December 1999 Vol. 220 No. 12  International Politics

A.F. Alhajji,  Contributing Editor

Will Gulf states open their upstream to foreign investment?

The idea of introducing "foreign" investment into Persian Gulf states appears to be motivated more by politics than economics. Mixed signals, Saudi Arabia’s slow response, and the limits put on foreign investment in Kuwait suggest that the Gulf countries are unsure of the benefits that foreign investment brings to their oil sectors.

Oil companies were overly optimistic when Saudi Crown Prince Abdulla met with the CEOs of seven U.S. majors in September 1998, during a visit to the US. The prince hinted that Saudi Arabia might open its upstream sector to foreign investment and asked oil companies for proposals. Many U.S. firms submitted proposals, including Arco, Chevron, Conoco, Exxon, Mobil, Phillips and Texaco.

A few months later, Saudi Oil Minister Ali Al-Naimi declared that the kingdom has no interest in allowing foreign companies to produce its oil. However, he stated that the kingdom would allow foreign investment in "integrated projects" that are "mutually beneficial."

Some analysts attributed this change in attitude to changes in oil prices. Saudi Arabia was considering foreign investment seriously when oil prices were below $10/bbl. After the recent increase in prices, this interest evaporated. Others see no change in attitude and blame the oil companies for misreading the Saudis’ signals.

After lengthy debates in parliament, Kuwait allowed foreign investment in the upstream. Since Kuwait’s constitution prohibits foreign ownership of crude, the oil companies cannot sign "lucrative" sharing contracts. Foreign companies will operate the oil fields and provide technical advice, in return for a fixed payment per barrel extracted. However, new reports indicate that some payments are linked to profitability. Serious limitations are imposed on these firms. For example, they are allowed to invest up to $7 billion, but only in relatively poor, politically sensitive fields of northern Kuwait. Some of these fields, such as Al-Rumaila, are shared with Iraq. Allowing companies to invest only in Kuwait’s northern fields may amount to establishing a "security zone" between Kuwait and Iraq that would be "manned" by foreign capital. Again, however, any introduction of foreign investment into some Gulf states appears to be politically motivated, not economically induced.

In fact, the Gulf countries have no interest in such investments, because they do not need additional capacity, especially at a time when they are cutting production to increase oil prices. In addition, the Gulf countries do not lack investment capital. Even as Kuwait is allowing foreign companies to invest up to $7 billion, the country’s oil minister declared that Kuwait Petroleum Company, which he heads, has $10 billion in cash that is looking for investment.

Because all the Gulf countries are OPEC members, foreign upstream investment creates serious problems for the group. It increases the supply of oil, and countries may have no choice but to violate their OPEC quotas.

While Gulf countries may not open their oil sectors to foreign investment, they are likely to open their natural gas and petrochemical sectors soon. The national oil companies of the Gulf states are highly experienced with all aspects of the oil sector, but this is not so for natural gas and petrochemicals. In addition, unlike oil investments, natural gas and petrochemical projects require massive amounts of capital. Construction of these projects also may take a long period of time. Oil projects involve less capital, less time and less risk.

However, individual governments may not be willing to open their economies to even this form of foreign investment, because such situations require a skilled labor force that does not exist. If they were to go down this path, more expatriates would have to return to the region at the very time when governments are trying to lower the number of foreign workers.

Yemen looks for dollars. The Yemeni government is conducting an aggressive promotion campaign to attract investment in new blocks, by publicly lobbying foreign capital in London and Houston. The intent is to change Yemen’s image as a risky place for investment. This risk involves political and economic factors. Political factors include civil war, killing, kidnapping, and the bombing of pipelines and various oil facilities. Economic factors include a low success rate for new discoveries, unattractive contracts and heavy taxes.

The government is reducing political risk by cracking down on the opposition and executing killers. Economic risk will be reduced by instituting new investment laws that encourage foreign capital. Yemen’s new foreign investment laws are hampered by the area’s political turmoil. During the past six years, Yemeni tribesmen have abducted more than 100 Westerners and oil workers. The main export pipeline has been bombed more than 18 times in the past year. Indeed, the most recent blast occurred on October 23, when tribesmen cut off a communications station used by Hunt Oil.

While the "majors" are not showing strong interest in Yemen, small oil companies are pouring in, despite the political risk. Their interest is explained by improved investment terms, proximity to oil giants in the Gulf and by low production costs. It costs $1.70/bbl to produce oil in Yemen, while it costs $4 in neighboring Sudan and $10 in the North Sea.

Investment incentives include a reduction in signature payments, to $250,000 to 500,000, from previous production sharing agreement terms that were between $2 million and $10 million. Royalties are on a sliding scale of 3% to 10%, instead of a fixed 10% rate. Investment in political stability should be the government’s main priority, in order to attract major operators. Only then will investment incentives work.

The importance of Yemeni oil stems from the country’s strategic location. Yemeni oil is more accessible than other Gulf crudes, because those flows are influenced by the status of two politically unstable waterways, the Strait of Hormuz and Bab Almandeb. Finally, it is worth mentioning that Yemen produces 400,000 bopd, and its estimated reserves are around 4 billion bbl.

Dr. A. F. Alhajji is an award-winning assistant professor at Colorado School of Mines’ Division of Mineral Economics and author of the upcoming book, OPEC and the World Oil Market: An Alternative View. He will be a regular contributor to this column, which now features oil-and-gas-related political news from various world regions, in addition to quarterly U.S. governmental reports.

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Copyright © 1999 Gulf Publishing Company