Flares are common sights in the oil business. But the giant flares at Rawdatain, which burn just a few miles south of the heavily fortified Iraq-Kuwait border, are orders of magnitude greater than any that exist in the American Oil Patch. They are also indicative of the contradictions and tensions within Kuwait. One of the most obvious contradictions: Kuwait is desperately short of natural gas and is looking to its neighbors, particularly Iran, for new supplies. And yet, rather than capture the gas from Rawdatain, the KPC is burning it. Two more facts about the field should be noted here: the Kuwaitis want to increase production from Rawdatain and the other northern oil fields. They could re-inject that gas to maintain pressure in the reservoir. Further, Kuwait considers itself to be a leader in oilfield technology. And yet, according to one former KPC official who is familiar with Rawdatain, the condensate recovery units on the field are in such disrepair that they are burning the associated gas – and the condensate. “That’s why the smoke is so black,” explained Sara Akbar, a petroleum engineer who left KPC to become the CEO of a new private upstream company, Kuwait Energy. “It’s tremendously wasteful. We have a gas shortage and they are burning the gas? It makes no sense.”

The flares near the Iraq border are just one aspect of the many challenges – in energy, politics, and religion – that are now facing Kuwait. How it resolves those issues will have big impacts on the global energy market and on Kuwait’s main sponsor (some would say colonial master) the United States. Kuwait is America’s single most important ally within OPEC, not to mention in the Persian Gulf, particularly given the war in Iraq. Kuwait is America’s main logistical base for that war, and some 20,000 U.S. troops are based there. And having bases in Kuwait, particularly Camp Arifjan, ensures that American troops in Iraq get the supplies they need. The Kuwaitis also provide huge amounts of free fuel to American forces in Iraq. By some estimates, the Kuwaitis have given the U.S. $500 million worth of free fuel since the start of the Second Iraq War.

Indeed, as the meltdown in Iraq continues, Kuwait becomes even more critical to the U.S. military. No longer publicly welcome to put its bases in Saudi Arabia, the U.S. must instead rely on installations like Arifjan, a hot, dusty, 2,500-acre mix of Humvee parking lots and low-slung warehouses, that is located just a few miles south of the sprawling refineries at Shuaiba and Mina al-Abdullah.

But Kuwait’s support for the U.S. has limits. The Kuwaiti government has been a vocal critic of Israel – both for its devastating bombing campaign and invasion of Lebanon, and its recent military assaults in the Gaza Strip. In late July, the Kuwaiti cabinet called Israel’s bombing campaign in Lebanon “organized terrorism” and said that Israel was purposely targeting unarmed civilians and infrastructure. The Kuwait parliament called Israel’s assaults “barbaric aggression.” Further, Kuwait and Saudi Arabia continue to provide funding for Hamas, the Islamic political party that recently won control of the Palestinian Authority through democratic elections.

In addition to Kuwait’s political opposition to U.S. and Israeli policies, it faces rising internal debate. The historic June elections – in which women were allowed to vote and run for office for the first time – resulted in the installation of an entirely new parliament. Although none of the female candidates won a spot in parliament, the full impact of women as an emerging power in the country has yet to be felt. Nor is it clear how Kuwait’s ruling family, the al-Sabahs, will deal with the more restive elements in parliament that are demanding reform. When members of the Kuwaiti parliament began calling for electoral reform earlier this year, the new emir of Kuwait, Saban al-Ahmad al-Jabir al-Sabah, dissolved the parliament and called for new elections.

The political debates are part of other divisions. Thus far, Kuwait has maintained relative calm among its Islamic citizens. Kuwait’s population is 45 percent Sunni and 40 percent Shia. (The balance of the population is Christian and other religions.) Fortunately, those divisions have not prevented Kuwait from doing business. Kuwait remains one of the richest countries in the world and its economy is booming. Over the next year, U.S. government officials expect the Kuwaiti government will have a surplus of some $25 billion. More than a dozen construction cranes are active in downtown Kuwait City and new buildings are springing up all over the city.

Kuwait is a country in transition. This piece will provide a brief survey of what’s happening in Kuwait’s upstream and the prospects for its downstream investments.

Upstream

How much oil does Kuwait have? That’s the key question. And no one seems to have a ready answer. Earlier this year, the country was roiled after Petroleum Intelligence Weekly published reports suggesting that Kuwait had overstated its reserves: instead of 99 billion barrels, it had something closer to 50 billion barrels. Kuwait Petroleum Company officials, rather than responding directly to the charges, kept quiet, which served only to amplify the claims of critics who insisted that something was amiss with the country’s reserve numbers. “No one trusts the government figures,” says Dr. Khaldoun Al-Naqeeb, a professor of political sociology at Kuwait University. Further, there is broad disagreement in the Kuwaiti parliament over how much Kuwait should expand its upstream production.

Earlier this year, Hani Hussein, the CEO of the Kuwait Petroleum Company, said Kuwait will spend about $60 billion over the next 15 to 20 years to increase production from 2.6 million to 4 million barrels per day. But Al-Naqeeb claims that many members of the new parliament are saying that if Kuwait only has 50 billion barrels of reserves, the country “should actually reduce production so that the oil lasts longer.” According to Al-Naqeeb, the critics say that the Kuwaiti government’s “budget was calculated on a price of $19 per barrel. Now Kuwaiti oil is selling for $62, so why should we increase production?”

Indeed, opposition within the Kuwaiti parliament, not geology or technology, could be the biggest constraint on Kuwait’s future production. Thanks to the June election, opposition MPs now control 33 of 50 seats in the parliament. Those opposition members have been particularly critical of KPC. And parliament could prevent the state-owned company from following through with its spending plans. Opposition MPs have also focused on corruption within the Kuwaiti government. “We don’t have a private sector,” says Al-Naqeeb. “We have 25 families connected to the [ruling] al-Sabah family and they get all the contracts. And they create local monopolies. By doing that you crush the entrepreneurial class. And that’s what’s happening. And that corruption could constrain the production both upstream and downstream.”

Suspicion in parliament that officials inside KPC will open some of Kuwait’s northern oil fields to the supermajors – Chevron and BP are the companies mentioned most often – has largely prevented Kuwait from making much progress on Project Kuwait, the ambitious expansion plan that was announced nearly a decade ago to increase its oil output. That plan called for investing some $8.5 billion in the northern oil fields alone. And while much of Project Kuwait remains to be completed, Kuwait’s production has still been increasing. In 2003, it was producing about 2.1 million barrels per day. Today, that figure is about 2.5 million barrels per day.

Ultimately it may not matter whether Kuwait has 50 billion barrels or twice that amount. Even at 50 billion barrels, it would still rank number seven among the world’s nations in total proved reserves. And there are many informed people within Kuwait, including Akbar of Kuwait Energy, who believe the country’s estimate of 100 billion barrels is too conservative. Akbar said Kuwait should have no trouble increasing its crude output. She points out that Kuwait has recently found a deposit of heavy oil in the Ratqa field, in the northwest part of the country, which lies just 600 feet below the surface. The field may contain 13 billion barrels of crude.

Kamel al-Harimi, an oil analyst in Kuwait City who has published widely on Kuwait’s energy sector, also thinks reserves exceed 100 billion barrels. He believes the country’s critical problem is not lack of resources, but lack of direction combined with a huge surplus of funds that have no destination. “We have too much money,” he said. “And that makes me worried.” That enormous cash horde, combined with the current high price of oil, shows that Kuwait “needs a new economic roadmap,” al-Harimi told me. “We haven’t been innovating.” He believes the government must begin investing some of the billions in excess capital that it earns from the oil sector, plowing that money back into energy projects and other larger infrastructure plans. It also needs to look at Dubai – which is liberalizing its markets and its cultural policies. The solution, al-Harimi believes, lies in bringing in experts from around the world to draw up “big plans” for the future.

Part of those big plans will necessarily involve capturing bigger portions of the crack spread. And Kuwait is aggressively looking in that direction.

Kuwait was the first member of OPEC to aggressively expand into the downstream. And the country has ambitious plans to continue garnering market share in the refined products business. Those plans hinge on a proposal to build a new refinery in Mina al-Zour in southern Kuwait, near the Saudi border. The project, billed as the world’s largest refinery, will have 615,000 barrels per day of capacity. The winning bidders for the $6.3 billion project are expected to be decided by the end of this year.

The huge spending on the al-Zour refinery – as well as some $3 billion in upgrades to existing refineries at Mina Abdullah and Mina al-Ahmedi – mean that among the 11 members of OPEC, Kuwait is second only to the Saudis in terms of downstream investment. By 2011, the country plans to have 1.4 million barrels of refining capacity. Of course, that capacity will depend somewhat on Kuwait’s ability to ramp up its own upstream production. But the country has also chosen a good spot for the new mega-refinery, which will sit adjacent to several onshore and offshore oilfields shared with Saudi Arabia. That location should assure ready access to crude – either from Kuwait or elsewhere.

“We have always been very, very strong believers in the importance of the refining industry,” KPC’s Hussein told a reporter earlier this year. “Even when people weren’t concentrating on refining, we have always been strong believers in refineries.” Kuwait also is expanding its petrochemical output. Last year, the state-owned Petrochemical Industries Company broke ground on new $3.4 billion olefins and aromatics plants that are expected to be on-stream by early 2008. Dow Chemical Company is a partner in the joint venture. But fueling additional petrochemical expansions will require more natural gas. And so far, Kuwait hasn’t been able to get the gas it needs. For months, it has been trying to negotiate an $800 million gas deal with Iraq, but the unrest in Iraq, combined with the changeover in government, has prevented the deal’s completion.

The Kuwaitis have also been stymied in their attempts to get gas from Qatar. The two countries have been trying to build a pipeline, but the line must pass through Saudi Arabian waters and the Saudis have refused to allow the project because of its quarrels with Qatar. All of that means that Kuwait may have no choice but to get a significant chunk of its gas from Iran – the sworn enemy of the United States.

But Kuwait isn’t limiting its refining and petrochemical options to its own country. KPC is also talking to officials in China and India about possible joint refining and marketing ventures. “We think these ventures help keep a stable market for our products…as well as cementing relationships between consumers and producers,” Hussein said earlier this year.

In short, Kuwait is stuck. It’s stuck between the ancient religious world of Islamic law and the modern secular world of business law and international commerce. It’s also stuck geographically between two neighbors – Iraq and Iran – who have been waging periodic wars for nearly three decades. It’s stuck politically between a government ruled by a monarch and his cronies who are used to getting exactly what they want, and a modern parliament that wants more power. In short, as one Kuwaiti businessman told me, the country’s “rules are old and need to be modernized.”

How soon that modernization happens is anybody’s guess. But whether or not it occurs right away, Kuwait will continue to be a dominant player in the Persian Gulf and OPEC.

Kuwait at a glance

Size: 17,820 sq km
(about the size of New Jersey)

Population: 2.4 million
(more than half are foreign nationals)

Oil reserves: 99 billion barrels

Daily oil production: 2.5 million barrels

Daily per capita oil consumption: 5.46 gallons. Kuwait has one of the highest per capita oil consumption rates on earth, largely due to the huge amount of oil used to fire the country’s electric plants. For comparison, the daily per capita American use is almost 3 gallons.

GDP: $52.7 billion

GDP per capita: $19,200

Chief of state: Emir Saban al-Ahmad al-Jabir al-Sabah

Internet usage: 22.8% market penetration. Kuwait has the Middle East’s second-highest Internet usage among Arab countries. (The UAE is first, with 35.8% market penetration.)

Military spending: $3 billion

Religious affiliations: 45% Sunni, 40% Shia, 15% other (Christian, Hindu, etc.)

Daily income from sales of Iraqi crude to satisfy claims made by Kuwait after the First Iraq War: $5 million*

Number of U.S. troops: 20,000

Number of U.S. military vehicles: 17,000

Sources: Nationmaster.com, Energy Information Administration, BP, CIA Factbook, U.S. Army Public Affairs Office, Camp Arifjan, Kuwait, U.S. State Department, Internet World Stats.

* Kuwait currently gets five percent of the revenue from Iraq’s oil sales.