Report No. 40405-MNA Investing In Oil In The Middle East .
Public Disclosure AuthorizedReport No. 40405-MNAReport No. 40405-MNAInvesting in Oil in the Middle Eastand North AfricaInstitutions, Incentives and the National Oil CompaniesSustainable Development DepartmentMiddle East and North Africa RegionPublic Disclosure AuthorizedPublic Disclosure AuthorizedInvesting in Oil in the Middle East and North AfricaPublic Disclosure AuthorizedAugust 2007Document of the World Bank
Investing in Oil in the Middle East and North AfricaAbbreviations and mcmdMENAMGSNAMANGLNGONIOCAbu Dhabi National Oil CorporationBarrelBillion cubic feet per dayBillion Cubic MetersBritish PetroleumBritish Thermal UnitChief Executive OfficerCompressed Natural GasExploration and ProductionEgypt Gas Production CompanyExtractive Industry Transparency InitiativeForeign Direct InvestmentFormer Soviet UnionGulf Cooperation CouncilGross Domestic ProductGas to LiquidsHeavy Fuel OilHealth, Safety, EnvironmentInternational Energy AgencyIran-Libya Sanction Act, 1996Iraq National Oil CompanyInternational Oil CompaniesKuwait National Petroleum CompanyKuwait Oil CompanyKuwait Petroleum CompanyLiquefied Natural GasLiquefied Petroleum GasMillion Barrels per DayMillion Cubic Meters per DayMiddle East and North AfricaMaster Gas SystemArabian Industrial Development CorporationNatural Gas LiquidsNon-Governmental OrganizationNational Iranian Oil CompanyVice President:Sector Director:Sector Manager:Task Team EUNDPWEOWTIWTOYGCYICOMYLNGYOGCNational Iranian Oil Refining and Distribution CompanyNational Oil CompanyOrganization of Arab Petroleum Exporting CountriesOrganisation for Economic Cooperation and DevelopmentOrganization of Petroleum Exporting CountriesPetróleos de VenezuelaPetroleum Engineering Development CompanyPetroleum Economic LimitedPetroleum Exploration and Production AuthorityPetroleum Intelligence WeeklyPoverty Reduction Strategy PaperProduction-Sharing AgreementQatar PetroleumReserve to ProductionResource-Poor, Labor-AbundantResource-Rich, Labor-AbundantResource-Rich, Labor-ImportingSaudi Arabia Basic Industries CorporationSafer Oil Exploration and Production CompanySaudi Arabian Monetary AgencySaudi Arabia Marketing and Refining CompanySupreme Petroleum CouncilThousand Cubic MetersUnited Arab EmiratesUnited Nations Development ProgrammeWorld Energy Outlook (IEA)West Texas IntermediateWorld Trade OrganizationYemen Gas CompanyYemen Investment Company for Oil and MineralsYemen LNGYemen Oil and Gas CompanyDaniela GressaniInger AndersenJonathan D. WaltersPierre Audinet
Investing in Oil in the Middle East and North AfricaTable of ContentsEXECUTIVE SUMMARY . IWhy structure matters for petroleum supply, revenues, and development: lessons fromfour case studies . iThe case studies . iiPolicy implications of the case studies. iv1. OIL IN THE MIDDLE EAST AND NORTH AFRICA: WHY SECTOR STRUCTUREAND NATIONAL OIL COMPANIES MATTER . 1The analytical framework . 5Main lessons from petroleum sector context . 8Main lessons on sector structure and performance . 162.KUWAIT CASE STUDY. 30Political economy of the petroleum sector structure . 30Structure and sector performance . 353.SAUDI ARABIA CASE STUDY . 43Political economy of the petroleum sector structure . 43Sector structure and performance . 474.IRAN CASE STUDY . 54Political economy of the petroleum sector . 54Sector structure and performance . 635.YEMEN CASE STUDY . 71Political economy of the sector. 71Sector structure and performance . 77ANNEX 1: THE MIDDLE EAST AND NORTH AFRICA IN GLOBAL OIL AND GASMARKETS . 832. Global Oil Market 1960-2006 . 853. Recent Global Oil Market Developments and the Fourth Oil Price Shock. 924. MENA Energy Production, Consumption and Trade. 1015. Long-Term Outlook for Oil and Gas Production . 1226. MENA Near-Term Oil Development Plans (OPEC Producers). 127ANNEX 2: STATISTICS ON MENA OIL AND GAS RESERVES, PRODUCTION,CONSUMPTION AND REVENUES . 131REFERENCES. 157
Investing in Oil in the Middle East and North AfricaBox 2.1: Project Kuwait. 34Box 2.2 Key Observations – Kuwait . 42Box 3.1:The Oil and Gas Upstream Opening in Saudi Arabia . 51Box 3.2 Key Observations – Saudi Arabia . 53Box 4.1 The Oil and Gas Upstream Opening in Iran. 57Box 4.2 Key Observations – Iran. 70Box 5.1 Key Observations – Yemen. 81Figure 1.1 IEA World Energy Supply Growth . 3Figure 1.2 MENA Real Oil Export Revenues . 3Figure 1.3 MENA Oil Production and Oil Prices . 4Figure 2.1 Organizational Structure of the Kuwaiti Petroleum Sector. 31Figure 2.2 Kuwait: Government Oil Revenues. 38Figure 2.3 The Downstream in Kuwait, 2000–05. 39Figure 2.4 Kuwait: Natural Gas Production and Usage, 2003–05. 41Figure 3.1 Saudi Arabia: Petroleum Sector Structure. 44Figure 3.2 Saudi Arabia: Government Oil Revenues as a Percentage of Oil and gas GDP . 48Figure 3.3 The Downstream in Saudi Arabia, 2000–05 . 49Figure 3.4 Saudi Arabia: Natural Gas Production and Usage, 2003–05 . 50Figure 4.1 Iran: Petroleum Sector Structure . 55Figure 4.2 Iran: Oil Production, 1965–2004. 60Figure 4.3 Iran: Downstream Petroleum Production and Consumption, 2000–05. 66Figure 4.4 Iranian Gasoline, 1995–2005. 66Figure 4.5 Iran: Natural Gas Production and Usage, 2003–05 . 68Figure 5.1 Yemen: Petroleum Sector Structure . 72Figure 5.2 Yemen: Oil Production. 74Figure 5.3 Yemen: Government Oil and Gas Revenues as a Percent of Oil and Gas GDP . 79Figure 5.4 Yemen: Domestic Oil Consumption by Fuel, 1999–2003 . 80Table 1.1 Petroleum Fiscal Systems and Contracts . 17Table 2.1 Kuwait: Membership of Various Sector Institutions . 31Table 2.2 Production Costs in Kuwait ( per bbl) . 36Table 3.1 Saudi Arabia: Membership of Various Sector Institutions. 44Table 4.1 Members of General Assembly . 55Contributors:This report was written by a team comprising Pierre Audinet, Paul Stevens, and Shane Streifel.The report also benefited from the helpful comments of Mustapha Nabli, Hossein Razavi, JonathanWalters, Habib Fetini, Robert Bacon, Michael Levitsky, and Alex Kremer.
Investing in Oil in the Middle East and North AfricaEXECUTIVE SUMMARYThis report asks the question: how can oil-producing countries maximize the contribution of the oilindustry to their economic development goals? This is a complex process of ensuring that the rightinstitutions and incentives govern petroleum companies’ operations in a sector where the rents are highand the global markets imperfect. The issue is examined in four case studies: Iran, Kuwait, Saudi Arabia,and Yemen.High oil prices can hide a number of inefficiencies in the ability of the petroleum sector to maximizehydrocarbon extraction efficiency and the spillover benefits to domestic economies. Yet, governments ofoil-producing countries always seek to eliminate these inefficiencies and increase the value they canextract from their hydrocarbon resources. The reason why this report focuses on Middle East and NorthAfrica (MENA) countries is twofold. MENA countries’ experience in managing their petroleum sectorhas a number of useful lessons to offer to other oil-producing countries that seek to respond to similarquestions. MENA countries often find themselves having to make difficult choices in order to maximizepetroleum sector revenues, while at the same time maintaining sufficient levels of investment in the sectorand finding efficient ways to redistribute the rent among their citizens. In addition, the importance ofMENA to the global oil supply is such that inefficiencies in the management of the petroleum sectoraffect not only its economies, but also the rest of the world—in particular the poorer economies, whichare most vulnerable to high-priced hydrocarbons.WHY STRUCTURE MATTERS FOR PETROLEUM SUPPLY, REVENUES, AND DEVELOPMENT:LESSONS FROM FOUR CASE STUDIESSector governance should be conducive to investments and efficient oil and gas production—but is it? Acloser examination of the structure of the petroleum sector points to deficiencies, suggesting ways toimprove investment-allocation mechanisms in the sector, and increase development linkages.In managing oil and gas resources, governments seek to respond to a number of important questions, suchas: Who should set the objectives for the oil sector? Should the government set a production target or should this be left to the operator? How should the oil and gas sector be regulated? What is the role of private investment? If the country owns a national oil company (NOC), how should the financing of that NOC beorganized? What decisions should be left to the NOC without government interference? Should the NOC be allowed to operate on a commercial basis and pay taxes? Should the NOC face domestic competition? Should the NOC be allowed to operate abroad? Should the minister of oil be the chairman of the NOC board? How much information about NOC operations should be made public? On what basis should the domestic oil product prices be set? Should there be a policy for developing domestic gas resources? Should the level of local inputs to the sector be subject to regulation?-i-
Investing in Oil in the Middle East and North AfricaResponses to these questions will shape the sector structure and its incentive to operate efficiently.Assessing sector structure can be done using the conventional theory of assessing the dynamics of firmstrying to maximize profit (or market share, sales, and profit). Using such a model, however, is of limitedpolicy relevance to the work, mainly because the oil sector has two specific features that need to beconsidered: (1) the international oil market is structured by a large group of players operating within theOrganization of Petroleum Exporting Countries (OPEC), and (2) the size of the rents available to firmsand governments is very large. As a result: There is a notable absence of numerical data (on production, costs, discount rates, and so on) thatcan be used to empirically test a model of the firm. This absence of data is at the heart of thestrategy to increase the asymmetry of information about—and therefore control over—the rentfrom oil and gas extraction and sale. Asymmetry of information is found between oil-producingand importing countries, but also affects the relations between the industry and the governmentsof oil producing countries. Given the high rents, there is considerable competition within governments to achieve andincrease control over part of those rents. This competition determines how the sector operates bygradually structuring the institutional framework, defining control and regulatory mechanisms,deciding whether private investors are allowed to invest or not, choosing rules to allocaterevenues from oil and gas sales, and so on. Capturing the essence of the context in which thepetroleum sector operates and how the sector’s objectives are defined is therefore essential tounderstanding the dynamics of the operators themselves.Given the importance of NOCs, which dominate the region’s petroleum industry, efficiency of investmentallocation in the petroleum sector is strongly linked to the role assigned to NOCs and the specificarrangements of their regulation. The four case studies presented in this report investigate howarrangements governing the petroleum sector affect the productive efficiency of the sector, as well as itsability to stimulate economic development through fiscal, backward, and forward linkages.THE CASE STUDIESKuwaitAuthority over the oil sector is dispersed, with an unclear division of responsibility. This means that theNOC lacks clear and stable objectives. Political influence sometimes leads to the hiring of relativelyinexperienced managers. The NOC has limited financial incentive to reduce costs. A weak institutionalframework and lack of incentives have prevented Kuwait from meeting its formal targets for capacityexpansion.Downstream, domestic supply matches demand, but the sector structure has clearly affected the efficiencyof resource allocation (as in the case of natural gas use). The private sector was envisaged as playing arole both upstream (Project Kuwait) and downstream (in the privatization of refining activities). Decisionsregarding private sector entry have, however, been limited to some technical assistance upstream andprivatization of peripheral activities downstream.Saudi ArabiaThe oil sector has been protected from political interference and driven by a high degree of alignmentamong the various actors, resulting in a clear vision of the contribution expected from the sector in the useand allocation of investments. The operation of the NOC takes place within the government policyframework, which reflects Saudi Arabia’s price-making role in global oil markets and the country pivotal- ii -
Investing in Oil in the Middle East and North Africarole in the OPEC. The NOC is treated as a corporate entity with a financial system that creates incentivesfor low-cost operations, although lack of quantitative data makes it difficult to fully support this assertion.Observers conclude that investments are made to maximize the recovery factor. This is in line with thechoice of maximizing revenues from petroleum because of the dependence of economic development ongovernment revenue from oil. In spite of some government efforts, private sector investment upstream hasbeen restricted so far, not least by the incumbent NOC.Day-to-day operations are left to professional decision making within the company. This has resulted in asector that is self-regulated. While this presents a risk of excessive rent seeking, it appears that thecorporate culture within the NOC has managed to constrain such tendencies. A result is that the sectorseems to have developed high levels of competency, especially in technical fields.In the provision of oil products and gas to the rest of the economy, the sector has a strong record ofdelivery, although domestic prices are well below international levels. The NOC has a long history ofaiding local economic development by seeking to maximize backward linkages through a variety of ways,such as nurturing spillover investments.IranThe oil sector seems to suffer from significant political interference. This is due to the nature of theIranian political system and its constitution’s specific checks and balances, which, combined, tend tofragment the control and operations of the sector. In particular, there seems to be conflict over whether toinvolve the private sector more or less. Attempts to secure greater foreign direct investment (FDI)upstream by means of buy-back contracts have generally raised limited interest among investors(although this is also due to the existence of sanctions). The fragmentation of the sector itself alsotranslates into gaps in the coherence and coordination of its operations. The main result is that the sectorfaces difficulties meeting its capacity expansion targets and serious problems in reducing the decline incrude export levels. These problems have been compounded because the hybrid budget model underwhich the NOC operates gives it limited access to investment revenues to offset the high, natural declinerate in the fields.A decline in export capacity is also driven by downstream policy. Highly subsidized oil product priceshave led to excessive growth in domestic consumption and smuggling, eroding the crude export surplusand challenging the delivery of products to the economy. Development of the natural gas potential hasbeen delayed because of growing opposition within Iran to developing gas for export purposes, and thepoor financial
Report No. 40405-MNA Investing in Oil in the Middle East and North Africa Report No. 40405-MNA Investing in Oil in the Middle East and North Africa Sustainable Development Department Middle East and North Africa Region Public Disclosure Authorized Institutions, Incentives and the National Oil Companies Public Disclosure Authorized
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