RESOURCE NATIONALISM: NOT THE MAIN OBSTACLE TO

C O N F I D E N T I A L SECTION 01 OF 04 KUWAIT 001626

SIPDIS

SIPDIS

FOR EB/ESC

E.O. 12958: DECL: 11/13/2017
TAGS: EPET PGOV
SUBJECT: RESOURCE NATIONALISM: NOT THE MAIN OBSTACLE TO
FOREIGN PARTICIPATION IN KUWAIT'S OIL SECTOR

REF: SECSTATE 150999

Classified By: Acting DCM Tim Lenderking for reasons 1.4 (b) and (d).

Summary and Comment
--------------


1. (C) While resource nationalism was a factor leading to the
nationalization of Kuwait's oil industry in the mid-70s, and
populist and or Islamist MPs still use nationalist language
in public comments on Kuwait's oil sector, resource
nationalism is not the biggest obstacle to opening Kuwait's
oil sector to greater involvement by foreign companies.
Overall, resource nationalism seems to be diminishing
slightly in Kuwait as evidenced by recent public and private
statements by the Amir, Prime Minister, and oil sector
officials. Even in the Parliament, the Government estimated
in early 2006 that draft legislation to invite international
oil companies (IOCs) to participate in Kuwait's upstream oil
industry would pass with 33 out of 50 votes. Nevertheless,
obstacles to greater IOC participation remain. First,
ongoing political wrangling between the Government and the
Parliament has led to a legislative stalemate in which
important draft laws are shelved indefinitely, ministry
officials are risk-averse to the point of paralysis, and
special interests and populist showmanship trump the national
interest. Second, the enormous wealth created by high oil
prices diminishes the incentive to liberalize the oil sector
while contributing to perceptions that oil revenues are
rising much faster than the country's need for the money and
"oil in the ground is better than money in the bank."


2. (SBU) The common interpretation of Kuwait's constitution
holds that no entity other than the state may take an equity
interest in the country's upstream oil and gas resources.
However, recognizing that some kind of cooperation with
international oil companies (IOCs) will be critical if Kuwait
is to achieve its ambitious oil and gas production targets,
the leaders of Kuwait's oil sector are exploring different
contractual models to take advantage of IOC technology and
expertise without conceding equity. In the most tangible
sign of progress, Kuwait Oil Company signed a Heads of
Agreement (similar to an MOU) with ExxonMobil in July 2007 to
develop Kuwait's heavy oil reserves. End Summary and Comment.

Background: Foreign Oil Companies and Kuwaiti Politics
-------------- --------------


3. (C) Kuwait Oil Company (KOC) was formed in 1933 as a joint
venture between BP and Gulf. Commercial production began in
1946 and reached a historic maximum of 3.2 mb/d in 1972.
Seeking higher profits and greater control, Kuwait
nationalized KOC in 1975. In the onshore neutral zone,
Kuwait nationalized American Aminoil in 1977, although it
allowed Japanese Arabian Oil Company to continue to operate
in the offshore neutral zone until its concession expired in

2003. Following the steep drop in oil prices in the early
80s, KOC tried to ramp up production, which had reached a low
of 824,000 b/d in 1982 but found itself constrained partly by
OPEC quotas but mostly by limited production capacity. Even
after recovering from the damage sustained during the 1990-91
Iraqi invasion and occupation, KOC has struggled to meet its
production goals. Now producing roughly 2.5 mb/d, Kuwait has
failed to reach its goal of producing 3 mb/d by 2005 and
seems to be making little progress towards its revised goals
of producing 3 mb/d by 2010, 3.5 mb/d by 2015, and 4 mb/d by

2020. Current and former leaders of Kuwait Petroleum
Corporation and Kuwait Oil Company have told Post that they
will need the help of the IOCs to reach these targets.


4. (C) Although Kuwait's constitution grants the State the
exclusive power to exploit, utilize, and safeguard Kuwait's
oil
resources, it also gives the State the right to grant
concessions for a limited time by the passage of an enabling
law.
In 1997, Kuwait's Supreme Petroleum Council approved the
concept of allowing foreign oil companies to participate
in development of Kuwait's northern oil fields and tasked KOC
with developing proposals as to what form foreign
participation might take. Since Kuwait's constitution
forbids foreign ownership of upstream oil and gas resources,
traditional production sharing agreements were off the table.
There were two principal reasons for the proposal, which
became known as Project Kuwait. First, from an engineering
and geological standpoint, the northern fields are difficult
to develop, and KOC needed the help of IOCs to boost their
production. Second, following liberation, the Kuwaitis hoped
that the presence of major international oil companies near
the border with Iraq would give the U.S, UK, and France an

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additional incentive to continue to protect the integrity of
that border.


5. (C) Draft legislation was introduced in Parliament in 2003
enabling Kuwait Petroleum Corporation (KPC),the parent
corporation of Kuwait's state-owned petroleum companies, to
sign contracts with foreign oil companies giving them
operational control over certain oil fields. The
Parliament's Financial and Economic Affairs Committee began
to study the legislation in 2004 and issued a favorable
report in 2005. However, after the State Audit Bureau
questioned the constitutionality of the legislation, the
committee withdrew the report. The Government estimated that
the legislation would pass with the votes of 33 out of the 50
elected members of Parliament but, considering this too small
a majority, decided to defer the vote. Anticipating the
eventual passage of Kuwait Project, KPC created a new
subsidiary, the Oil Development Company, in 2005 to supervise
the participation of foreign companies. In January 2006, the
Amir died, and the vote was delayed to accommodate the
mourning period and succession. In May 2006, the new Amir
dissolved the Parliament due to ongoing confrontation with
the Government. The new Parliament was elected in June 2006
and a new Government was appointed in July. However, the new
"reformist" Parliament took a number of Ministers to task on
alleged corruption issues until the Government decided to
resign in March 2007.


6. (U) A new Government was appointed later in March 2007,
but the relationship between the Government and Parliament
continued to be adversarial with Oil Minister Shaykh Ali
Al-Jarrah Al Sabah resigning in June 2007 following a
Parliamentary grilling over alleged corruption. In an effort
to alleviate the ongoing friction, the Amir reshuffled the
Cabinet in October 2007, appointing Former Finance Minister
Bader Al-Humaidhi to the position of Oil Minister. However,
MPs continued to target Al-Humaidhi over alleged
mismanagement of public funds during his tenure as Finance
Minister, until Al-Humaidhi was, in turn, forced to resign in
November 2007 after eight days in office. Electricity and
Water Minister Mohammed Al-Olaim currently serves as Acting
Oil Minister.

Current IOC and Oil Service Company Presence
--------------


7. (SBU) International oil field services companies are
prospering in Kuwait. The lack of technology and expertise
within the state-owned companies combined with the very
limited role of IOCs leaves a vacuum for contractor services
that has been lucratively filled by Halliburton and
Schlumberger, which each have several hundred employees in
Kuwait. The IOCs, in a holding pattern since the Project
Kuwait proposal was first put forward a decade ago, have
maintained a token presence in Kuwait in order to have a foot
in the door when an opportunity finally presents itself.
Currently, BP and Chevron each have about 20 engineers and
technicians in Kuwait, down from 30 and 40 respectively last
year. BP is working in the North and West, Chevron is
working in Burgan. Total has 15 people spread around the
country, but concentrated in the onshore neutral zone. Shell
has one consultant working downstream in refineries.
ExxonMobil has a handful of engineers working on specific
projects around the country. KOC is eager to have more IOC
engineers working in Kuwait, but in the absence of the
ability to book reserves or very high fees for services, IOCs
have little incentive to draw their relatively scarce
personnel resources away more profitable projects in other
countries.

Project Kuwait Prospects Grim
--------------


8. (C) In Post's assessment, the short-to-medium-term
outlook for Project Kuwait is bleak. Despite press
statements in April by the Amir, Prime Minister, and Oil
Minister in apparent support of the Project, the combination
of strained relations between the Parliament and the
Government, exceptionally strong government finances, and a
lack of consistent leadership in Kuwait's oil sector (eight
ministers in the 16 years since liberation compared to Saudi
Arabia's three oil ministers in the last 45 years),all
diminish the chances of getting Project Kuwait through the
Parliament. As a result of the continuing barrage of
corruption allegations, the Government has been risk-averse
in the promotion of major projects, and MPs have been
especially aggressive in scrutinizing and obstructing such
projects. One embassy contact from the Supreme Petroleum
Council says that most MPs understand the need for Project
Kuwait but continue to play politics and cater to special

KUWAIT 00001626 003 OF 004


interests, allowing patronage and tribalism to trump broader,
long-term national interests.


9. (C) Under the terms of the existing draft legislation for
Project Kuwait, generally described as an Operating Service
Agreement (OSA),IOCs would be paid fixed fees per quantity
of oil and gas produced up to a baseline level, with the fee
per barrel increasing for any production beyond this
threshold. The current draft contracts were prepared as
commercial
agreements between two companies: Kuwait Oil Company and an
IOC. Some MPs now argue that these contracts should be
rewritten as government contracts which would have to adhere
to more stringent standards. When the draft contracts were
last reviewed by the IOCs in 2003, the IOC country managers
said that the terms and conditions were not economically
attractive enough. These IOC managers now suspect that the
current terms and conditions of contracts would not reflect
current market conditions, so even if the Project Kuwait
legislation is approved by the Parliament, the major IOCs may
decline to bid.


10. (U) Over the past few years, Kuwait's economy has grown
significantly on the back of high oil prices. The economy
still relies on the petroleum sector for about 50% of GDP,
95% of exports, and 90% of government revenue. GDP growth
last year was approximately eight per cent. In the fiscal
year that ended on March 31, Kuwait is
estimated to have amassed a USD 17 billion budget surplus
(19% of GDP). The 2006/7 trade surplus is estimated to be
USD
40 billion (44% of GDP). Overall, the Kuwaiti public enjoys
a high standard of living and economic security supported by
a cradle-to-grave welfare state. In this context, the
Kuwaiti public does not perceive any pressing economic need
to
grant foreign entities a major stake in Kuwait's oil
resources, which many still consider to be their national
patrimony.

New models for IOC participation
--------------


11. (C) In the long absence of any progress on Project
Kuwait, KOC managers and some of the IOCs are now pursuing
"enhanced" technical service agreements (ETSAs) as an
alternative. In order meet its production targets, KOC
recognizes that more IOC technology and expertise will be
needed to develop more complex reservoirs and process heavier
and more sour crudes. Under the ETSA model, Kuwait would pay
premium prices to have IOCs assign engineers and managers to
Kuwait Oil Company as long-term consultants. High fixed fees
would be complemented by variable, performance-based pay
contingent upon meeting agreed production targets. The KOC
Chairman told the Ambassador in January 2007 that under
existing TSAs the IOCs do "everything for us" (i.e. provide
assistance with exploration, reservoir mapping, production
planning, and field operations),and "they don't get paid
enough for doing it." Outgoing KPC CEO Hani Hussein told the
Ambassador in early May that he had convinced then Oil
Minister Shaykh Ali Al-Jarrah Al-Sabah that ETSAs are an
excellent option. Furthermore, he said he had linked bonuses
for KOC managers to the effective crafting and implementation
of ETSAs.


ETSAs with BP and Chevron?, JV with ExxonMobil?
-------------- --


12. (U) KOC announced in October that it has signed a Heads
of Agreement (similar to a memorandum of understanding) with
ExxonMobil to develop its heavy oil reserves under an ETSA.
As Kuwait's light crude reservoirs age, KOC will
increasingly need to turn to its abundant heavy crude
reserves to meet its ambitious oil production targets.
According
to KOC Deputy Managing Director for North Kuwait Khalid
Al-Sumaiti, as reported in the Middle East Economic Digest,
"The plan is to have heavy oil constituting almost 25 per
cent of Kuwait's 2020 oil production." Yet, KOC has almost
no experience with heavy oil production, processing, or
marketing, so under the terms of the prospective deal, Exxon
would be "involved in all aspects of the production chain
from upstream to downstream", said Al-Sumaiti. "We will use
the enhanced TSA framework for the upstream element, and
probably a joint venture for the downstream aspect (which is
not subject to the constitutional restriction on foreign
equity)." The final terms will be ironed out once a
feasibility
study is completed in July 2008.

KUWAIT 00001626 004 OF 004




13. (C) Separately, both Chevron and BP are believed to be in
the advanced stages of negotiating ETSAs with KOC for the
Burgan field and Kuwait's Western oil fields respectively.
KOC seems to be proceeding on the hope that the ETSA
framework will obviate the need for parliamentary approval.
The Parliament is bound to watch developments closely.
Populist MP Ahmed Al-Saadoun, a long-time critic of IOC
involvement in Kuwait, has already demanded clarification
from
the Oil Ministry on the terms of the Exxon deal.


14. (C) Current KPC CEO Saad Al-Shuwaib has direct experience
with the benefits of partnering with an American
multi-national as former CEO of Kuwait's Petrochemical
Industries Company, which has enjoyed a hugely successful
joint venture (known as Equate) with Dow Chemical since 1995.
Al-Shuwaib already has plans to replicate the model in some
of KPC's overseas investments and is likely to be supportive
of additional downstream joint ventures and upstream ETSAs
within Kuwait's borders.

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For more reporting from Embassy Kuwait, visit:
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Visit Kuwait's Classified Website:
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