Contract row stalls Kuwaiti energy plans

23 October 2008

Parliamentary concerns over awards for the giant Al-Zour refinery have left Kuwait’s downstream oil and gas developsment programme in disarray.

Kuwait’s oil sector continues to be a story of missed opportunity. The country has about 10 per cent of the world’s proven oil reserves, and is the world’s seventh-largest oil exporter.

But political issues continue to hamper progress on the country’s flagship upstream development programme, Project Kuwait, and an ambitious downstream programme that includes the development of one of the largest refineries in the world at Al-Zour and upgrades to two existing refineries.

“There is more gloom about Kuwait than there has been in a long time,” says one senior international oil executive.

The country’s hydrocarbons sector does not lack ambition. The government plans to increase oil production from the current 2.6 million barrels a day (b/d) to 4 million b/d by 2020 (see Special Report, page 57).

A representative of the Kuwait Petroleum Corporation (KPC), the national oil company, said earlier this month that it would invest KD20bn ($75bn) in oil and gas infrastructure over the next five years.

This is $20bn more than KPC announced it was planning to spend earlier in the summer.

But if developments continue to be stalled by ongoing wrangling over the contract award process, spending projections will be academic.

Increasing capacity

The plans include the $18bn Clean Fuels Project to upgrade the Mina al-Ahmadi and Mina Abdullah refineries to international standards, and increase their combined capacity from 736,000 b/d to 800,000 b/d, as well as a $16-18bn project to build a 615,000-b/d refinery at Al-Zour.

The Al-Zour refinery will be used to provide feedstock for the local power market, as well as producing advanced products such as diesel and jet fuel for overseas export, in particular to China and the Far East.

Speaking at a debate on the scheme in early October, Sami al-Rasheed, head of KPC subsidiary Kuwait Oil Company (KOC), described the flagship Al-Zour project as a “strategic” scheme that is essential both for environmental reasons and for meeting domestic energy requirements.

According to Al-Rasheed, the country will still face a feedstock deficit for domestic power plants in 2017, even once feedstock from Al-Zour is taken into account.

The local environmental considerations are visible in a yellow layer of smog over Kuwait City. “Kuwait burns about 250,000 b/d of oil for power generation, and Kuwait crude has a high sulphur content,” says the oil executive.

But the project has been hamstrung by bureaucratic problems. The tender process for the award of the major construction contracts has already been abandoned once, when prices came in at more than KD5.1bn, outstripping not only the original KD1.85bn budgeted for the project, but also the revised figure of KD4bn agreed in mid-2007.

Letters of intent for $9bn worth of contracts were awarded in July for companies to carry out work on a cost-reimbursable basis, a format that is designed to increase the competitiveness of the offers.

But the National Assembly (parliament) has objected that the awards have not been approved by the Central Tenders Committee (CTC), the state body that supervises major contract awards. By way of compromise, the government referred the awards to the State Audit Bureau for review in August.

Parliamentary intervention

Parliament is still not satisfied with this solution and may yet intervene to force a more detailed examination of the contract awards. At best, such an intervention could delay the project for another year or two, and at worst it could derail it completely.

But there is some sympathy with both parliament and the national companies’ positions. Industry analysts say that if Kuwait Oil Company (KOC) and Kuwait National Petroleum Corporation (KNPC) - both subsidiaries of KPC - had communicated their priorities more effectively to parliament, the political deadlock could have been avoided.

“KOC and KNPC should have been able to have a dialogue with the Central Tenders Committee to work with them to establish new rules or procedures,” says Kamel al-Harami, an independent oil analyst based in Kuwait.

“When you have a law or a procedure, you should abide by it. You cannot just pick and choose which procedures you want to follow.”

Jasem al-Sadoun, managing director of the local Alshall Consulting, agrees. “The government is reluctant to follow a system,” he says.

In the government’s favour, it may have decided to bypass the CTC for two reasons. First, parliamentary approval had already been granted for the cost-reimbursable model, known as ‘cost-plus’, when the original tender was abandoned.

Second, the administration may have felt that the CTC was insufficiently qualified to make a judgement on the best offer when more than just the price had to be assessed.

Such a judgement was unjustified, argues Al-Harami. “You have to tell the CTC what you want,” he says. “You need to drive the project. Be organised.”

Al-Sadoun agrees. “You do not have to accept the lowest price, you can change the specifications,” he says. “But it has to go through an independent body.”

This fundamental distrust between the different arms of state has been the constant backdrop to the protracted negotiations on the Al-Zour project.

Corruption scandals have blighted the history of Kuwait’s oil and gas sector, and parliament is suspicious of any process that is not carried out with the utmost transparency and scrutinised in every detail.

Raising concerns

There are also concerns about the role of Fluor, revolving around its unopposed bid for the $2bn third construction package on the scheme, and its involvement in both the Al-Zour project and Kuwait’s refinery upgrade programme, on which it is a consultant.

“Maybe we are fortunate to have Fluor,” says Al-Harami. “But who is going to manage Fluor?”

Competing interests within parliament itself muddy the waters still further. “The main merchant families have a feeling of entitlement to participate in the leading projects,” says David Pfeiffer, managing partner of the Kuwait office of UK-based law firm Denton Wilde Sapte.

“These are not petty arguments. It is an emotional high-stakes debate with hundreds of millions of dollars at stake.”

There are practical concerns with the project too. Parliament has complained that its viability has not been demonstrated.

Some, including Al-Harami, argue that it would be better to concentrate on the refinery upgrade programme and keep open the existing Shuaiba refinery, which the government indicated in October is to be shut down, rather than building an expensive refinery when its necessity remains unproven.

“Whether the project makes economic sense is questionable,” says the oil executive. “But it depends how much you value environmental conditions.”

The cost-plus model also has its disadvantages. Under such a contractual form, companies are paid for what they actually spend, rather than agreeing a fixed price for the work up front.

While this is attractive for contractors, it requires careful monitoring from the client.

“The problem is that you have to be as good as your contractor in order to supervise him,” says Al-Sadoun. “Kuwait does not have a system that is efficient enough to do that.”

Al-Harami is particularly vocal when it comes to the overwhelming role of contractors from one country on the project, despite its retendering.

“Some 80 per cent of the contracts on the fourth refinery were awarded to [South] Korean companies, which is a dangerous strategy,” he says.

“If something goes wrong, particularly in today’s financial market, what happens to the project?”

The future of the project is in the balance. Some are still cautiously optimistic that it will go ahead. Others foresee a long struggle ahead that could push it onto the sidelines.

“I don’t think the project will get off the ground,” says Al-Harami. “If the government does not take the project to the Central Tenders Committee, parliament will take [the issue] all the way. There are so many people involved in the process that it will take years.”

If the government is forced to accede to parliamentary pressure, senior officials could lose their jobs. “The oil minister is in the firing line,” says Al-Harami.

“If it does go back to the CTC, it is likely that he will resign. Some people want to see the prime minister on the stand.”

The uncertainty over the future of Al-Zour leaves the country’s downstream strategy in disarray.

The shortlisting of firms for the main contracts on the Clean Fuels Project has been delayed from mid-September to mid-November to accommodate the continuing Al-Zour debate, and in the absence of a clear path ahead for any of these projects, the certainty over the closure of the Shuaiba refinery looks premature.

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