Thursday, December 1, 2011

Kuwait's Oil and Gas Contractual Framework and the Development of a Modern Natural Gas Industry

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December 1, 2011

ABSTRACT

Since 2008 Kuwait has been experiencing natural gas shortages with serious implications for the development of its economy. The exploration and then the production of both non-associated (from new gas fields) and associated (from complex crude oil fields) natural gas require the assistance of international oil companies (I.O.C.s) that possess the necessary expertise. Given Kuwait's contradictory political debate about awarding more interesting contracts to I.O.C.s, up to now I.O.C.s have been only awarded technical service agreements (T.S.A.s), now upgraded to enhanced technical service agreements (E.T.S.A.s), which the companies subscribe in order not to  be completely cut off from Kuwait's oil and gas market. In the first chapter, this paper analyzes Kuwait's oil and gas contractual framework from the concessions of the 1930s to today's E.T.S.A.s. The second chapter is an analysis of Kuwait's natural gas industry, which is now not sufficient any longer to satisfy the country's gas needs. Considering the long-term timeframe for developing domestic non-associated gas fields, importing expensive L.N.G. — which was initially regarded as a temporary solution — will probably be structured on a more permanent basis.

CONTENTS

Abbreviations  
       
Introduction
    
Chapter 1 - Kuwait's Energy Sector Set Up: Opening, Closedown and Partial Reopening of the Market    
  • 1.1 Kuwait Before the Oil Age  
  • 1.2. The Creation of the Kuwait Oil Company (K.O.C.)        
  • 1.3. The Nationalization of Kuwait's Natural Gas    
  • 1.4. The 1975 Complete Nationalization of the Energy Sector, Oil Included    
  • 1.5. Recent Years' Attempts Aimed at Reversing the Complete Nationalization of the Energy Sector (Oil and Gas) -- The Kuwait Project
  • 1.6. The Current Contracts for I.O.C.s: Enhanced Technical Service Agreements (E.T.S.A.s) for both the Oil and the Gas Sectors   
  • 1.7. Organizational Structure of Kuwait's Energy Sector with No Differentiation Between Oil and Gas Companies        

Chapter 2 - Analysis of Kuwait's Natural Gas Sector        
  • 2.1. Natural Gas Reserves and the Development of Middle East Gas Industry
  • 2.2. Gas Exploration and Current Gas Production 
  • 2.3. An Ever-Increasing Consumption and the Necessary Gas Imports   
  • 2.4. Kufpec's Investment in North-Western Australia's L.N.G. Projects   
  • 2.5 L.N.G. Isn't a Temporary Measure and Needs Better Management   

Conclusion
       
Bibliography 

ABBREVIATIONS

A.P.O.C. — Anglo Persian Oil Company
A.O.C. — Arabian Oil Company
API — American Petroleum Institute
B or bbl — Barrels
B.T.U. or Btu — British thermal unit
BB — Billion barrels
BBL — Billion barrels of petroleum liquids (crude oil, condensate and N.G.L.s)
BBO — Billion barrels of crude oil
BCFG — Billion cubic feet of natural gas
BCG —Billion cubic feet
BCM — Billion cubic meters
BG — British Gas
B.G.C. — Basrah Gas Company
BL — Barrels of petroleum liquids (crude oil, condensate and N.G.L.s)
BOE — Barrels of oil equivalent
BP — British Petroleum
E.I.A. — Energy Information Administration
E.O.R. — Enhanced Oil Recovery
E.T.S.A. — Enhanced technical service agreement
E.U. — European Union
F.D.I. — Foreign Direct Investment
ft - Feet
G.C.C. — Gulf Cooperation Council
G.D.P. — Gross domestic product
G.E.C.F. — Gas Exporting Countries Forum
I.E.A. — International Energy Agency
I.O.C. — International oil company
IBBC — Incentivized buy-back contract
K.I.A. — Kuwait Investment Authority
K.P.I. — Kuwait Petroleum International
K.N.P.C. — Kuwait National Petroleum Company
K.O.C. — Kuwait Oil Company
Kogas — Korea Gas Corporation
K.P.C. — Kuwait Petroleum Corporation
Kufpec — Kuwait Foreign Petroleum Exploration Company
L.N.G. — Liquefied Natural Gas
L.P.G. — Liquid Petroleum Gas (propane and butane)
M.O.U. — Memorandum of understanding
MB — Thousand barrels
MBL — Thousand barrels of petroleum liquids (crude oil, condensate and N.G.L.s)
MBO — Thousand of oil equivalent
MBOE — Thousand barrels of oil equivalent
MCF — Thousand cubic feet
MCFG — Thousand cubic feet natural gas
MMB — Million barrels
MMBL — Million barrels of petroleum liquids (crude oil, condensate and N.G.L.s)
MMBO — Million barrels of crude oil
MMBOE — Million barrels of oil equivalent
MMCF — Million cubic feet
MMCFG — Million cubic feet of gas
N.O.C. — National Oil Company
N.G.L.s — Natural gas liquids (ethane, propane and butane)
No. — Number
O&G — Oil and gas
O.S.A. — Operating Service Agreement
Oapec — Organization of Arab Petroleum Exporting Countries
OPEC — Organization of Petroleum Exporting Countries
P.I.C. — Petrochemicals Industries Company
P.N.Z. — Partitioned Neutral Zone
P.S.A. — Product Sharing Agreement
Q.G. — Qatargas
Q.P. — Qatar Petroleum
S.A. — Service agreement
S.P.E. — Society of Petroleum Engineers
SOC — Southern Oil Company
T.S.A. — Technical Service Agreement
TCF — Trillion cubic feet
TCFG — Trillion cubic feet of natural gas
TCM — Trillion cubic meters
T.P.A.O. — Turkish Petroleum Corporation
U.K. — United Kingdom
U.S. or U.S.A. — United States
U.S.G.S. — U.S. Geological Survey   


INTRODUCTION 

Kuwait is worldwide known as an oil exporting country. At the beginning of 2011 Kuwait owned within its territorial boundaries an estimated 101.5 billion barrels (BBL) of proven oil reserves equal to around 7 percent of the world total. In addition, the country has other reserves located in the Partitioned Neutral Zone (P.N.Z.), which is an area shared on a 50-to-50 basis with neighboring Saudi Arabia. This neutral zone should contain at least 5 BBL of proven oil reserves. The reserves within Kuwait's territory plus the reserves in the P.N.Z. should be equal to around 104 BBL[i].

The country is a member of the Organization of Petroleum Exporting Countries (OPEC), and it exports the fourth largest volume of oil within the 12-member organization[ii]. Petroleum exporting revenues account for around 50 percent of its overall gross domestic product (G.D.P.), 95 percent of total export earnings, and 95 percent of government revenues. Kuwait’s economic performance largely correlates to the oil sector, and its economy is one of the least diversified within the Gulf Cooperation Council (G.C.C.)[iii]. In other words, up to now talking about Kuwait has meant talking almost exclusively about oil. Something is now changing.  


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As Middle Eastern economies — with a particular attention given to G.C.C. countries — develop and grow at a consistent rate, they need to have rising quantities of natural gas. In fact, gas is the ordinary feedstock for power generation, water desalination and other energy-hungry industries like aluminum, steel, cooling, petrochemical and construction. Apart from Qatar — which stands in third position in the ranking of natural gas proved reserves at the world level — all the other five G.C.C. members are currently experiencing gas shortages (Oman included). Considering that the Middle East is home to 40.5 percent of proven natural gas reserves (including 15.8 percent belonging to Iran, a country also experiencing the same problems)[iv] the current gas shortages are a real paradox and they suggest that the Middle East's share of natural gas resources is relatively undeveloped.  

Kuwait's gas resources are proportionally not as big as the country's oil reserves but still with 1 percent of the world natural gas reserves, i.e., 1.8 trillion cubic meters — most of which is associated gas — the country should be in the position of avoiding importing gas. Instead, natural gas — being mainly associated gas — in Kuwait has always been considered a problem for the oil sector, a trouble when extracting crude. In practice, associated natural gas ended up being flared or burnt when extracting oil. 

Since 2009 Kuwait has been obliged to import natural gas in order to reduce recurring electricity outages, especially during the summer season (from April to October) when electricity demand springs up. What is interesting to understand is the real changeover in dealing with gas in Kuwait. No longer is it considered a disgrace when pumping out of the ground crude oil. Kuwait has recently initiated a spending spree worth $90 billion aimed at expanding both the upstream and downstream sectors. This spending spree should increase oil production capacity to four million barrels per day (MMBO/d) by 2020 from 2.5 MMBO/d in 2010. In Kuwait, given the presence of associated gas in crude oil fields, increasing oil production means increasing the output of gas. But, despite this increase, numbers say that continuing to rely on associated gas will not be sufficient, so Kuwaiti authorities are propping up the exploration for additional gas reserves in order to satisfy the country's ever-increasing natural gas needs.

Summing up, although augmenting the output of crude oil by 2020, natural gas imports are expected to continue until the country is really able to boost its production of natural gas from gas fields located in northern Kuwait and offshore along Kuwait's coastline.

CHAPTER 1 — KUWAIT'S ENERGY SECTOR SET UP: OPENING, CLOSEDOWN AND PARTIAL REOPENING OF THE MARKET

1.1 Kuwait Before the Oil Age
At the beginning of 1700 Kuwait was inhabited by nomadic populations from neighboring territories: Saudi Arabia, Iran and Iraq. At that time Kuwait was a base for trade flows between India and Africa. Kuwaiti people became rich merchants. One century later the most important merchant families decided to hand over the business of government to an important family, the Al-Sabahs, who were not involved in trade. This family still holds the power today, and consequently the current emir, Sabah IV Al-Ahmad Al-Jaber Al-Sabah, is one of its members. This relationship between the ruling family and the merchant families is at the foundation of the Kuwaiti state and up to nowadays it has been at the cornerstone of the country's politics.

Then in 1899 Kuwait — both the then emir and the merchant families agreed on this — subscribed a treaty with the United Kingdom (U.K.). The idea on the Kuwaiti side was to get protection from the Ottoman Empire, while on the U.K. side it was meant to counterbalance the expansion of German influence in the Persian Gulf (in those years it was proposed the construction of the Berlin-Baghdad railroad). In practice, Britain obtained the control of Kuwait's foreign policy in exchange for protection and of an annual subsidy. 

At the beginning of 1900, the desert country was relying mainly on fishing pearls, shipbuilding and trading merchandises between India and Africa. Kuwaitis were around 70,000 and the majority of them used to live in Kuwait City, a trading center. Given the harsh weather conditions agriculture was poorly developed and most food and water had to be imported.

Things changed dramatically for the worse in the 1930s when pearl fishing was not anymore a relevant source of income. In fact, the Japanese entrepreneur Mikimoto had developed cultivated pearls which started replacing Gulf's natural pearls. 

1.2. The Creation of the Kuwait Oil Company (K.O.C.)
Given the dire economic conditions, there was the hope of getting some financing from oil concessions to foreign oil companies as it was happening in Iran and Iraq. Sheik Ahmed (1921-50) could see the example of Bahrain where oil was discovered in 1932, but at his disappointment the English seemed not too much interested into Kuwait. At that time, the U.K. Anglo Persian Oil Company (A.P.O.C.) was already badly economically exposed in both Iran and Iraq and was not thinking of investing additional resources also in Kuwait.

The American company, Gulf Oil was quite interested into Kuwait, but British authorities claimed Kuwait as a territory under their exclusivity right. After Gulf Oil's strong protests with the Department of State, in April 1932 the Foreign Office communicated to the Americans that the U.K. was renouncing to its exclusivity right.  But when the following month (May 1932) oil was discovered in Bahrain, A.P.O.C. changed immediately its plans. Strategically A.P.O.C. wanted to avoid what previously had happened in Saudi Arabia where the British company had lost positions in favor of the Americans.

This was the best outcome for Sheik Ahmed: Two groups were now competing for the same territory. It started one year and a half of bids and counterbids between the two oil groups. In the end A.P.O.C. understood that the bidding game with Gulf Oil was too expensive a negotiation for a territory where oil had still to be discovered. The best solution was to find an agreement with Gulf Oil. So, in December 1933, the Kuwait Oil Company (K.O.C.) was created. This was a 50 percent joint venture between A.P.O.C. and Gulf Oil. The first step was over. Now, it was necessary to negotiate the concession price with Sheik Ahmed. 

The joint venture between the British and the Americans was absolutely bad news for Kuwait. An agreement between the two companies was really depriving Sheik Ahmed of his most powerful contracting tool, an auction. Notwithstanding this, Kuwait was very capable of understanding and then utilizing the experiences of the oil concessions previously assigned in Iraq, Iran and Saudi Arabia. The negotiation for the concession was tough[v] and was over only after one year in December 1934. K.O.C. got a 75-year oil concession for the whole Kuwaiti territory. Sheik Ahmed obtained an initial payment worth 450,000 rupees (£35,000), a guaranteed minimum annual payment of 95,000 rupees  (£7,150) until oil discovery and then as soon as oil was extracted for commercialization a minimum amount of 250,000 rupees (£18,,800) in royalties. In practice, K.O.C. would pay $0.13 a barrel[vi] and it got full ownership of petroleum and derivative products from onshore Kuwait, all Kuwaiti islands and the territorial waters.


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Oil was then discovered in 1938, and in a few years the Kuwaiti economic conditions improved consistently. In 1961, Kuwait had a population of 320,000 people of whom 50 percent were nationals with one of the world's highest per capita income. Kuwaiti people received free healthcare, education and many other additional services. After the discovery of oil the risk connected with oil explorations abased and it emerged that a good portion of the Gulf area was very profitable in relation to oil exploitation. Then, in the 1950s, Middle East countries started to ask for improved stakes in the oil business. For example, in Kuwait state participation was required when releasing small concessions to Aminoil in 1948 and to the Arabian Oil Company (A.O.C.) in 1959.

But the real turning point was in 1951 when K.O.C. modified its concession with the state of Kuwait on the basis of a 50/50 agreement, which meant that from now on Kuwait would get half of the profits. In addition to this, K.O.C. prolonged the duration of its concession by 17 years. Worldwide the relations between owners of energy resources (like oil and gas) and international oil companies (I.O.C.s) were changing. In those years, Venezuela moved away from a concession regime to profit sharing agreements (P.S.A.s). Nationalization winds were blowing on the concession regime still applied in the energy sector.

From the 1960s it emerged a confrontation between the emir and the government on one side and the National Assembly/Parliament — composed by members of the most relevant merchant families and the tribal leaders — on the other side. This confrontation is still alive today. In fact, the National Assembly/Parliament has always been a powerful institution and it has fundamental value in order to address all major political, economic and social transformations in Kuwait. Accepting the nationalization doctrine, the Parliament espoused the nationalization process of Kuwaiti commodities: oil and gas.      

The Constitution of 1962 reflects the changed atmosphere in dealing with the management of natural resources. The National Assembly's effort brought in the inclusion in the Constitution of Article No. 21 and Article No. 152, which directly affirm that the state owns and controls all oil resources. The National Assembly put inside the Constitution these two articles in order to have two obstacles to an easy involvement of I.O.C.s in the Kuwaiti oil and gas sector.


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On the one hand, the members of the National Assembly since 1962 have been interpreting articles 21 and 152 in a very strict and literal manner, i.e., any agreement concerning natural resources needs the approval of the Parliament. On the other hand, the government and the public holding company controlling the Kuwaiti oil and gas sector, the Kuwait Petroleum Corporation (K.P.C., see: Chapter 1.4: The 1975 Complete Nationalization of the Energy Sector, Oil Included) have been interpreting Article 152 more openly meaning that Parliament is supposed to approve only new concessionary agreements and not operating service agreements (O.S.A.s). After continued disagreements between the two positions with reference to the correct interpretation of Article 152, the case could be referred to the Constitutional Court, which has the final word about constitutional interpretations.

It goes by itself that it is a very delicate argument and that the government does not want to have a confrontation with Parliament to be ruled by the Constitutional Court. A Constitutional Court's ruling in favor of Parliament could in fact be very dangerous for the Kuwaiti political environment[vii].  

1.3. The Nationalization of Kuwait's Natural Gas 
From the 1960s onward, the National Assembly did not accept K.O.C.'s practice of flaring off the natural gas released when extracting crude oil. It's quite normal to get associated gas when extracting oil, and in many oil fields it's exactly the gas pressure to push oil toward the surface. Associated gas can exist separated from the crude oil in the underground formation, or dissolved in the crude oil. The release of natural gas when producing crude oil is dangerous because gas may explode. In general, there are four solutions for getting rid of this problem:
  • Flare the obtained gas in a controlled manner (easy to be accomplished).
  • Commercialize and subsequently sell the gas in a near market (the proximity of a market was a fundamental element especially in the past).
  • Reinject the gas back into the reservoir in order to maintain constant the pressure of the oil well (this procedure is both complicate and expensive).
  • Stop producing crude oil (economically the worst scenario).    

In Kuwait, following economic considerations (and because the task was easier) K.O.C. chose to flare gas. And every day several million cubic feet of gas (MMCFG) were flared. For the National Assembly — but it would be correct to say for the public at large — flaring gas was absolutely wrong because it hold back Kuwait from having a feedstock fundamental for electric power generation and desalinization. The issue of gas utilization started to be discussed in Parliament since 1969. The government was reluctant to discuss this topic with I.O.C.s, but it was under attack by Parliament, which was calling for full nationalization of natural gas.

After a couple of years, in July 1971, the Kuwaiti minister of oil and gas had a meeting in London with the executives of British Petroleum (BP, previously A.P.O.C.) and Gulf. The minister carefully explained that the government absolutely wanted to avoid a full scale confrontation with Parliament in relation to gas and that a solution was needed. Missing a solution the only viable alternative would be gas nationalization. The meeting was a failure and the proposal did not get sufficient consideration by the two companies, which denied the Kuwaiti Parliament its actual influence over the country's politics. When on October 28, 1971, the Kuwaiti Parliament reconvened after the summer break, gas nationalization was the moment's hot topic. Then, by order of Parliament the gas industry was de facto nationalized. The result of the nationalization was a relevant increase in the utilization of gas[viii].       

1.4. The 1975 Complete Nationalization of the Energy Sector, Oil Included
Nationalization winds were already blowing over the MENA region and oil was becoming a nationalistic tool used to shape domestic and international politics. In May 1962, K.O.C. spontaneously renounced to concession rights with reference to half the initial concession. The renounced area was assigned to the Kuwait National Petroleum Company (K.N.P.C.), a company established in 1960. Its shareholders were 60 percent public and 40 percent private. In addition to this, the company had the monopoly for the distribution of oil products within Kuwait.

The traditional system of oil concessions was changing toward two extremes: pure nationalization (supported by the Arab League) and participation supported by some Arab technocrats. The first real nationalization happened in Libya in December 1971 (not considering the minor one in Algeria in 1967). Other nationalizations followed in Algeria, Venezuela and Iraq.

Completely different was the strategy of participation followed by another group of countries led by Saudi Arabia and including Abu Dhabi, Kuwait, Qatar, Iran and in part Iraq. According to the pragmatic philosophy of Yamani [Saudi Arabia's oil minister Zaki Yamani], their aim was to take control of the oil industry gradually without threatening the stability of the markets and taking into account the time needed to acquire full awareness of its operating mechanisms. This strategy coincided precisely with the wishes of the western companies[ix].  
      
In January 1973, the Kuwaiti government approved the General Participation Agreement championed and negotiated in New York City by Oil Minister Zaki Yamani of Saudi Arabia on behalf also of the other Arab countries. According to this agreement the companies agreed to hand over a growing share of their businesses: They started with 25 percent in 1973 to reach 51 percent in 1981. In other words, K.O.C.'s 25 percent had to be nationalized immediately following compensation equal to the book value of the to-be-nationalized infrastructures. Within 1982 the Kuwaiti government would get the majority of the company's shares.

Kuwait's National Assembly refused ratifying the agreement claiming that it was necessary to nationalized immediately the whole company and it accused the government to be too much patronizing with K.O.C.'s owners British Petroleum and Gulf. Limited trust between the National Assembly and the government would be a constant element of their relation during the coming decades and it is still so today.  
  
In the summer of 1973 Kuwait announced the intention of renegotiating its participation quota in K.O.C. with the aim of getting the majority of its capital immediately. In September 1973, Kuwait hosted the 11th meeting of the Organization of Arab Petroleum Exporting Countries (Oapec, not to be confused with OPEC) and the nationalization principle was approved. Then, following the October 1973 Yom Kippur War, events moved forward very fast. Oil and Finance Minister Abdal Rahman Atiqui met with K.O.C.'s officials in order to renegotiate shareholders' quotas. The minister asked for obtaining 50 percent of K.O.C.'s shares, but later this agreement did not satisfy Parliament. Then, in January 1974, the minister reached an agreement for 60 percent of the company and Parliament ratified this agreement the following May. BP and Gulf received compensation of $112 million according to the value of the nationalized infrastructures. 
   
After the parliamentary elections of January 25, 1975, the opposition party strongly criticized the energy policy of the government; this policy was considered too much in line with the interest of Big Oil and the U.S. Following these tensions in March 1975, the new Kuwaiti oil minister Al Kazemi announced the intention to nationalize the remaining 40 percent of the shares still in the hands of the BP-Gulf joint venture[x]. The two companies opposed such a move underlining the fact that they literally had helped the Kuwaiti energy sector to be set up. Their attempts were to no avail in order to reverse the nationalizing trend. And in specific, nationalizing the commodities was considered by Arab countries an act of sovereignty. BP and Gulf demanded compensation worth $2 billion, but in the end they got only $50 million. Similarly, for them it was not possible to get Kuwaiti crude at a preferential price from then onward.

The following steps were the "Kuwaitization" of K.O.C.'s personnel and the nationalization of K.N.P.C. The entire oil sector was under the control of the Supreme Petroleum Council (S.P.C., headed by the prime minister), which had been established thanks to Decree for Establishing the Supreme Petroleum Council of August 26, 1974. The basic idea behind the institution of the council was to have an institution for drawing the general policy of petroleum wealth within the framework of the national economic and social development plan.


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Later, on January 27, 1980, it was created the 100-percent government-owned Kuwait Petroleum Corporation (K.P.C.), which is Kuwait's national oil company. It's based in Kuwait City, and it's an umbrella company incorporating several fully owned subsidiaries. K.P.C. manages domestic and foreign oil and gas reserves. Some of its subsidiaries, like K.N.P.C. (Kuwait National Petroleum Company), Petrochemicals Industry Company (P.I.C.) and Kuwait Oil Company (K.O.C.)[xi] had been created in the 1960s by the state together with private investors. By 1980, thanks to Law No. 6 of 1980 (establishing K.P.C.) they all were transferred to K.P.C.'s full ownership.

Finally, in 1986 the Ministry of Oil was established as separate from the Ministry of Commerce and Industry, and it started to have policy-making powers in conjunction with S.P.C. In specific, the minister has been given a supervisory role over all public institutions related to the oil and gas sectors.

1.5. Recent Years' Attempts Aimed at Reversing the Complete Nationalization of the Energy Sector (Oil and Gas) — The Kuwait Project
Thanks to the nationalizations of natural gas in 1971 and of oil in 1975, Kuwait's energy sector was totally nationalized and no I.O.C. was allowed to operate in the country. During the nationalization period, the only I.O.C. that had (and still runs this activity today) business relations with Kuwait was America's Chevron, which had operations onshore in the so-called partitioned neutral zone between Kuwait and Saudi Arabia.


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In this area, Saudi Arabian Chevron Inc. and K.O.C. explore for and produce oil and gas. The energy production from this area is shared between the two countries.

Nowadays, although with great difficulties for the I.O.C.s, it's possible to operate in Kuwait through service agreements (S.A.s). In practice in the MENA region Saudi Arabia's energy sector is the only one that is still totally close today to foreign companies (in reality, Saudi Arabia has attempted to find more natural gas by allowing I.O.C.s a partial access, which it does not permit in the oil sector where Saudi Aramco rules). The table above showed the current different approaches to energy contracts in the MENA region.

The nationalized K.O.C. had in 1975 advanced technological skills and was by that time capable of extracting crude oil without the assistance of I.O.C.s. This was possible because in general Kuwait's oil fields — among them there is Burgan, the second largest crude oil field in the world (it started production in 1938) — are easy to operate. In 1975, the on-production crude oil fields were onshore, at an early stage of development and with high underground pressure. In practice, it was necessary just to drill vertically wells (between 3,500 to 5,000 feet) and then oil would flow to surface. By 1990, K.P.C. was the only Third World's state-owned company capable of selling its oil using its own brand name and through its own service stations. These results were an important milestone for Kuwait.

The full shutting down of the oil and gas sector to I.O.C.s had lasted for 15 years, when practically the course of events was changed by the First Gulf War (August 1990-February 1991). Since the liberation of Kuwait in 1991 it appeared clear that the oil sector was in a difficult situation owing to the ruinous Iraqi invasion. K.P.C. immediately looked for technical assistance from I.O.C.s and there was a tacit understanding that once the oil industry was reconstructed the upstream sector would be open to the assisting I.O.C.s. Effectively, since 1991 some I.O.C.s have been involved in the upstream sector providing simple technical assistance. Two years later surfaced the idea of allowing I.O.C.s not only to provide technical assistance, but also to invest in the upstream sector with reference to a new-and yet-to-be-developed project called Project Kuwait, which aimed at increasing oil production capacity from four northern oil fields: Raudhatain, Sabriya, al-Ratqa and Abdali. 


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Apart from general advantages that could be obtained from the involvement of I.O.C.s (see the above box) one reason emerged above all: securing military support from abroad. The initiative of developing oil fields located on the border with Iraq and of requesting the active role of I.O.C.s was backed by the idea that having foreign workers stationing in the area of Project Kuwait would facilitate military alliances with the countries to which belonged the involved I.O.C.s. In this regard, it should be understood that President Saddam Hussein lost the war, but still held power in Iraq. In practice, Kuwait wanted to create a sort of economically driven buffer zone making the border area much safer.      

In the meanwhile, under a 1994 agreement with the K.O.C., Chevron subsidiaries provided technical expertise for the continued development of the Burgan field. The K.O.C. agreement expired in 2008. Recalling Chevron for service agreements in relation to Burgan was quite obvious in 1994. In fact, Gulf Oil Corp., which had  become part of Chevron in 1984, had discovered Kuwait's super-giant Burgan field in 1938 and had been working there up to 1975. In practice, it was the Burgan discovery that had transformed Kuwait into a top oil producer. Another example of technical service contract was the one awarded in 1994 to Burgan Equipment Co., a private company based in Kuwait (it's not an I.O.C.). It consisted of supplying, installing and commissioning training equipment in the K.P.C. training center. This service agreement was completed successfully, but with reference to Project Kuwait, the 1995 initial proposals from K.P.C. were opposed by both Parliament and S.P.C.


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Then at the end of the 1990s it appeared clear that Kuwait's oil and gas sector was behind its production potential. Already there was the need to explore for and then develop more difficult oil fields — like those located in the northern part of the country — than the ones that had been pumped for the previous 50 years. On-production crude oil fields were mature so that their internal pressure was not sufficient for permitting an easy oil recovery. Also the giant Burgan oil field , the cash-cow oil field was at risk of being permanently damaged. This situation was partly due to a regulatory system banning foreign ownership of hydrocarbon resources. In short, K.P.C. and its subsidiaries, although trained, were missing the skills for working oil and gas out of difficult fields. It was a too big bet for K.O.C. to work alone. Given the infancy of its ability in harnessing top-notch technologies, it was uneconomically for K.O.C. to assume full risk in completely handling new difficult oil fields.   

Finally, the Supreme Petroleum Council made the appropriate decision in 1997 and understood the non-lingered necessity of opening the oil and gas sector to I.O.C.s. The plan was to invite selected I.O.C.s (Chevron, Conoco, ExxonMobil, Total, Shell, BP and ENI) to participate in the development of oil fields located in north and western Kuwait. Technically, the big change happened in March 2001 when the National Assembly passed Law No. 8 Foreign Direct Capital Investment Law of 2001, which partially facilitated some foreign direct investments (F.D.I.s) in the Kuwaiti energy sector. In fact, according to Article No. 3 of the law (and to the explanatory memorandum to the law) the procedure for foreign investments in natural resources is now permitted, although not with a simple license as it happens in other sectors, but only pursuant to a law and for a limited period of time. In other words, Parliament needs to know and approve every contract that is going to be subscribed between K.P.C. and any I.O.C.


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The target of this complex procedure is preventing corruption and ensuring transparency in investment practices. This law spurred one more time a lot of debate given the different mindsets in relations to the energy sector: opening (although through just service agreements) or closure to I.O.C.s. But following this law, K.P.C. announced reinvigorated plans to permit foreign companies to develop the oil fields located in north Kuwait. In the end, this law proved useful to implement improved service agreements although it took nine years before the signature of the first such contract with an I.O.C. 

And in relation to the development of the oil fields located in north Kuwait, swiftly K.P.C. started lobbying in favor of modifying Kuwait's oil and gas sector regulatory regime asking for permitting I.O.C.s to participate in the oil industry through operating service agreements (O.S.A.s).

For K.P.C. three principles should govern the relationship between Kuwait and I.O.C.s:
  • O.S.A.s should be consistent with Kuwait's Constitution.
  • Kuwait should have the ownership of all the produced oil and gas and the obtained revenues.
  • I.O.C.s should not get any ownership title over crude oil and gas

The draft legislation regarding O.S.A.s (they were planned to have duration of 25 years) was introduced in Parliament in 2003. In order to get I.O.C.s' investment it was established an incentivized buy-back contract (I.B.B.C.) neither implying a P.S.A nor a concession. O.S.A.s, i.e., the operative services agreements would in detail define I.O.C.s' position.    
  
According to this draft, Kuwait would have sovereign control over the production and would manage the strategic side, while I.O.C.s would control the operational management providing for services and construction primarily on a contractual basis.


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I.O.C.s would be remunerated for 50 percent of operating costs on a monthly basis and for 50 percent of capital costs over a 10-year period. The I.O.C. compensation would be based on a variety of fees (an old oil fee to be paid on production that could be produced by K.O.C., an oil fee to be paid on production over the old oil curve, a gas fee, an allowance for recovering the invested capital, and another allowance for annual capital investments) with the aim of covering costs, incentivizing a positive behavior and rewarding the obtained results. According to the draft, there was also the idea of permitting foreign investors to transfer their O.S.A.s to another foreign investor, to repatriate capital and profits, and to be entitled to compensation in the case of a takeover by the state.    

Violating the terms of an O.S.A. — at least as prescribed by the draft legislation — would include an initial warning, the withdrawal from the investment, and at last the liquidation of the investment. 


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The proposed relationship between Kuwait and I.O.C.s in the Kuwait Project is the natural evolution from what we have today. It is this second phase of our relation that takes into account the strengths and limitations of the existing relation. The Kuwait Project proposes to expand I.O.C.s role from an advisory role to a fields' management and operation role, where I.O.C.s will act as a super contractor under the guidance and strategic management of the state. ... In essence, Kuwait requires the type of relationship with I.O.C.s, which is primarily based on operating services where I.O.C.s are paid a fee per bbl of oil produced.[xii]    

In 2005, the Financial and Economic Affairs Committee of Parliament issued a favorable report about the draft, but in the same year the State Audit Bureau expressed reservations about the constitutionality of the legislation. After the issue was raised the committee withdrew its report espousing the unconstitutionality of the draft law.

The problem was in the fact that for the government there was no need to have a specific law authorizing a specific I.O.C. to work in Kuwait under a service agreement while for Parliament a case-by-case law was required (different interpretation of Article No. 152 of the Kuwaiti Constitution). The government considered that there were the numbers for approving the draft law in Parliament, but it postponed the vote to early 2006. In January 2006, Emir Jaber III al-Ahmad al-Jaber al-Sabah died and the new emir, Sheikh Sabah IV Al-Ahmad Al-Jaber Al-Sabah, following an increasing confrontation between Parliament and the government dissolved the former. Since then the relations between Parliament and government have been very tense with the former accusing many ministries (including the ministry of oil) of corruption.[xiii]    

In 2007 the situation was still totally frozen in relation to the legislation concerning the energy sector, so the emir expressly conceded to Parliament the power of approving every I.B.B.C. related to Project Kuwait. But such a move did not prove to be good for speeding up the project because Parliament continued delaying it. And, given the difficulties to get some I.O.C.s to work with Project Kuwait until a couple of years ago there was the idea that neither an improved version of T.S.A.s nor O.S.A.s could ever materialize in Kuwait.

In this regard, it needs to be pointed out that I.O.C.s' country managers were (and probably still are) not convinced about the attractiveness of the offered contractual terms and even if the draft law were approved there would be the risk that all I.O.C.s might decline to bid. Plus, maintaining relations with counterparts like the oil minister, K.P.C. and K.P.C.'s related subsidiaries' C.E.O.s, who serve for very short terms, is an additional hurdle. In 2009, Chevron and BP, which had been assisting Kuwait since post-First Gulf War reconstruction, finally withdrew their senior executives after giving up on finalizing an agreement.


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1.6. The Current Contracts for I.O.C.s: Enhanced Technical Service Agreements (E.T.S.A.s) for both the Oil and the Gas Sectors. 
Given the mentioned stalemate with no real progress for Project Kuwait, in the last years both K.P.C.'s and I.O.C.s' managers have been pursuing as a viable alternative the so-called enhanced technical service agreements (E.T.S.A.s). Not implying any level of foreign control over oil and gas (absence of any bookable reserves)[xiv], these agreements are not equivalent to O.S.A.s, while they still are one step ahead than normal T.S.A.s. In fact, with E.T.S.A.s Kuwait would pay premium prices to have I.O.C.s' engineers assigned as long-term consultants to K.O.C. Moreover, high fixed fees would be coupled by variable performance-based payments related to the achievement of production targets. E.T.S.A.s are a hybrid between P.S.A.s and traditional T.S.A.s. In the end, E.T.S.A.s would incentivize international companies to increase their scope and level of involvement in upstream activities obtaining at the same time more supervisory authority.    
   
But the real advantage of E.T.S.A.s lies in not requiring any approval by Parliament although it's clear that they could still spark a loud political debate as a result of the magnitude of the paid fees and the size of the I.O.C.'s footprint. It's evident that the continued power struggle between Parliament (protecting its right to legislate) and the government (feeling itself too much bound by Parliament's consent) is not helping also the implementation of E.T.S.A.s. And the State Audit Bureau is suspicious about why the government is paying ten times as much for an E.T.S.A. as for a usual T.S.A.  
      
All this said, E.T.S.A.s are not a universal remedy for the current stalemate. In fact, I.O.C.s are less enthusiast about this kind of contracts than about the planned O.S.A.s, formerly targeted at Project Kuwait. Given the not quite appealing contractual conditions, there is also the possible danger that I.O.C.s may be tempted to maximize short-term returns (like for instance maximizing production) versus a more strategically oriented business plan. I.O.C.s consider E.T.S.A.s as a viable option as long as the received fees are able to cover their costs (also with no profit at all). With E.T.S.A.s energy companies would carry out the same role that they have when they sign T.S.A.s. In practice, the interested companies would subscribe E.T.S.A.s just for having a working relation with K.O.C. Thanks to these agreements the companies would be well positioned at the government level and it could it be possible in the future to be awarded an O.S.A.  Fees — I.O.C.s would also be interested into getting production incentives — should cover costs otherwise there is no real interest into entering a market for simply losing economic resources.

Another unclear point is whether E.T.S.A.s can be a consistent substitute for O.S.A.s and can permit also the implementation of Project Kuwait. But again the kernel of the issues rotates all around the necessity of tracing a fair balance between K.P.C. on the one side, and I.O.C.s on the other side. The correct incentive — also with E.T.S.A.s — could permit I.O.C.s to be focused on the long term and on technological quality.

Finally, in February 2010, Shell signed an E.T.S.A. to exploit some 2005-06 oil discoveries (20 to 25 BBL of heavy and sour oil) in the Sabriya and Umm Niqa areas in northern Kuwait. Currently, this project is proceeding slowly. Similarly, in August 2010, still in northern Kuwait, British Petrofac signed another E.T.S.A. with K.O.C. in order to boost production capacity in the Raudhatain and Sabriya oil fields.      

The future move will be either maintaining the status quo (remaining within the E.T.S.A. contractual scheme) or developing an eventual and alternative type of agreement between K.P.C. and I.O.C.s. There is no silver lining if a fair balance isn't established between Kuwait on the one side, and I.O.C.s on the other side. In this regard, a good example comes from Iraq and Iraqi Kurdistan (a semiautonomous region of Iraq). In fact, while Baghdad does offer just service contracts with low fixed earnings, in Iraqi Kurdistan there are already on offer production sharing contracts with their fairer profit share for I.O.C.s. It goes by itself that I.O.C.s are at present reaping service contracts in Iraq only under the auspices of getting improved and fairer contracts in the future, while the attractive and interesting Iraqi Kurdistan contracts are hampered by the bickering between Iraq and Iraqi Kurdistan on how to divide hydrocarbon riches.


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Moreover, it is worth underlining that Kuwait's population, who is accustomed to a high standard of living from cradle to grave thanks to an ever-present welfare where the state fully covers some priority costs (healthcare, housing and education) and subsidizes some secondary costs (fuel, electricity and water), does not identify any real and urgent economic needs to allow I.O.C.s to work in Kuwait under different terms and with an increased operational role. The majority of the population deems Kuwait's commodities to be integral part of Kuwaitis' national patrimony, which has to continue staying in Kuwait's hands.


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Summing up, today's private role in Kuwait's oil and gas sector is limited to contracts related to providing at maximum E.T.S.A.s at the upstream level. Political disputes between a royally appointed prime minister and the partially elected Parliament are stalling possible and necessary reforms.

1.7. Organizational Structure of Kuwait's Energy Sector. No Differentiation Between Oil and Gas Companies  
In 1980 it was created the 100-percent government-owned Kuwait Petroleum Corporation (K.P.C.), which is Kuwait's national oil company owing all the national oil and gas reserves. Based in Kuwait City, K.P.C. has a network of fully owned subsidiaries covering several different activities within the oil and gas sector: exploration, refining, oilfield services, product shipping and petrochemicals. The table below shows the structure of the oil and gas industry in Kuwait with the specific role performed by all the K.P.C. subsidiaries.


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In Kuwait there aren't different companies — while belonging to the same holding — that deal only with gas or only with crude oil. In 1938, oil was discovered and since then the country had been producing only crude oil up to the beginning of 1970s when the recovery of associated natural gas was added to crude oil production. In other words, there is no single subsidiary dealing only with gas or only with oil as is for instance the case in Qatar with Qatar Petroleum dealing with oil and Qatargas dealing with gas.

CHAPTER 2  ANALYSIS OF KUWAIT'S NATURAL GAS SECTOR

2.1. Natural Gas Reserves and the Development of the Middle East's Gas Industry
Since last century, the Middle East area has been deemed as one of the key regions for oil and gas. The table below shows the first twenty-five countries ranked according to the world's proved natural gas reserves. It immediately stands out that Iran, Qatar, Saudi Arabia, U.A.E., Iraq and Kuwait, are respectively in second, third, fourth, seventh, eleventh and twenty-first position. Together, their share of natural gas proved reserves amounts to a staggering 39.5 percent. The share of the six G.C.C. countries is equal to 22.5 percent.


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These numbers should suggest that the Middle East has a huge quantity of available natural gas (apart from Qatar's, much of this consists of associated reserves, and for OPEC members this means that the production is restricted by OPEC quotas) and that gas shortages should be practically a nonsense.

On the opposite, in the last five years, many Middle Eastern countries have been experiencing gas shortages with all the subsequent bad economic outcomes. With the exception of Qatar, the natural gas industry in the Middle East has always been considered less important than the oil industry. While petroleum was getting powerful investments, natural gas was developed with poor economic resources (not to mention that at the beginning of the oil industry associated gas was flared or burnt), lacking storing and transporting infrastructures and following an almost inexistent regulatory framework. Behind this absence of investments there was probably across all countries the practice of maintaining low domestic gas prices (subsidized prices introducing market distortions). Without any incentive both private companies and governments were not much inclined toward pouring in resources for natural gas exploration, production and infrastructure. Moreover, in order to develop the natural gas industry many different factors do need to act toward that end: the political environment, the presence of the required technology, investments availability and some country-specific reasons[xv].  
      
In today's Middle East, the only countries where natural gas production tops domestic consumption are Egypt and Qatar[xvi]. These countries are net exporters. The other countries are all experiencing natural gas shortages. An interesting example is the U.A.E. In five years this country has moved from being a net exporter to becoming a net importer.

Natural gas is needed because the Middle East economies (and in specific the G.C.C. economies) are developing and growing at so significant a rate with the consequence of demanding ever-increasing quantities of natural gas, which is the main feedstock for electricity generation, water desalination[xvii] and the petrochemical industry (and obviously a number of other industries like steel and aluminum). Moreover, for power plants the swing toward gas is supported by its greater efficiency and environmental friendliness than utilizing heavy fuel oil or coal.  

Given the current situation, some Middle East countries are already obliged to import natural gas or to look for alternative energy sources notwithstanding the fact that globally there is a surplus of natural gas. 

Kuwait is one of the Middle East countries where there is natural gas but at the same time the industry is underdeveloped. Kuwait's gas resources are in proportion not as big as the country's oil reserves, but still at 1 percent of the world's natural gas reserves with 1.8 trillion cubic meters — the majority of which is associated gas — the country should be in the position of being self-sufficient in relation to its gas necessities, of course if the natural gas industry were well managed.

In the last years relevant discoveries of non-associated natural gas have occurred in north Kuwait. And I.O.C.s have shown interest for these discoveries. Up to date the involvement of Big Oil into gas projects in Kuwait has been characterized by the same two impediments that are present in the oil sector: unattractive contractual conditions summed to political uncertainties about how managing Kuwait's oil and gas sector. 

In practice in Kuwait there is no factual shortage of natural gas under the ground (onshore) or the seabed (offshore), but — and this is the real problem — there is a serious deficiency in investment and policies to get it out[xviii]

In order to develop Kuwait's still embryonic natural gas industry and consequently tackling the ever more occurring gas shortages, today's strategy is based upon two pillars:
  • Exploring and then developing domestic non-associated natural gas fields.
  • Importing natural gas with different means of transportation. 

2.2. Gas Exploration and Current Gas Production
According to E.I.A., in 2010 Kuwait produced 1.17 billion cubic feet per day (BCFG/d) with an 8 percent increase in comparison to 2009. This gas is mainly associated and this means that domestic natural gas supplies are directly linked to OPEC's crude oil production quotas. Pumping out less crude means for Kuwait having at disposal less natural gas, while the country needs ever-increasing quantity of gas for generation of electricity, water desalination, the petrochemical industry and the enhanced oil recovery (E.O.R.) techniques, which are required for boosting the rate of oil recovery. In 2010, around 85 percent (1 BCFG/d) of the overall natural gas production came from associated gas, while non-associated gas accounted for a quantity of 150 million cubic feet per day (MMCFG/d) to 200 MMCFG/d.


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Up to the 1971 natural gas nationalization, associated gas in Kuwait had always been considered a problem for the oil sector — a trouble when extracting crude. In practice, associated natural gas ended up being flared when extracting oil. Instead, after 1971 natural gas has been employed as a domestic feedstock in different activities and since then Kuwait has been consuming ever-increasing quantity of natural gas for the different above-mentioned utilizations.
 

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Dependence upon gas imports is not a recent phenomenon, but that it dates back to at least 20 years ago. In fact, prior to the 1990 invasion by Iraqi troops, Kuwait was already becoming dependent upon importation of Iraqi natural gas. Afterward, the 1990 invasion messed up things and once war was over this natural gas relation with Iraq was not doable anymore. In practice, after the liberation specific plans for importing natural gas surfaced the Kuwaiti political debate and in specific two countries were essentially considered as gas suppliers: Qatar and Iran. Basically, twenty years ago there was the idea of importing natural gas and not of exploring for domestic non-associated natural gas.  At least at the beginning Kuwait was able to compensate for gas shortages through the availability of cheap fuel for energy necessities and through naphtha as a petrochemical feedstock. But following this policy, today's 70 percent of electricity generation in Kuwait derives from crude oil. K.O.C. has recently announced its intention of reaching a production target of 4 BCFG/d by 2030. This value is approximately four times as much the 2010 gas production.

In order to increase the production of non-associated gas the first ranked option is developing gas fields from north Kuwait. Another possibility could be exploring offshore, but Kuwait's fiscal and political situation does not proactively work towards this target.

In 2006 it was discovered the Jurassic non-associated gas field possessing an estimated 35 trillion cubic feet of reserves. Preliminary studies completed by Schlumberger and Shell suggested considering the field as one of the most challenging fields in the world in light of two factors: the geological composition and the technical complexities. This gas is mostly condensate, plus it's very sour because it contains high concentrations of toxic and corrosive hydrogen sulfur. Initially, a first phase projected to obtain 175 MMCF/d and 50,000 bbl/d of condensate by 2008, but it apparently releases only 140 MMCF/d. The second phase, due on line by 2013, should have a production capacity of 500 MMCF/d and it is implemented by the two companies Kuwait's Kharufi National and Italy's Saipem. At the beginning, the development plan of the Jurassic field envisaged a 600 MMCF/d by 2012 and 1 BCF/d with also 350,000 bbl/d of light crude or condensate by 2015. Experts say that this target is unlikely right now. Anglo–Dutch Shell is developing the Jurassic gas field thanks to its February 2010 E.T.S.A. valued at $700 million.

 
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This deal is currently considered a sort of landmark deal because it is helping to boost non-associated gas production (and consequently boosting the country's domestic utilities facilities) but also because it should finally indicate a Kuwaiti real interest in collaborating with I.O.C.s in order to develop Kuwait's upstream activity. In specific, if K.P.C. does have some know-how in dealing with oil, it's really missing the required technical skills for extracting gas and heavy oil.    


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Another possible solution for increasing Kuwait's quantity of non-associated gas is the Dorra gas field, which is located offshore in the P.N.Z. Three countries are sharing this field: Kuwait, Saudi Arabia and Iran (the latter calls the field Arash). Kuwait and Saudi Arabia announced plans to start by 2017 a gas production of 500 MMCF/d to 800 MMCF/d. Until now, Iran has announced that it would develop by itself its own side of the field. As to the current political tensions between Arab countries on the one side, and Iran on the other side, it's highly presumable that the development of this gas field won't be void of disputes among the neighboring countries.


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Increasing the availability of natural gas does have scarce meaning if contextually Kuwait isn't expanding its gas processing infrastructure. In this regard, South Korea's Daelim is constructing Kuwait's fourth gas processing plant with an 800 MMCF/d capacity. This new unit (the largest to date) located on the site of the Ahmadi refinery is scheduled to increase in 2013 Kuwait's gas processing capacity to 2.3 BCF/d. A fifth gas processing plant is in the planning stages and if completed it will expand the overall gas processing potential to more than 3 BCF/d. All this said, also after completion of the fourth and fifth trains, Kuwait won't be able to meet the growing levels of its domestic demand.


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Realistically, it is quite likely that Kuwait's gas production will only cater to the country's domestic needs. In fact, the aggressive exploration program aimed at expanding non-associated gas reserves (there is optimism about finding additional reservoirs) is targeted at satisfying domestic needs. K.O.C.'s officials point out that it's not probable for Kuwait to become a major gas exporter. Kuwait is only a small-quantity exporter of liquid petroleum gas (L.P.G.) extracted from natural gas. 

2.3. An Ever-Increasing Consumption and the Necessary Gas Imports
In 2010, Kuwait utilized around 529 BCF of natural gas. This value is equal to 1.45 BCF/d against a production which amounts to 1.17 BCF/d (approximately the gap is equal to around 270 to 280 MMCF/d). Virtually, in 2010, the country consumed around 24 percent more than the produced quantity. This problem is not new but it had emerged also before the 1990 invasion. What is happening is that since 2008 Kuwait has been unquestionably consuming more natural gas than it has produced. The country has been experiencing in the recent years gas shortages, which have translated into electricity outages especially during summer months (April to October). Outages have brought in the shutdown of refinery and petrochemical operations in order to provide electricity to the population, but this has resulted in consistent losses for Kuwait's economy. A possible solution — apart from increasing the production of domestic non-associated gas, which in any case would not be sufficient for covering all consumption requirements and would take several years before being available, while the problem is already a reality —is importing natural gas.

Gas imports may be implemented in two ways:
  • Through pipeline or  
  • As liquefied natural gas (L.N.G.).      

For Kuwait, pipeline imports mean importing gas from Iran, Iraq or Qatar. But this solution — if it isn't to be ruled out given different political tensions between neighboring countries — will be implemented only in the medium term.  At the end of 2009 beginning of 2010 there had been some talks about the opportunity of building a 570-kilometer (mainly submarine) pipeline transporting 3 BCM/y to 4 BCM/y of gas from South Pars gas field in Iran to the border with Kuwait. At present, this plan is not progressing at all. According to some analysts, settling eventual disputes with Iran in relation to the development of the Dorra offshore gas field (non associated gas) located off the coast of the P.N.Z. could speed up things with the pipeline project from South Pars, but in the last twenty years there have been a lot of discussions with Iran about the construction of pipelines but no tangible results.    

In the end, the most viable, although expensive solution, for importing gas to Kuwait is to liquefy it. The country became the second in the region after Dubai, to turn to L.N.G. imports. This solution is getting more credit especially after the October 2011 Kuwait's decision of abandoning the development of nuclear power energy. In fact, Kuwait was supposed to utilize nuclear energy in the long run. In 2009, it announced the intention of establishing a nuclear commission and the following year in January 2010 the country announced a 20-year deal with France's Atomic Energy Commission for the development of nuclear energy in Kuwait[xix]. The initial plan was to build 4 nuclear plants by 2022 (one had to be located on the island of Warba and a second one on the island of Bubiyan, which both have been reclaimed by Iraq for more than 70 years). Although other regional countries remain committed to nuclear power plants, it's very difficult for Kuwait's leaders to proceed with the nuclear program, especially in consideration of the strong parliamentary opposition to the program.   


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In 2010, Kuwait imported 270 to 280 MMCF/d of L.N.G., which was sourced mainly from Oman, Egypt and Trinidad and Tobago. But the country is also taking re-exports of L.N.G. from Qatar via Abu Dhabi. This is a direct consequence of the fact that three years ago Saudi Arabia blocked a projected pipeline from Qatar to Kuwait.

L.N.G. gas imports rose from 11 cargoes in 2009 to an estimated 43 to 47 in 2011 (meaning a 409 percent increase in only two years considering 45 cargoes in 2011). And in 2011 Kuwait will import up to 42 percent more L.N.G. than the previous year, having extended the buying period into November.



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Natural gas demand is highly seasonal depending on several factors. Weather conditions, income, demographic trends, consumer and politicians preferences, and alternative fuels have all an impact.

L.N.G. may be traded thanks to spot contracts (short-term contracts) or medium- to long-term contracts. Since 2009 Kuwait has been implementing both spot contracts (the country is probably buying British Gas Group cargoes originating from Trinidad and Tobago) and medium-term contracts like the 4-year contracts with Netherlands' Vitol, an energy trader, and Shell. Which price structure these two typologies of contracts follow when one counterpart is Kuwait is not clear. While it's presumable that cargeos originating from the Atlantic Basin may be priced according to that region's pricing structure, for the signed medium-term contracts there is less transparency. The contracts for L.N.G. shipments signed with Vitol and Shell do not precise the price to be paid. The only released comment said that costs would be calculated according to delivery criteria and to a formula linked to crude oil. Both companies could be providing Kuwait with L.N.G. from a secure portfolio of geographically differentiated options. It would be interesting to understand how to price intraregional L.N.G. trade (for instance between two G.C.C. countries) occurring within a less-than-3,000-mile distance. In fact, 3,000 miles is the minimum distance for economic viability of the L.N.G. business. Up to now, L.N.G. movements from the Persian Gulf have been interregional, mainly oriented from the Middle East to Asia and not intraregional. And when selling to Asian countries the price has been established according to the Asian L.N.G. market. Currently, only the U.A.E. and Kuwait are importing L.N.G. Bahrain will begin importing it around 2014 and recent rumors (October 2011) from Oman say that the country could build an import terminal for L.N.G. to tackle a shortage of fuel, which indeed may impact both Oman's industry and power generation.     


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At the beginning of 2009, Kuwait was in talks with RasGas, a joint venture of Qatar Petroleum (Q.P.) and ExxonMobil.  The negotiations were aimed at subscribing a long-term deal for the supply of L.N.G. The deal was not finalized because K.P.C. did not accept the requested price. QatarGas had already secured long-term contracts and so was not available. Recently, K.P.C. has also been purchasing spot L.N.G. Part of this spot L.N.G. seems to come from Trinidad and Tobago with a major discount by British Gas (BG). Shell's QatarGas-IV train was available for serving Kuwait because this train was originally destined to serve the U.S. market where currently there is a lot of surplus of domestic gas and consequently prices are low. In practice, Shell had a surplus, which could be easily diverted toward Kuwait and the U.A.E. although with no economic convenience on the buyer's side.  
    
And in August 2009, Shell made its first L.N.G. delivery to K.P.C.'s floating terminal to help meet peak summer demand. The country uses Excelerate's (an L.N.G. importing and regasification company) tankers as a floating import terminal at the Mina Al-Ahmadi gas port (up to 500 MMCF/d of L.N.G.). The following year, in April 2010, K.P.C. signed two very similar contracts for receiving L.N.G. for the summer months (April to October) from 2010 to 2013. One was signed with Vitol, while the second contract was signed with Shell. With these two agreements K.P.C. wanted to import 2.1 million tons a year of L.N.G. This amount corresponded to five L.N.G. cargoes per month: three supplied by Shell and two by Vitol. Thanks to these two deals Kuwait should be able to avoid burning around 800,000 crude oil barrels per day. 


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Last April, Kuwait started some negotiations with Royal Dutch Shell — a company that has quite well established contractual relations with Kuwait — in order to import L.N.G. from southern Iraq. Prior to the First Gulf War, Iraq had already exported significant volumes of natural gas to Kuwait.

This gas came from Iraq’s southern Rumaila field through a 40-inch, 100-mile, 300 MMCF/d pipeline to Kuwait at Ahmadi. This time Kuwait is not dealing with the Iraqi government (the Kuwaiti Parliament would block any deal that put Kuwait directly dependent on Iraq's government) but with an I.O.C. like Shell. Kuwait would like to implement this project in maximum one year and a half year, but it's a short timeframe.

In this regard, it should be underlined that only in November 2011 Shell signed a $17.2 billion associated-gas gathering and monetization joint venture called Basrah Gas Company (B.G.C., 51 percent Iraq's South Gas Company 44 percent Shell, and 5 percent Japan's Mitsubishi) for three major Iraqi oil fields (Rumaila, Zubair and West Qurna all literally close to the Iraqi-Kuwaiti north border)[xx]. This 25-year deal will help Iraq to capture more than 700 million cubic feet per day of gas. Shell officials previously affirmed that with the utilization of a floating L.N.G. terminal, the first shipment could arrive within 18 months of signing a contract. This Iraqi gas — whose 70 percent is currently flared — is supposed to support electricity generation in Iraq, but, given that some power plants have still to be constructed, in the first years of the construction project there will be a gas surplus available for export. Probably working with L.N.G. could give some flexibility, but it should be considered that being the distance less than 3,000 miles, the economic viability of the project is yet to be found and it seems better to fix the old pipeline that was halted in 1990.

Still in Iraq, in October 2010, the Kuwait Energy Company, an independent oil and gas company from Kuwait, was awarded a 20-year contract for developing Siba and Mansuriya gas fields.  Siba field is located in Basra Governorate and Mansuriya field in Diyala Governorate. The Kuwait Energy Company jointly bid with the Turkish Petroleum Corporation (T.P.A.O.), the national oil company of Turkey, for both gas fields. The Kuwait Energy Company will be the operator at Siba, participating with a 60 percent contractor share, while T.P.A.O. will have the remaining 40 percent. T.P.A.O. will be the operator of Mansuriya, participating with a 50 percent contractor share. There, the Kuwait Energy Company and Korea Gas Corporation (Kogas) will have respectively a 30 percent share and 20 percent share. In particular, Siba — which is the smallest with 34 BCM — could provide Kuwait with Iraqi gas, but political relations are not yet well defined in order to materialize the project. Plus, before 2016 it's unlikely to have any gas to export.   

With no doubt dependence on gas imports is deemed a source of energy insecurity especially in a very unstable region as the Persian Gulf, but alternative solutions do not abound, especially in consideration of the current political tensions in the Gulf area. And the same Kuwait is not immune to this climate of instability (since 2006 the prime minister has resigned seven times because of political turmoil).

2.4. Kufpec's Investment in North-Western Australia's L.N.G. Projects             
The Australian projects represent for Kufpec, Kuwait's company for foreign petroleum exploration, part of a plan aimed at increasing Kuwait's access to global gas supplies and improving its oil and gas technical expertise. Other Kufpec's projects are also developed in Pakistan, Indonesia and Malaysia with similar targets. But Australia offers two interesting advantages: very stable fiscal terms and high geological potential.

In particular, two operations stand out in Australia: the partnership with the American energy company, Apache in the Carnarvon Basin, and the participation as equity holder of the Wheatstone Project.

Kufpec joined forces with Apache to explore and develop gas prospects including the Julimar and Brunello fields in the Carnarvon Basin, off the north-west coast of Australia. The partnership has licenses for areas located close to the Wheatstone gas field (Chevron has 100 percent interest there) and to the Gorgon and Pluto gas fields where two other large L.N.G. projects are under development.

Then, in October 2009, Kufpec-Apache signed an agreement with Chevron to supply gas to Wheatstone L.N.G. plant (located at Ashburton North, Western Australia and operated by the American company, Chevron) in return for equity stakes in the project. Presently, Kufpec owns 7 percent of the project[xxi]. In specific, Kufpec-Apache will be supplying gas from their Julimar-Brunello joint venture block (where Kufpec has a 35 percent interest, while the remaining 65 percent belongs to Apache) which is operated by Apache. On completion, the Ashburton North plant will receive gas from the Wheatstone, Lago, Brunello and Julimar gas fields and it will have a production capacity of 15 million tons.[xxii]  


BACCI-Kuwait-Oil-and-Gas-Contractual-Framework-and-the-Development-of-a-Modern-Natural-Gas-Industry-26-Dec-2011


2.5 L.N.G. Isn't a Temporary Measure and Needs Better Management       
No country would like to be dependent upon importing energy resources. And Kuwait does not shirk this unwritten rule when dealing with gas needs. Once the construction of nuclear power plants in Kuwait was ruled out it appeared evident that L.N.G. imports would not be just a temporary measure, but that they would be part and parcel of Kuwait's energy mix. At the beginning L.N.G. importation was considered just as a move for getting additional energy especially during summer months with simple L.N.G. cargo purchases from international energy companies (for instance: Shell). Now, such purchases do not cover the current necessities, and L.N.G. trade should be organized in a much more larger scale and permanent basis. At least Kuwait could try — as it is partially doing — to increase its domestic production of both associated and non-associated gas with the final target of limiting L.N.G. imports.

In order to receive L.N.G. supplies on a permanent basis some steps need to be implemented soon both with reference to the infrastructure side and to the contractual side. On the one end, for a cash-rich country like Kuwait, it's not difficult to built new gas infrastructures. In this regard, there are already some plans to build a permanent L.N.G. regasification facility to take the place of the current L.N.G. infrastructure at the Mina Al-Ahmadi gas port.  On the other end, defining a strategy for long-term L.N.G. supplies from a bilateral and reliable supplier could be not so easy. In the last two years Shell and Vitol have provided for the required gas necessities, but at the end of 2013 summer season those contracts will expire. Kuwaiti officials point out that they will buy gas on the open market, but it seems quite a bet not to sign any long-term contract with an L.N.G. producing country.

Although up to now there has been no room for an accord with either Q.G. or RasGas, a  real candidate for an L.N.G. contract relation is Qatar, which has the world's third proven natural gas reserves, is capable of producing 77 million tons of L.N.G. per year, and is by far the largest L.N.G. exporter in the world. For Kuwait, which is geographically close to Qatar (Kuwait City is just 357 miles from Doha) renouncing to Qatari gas would mean relinquishing a good opportunity, although the proximity between Kuwait and Qatar reduces the economic viability of utilizing L.N.G.

Perhaps Kuwait and Qatar will have to reassess their pricing structures: The latter has to reconsider the selling price structure and the former the purchasing price structure. Taking into account Qatar's L.N.G. glut (it will have to sell L.N.G. more to Asia than to America as previously planned), Qatar may well agree to sell gas for a lower price. But Kuwait needs to raise the price it's willing to pay for L.N.G. shipments[xxiii]. In effect, considering the global oversupply of L.N.G., both Qatar and Oman could start renegotiating their L.N.G. export agreements (in general including off-take or take-or-pay conditions). In this way, these countries would have more natural gas to be traded at the intraregional level (for instance between G.C.C. countries)[xxiv] that is a market which in the next years will be booming. 

CONCLUSION 

Importing natural gas to Kuwait — an oil-rich country which possesses also 1 percent of the world's natural gas proved reserves — seems a paradox, but it's real and it's happening right now. Also some other G.C.C. countries, all with consistent natural gas resources, already started importing gas or are developing plans for gas importation.

After Kuwait's oil and gas complete nationalization (gas in 1971 and oil in 1975), no I.O.C. was allowed to operate in Kuwait for at least 15 years. The oil and gas sector became closed to foreign actors. The only exception was Chevron in the P.N.Z. Then, after the end of the First Gulf War, as a consequence of the war damages to crude oil fields and of the understanding that the era of easy oil was close to an end, Kuwaiti authorities permitted I.O.C.s to sign T.S.A.s (now E.T.S.A.s) in relation to Kuwait's oil and gas sector. These contracts proved not very successful for both sides of the deal. In fact, I.O.C.s are not able to make a profit, and Kuwait is not getting the modernization and upgrade of its oil and gas sector.

The current contractual framework seems unable to produce the corrective measures for solving the problem of gas shortages. Kuwait would like to increase its production of non-associated gas fields, but this task is not easy because K.P.C. does not have the skills for developing geological and technically complex gas fields both onshore and offshore. All these said, gas shortages are today's problem and the development of non-associated gas fields — assuming that I.O.C.s could better assist K.P.C. in the development operations — will require some years before giving a reliable and consistent output (at the Dorra offshore gas field there could be also political problems with Iran).        
   
Apart from the non-deferrable reform of Kuwait's contractual oil and gas framework, in order to be successful in avoiding gas shortages, Kuwait's strategy should be based on the following 5 pillars:   
  • Developing Kuwait's non-associated gas from the gas fields located in the northern part of the country.
  • Developing the Dorra offshore non-associated gas field located in the P.N.Z.
  • Purchasing L.N.G. on a permanent basis in the spot market as well as with medium-term agreements.
  • Importing natural gas via pipelines from neighboring countries
  • Directly investing into L.N.G. operations abroad (Kufpec)

All these five pillars may give positive outcomes, but in the near- to medium-term the only available and fast solution (for instance with floating terminals) for covering Kuwait's natural gas consumption in excess of natural gas domestic production is through L.N.G. spot and medium- to long-term contracts. It's true that when L.N.G. shipments are routed for less than 3,000 miles — and it's quite probable to have L.N.G. shipped to Kuwait from countries located within the Persian Gulf (615 miles long at its longest point and 180 miles wide at its widest point — it's difficult for the buyer (in this case Kuwait) to have also a sort of economic viability. The problem is that the regional political instability also makes very difficult to realize pipelines. But with no doubt, pipelines would be much more economically convenient than importing L.N.G. for short distances like within the Persian Gulf.       

If Kuwait is going to import L.N.G. on a more-than-temporary basis it would be advisable to have some reliable suppliers with medium- to long-term contracts more than just spot contracts. A candidate supplier could be Qatar, although the proximity of the two countries eats out any economic convenience for Kuwait. The failed negotiations between Kuwait on the one side and RasGas on the other side well testify the difficulties of reaching an agreement under narrow economic margins. In this regard, it would be interesting to obtain full disclosure about the price paid by Kuwait in relation to the two medium-term L.N.G. contracts with Vitol and Shell. For the moment, the only thing that is sure is that at least for the next three years alternatives to L.N.G. imports do not abound. 





[i] E.I.A., Country Analysis Briefs Kuwait, Updated in June 2011, in http://www.eia.gov/countries/cab.cfm?fips=KU
[iii] Bahrain, Kuwait, Oman, Qatar, Saudi Arabia and the United Arab Emirates are the six G.C.C. members. Jordan and Morocco have been invited to join the G.C.C.
[v] CHISHOLM A., The First Kuwait Oil Concessions: a Record of the Negotiations. Cass, London, 1975.
[vi] BELTRAME S., Storia del Kuwait, CEDAM, Padua, 1999.
[vii] ABULHASAN, A. M., Future Relations Between Kuwait Petroleum Corporation and the International Oil Companies, Fletcher School of Law and Diplomacy, Tufts University, Medford, May 2004 in http://fletcher.tufts.edu/Congratulations/faces/~/media/Fletcher/Microsites/congratulations/PDFs/Abulhasan-Arwa.ashxhttp://fletcher.tufts.edu/Congratulations/faces/~/media/Fletcher/Microsites/congratulations/PDFs/Abulhasan-Arwa.ashx, accessed on November 16, 2011
[viii] AL-SABAH FADEL, Y.S., The Oil Economy of Kuwait, Keagan Paul International Ltd., London, 1980. 
[ix] CLO' A., Oil Economics and Policy, Kluwer, 2000, p. 105. 
[x] JOHNS R., FIELD M., Oil in the Middle East and North Africa in The Middle East and North Africa, 1987 (33d ed.) , London.
[xi] Here it's considered not the original K.O.C. created by Anglo Persian Oil Company (then British Petroleum) and Gulf Oil in 1933, but the mixed private/public company born in 1974 whose 60 percent belonged to BP/Gulf, while the remaining 40 percent to the Kuwaiti state.  
[xii] EL-RIFAAI, H. M., Kuwait Project: a New Form of Relationship, 2005, in http://www.kuwaitproject.com/common/speech_eurogas_english.pdf 
[xiii] Prime Minister Sheikh Nasser has so far resigned seven times since he was appointed prime minister in Feb 2006.
[xiv] Oil and gas reserves are the principal assets of an oil and gas company company and booking is the process by which reserves are added to the company's balance sheet. This is done according to a set of rules developed by the Society of Petroleum Engineers (S.P.E.).
"The essence of upstream investment is the ability to book new reserves. Booking reserves means that the corporation has the contractual right to produce the reserves even if it does not actually own the reserves. Booking is a vehicle under U.S. securities law used for accounting purposes. The producing countries generally care about reserve ownership in a legal and political sense and less about booking reserves. In fact, according to the laws of most countries a corporation can no longer own subsoil resources but can book them, indicating an ability to increase its production.
The benefit of booking new reserves is that it signals to the investment community that the company has tangible assets that can support earnings growth. Also, booking new reserves will present a good outlook on consistency and sustainability of future earnings to investors. By showing that I.O.C.s can add to their reserves the I.O.C.s hope to convince investors to buy their shares and financial analysts (like Morgan Stanley, Merrill Lynch etc.) to recommend their companies to investors. Because the analysis of the future value of the company and its share price is dependent on maintenance and growth of reserves, the I.O.C.s must constantly replace reserves declining through production" in ABULHASAN, A. M., Future Relations Between Kuwait Petroleum Corporation and the International Oil Companies, Fletcher School of Law and Diplomacy, Tufts University, Medford, May 2004 in http://fletcher.tufts.edu/Congratulations/faces/~/media/Fletcher/Microsites/congratulations/PDFs/Abulhasan-Arwa.ashxhttp://fletcher.tufts.edu/Congratulations/faces/~/media/Fletcher/Microsites/congratulations/PDFs/Abulhasan-Arwa.ashx
[xv]  WILLIAMSON, N., MAIN GARCIA, M., Gas Shortages in the Middle East: An Unlikely Paradox, in GLOBAL LEGAL GROUP, The International Comparative Legal Guide to Gas Regulation 2011, 2011 in http://www.iclg.co.uk/khadmin/Publications/pdf/4139.pdf   
[xvi] Oman — which last year exported 11.5 BCM — seems to be experiencing gas shortages and it could build an import terminal for receiving L.N.G.
[xvii] "Water scarcity is one of the biggest challenges threatening the MENA region, where more than 60 percent of the world’s desalinated water is produced. The U.A.E. alone spends around U.S.$3.2 billion on desalination every year, while Saudi Arabia spent U.S.$25 billion in 2010 on desalination projects to meet its long-term water demands" in ETULLY, Steering the MENA’s Nuclear Energy Drive to Energy Independency, in Nuclear Energy, November 18, 2011, in http://analysis.nuclearenergyinsider.com/new-build/steering-mena%E2%80%99s-nuclear-energy-drive-energy-independency.
[xviii] MILLS,  R., It's Time to Be Bold in Developing Middle East Gas, The National, March 15, 2011, in http://www.thenational.ae/thenationalconversation/industry-insights/energy/its-time-to-be-bold-in-developing-middle-east-gas
[xix] The Kuwait Investment Authority (K.I.A.) with $794 is the third largest investor in French nuclear giant Areva.
[xx] "They are the 17.8-billion-barrel Rumaila field being developed by a BP-C.N.P.C. consortium, the 4.1-billion barrel Zubair field, handled by an Eni-led consortium with as partners Occidental Petroleum Corp. and Kogas, as well as the 8.6-billion-barrel West Qurna Stage 1, which is being developed by an ExxonMobil-Shell consortium" in SALAHEDDIN, S., Iraq Signs Gas Deal with Shell, Mitsubishi, in Associated Press, November 27, 2011, in http://hosted.ap.org/dynamic/stories/M/ML_IRAQ_GAS_DEAL?SITE=FLFNW&SECTION=HOME&TEMPLATE=DEFAULT
[xxi] The Wheatstone Project is a joint venture between the Australian subsidiaries of Chevron (operator, 73.6 percent), Apache (13.0 percent), Kuwait Foreign Petroleum Exploration Company (Kufpec) (7.0 percent) and Shell (6.4 percent).
[xxii] CARLISLE, T., Kuwait Eyes L.N.G. Project Down Under, The National, April 7, 2011, in http://www.thenational.ae/business/energy/kuwait-eyes-lng-project-down-under
[xxiii] GAVIN, J., Kuwait Turns Towards L.N.G. After Ditching Nuclear, 6 Natural Gas Daily, October 21, 2011, in http://interfaxenergy.com/free/NatGasDaily.pdf
[xxiv] STRATEGY&, Gas Shortage in the G.C.C. How to Bridge the Gap, 2010 in http://www.strategyand.pwc.com/media/uploads/Gas_Shortage_in_the_GCC.pdf


BIBLIOGRAPHY
  

  • AL-SABAH FADEL, Y.S., The Oil Economy of Kuwait, Keagan Paul International Ltd., London, 1980. 

  • BELTRAME S., Storia del Kuwait, CEDAM, Padua, 1999.




  • CHISHOLM A., The First Kuwait Oil Concessions: a Record of the Negotiations. Cass, London, 1975.

  • CLO' A., Oil Economics and Policy, Kluwer, 2000. 





  • JOHNS R., FIELD M., Oil in the Middle East and North Africa in The Middle East and North Africa, 1987. (33d ed.), London.

  • LIKOSKY, M., Contracting and Regulatory Issues in the Oil and Gas and   Metallic Minerals Industries, in Transnational Corporation Vol. 18, No.1 April 2009.

  • MAUGERI, L., Con tutta l'energia possibile, Sperling& Kupfer, Milan, 2008.




 

 

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