint venture. PIC has also used the joint venture model to expand its presence in the region and beyond. As early as 1979 it teamed up with the government of Bahrain and the Saudi Basic Industries Corporation to form the Gulf Petrochemical Industries Company, a producer of ammonia, urea and methanol, in which PIC retains a 33% stake. It has also entered into joint ventures with Dow Chemical to produce ethylene glycol in Canada and PTA/PET in Switzerland under the trading name MEG lobal.

This dual approach of investment at home and expansion abroad forms the basis of PIC’s development strategy, which represents the most significant driver of future growth in the wider industrial sector. At home, the two olefin plants currently operating (Equate and TKOC) are to be supplemented by a third cracker, Olefins III, for which feasibility studies are already at an advanced stage. Abroad, PIC is concentrating its efforts on developing its China project – a refinery and petrochemicals complex that will be constructed on an island off the coast of the southern city of Zhanjiang (see analysis).

NON-OIL INDUSTRIES: In common with all Gulf economies, Kuwait has adopted a long-term strategy of economic diversification in order to reduce its reliance on hydrocarbons, but to date the non-oil component of GDP has been dominated by financial institutions, transport, storage, communications and real estate that together accounted for 60.5% of non-oil GDP in 2010, according to the most recent government statistics. Non-oil industrial activity remains at a relatively undeveloped stage due to the local market’s early phase of development and a traditional emphasis on oil, gas and petrochemicals.

However, manufacturing, including refined products, accounted for 11.7%, or KD1.9bn ($6.85bn), of all non-oil economic activity in 2010. It is the government’s intention to build on a non-oil industrial base that is currently composed of food processing (including dairies, bakeries, fruit juices production, confectionaries, and vegetable and fish processing), semi-processed food products (such as beverage bases, dried pulses and food ingredients for the snack and bakery segment), textiles, paper, detergents, durable household goods, construction materials (most notably cement), furniture, décor and electrical goods, and a small metals industry. According to research carried out by the Public Authority for Industry, 84% of firms in the non-oil industrial sector are small businesses with fewer than 10 employees, while medium-sized businesses with between 10 and 49 employees account for 14% of the sector total.

GROWTH DRIVERS: The expansion represented by these small and medium-sized businesses is one of the most significant areas of potential growth for Kuwait’s industrial sector, and a number of government or quasi-government entities are trying to ensure its success. The Industry Law of 1996 established the Public Authority for Industry (PAI) and gave it a mandate to develop and protect local industries, expand industrial and workshop production, and coordinate between existing industries and proposed ones within the GCC and the other foreign markets, among other responsibilities.

The autonomous authority began operations in 1997 under the supervision of the Ministry of Commerce and Industry. Since then it has taken on the duties of industrial licensing, played a leading role in the research and development of industrial export markets, and conducted studies concerning the national industrial sector. PAI labs, which deal with building materials, chemicals, paint, textiles, electronics, and metrology and calibration, have also been instrumental in helping Kuwaiti companies fulfil the technical standards necessary to successfully export their products to foreign markets and meet customer expectations locally.

FINANCING: Companies looking to export into foreign markets can turn to the Industrial Bank of Kuwait, a joint venture between the Ministry of Finance, the Central Bank of Kuwait, and a number of commercial banks, investment companies and some large industrial establishments that began operations in 1976. The bank provides medium- and long-term financing for the establishment, expansion and modernisation of industrial units at favourable rates (3.5% fixed interest for long-term lending, for example), as well as offering commercial banking and treasury products to meet the working capital needs of local industry. In 2001 its lending capacity was increased with the announcement of a law that allows the government to provide the bank with a loan in the form of revolving facilities within a KD200m ($721m) limit. By 2010 the bank had cumulatively lent KD889.4m ($3.21bn) across 885 projects.

More support to industry is available from the Kuwaiti Chamber of Commerce and Industry, established in 1959. The chamber, which runs a dedicated labour and industry department, offers insights into potential export markets, sector economic studies, information on trade laws, arbitration and commercial relation services. The chamber also hosts a number of investment forums throughout the year.

NDP: The Kuwaiti government, when consensus can be reached in the National Assembly, also acts as a significant driver of industrial growth – most visibly in recent years through its adoption of the National Development Plan (NDP) in February 2010. The plan’s objective is to support a number of economic sectors and raise their contributions to GDP. The industrial sector receives considerable attention within the NDP, which envisions an average annual investment in industry of KD484m ($1.74bn), bringing its GDP contribution to 12% by 2014 (see analysis).

Amani Khalid Bouresli, the former minister of commerce and industry and minister for planning and development, said, “Clarity and transparency in the NDP will be key to its success, and necessary in order to attract the quality international and local players that we are looking for.”

LOCATIONS: The anticipated expansion of industry is likely to take place across several locations. The majority of the nation’s heavy industry, including its important petrochemicals interests, is located in the Shuaiba Industrial Area, a coastal development located some 32 km south of Kuwait City and served by a main highway and a small port. Shuaiba forms part of a network of official industrial zones across three geographic sectors operated by the PAI: the Southern Sector, which includes the industrial areas of Shuaiba, Faheel, East Ahmadi and Highway Road; the Middle Sector, which contains the industrial areas of Subhan, Ardhiya and Sulaibiya; and the Northern Sector, with the industrial areas of Amghara, Jahra and the Ship Repairing Area. Businesses that successfully apply for land in the state-owned industrial zones enjoy incentives that include paying a nominal fee for land and subsidised rates for utilities.

In July 1995 parliament passed Law No. 26, which authorises the Ministry of Commerce and Industry to establish free trade zones (FTZs) in the country. In May 1998 the privately owned National Real Estate Company won the tender to operate, manage and market the first such zone at Shuwaikh Port – the country’s main commercial seaport. In addition to commercial and service licences, the 50-sq-km FTZ offers an industrial licence allowing for light activities such as filling, packing and repacking, and assembly. Businesses operating within the FTZ are offered a number of benefits such as tax-free income ( including corporate and individual income), freedom of currency and profit transfer, 100% ownership by foreign companies, an interface with government bodies through the zone’s Department of Government Relations and on-site technical support.

MANY ADVANTAGES: The benefits offered by Kuwait’s first FTZ are not the only advantages enjoyed by industrial firms based in the country. Land prices as low as KD0.2 ($0.72) per sq metre for industrial plots and KD2.4 ($8.66) per sq metre for non-industrial plots within the nation’s designated industrial zones make them some of the most competitively priced in the region. Similarly, subsidised utility prices offer a significant competitive advantage for businesses operating within the PAI’s industrial areas. For example, electricity rates for 2011 stood at just KD0.002 ($0.007) per KWh.

Moreover, local businesses are exempt from corporate income tax, while foreign-owned firms, and foreign-owned portions of joint ventures, have had their exposure to taxation considerably lessened in recent years. In December 2007, for instance, Kuwait’s parliament promulgated a new tax law that reduced the rate on foreign firms from 55% to 15%, creating a flat tax on annual profits. Also, under a new Direct Foreign Capital Investment Law, foreign investors may be exempted from all taxes for up to 10 years.

While the local market for most industrial products originating in Kuwait is a small one, industrial firms based there benefit from bilateral trade agreements with nearly 50 countries, including China, France, Germany, India, Iran, Iraq, Malaysia, Russia, Spain, Turkey and the UAE. As a member of the GCC, Kuwait has implemented its Unified Customs law and Single Customs Tariff and is party to free trade agreements the GCC has with Singapore (2008) and the European Free Trade Association (2009), which includes the countries of Iceland, Liechtenstein, Norway and Switzerland. Kuwait has also signed a Trade and Investment Framework Agreement with the US, through which the two parties aim to bring about economic reform and trade liberalisation.

LIMITED LAND AVAILABILITY: Despite the considerable benefits offered to industrial firms, a number of challenges remain. The industrial areas currently in existence are almost at capacity, and pressure on officially designated industrial land is driving many light industries to the open market, where prices have been pushed upwards by limited land supply. This is exacerbated by the fact that the government owns around 90% of the nation’s land and has not released many tranches for commercial use, having traditionally favoured reserving it for exploration and the development of hydrocarbons activities.

The once-reliable national grid has also come under increasing pressure in recent years, with summer blackouts becoming more frequent as the nation’s air conditioners combat temperatures in excess of 50°C. The government is addressing this problem by commissioning a number of new power stations and desalination plants, which are detailed in its current five-year development plan.

GAS FEEDSTOCK SHORTAGE: Perhaps the primary concern of Kuwait’s petrochemicals sector is the supply of gas feedstock. Although there are significant natural gas reserves, until adequate extraction infrastructure is in place, the industrial sector is competing with the nation’s power generation facilities for gas supplies. It is the power stations that are being given prior causing shortages in the supply to the country’s heavy industries. For example, operations at PIC’s fertiliser plant were suspended during the summer of 2010 due to the 50% reduction of its natural gas supply from KPC. The speed with which Kuwait can ramp up the extraction of its natural gas reserves is thus of great importance to the future growth of the industrial sector. In the meantime, the country’s petrochemicals sector is considering alternative feedstocks to reduce dependence on gas when formulating expansion plans (see analysis).

OUTLOOK: While issues such as land and feedstock supply remain a concern for growth, the long-term expansion of Kuwait’s industrial sector is underwritten by several factors. These include the government’s intentions to diversify the industrial base from its reliance on oil and the budget surpluses that will allow it to make the necessary investments, a growing local market and improved access to regional markets, a history of successfully working in partnership with local, regional and international industrial players to expand into new technologies and processes, and abundant energy supplies and feedstock (once the necessary infrastructure is put in place) to drive industrial growth for decades yet to come.