Kuwait's New Realism Owes More to Oil Majors Than to Greta

(Bloomberg Opinion) -- The best way to avoid owning a stranded asset is to not have that asset in the first place. 

Kuwait is considering cutting expansion plans for its oil production, as reported by Bloomberg News. This is apparently due to  expectations that mounting concern about climate change will curb demand. Yet there are also more prosaic considerations of cost and competition at play here.

State-owned Kuwait Petroleum Corp. had a goal of getting production to 4 million barrels a day by 2020 and 4.75 million a day by 2040. As of now, capacity is pegged by the International Energy Agency at slightly below 3 million barrels a day. And production so far this year, which is subject to ongoing OPEC+ restrictions, has averaged about 2.7 million barrels a day.

The 2020 target is obviously redundant regardless of the Greta Thunbergs of this world. OPEC’s own projections imply demand for its crude oil will drop another 1.2 million barrels a day in 2020. A year ago, in its most recent medium-term outlook, OPEC wrote that demand for its oil wouldn’t recover to 2018 levels until the late 2020s. Incidentally, OPEC now pegs demand for its crude oil next year at 29.6 million barrels a day, fully 3.1 million barrels less than what it projected only last November, which is equivalent to all of Kuwait’s output and then some.

All this is more a function of rising U.S. supply rather than expectations of imminent peak demand; OPEC doesn’t foresee that happening this side of 2040, at least. Kuwait’s 2020 target was set almost two decades ago, when Pets.com was still a thing but neither fracking nor renewable energy were expected to take off. Delaying it by another 20 years is merely a belated recognition of reality.

The new 2040 target is also somewhat redundant, but in a different way. The revision to the 2020 target reflects a global energy business that has become unpredictable across multiple dimensions, encompassing not just climate change, but technological and geopolitical changes too. To predict the world’s energy mix, or one country’s production, with any degree of exactitude 20 years out is is to get it wrong these days.

What is important about Kuwait’s new target is the trend. The long-standing position of enormous expansion has given way to caution. Scenarios where oil demand peaks play a critical role in that. More pertinent is the sheer range of outcomes and what they imply for oil demand and prices. Oil has entered a period of greater competition, both between suppliers and with other fuels, meaning the range of pricing outcomes is very wide.

Kuwait, like its much larger neighbor Saudi Arabia, is technically a low-cost producer. But its reliance on oil rents to fund its social contract means it actually requires a higher price: north of $50 a barrel, according to estimates from RBC Capital Markets (Saudi Arabia’s are higher still). Regardless of whether global oil demand peaks in the 2020s, ‘30s or whenever, the strategy for both countries boils down to one thing: Keep production costs as low as possible, both to be the last producers standing and to preserve as much rent as possible to ease an economic transition as and when oil demand does peak and decline.

One thing we know, even if we don’t have exact numbers, is that the future barrels Kuwait and Saudi Arabia are developing today will be more expensive than those produced in the past (something any investor in any eventual IPO of Saudi Arabian Oil Co. should ponder). There’s a lesson here from the recent experience of the western oil majors. They invested vast sums in new projects in the decade leading up to 2014 on the premise of $100 oil being the new normal. The subsequent crash and realization of structural changes centered on shale and climate change exposed the fallacy of this, and those companies have paid a heavy price in the stock market. Their new mantra — most of them anyway — is to be cautious on spending, prioritizing payouts to shareholders and profits over sheer volume.

Think of Kuwait’s new 2040 target in those terms. It sees the world is changing, but getting a handle on what that will mean in 2040 (or even 2030) is essentially impossible, as today’s surprising reality attests. When the path ahead is that dark and prone to pitfalls, it’s better to take incremental steps rather than big strides — or, in this case, set smaller capex budgets and stay flexible. In that sense, the climate for this industry has changed fundamentally already.

To contact the editor responsible for this story: Mark Gongloff at mgongloff1@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal's Heard on the Street column and wrote for the Financial Times' Lex column. He was also an investment banker.

©2019 Bloomberg L.P.