Projects sector benefits from offset freeze

16 June 2015

Kuwait’s offset programme was a barrier to foreign companies wanting to do business in the country. Following its suspension, overseas firms are seeking out new opportunities

In September last year, Kuwait’s government removed a major obstacle to foreign participation in its economy by putting a freeze on its offset programme.

Under the programme, contractors and suppliers awarded major government contracts were mandated to invest in local services and the economy. The offset programme was introduced in 1992 as of way of boosting Kuwait’s recovery in the wake of the Iraqi invasion of 1990-91.

Key fact

The offset programme was created in 1992 to boost Kuwait’s recovery in the wake of the Iraq invasion

Source: MEED

However, as Kuwait looked to move ahead with major infrastructure schemes, the offset structure was discouraging international contractors from bidding on work.

International participation in major tenders is vital for Kuwait to access expertise and also to keep the bidding processes competitive; the offset freeze should increase the country’s attractiveness to foreign companies across the business and services sectors.

“The decision [to freeze the offset programme] has been welcomed by everyone,” says a senior local banking source. “Contractors, suppliers and banks should benefit if more companies want to work and invest in Kuwait.”

Offset programme

The offset programme was originally introduced to reduce Kuwait’s long-term reliance on foreign labour, and enable it to develop its own technologies and skilled workforce.

The offset obligations applied to military contracts of a value equal to or above KD3m ($10.5m) and civil and government contracts of a value equal to or above KD10m. For downstream oil and gas contracts, foreign suppliers or contractors were required to invest 35 per cent of the contract value in an approved local services or business venture.

While other GCC states such as Saudi Arabia and the UAE have implemented offset agreements solely for military deals, Kuwait’s application of the programme for government and civilian contracts has had a major impact on international firms seeking to win work in the country’s projects market.

[The offset freeze] will mean more choice, more partners and reputable partners for projects and investments

Senior banking source

An example of the offset regulation causing consternation among international contractors was seen during the initial procurement phase of the estimated $3.3bn new terminal planned for Kuwait International airport.

In late 2013, international contractors lobbied the government to remove the offset programme. In addition to its restrictive nature, the offset programme usually resulted in government clients holding back part of the payment until the contract was complete. This can have a significant impact on cash flow for contractors if a contract lasts for two or three years.

“The client needs experienced, international contractors for the project - but at the same time the companies required were being forced to accept the costs of offset. There was a mutual feeling that [the offset] had to be removed for a project of this size,” says a source at a major contractor that participated in the tender. “It is not just restrictive for contractors - but can be more expensive for the client - as bidders will just add costs on their prices.”

The airport project is representative of the struggles facing Kuwait’s projects market. Prequalification for the contract to build the estimated $3.3bn main terminal was launched in early 2012, but bids were not submitted until November 2014. In May 2015, companies were asked to resubmit prices due to bids coming in over budget.

As well as causing problems for contractors, the offset programme has contributed to delays during the tendering phase of major projects adding to the inertia in Kuwait’s projects sector over the past decade.

A further criticism of the offset rules was that it gave an undue advantage to the largest multinational companies, which were better placed to absorb extra costs from the offset; smaller contractors and suppliers were penalised as a result.

Under pressure from contractors, bankers and lawyers, the Finance Ministry took the move to suspend the offset programme towards the end of 2014.

Welcome decision

Anas al-Saleh, Kuwait’s finance minister said in early September that the offset had been “frozen temporarily… to make sure it is not an obstacle for firms to come in”. He said that revisions and new regulations for the offset programme would be ready in six months. However, nine months later, little more has been said.

“The [government] has said it is currently revising and making amendments and changes - that is the extent of it,” says the senior banking source. “I think it will remain on hold for some time.”

The banker says the decision to suspend the offset has been welcomed by Kuwait’s financial sector.

“It will mean more choice, more partners and reputable partners for projects and investments,” he says. “Encouraging international participation and private sector support is crucial for Kuwait’s development.”

The removal of the offset has been taken in parallel with several other structural and legislative reforms that have been implemented in the past year to make it easier for international companies to win work and invest in Kuwait.

In addition to the offset suspension, the government has taken steps to strengthen the country’s public-private partnership (PPP) infrastructure and reform the direct investment promotion authority.

Partnerships body

In 2014, the PPP legislation was amended and in early 2015, Kuwait’s PPP body, formerly the Partnerships Technical Bureau (PTB), was rebranded and relaunched as the Kuwait Authority for Partnership Projects (KAPP).

While the jury is still out on whether the new entity can improve on the sluggish performance of its predecessor, the signs so far have been very encouraging.

There is more emphasis on encouraging the private sector… and this is definitely a positive sign

Senior banking source

Since its inception, KAPP has moved ahead with the tendering process for the country’s next independent water and power projects, Al-Zour North 2 IWPP and Al-Khiran 1 IWPP. It has also resurrected the long-stalled Umm al-Hayman wastewater project and the Al-Abdaliyah integrated solar and combined-solar gas scheme.

On 29 December, the Kuwait Direct Investment Promotion Authority, which replaced the Kuwait Foreign Investment Bureau, started operations. In February, it approved the first 100 per cent foreign-owned project under the direct investment promotion law.

The reforms are part of the government’s increasingly aggressive strategy to accelerate economic diversification and improve international investment.

“There is more emphasis on encouraging the private sector,” says the banking source. “It is too early to tell if [the reforms] will be successful and make an impact, but there appears to be more pressure from the top, and this is definitely a positive sign.”

Despite its low budget breakeven oil price, Kuwait is vulnerable to the drop in oil prices that began in mid-2014, as the hydrocarbons sector accounts for 90 per cent of government revenue and about 95 per cent of exports.

Private sector stimulation

As such, it is more important than ever that Kuwait is able to stimulate its private sector, which continues to lag behind those of its regional neighbours.

The removal of the controversial offset scheme and progress with other private sector initiatives has laid solid foundations for Kuwait to attract foreign partners and investment in 2015 and beyond.

It is now imperative that government clients and other decision-makers remain committed to delivering on their development promises.

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