Challenges of opening up upstream
Kuwait needed to have a consensus on the need to re-invite the international companies to its upstream, especially since it had nationalized its operations in the 70s,according to the Deputy Chairman and Chief Executive Officer at Kuwait Petroleum Corporation (KPC).
Addressing the Oil and Money 2003 Conference in London last week, he shared his perspective with other participants and elaborated on the challenges and issues faced by Kuwait in opening up the upstream.
“As back ground, around 1995, when we had established new production target to reach three million bpd by 2005, it was brought to attention by our upstream people that we would not able to achieve this without active assistance from the international oil companies. To increase production would require us to diversify our production beyond our large and easy reservoirs like Burgan, and go to more complex reservoirs with a deepwater cut.The reservoirs by their nature would be higher cost so there was a concern about managing the future increase in production costs. Finally, it was felt that the expertise to manage the complexities of such reservoirs were not available in our company. So there was a strong conviction that the technical oil companies were needed.
At the same time it was not lost on us that Kuwait was amongst the only three hydrocarbon rich countries in the world not using the capabilities of the international oil companies.
However, we had to address two important questions. Firstly did not Technical Service Agreements (TSAs), which we had signed with three of the oil companies suffice? Secondly, could not we get the required expertise from the major service companies?
The nature of the TSA was that we got consulting and technical advice but the risk and decision making was let with us. So there were occasion when we felt based on our relative experience that what they were recommending was “too risky”. As we shifted our focus to the more complex, and therefore more risky reservoirs we became convinced that the nature of the relationship needed to change. To get the best capabilities of these companies, and to have them dedicate their best resources, we needed a relationship where they invested their money and were allowed to make the complex technical decisions. In a sense, a relationship where they were exposed to the consequences of their decisions.
In talking to the service companies, this was not the type of relationship they favored.They were reluctant to invest their money,especially in such large-scale upstream projects. At the same time, owning and operating large reservoirs was not a core activity for them.
So we chose the route of the best of both worlds, namely to bring in the oil companies to invest and operate the fields and through them use the best capabilities of the service companies.
Once we were convinced of the need for the oil companies, the second challenge was to have clear objectives as to what precisely we wanted to achieve. When it became known to the oil companies that we were considering opening up the upstream, we began to receive different proposals. They were not very detailed but it soon became clear that we needed to first define our objective and put them to the oil companies so that we could evaluate any proposal from a common platform.
Objectives
So we established a few key objectives to put to the companies:
- Reach a target production level within an agreed time frame, and extend the plateau.
- Increase our reserve base and recovery factors.
- Reduce the potential increase in production costs.
- Allow for the transfer of technology and establish a focused R & D programme.
- Create employment for and develop the technical capabilities of our national workforce.
- Finally ensure added value for the state in a way, which minimizes risk.
Having defined our objective the next challenge was how to structure the relationship.
We studied the history of the upstream contracts from the older concession type agreement to the more recent production sharing ones and finally the newest service agreements in Venezuela. Since our problem was to increase production from existing producing fields, and as there was no exploration risk, we felt that the Venezuelan approach, modified to our specific needs, was the most appropriate.One important consideration here was to ensure that the agreement had to be in line with the constitution and did not require a
new law for it to be approved.
As a lesson learned to create a somewhat unique agreement, to fit our specific needs,was a more time consuming approach.
A major consideration within the structure of the relationship was the fiscal terms. As I mentioned earlier, one clear objective we had was to be able to compare different proposals or development plans from a common basis. We would have asked the oil companies to each give us their proposals on the fiscal approach, but then it would have been very difficult to compare them on an equal basis especially if their development plans were different.
In creating the fiscal terms, one overriding principle that we set was to ensure final transparency. What I mean by this is that we recognized that at the end of the process we would come to the bidding stage and here we needed to able to demonstrate that our choice of the winner was clear and transparent. This required us to make common as a many parameters as possible and not have too many variables.
We decided that the contract and the fiscal terms needed to be a common element given to the potential bidders. By deliberately choosing this approach of developing unique contractual and fiscal terms, we effectively chose longer route.
Fiscal Structure
Another challenge here was to create a fiscal structure and relationship where we aligned the interests of the two sides. It was important that the elements of the fiscal terms did not create any incentive for the oil company to act against the interest of the state. So the way the fiscal terms are set,there is an incentive for them to increase production in the most cost efficient way as they are also rewarded for cost savings.
Another key objective was to ensure a stable long-term commitment from the oil companies.
At the same time, we recognized that the structure also had to meet the objectives of the oil companies. The project had to be of a material size and should allow them to earn our acceptable & competitive return,relative to the risk.
The final challenge in the contract structure was how to cover the “Soft” but critical,objectives that we had, in three areas. The first was in the recruitment, training and development. The second was in research and development. The third was in technology transfer. We struggled to reflect in the contract certain obligations in these areas in way that would result in successful practical programme. So we inserted elaborate section on these in the contact.We have also made clear to the companies that when we come to the final stage of evaluating proposals, a critical review will be made of their submission covering these subjects.
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