KUWAIT - Oilfields Producing Water.

Project Kuwait's executives have warned of increasing water incursions into the emirate's oilfields. They estimate that if foreign assistance is not called in, output from the four northern fields will drop from a peak of 700,000 b/d in 2007 to less than 300,000 b/d by 2025. Water cut rates will increase from below 10% now to nearly 70% by 2020, making production much costlier if new technology is not introduced. Forecasts suggest operating expenditure could rise from just $0.75/barrel to almost $2 as a result over the same period. IOC participation will, over the 20-year lifetime of their operating services agreement signed with KOC, substantially lower operating costs through superior reservoir management practices. There are other benefits from a role by the IOCs.

The IOCs will be able to develop more challenging reservoirs, beyond the technological capabilities of KOC, and transferring this technology to the upstream operator. A minimum local staff contribution of 60% will ensure that Kuwaitis develop the necessary technical and managerial skills. Even the most vociferous of Project Kuwait's opponents - an uncommon alliance of liberals, conservatives and nationalists - accept that KPC and its subsidiaries lack the technology and expertise to push ahead with the state's ambitious oil plans. But they maintain there is no guarantee that any of the benefits put forward by the government will be achieved, and that its refusal to make public the exact contractual model it is expected to sign with the successful IOC consortium means it is trying to hide something. MPs could demand, under article 152 of the constitution, that they be allowed to scrutinise in detail the terms of the offer to be made to the consortia. If this happens, government officials suggest the assembly could be dissolved to force the measure through.

Most of the oil reserves in northern Kuwait are in the geologically more complex Mauddud carbonate and layered sandstone Upper Burgan reservoirs. Project Kuwait's Executive Assistant Managing Director Hashim Al-Rifa'i on May 17 told a conference in Kuwait: "These reservoirs are significantly pressure-depleted due to a lack of aquifer support and now require pressure maintenance. As a result of low reservoir pressures and water injection programmes, these wells will ultimately produce significant volumes of water and require artificial lift to maintain production rates".

Rifa'i said: "Parliament has a right to meddle with the [enabling] bill, but not the right to examine the contractual clauses", with the government and KPC saying they have nothing to hide. Rifa'i added: "[Project Kuwait] is an operating services agreement whereby the IOCs produce oil, provide all investments and fulfill the goals in return for pre-agreed service fees designed to create incentives for the IOCs to produce efficiently. It is designed to fit the constitutional requirements in the state of Kuwait. IOCs will therefore have no ownership to Kuwait's natural resources. The IOCs will have operational control under the state's oversight".

The project's critics say there has been little public access to the final financial model, with the government publishing only a general framework. What has been announced is that the IOCs will incur all capital and operating costs. In return for delivering the crude oil at agreed points, the IOCs will receive fees in cash to compensate them for their investment in addition to an "adequate" profit. If savings are determined to have been made, the IOCs will share in the cost savings. Any profits they make will be subject to a 25% tax.

Potential disputes centre on what constitutes profit and how cost savings will be determined. The exact remuneration model is as yet undecided and will be the subject of negotiation between KPC, the government and the IOC consortia. Another potential stumbling block is the peak production period. The IOCs, which have had access to field data, say it may be no longer than three to five years, while KPC claims it could be as long as 10 years. The issue may be the biggest bone of contention during contract negotiations.

Annual reports written by IOCs as part of their technical service agreements (TSAs) with KOC on the condition of the northern fields have repeatedly warned of the reservoirs' deteriorating condition.

The government is keen to stress that any eventual agreement will benefit all involved. IOC commitment to Project Kuwait will be guaranteed by requiring the operator and its partners to contribute all capital and operating costs, while any windfall profits will be mitigated by the cost savings share mechanism and the imposition of tax.

"An important objective of Kuwait is to ensure a long-term relationship with the IOCs and optimal economic performance", Rifa'i said, adding: "If Kuwait would simply pay fees from the first day of operation, IOCs will have a positive cashflow from day one. IOCs would not be exposed to risk. It is precisely the exposure to risk that provides the incentive to IOCs to achieve superior management. It is for that reason that the operating service agreement (OSA) includes a provision that unless a specific cumulative amount of oil is produced, the fees will be reduced to 10% of their value. This will create a significant negative cashflow in the first three years. This feature will ensure that only IOCs which achieve high production at low cost will achieve an attractive rate of return".

Rifa'i explained: "Our fiscal model is based on a combination of cost and production fees which acknowledge the technical uncertainty around the scale of future operating costs. Production-based fees will be based on production volumes, i.e., dollar a barrel. IOC revenues would be delivered from actual production levels. In other words, more production will mean more revenue, regardless of costs incurred. As for cost-related fees, these will be fees made as cash payments based on 50% of actual permissible costs incurred by the IOCs, and would be independent of production volumes. The use of cost recovery reduces the magnitude of production-based fees".

Kuwait is one of the few states in the world to have had no upstream IOC participation since nationalisation, with the constitution prohibiting foreign ownership of its natural resources. Senior officials from the Energy Ministry, KPC and KOC have been brought out to sing Project Kuwait's praises. The project, it is argued, is not just a move to bring the oil sector into the 21st century, but absolutely necessary if current output capacity is to be maintained. Central to the government argument is that most of the current production from the northern fields has been "easy oil". The fields are rapidly maturing. KOC does not have the technical capability nor the expertise to maintain the current production level of 550,000 b/d once the easy oil is depleted.