Ri Insights

Public Good

By Geoffrey Martin

Rai Insights Contributor

Kuwait: The privatization of the Kuwait Oil Company (KOC) and other oil subsidiaries is one of the key controversies in Kuwaiti legislative politics. The implications of selling off parts or the whole company to foreigners or local firms seems like a real possibility in the future.

 

I am not sure how near this event is, and no OPEC member has ever endorsed part- privatisation, although there is notable moves to increase joint ventures, especially in Qatar where Qatalum- a 50-50 joint venture between Qatar Petroleum or RasGas (70 percent Qatari owned versus 30 percent is owned by ExxonMobil) – have become more prevalent. Aramco is obviously top of the list when looking at the potential privatization of public oil, with a potential 5 percent sell-off of the Saudi oil giant expected to net $2 trillion in revenues being debated. This isn’t mere talk. In 2014 PEMEX, Mexico’s national oil company privatized parts of the monopoly, for the first time since the 1930s. And like Aramco the para-state company isn’t small, consistently providing nearly half of Mexico’s national budget, with $123 billion in net sales going to the federal government in 2013. Much of the decision to privatize was related to poor performance and the economic downturn felt worldwide.

 

Given the significant downturn in oil prices due increased cheap ‘shale’ oil from the northern U.S., and the recent economic policy shifts (reducing subsidization and curtailing significant public spending) in Saudi Arabia, Bahrain, and the U.A.E. it is worthy of a discussion to talk about the changes likely to come to Kuwait’s ‘National Oil Company’ (NOC).

 

This is especially a notable topic because of the current government programme to privatize, or partly privatize, some of Kuwait’s social institutions. Privatization of at least some of the cooperative societies, which account for approximately 70% of the country’s distribution of food, has been a policy of the last several governments. Furthermore, depending on how the current government chooses to handle its serious revenue decreases –  between 2014 and 2015 KOC’s oil exports fell from $104 billion to about $55 billion – attempts to increases the efficiency of services may put KOC in the bullseye.

 

To privatize or not to privatize?

 

First off, KOC is no stranger to private control so it wouldn’t be a giant leap in terms of implementation. Between1934 to 1975 before it was nationalized a variety of foreign companies including Anglo-Persian Oil Company and British Petroleum were directly involved in the oil industry.

From a theoretical perspective the “right” kind of ownership, whether it is private or public has been a debate since Adam Smith, the father of the free market, observed that “characters do not exist who are more distant than the sovereign and the entrepreneur” (Smith 1776, p.771).  Privatization of public institutions has been a growing trend that has grown over decades as neo-liberal economic policies have increased worldwide. In the beginning, the rise of Thatcher and Reaganomics in the 1980s led to the dismantling of significant portions of public ownership in many countries in the industrialized world. What was the impact? Three major studies by William Megginson, Robert Nash, and Matthias van Randenborgh (1994), Boubakri and Cosset (1998), and D’Souza and Megginson (1999), looking at over 211 companies from 42 countries, found that “privatisation significantly improves firm profitability, efficiency and output, decreases financial leverage and leads to higher dividend payments.” Yet as Djankov and Murrell argued, for privatization to be positive the level of development in courts, in legislative law, and the creation of stable anti-trust and corporate governance laws by the government of the state in which privatization takes place, especially in non-industrialised, non-democratic settings.

 

There is little research on the impact of ownership in the oil and gas sector. This is somewhat surprising as it is the sale of a minority stake in British Petroleum (BP) in 1977 which is often considered to have been the starting point of modern-day privatisation programmes. There is also the size of the sector. Although only 18 of the 50 largest oil and gas companies are fully state-owned in 2006, more than 90% of total hydrocarbon reserves and annual revenues of one trillion USD remain under the control of nation states. Multinational oil companies produce only 10% of the world’s oil. Not surprisingly then, the 13 largest energy companies in the world are owned and operated by nation-states. KOC is one of the top ten largest producers of petroleum products and fifth-largest exporter.

 

But are private firms more successful? One study by Al-Obaidan and Scully (1991) that looks at efficiency differences between 44 private and state-run petroleum companies found that state-owned NOCs are only 61-65% as efficient as private oil companies. Another study analyzing 28 private firms showed sustained improvements in performance, including an increased return on sales by 3.6%, total output by 40%, capital expenditure by 47%, and employment drops by 35%.

 

This isn’t always the case though. For example, Bolivia nationalized its own oil industry in 2006 and despite dire warnings of capital flight and economic collapse their profits have remained steady, and the state has increased annual revenues from an average of $332 million to  prior to more than $2 billion after nationalization.

 

Ok so they are more efficient, but what are the negative concerns for privatization?

 

There are typically two options to privatise a state-owned company: either a private trade sale to an industrial or financial buyer, or a public share offering; KOC will likely go for a public share offering. KOC and its subsidiaries control all development of the oil sector now, but if foreign companies or investors gain even partial control of KOC this could be a huge concern for Kuwait’s sovereignty. If foreign companies gain concessions to oil and gas exploration, they will have far greater control over Kuwaiti resources, and thus political and economic power. This is especially if investors are other GCC nationals tied to neighbouring governments. This could drastically change Kuwait’s negotiating position within OPEC and the very nature of pricing negotiations in OPEC itself against Kuwait’s interests.

 

Concerning employment, Gassner et al. and Kikeri found that privatization decreases employment by reducing the number of political or bureaucratic patronage appointments. Kuwaiti nationals depend heavily on oil income to subsidize their lifestyles, which according to IMF estimates accounted for 70% of government revenues in 2015. Lower employment may not be a negative outcome as it may free up workers to go to more productive sectors of the economy as public institutions are generally overstaffed. But as Nancy Birdsall and John Nellis argue that “[Privatization] is seen as harming the poor, the disenfranchised, the workers, and even the middle class…” While Kuwaiti nationals are not poor pressures of increased prices and inflation on the Kuwait middle class are already significant, especially in housing. Increased pressure on their livelihoods would be a very significant change in the class structure of the country, where typically foreigners are the only truly poorer class. This is why it is probably better to look at KOC as pursuing a higher goal than profit. Lower profits do not necessarily represent higher costs and technical inefficiencies but rather social outputs.

 

For KOC it might be suitable to plan a longer-term, sustained privatisation process in order to defend and build on gains in performance and efficiency.  Kuwait has ambitious plans to lift its production of crude oil to 4 million barrels per day by 2020, plans to upgrade its export infrastructure and build downstream facilities, and develop four northern oil and gas fields. It should do this before allowing private firms in. The danger otherwise is that private companies will not develop the proper infrastructure for the long term security of Kuwait’s oil resources, and focus on short-term objectives only.


* Geoffrey Martin is a PhD student at the University of Toronto and currently is a visiting researcher at the American University in Kuwait. He currently resides in Kuwait.


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