A question of sovereignty

04 March 2003
With the threat of war in Iraq, it is increasingly difficult to be neutral in the Gulf. For many, the issue of sovereignty extends further than the demarcation of boundaries. The Neutral Zone (NZ) shared by Saudi Arabia and Kuwait is a case in point: there is no dispute over ownership or co-operation between the two countries, but the question of sovereignty remains to the fore.

At the start of the year, the nationalisation of the NZ was completed when Japan's Arabian Oil Company (AOC) lost its drilling and production rights in the Kuwaiti portion of the NZ. On 4 January, AOC surrendered its 43-year-old rights to Kuwait Gulf Oil Company (KGOC) - the latest entrant on the list of nationalised Gulf oil companies operating in the upstream sector.

'It was a great feeling. What we have done is correct. We felt as if all our oil wealth was returned and we are now in total control,' says Mohammad Ali al-Jazzaf, chairman and managing director of the recently-established KGOC.

KGOC's establishment was the second stage in the nationalisation of the NZ. The first step was taken by Saudi Arabia in 2000, when it persuaded AOC to surrender its other rights and Saudi Aramco set up Aramco Gulf Operations Company (AGOC) to manage the offshore part of the concession. The two-stage removal of AOC leaves only one foreign operator left in the NZ - Saudi Arabian Texaco (SAT). Significantly, it is also the only concession held by any foreign company throughout Saudi Arabia and Kuwait. It is due to expire in 2009.

The NZ is spread, both on- and offshore, over Saudi Arabia and Kuwait (see map). Within its realm, four operators - AGOC, KGOC, SAT and Kuwait Oil Company (KOC) - produce at least 500,000 barrels a day (b/d) of oil and over 100 million cubic feet a day (cf/d) of associated gas.

Now there are plans for dramatic change. A joint operations committee (JOC) has been set up by AGOC and KGOC - based in Khafji - which will oversee an equally-shared $1,200 million, five-year investment programme.

The aim is to sharply increase production of both oil and gas but there are a number of hurdles, which is unsurprising given the ageing nature of the concessions and the need to invest in heavy maintenance works.

'For KGOC, there are two major challenges - management and operational,' Al-Jazzaf says. On the management side, the main concerns are maintaining a continuity of joint operations with AGOC and a smooth take-over from AOC and acquiring a full knowledge of the fields' characteristics, reservoirs, operations, systems and processes. 'We will develop a long-term strategic plan before the end of the year. KGOC started off with a skeletal staff of 30 from KOC. They all have onshore experience,' he says.

The obstacles on the operational front are more varied and possibly more daunting. On the gas side, the list is topped by the need to develop the non-associated gas reserves at the offshore Dorra field and to fully utilise the 50 million cf/d of associated gas produced from the offshore Hout and Khafji fields, which are at present flared.

On the oil front, attention will focus on plans to increase the capacity of the existing fields by exploring laterally and vertically to below 8,000-9,000 feet and carrying out further 3-D seismic surveys. The project will also examine ways in which production can be boosted through the expansion of gas-lift schemes. A greater focus on achieving higher production levels while minimising costs is also expected.

KGOC plans to produce an additional 30,000-40,000 b/d of oil from Hout and Khafji. At present, the two fields pump about 260,000-280,000 b/d. 'We cannot maintain production for long, unless we enhance reservoir capacity,' says Al-Jazzaf.

It has other challenges too. They include: the take-over of operations from KOC of three oil fields, South Umm Gudair, Humma and Wafra; the greenfield development of the offshore Lulu field; and the formation of a new JOC with SAT, along similar lines as that with AGOC.

Tricky as these problems will be, they are dwarfed by a larger issue - the inherent difficulties of developing smaller oil fields.

'In the past, the targets were for the discovery of large fields and production of easy oil. This is no longer available and we have to target more challenging minor fields,' says Al-Jazzaf. 'We need to penetrate into deeper reservoirs and implement secondary and tertiary production enhancement schemes. We are in a very competitive market and have to optimise reservoir management.'

AGOC and KGOC will also have to invest in the maintenance of AOC's assets. The surface production facilities in particular require attention and the proposed projects include the construction of a new offshore gas lift platform, installation of new oil transmission lines, submarine power cables and offshore production stations and the expansion of water treatment facilities. A contract has already been awarded for the building of a 60-MW power station at Khafji.

When all the proposed schemes are completed - the scheduled date is 2006 - Kuwait and Saudi Arabia will soon be faced with a new issue: the renewal of SAT's concession agreements in the NZ.

Although still six years off, the issue is already of great importance. First, the view taken by ChevronTexaco Corporation over its prospects in the NZ will impact its approach to investing in the current concession. Second, the NZ question is affecting the tortuous and troubled negotiations on the only other upstream prize in Saudi Arabia, the gas initiative.

SAT stands out for many reasons. It is the only foreign company to have access to the kingdom's upstream oil sector, which was effectively nationalised along with Saudi Aramco in 1975. As such, its story provides a touchstone to the development of foreign investment in Saudi Arabian energy.

SAT was formed when Texaco bought the Getty Oil Company concession in 1984. The original 60-year rights were first granted to the Pacific Western Company and later to Getty in early 1949. Joint operations between the Saudi and Kuwaiti sides began in 1960 when Getty and Aminoil entered into an operating agreement to improve efficiency.

SAT's parent company, ChevronTexaco, is the only oil supermajor not participating in the Saudi gas initiative, which began before the merger was completed.

Although Texaco sat out the entire process, Chevron participated in the early beauty parade that established the shape of the core venture consortia. Word in the industry has it that once the merger was assured, Chevron no longer felt it necessary to push for a place in the landmark scheme.

Given the painful path of negotiations, the company may well feel vindicated in its decision. However, the apparent failure of the gas initiative as originally conceived is only the latest indication that, far from opening up to foreign investment in the energy sector, the kingdom is actually still committed to nationalisation.

In light of the decision to terminate AOC's concession, it should not be taken for granted that SAT will be allowed to hang onto its acreage.

The decision will be the most important the kingdom makes regarding foreign investment and the oil industry for a generation. And there are contrary arguments over which way it will go. The termination of AOC's concession and the problems with the gas initiative point one way, the kingdom's gradual but definite shift towards greater openness to foreign investment an other.

Ultimately, the decision may be swung by AGOC. The company has been carrying out a broad programme of upgrades on its offshore facilities and will probably push - with Aramco's support - for the opportunity to carry out the onshore work too.

In the medium term, the greatest issue is how far the threat of a terminated concession will deter SAT from investing in the zone. The company worked extensively on boosting production after the 1990-91 Gulf war, but can hardly be expected to spend large sums of money on an asset that may be lost. One of the key determinants might be the success of the extensive development plans of AGOC and KGOC.

Activity in the NZ could also be an important indicator of Kuwait's approach to upstream development. The government has been unequivocal about its enthusiasm for Project Kuwait, an ambitious plan to double oil production from five northern oil fields to 900,000 b/d by enlisting the support of international oil companies (IOCs). The National Assembly (parliament) has been equally firm in opposing the plans, so the draft enabling law continues to gather dust.

The more effective KGOC is in the NZ, and the more successful its development programme, the easier it will be to argue against IOCs buying into the northern fields.

Few doubt the potential economic benefits of the $7,000 million project, but, for now, a majority of National Assembly members think the political price too high. For them it is an issue of Kuwait surrendering its sovereign rights.

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