AMBASSADOR DISCUSSES ENERGY ISSUES WITH KUWAIT OIL

C O N F I D E N T I A L SECTION 01 OF 03 KUWAIT 000164 SIPDIS NOFORN SIPDIS LONDON FOR TSOU DEPARTMENT OF ENERGY FOR IE EB/ESC/IEC FOR GALLOGLY, GRIFFIN E.O. 12958: DECL: 02/02/2017 TAGS: ENRG EPET ECON BEXP KU OIL SECTOR SUBJECT: AMBASSADOR DISCUSSES ENERGY ISSUES WITH KUWAIT OIL COMPANY CEO Classified By: Economic Counselor Tim Lenderking for Reasons 1.4 (b) an d (d) ¶1. (C/NF) Summary: On January 14, the Ambassador met with Kuwait Oil Company (KOC) Chairman and Managing Director Farouk Al-Zanki to discuss developments in the energy sector. KOC manages all of Kuwait's upstream oil and gas production. Al-Zanki highlighted the potential for "enhanced technical service agreements (TSAs)" to encourage greater participation by International Oil Companies (IOCs) in Kuwait's upstream oil and gas production. He described the enhanced TSAs (which incorporate substantial financial rewards for achieving production targets) as a hybrid of standard TSAs and traditional production sharing agreements (PSAs). The introduction of PSAs in Kuwait would be politically controversial and constitutionally problematic. Regarding controversial plans to build a 615,000 bpd mega-refinery on the doorstep of Saudi Arabian Texaco's (Chevron's) facilities in the Partitioned Neutral Zone (PNZ) shared by Kuwait and Saudi Arabia, Al-Zanki said that the project would need to be re-tendered in order to attract more affordable bids. The process of re-tendering could take four to five months. On gas production, Al-Zanki said the 35 trillion cu. ft. non-associated gas find announced in 2006 showed great promise with Phase I production expected to begin this year. However, some doubt exists about how easy it will be to develop the field. Hani Hussain, Deputy Chairman and CEO of Kuwait Petroleum Corporation, the parent company of KOC, will resign in 2007. His successor has not been named, Al-Zanki said, but offered it would not be him. End summary. ¶2. (U) Ambassador called on Kuwait Oil Company Chief Executive Farouk Al-Zanki on January 14. KOC, established in 1934, has lead responsibility for exploration and production of oil and gas within Kuwait and the country's territorial waters. KOC's current production capacity is estimated at approximately 2.5 million barrels per day. -------------- Enhanced Technical Service Agreements -------------- ¶3. (C/NF) Al-Zanki told the Ambassador KOC was exploring "enhanced" TSAs with IOCs in Kuwait. He acknowledged that under existing TSAs - with Exxon, Chevron, BP, and others - 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. (Note: In private conversations, IOC managers in Kuwait confess that revenues from TSAs barely cover costs, and that they enter into these contracts only to maintain a relationship with KOC in the hope of eventually being awarded a PSA.) "We admit that it's a consultation" relationship with the IOCs, Al-Zanki said. The enhanced TSAs would give the IOCs more supervisory authority and allow them to be rewarded for helping KOC reach designated production targets. The difficulty, he said, was that enhanced TSAs were likely to be reviewed by the State Audit Bureau, with questions asked about why the GOK was paying ten times more for services and technical expertise than under a standard TSA. How would we overcome this, even with the Kuwait Petroleum Corporation (KPC),he wondered. (Note: Mid-level sources within KPC have described frustration among some of the company's engineers that they are being relegated to a second-class status as consultants from IOCs assume greater responsibility and higher compensation. Post's sources say this perception that KPC management is undervaluing its organic talent is leading to morale problems within the KPC rank-and-file.) This is a new model and "bewildering" for the IOCs which are more accustomed to traditional PSAs, Al-Zanki said. ¶4. (C/NF) The Ambassador asked how the enhanced TSAs would affect the development of the northern oil fields. (Note: The $8.5 billion Project Kuwait is a proposal to invite IOCs to participate as partners in the development of four difficult oil fields in the North of the country through some type of production sharing agreement. The Project is controversial since foreign companies have been excluded from directly participating in Kuwait's upstream operations since nationalization in 1975. Kuwait's constitution bars foreign ownership or control of the country's oil. We are concerned that development of the northern oil fields under a TSA rather than a PSA could create an incentive for IOCs to "overdevelop" these fields in order to maximize short-term KUWAIT 00000164 002 OF 003 earnings, thus damaging the reservoirs and reducing the quantity of oil ultimately recovered. Under an extended PSA, IOCs might be more likely to take a long-term view to maximizing production.) Al-Zanki said part of the strategy for the northern oil fields was linked to gas production, for which Kuwait needed external help. He added that such help would also be needed for the development of the northern oil fields. Barring the possibility of a PSA, IOCs would prefer "enhanced TSAs," which would include production incentives, over existing TSAs, which only provided a fixed fee for services rendered. According to Al-Zanki, "Even the Iraqis are interested in the KOC approach (of enhanced TSAs)," which he described as a hybrid model of PSAs and conventional TSAs. -------------- Fourth Refinery -------------- ¶5. (C/NF) The Ambassador raised the controversial 615,000 bpd refinery, which Kuwait intends to build in the Partitioned Neutral Zone (PNZ) adjacent to the compound of Saudi Arabian Texaco (Chevron),and which Kuwait claims is an economic and security priority as it seeks to phase out aging refining facilities and replace them with a safer, more modern, and more environmentally-friendly plant. Al-Zanki said the refinery is going nowhere. (Note: In mid-January, KNPC announced that it would be reconsidering the refinery tender, since the bids received were too high. According to Project Manager Ahmed Al-Jimaz, the project was budgeted at $6.3 billion, but the bids came in at approximately $15 billion. Re-tendering the project with revised terms and conditions could take four to five months.) Al-Zanki said the refinery would need to be re-tendered using a different model. He thought a "cost-plus" model would be the only way to attract affordable bids. Al-Zanki acknowledged that the proposed site of the refinery was controversial. (Note: Both Chevron and the Government of Saudi Arabia have expressed their objections to Kuwait's plans to build the refinery next to Saudi Arabian Texaco's compound in the PNZ.) He said he had spoken with Chevron about the issue. -------------- Big Gas -------------- ¶6. (C/NF) The Ambassador asked about the new gas find. (Note: In 2006, Kuwait announced the discovery of a 35 trillion cubic foot (est.) non-associated gas field in the North of the country. In recent press statements, Al-Zanki has announced gas production goals of 175 million cubic feet per day (cfd) for 2007, 600 million cfd by 2011, and one billion cfd by 2015.) Al-Zanki said some were doubting the potential of the find although there was clearly a great deal of gas and a great deal of condensate to exploit. He said KOC was in contact with Shell for a preliminary evaluation. So far everyone was happy, he said. There was no doubt it was a big find - but how big was not clear. (Note: Post contacts at Schlumberger, which has been working with KOC to estimate the potential of the field, have said their preliminary studies indicate that the quantity is indeed close to 35 tcf but that that the field will be difficult to develop due to its geographic complexity.) Kuwait expects to use all of its Phase I production of 175 mcfd in domestic power plants. Al-Zanki said Kuwait still needs to explore deeper below the surface, where there is greater potential. ¶7. (SBU) As for the Dorra gas field which is shared by Kuwait, Iran, and Saudi Arabia, Al-Zanki said the field could provide 500 million cfd, but there is little discussion with Iran on the issue. (Note: Kuwait and Saudi Arabia came to an agreement in 2005 to begin exploration of the field, but Kuwait and Iran still need to negotiate their offshore border demarcations which will affect drilling rights.) -------------- The Future of the Industry, Here and There -------------- ¶8. (SBU) Hani Hussain, Deputy Chairman and Chief Executive of Kuwait Petroleum Corporation, has submitted his resignation which will become effective in 2007, Al-Zanki said. Al-Zanki denied he would succeed Hussain, as he wanted to remain on the "technical side" of the industry" and perhaps conclude "some things" with the IOCs. (Comment: Hussein's successor has not yet been named, but Sami KUWAIT 00000164 003 OF 003 Al-Reshaid, Chief Executive of Kuwait National Petroleum Company is rumored to be the leading contender.) ¶9. (SBU) Commenting on staffing in the oil industry in general, Al-Zanki complained there were not enough qualified Kuwaiti graduates to fill the demand for jobs. The focus in the industry is on "difficult" oil, Al-Zanki said, and Kuwait's oil companies need technicians and experts. He said the Saudis are snatching up technical experts with generous offers and incentives the GOK cannot match. Al-Zanki noted that Chevron representatives had similarly complained to him that there was an "anti-big oil bias" in the West that was discouraging young westerners from joining the industry. ********************************************* * For more reporting from Embassy Kuwait, visit: http://www.state.sgov.gov/p/nea/kuwait/?cable s Visit Kuwait's Classified Website: http://www.state.sgov.gov/p/nea/kuwait/ ********************************************* * TUELLER