In its latest Economic Brief on the impact of natural gas production on the public finances, NBK says that although Kuwait is better known for its crude oil, the announcement of a discovery of natural gas in the north of the country in March 2006 was of significant strategic importance to the country. While the size of the deposit is small in comparison to the huge existing gas reserves in Iran and Qatar, production looks likely to be large enough to cover most of the projected increase in Kuwait’s domestic gas demand over the medium-term, thus reducing the potential need to import gas and – in principle at least - allowing more of its crude oil production to be diverted to the export market. Accordingly, its impact could be felt not just on government revenues, but even the broader thrust of Kuwait’s industrial policy.
In this note, we focus primarily on the impact that future gas production is likely to have on Kuwait’s budget finances. Officials at the Kuwait Oil Company (KOC) have targeted production at the Umm Niga and Sabriya gas fields to begin in December 2007, so the financial effects will begin to be felt in the current fiscal year. The initial impact on budget revenues seems likely to be small, but by the time a full year’s worth of production comes through in 2008/09, the effects might start to look more meaningful.
Deposit size
The overall size of the discovery is estimated at some 35 trillion cubic feet (tcf). Although this represents a very large deposit, it is still fairly small in relation to proved reserves elsewhere in the world. Qatar, for example, has proved reserves of 895 tcf, Iran 993 tcf and Russia a massive 1,682 tcf. Kuwait’s new find is equivalent to 0.5% of the world’s existing proved reserves. Although the deposit is not yet officially classified as ‘proved’, if it were to be, it would leave Kuwait with the 11th largest gas reserves in the world.
Nevertheless, NBK mentioned that the discovery is significant for Kuwait itself, adding some 56% to its existing gas reserves of 63 tcf. What does this mean in money terms? For the lack of a local benchmark, if we use the average US natural gas wellhead price between January and August 2007 of $6.5 per thousand cubic feet, the current value of the new deposit is worth some $228 billion. The actual value of the find could be considerably less than this, however. Initial studies by KOC have found that for geological reasons, only 60-70% of the find is likely to be recovered and utilized. A more accurate valuation of the deposit, then, might put its monetary worth at between $135 billion and $160 billion at current market prices. Although this pales besides the $7 trillion value attached to Kuwait's estimated 102 billion barrels of crude oil, it is still a highly significant amount - more than enough to pay for the government’s entire budget outlays for the next three years. It goes without saying, of course, that the government does not receive all of this money at once, but accrues it alongside production of the gas over the lifetime of the deposit, which in this case is likely to be decades.
But beyond the absolute size of the discovery, there is also a financial significance attached to the nature of the deposit, according to NBK report. Up until now, Kuwait’s gas production has been of the ‘associated’ type and gas production therefore implicitly linked to the amount of oil it is permitted to produce under its OPEC quota. But since the new deposit is of free-flowing gas, production will not be crude-linked and Kuwait will be free to produce as much as it can.
Gas production
According to the latest KOC annual report of 2006/07, production is set to begin in December at a rate of 175mn cubic feet per day (cfd), and thereafter be ramped up to 600 million cfd in 2011 and 1 billion cfd by 2015. This would still leave Kuwait as a relatively small player in terms of world gas production. In addition to the 1.2 billion cfd it was estimated to have produced in 2006, an extra 1 billion cfd would leave Kuwait as the world’s 29th largest gas producer based upon today’s numbers, though producing less than 0.8% of 2006 total world production. The extra production would, however, be of greater strategic significance to Kuwait. At the moment, Kuwait is (notionally at least) self-sufficient in natural gas, consuming all that it produces as a by-product of its crude oil production. But because of a growing need for gas for the purposes of electricity generation, water desalination and petrochemical production, Kuwait’s gas demand is expected to rise to 2 billion cfd by 2010. The projected increases in production should allow it to remain self-sufficient in natural gas over the medium-term.
We do not know the exact production profile that output will follow – it may well be the case that production is increased gradually over time rather than in steps. But for simplicity’s sake, in the calculations that follow we assume that after beginning in December, production makes two step changes in 2011 and 2015 and remains constant in between. It is also worth noting that some observers are skeptical about the December start date for production and see it beginning sometime in 1Q 08, in which case the impact on this year’s public finances would be negligible, if any.
Financial impact
At the average (US wellhead) gas price of $6.5 per thousand cubic feet seen so far in 2007, an initial production rate of 175 million cfd would yield KD 38 million in revenue over the last four months of the current fiscal year. Although this is a large amount of money, it is small in relation to the government’s likely oil revenues of KD 18 billion or so for the financial year as a whole. But revenues start to look more significant over a full year of production. At the average gas price so far this year, production at the new gas fields for FY08/09 could be worth KD 115 million. This would be, for example, larger than the KD 88 million that the government projects that it will raise from profit and income taxes this year. As production steps-up, annual revenues would rise to KD 394 million in 2011 and to KD 657 million in 2015. These numbers are of a more significant nature. KD 657 million, for example, represents some 4% of total government revenues in FY06/07 and would have been enough to cover the government’s entire capital spending (excluding land purchases) outlays during that period.
NBK noted that the impact on the government’s budget balance, however, is a slightly different concept, for two reasons. Firstly, our estimates of likely revenues take no account of the likely costs of production for the gas deposit, which have not yet been made public. This is a complex issue, not just reflecting the costs of extraction but possibly the financing costs of the infrastructure needed to process or store the gas. Again, for simplicity’s sake, we will assume that costs represent 5% of revenues. Although this seems small, it is double the estimated cost of lifting Kuwait’s crude oil and fits in with anecdotal evidence that production costs of the gas will be broadly comparable. In this case, ‘net’ revenues for FY08/09 would fall slightly to KD 109 million and to KD 375 million and KD 624 million in 2011 and 2015, respectively.
Secondly, it is not clear that any revenues arising from the new gas production will actually be realized. Rather than being sold, the gas may simply be diverted to various government-supported industries. But this is a slightly slippery concept. One could argue that the financial gain would still be realized, just in a different part of the government’s balance sheet. If it were not for the diverted gas production, the government would simply need to foot the bill for additional gas imports. Moreover, the gas used for domestic consumption may see more of Kuwait’s crude oil production to be diverted to the export market and so the financial gain could be realized that way.
Aside from these two factors, our estimates of course also depend upon the prevailing price of natural gas. As chart 3 shows, gas prices have risen markedly over the past decade, peaking at $10.35 (per thousand cubic feet) in October 2005, and fluctuating around the $6-7 range in 2007. For illustrative purposes, we have calculated the revenue impact of Kuwait’s new gas production at two alternative price levels – each two dollars either side of the US$6.5 base case (see Table 1). At $4.5, annual gross revenues rise to KD 455 million by stage 3 of production in 2015. But at $8.5, gross revenues are worth KD 860 million per year from 2015.
New oil production
Although we have focused on the gas to be produced from the northern fields, financially speaking, there is another even more important aspect to the discovery at the Umm Niga and Sabriya fields. Alongside the gas, KOC announced the discovery of as much as 10-13 billion barrels of crude oil. Although it has always been suspected that Kuwait has plenty of ‘undiscovered’ crude within its borders, this represents a massive find, equivalent to 10% of Kuwait’s officially-estimated existing crude reserves. At current market prices, the value of this discovery could be worth more than $ 1 trillion in total.
According to NBK, two features make the crude discovery even more important than those numbers imply. First, the deposit contains light crude, which is more valuable than Kuwait’s traditionally heavy, sour oil – and therefore fetches a higher price on the international oil market. The price of one of the world’s ‘lightest’ benchmark crude oils – West Texas Intermediate (WTI) – for example, averaged $85.9 per barrel in October, while Kuwait Export Crude (KEC) was some $10 cheaper.
Secondly, although the exact nature of the oil deposit remains unclear, there appears to be a chance that the oil may be officially classified not as crude, but as condensate, or a gas by-product (‘natural gas liquids’). If so, as per OPEC policy, production will fall outside of Kuwait’s OPEC quota, thus allowing Kuwait to produce as much of it as it chooses. On the other hand, if the oil does end up being classified as crude it will add to Kuwait’s stock of existing reserves. This could allow Kuwait to try and negotiate an increase in its OPEC production quota, even though – with most countries producing near maximum capacity – the quotas now seem less binding than ever.
According to KOC, the production of this crude is also expected to begin in December at a rate of 50,000 b/d, rising to 165,000 b/d in 2011 and 275,000 b/d in 2015. Again, to estimate the value of production we need to make some simplifying assumptions. If we assume that the blend of the crude is not quite as sweet as WTI, but more so than existing KEC (and anecdotal evidence suggests that even this may prove too conservative), it seems reasonable to assume that its price will fall halfway between the current prices of the two blends. For simplicity, using a price of $84 per barrel, production would yield an extra KD 141 million in the final 4 months of FY07/08, KD 423 million per year starting from FY08/09 and rising to a massive KD 2.3 billion per year in 2015. The latter would be equivalent to around 15% of Kuwait’s total budget revenues in FY06/07.
It is possible that instead of selling the new crude outright, Kuwait Petroleum Corporation will decide to mix it with existing heavy crude to sell more of its lighter export blend. But either way, the long-term impact on the public finances should be approximately the same: the government will either get a much higher price on a small part of its oil production, or a marginally higher price on more of its crude exports.
Using our simplifying assumptions, the combined short-term impact of natural gas and light crude condensate production from the northern fields looks likely to be reasonably modest, adding up to KD 179 million in revenues to the current year’s budget revenues and KD 0.5 billion next year. As production steps up from 2011, however, the revenue impact becomes much more serious, rising to KD 1.8 billion per year in 2011 and to a massive KD 3.0 billion per year in 2015. The latter is equivalent to 19% of the government’s total FY06/07 budget revenues. In policy terms, the effect of this windfall may be to reduce the urgency with which the authorities approach the politically-divisive issue of upgrading the performance of Kuwait’s older oil fields. But in financial terms, the implications are less ambiguous: Kuwait’s fiscal position – already very strong – is set to get even stronger.
