Reversal of fortune in Iraq oil fields

Tamsin Carlisle

• Last Updated: November 14. 2009 6:01PM UAE / November 14. 2009 2:01PM GMT

Field of vision: a consortium led by Eni of Italy agreed this month to raise the production capacity of the Zubair field in southern Iraq by 930,000 bpd for remuneration of $2 per barrel. Nabil al-Jourani / AP Photo

After an initial rights auction that drew a tepid response at best, the war-torn nation has unleashed a flood of recent agreements to develop massive crude and gas fields. The chance to discover more reserves has international firms chomping at the bit.

A stunning change of attitude by Big Oil has put Iraq on course to become the third-largest global oil exporter within a few years.

Earlier this month, over a period of just four days, Baghdad signed three enormous deals that could raise Iraqi oil production capacity by 4.8 million barrels per day (bpd). That increment, if realised, would be equivalent to more than doubling the pre-recession oil output of neighbouring Iran, the second-biggest OPEC exporter, and generate revenue of about US$366 million (Dh1.34 billion) a day at current market prices.

Ever since the US invaded Iraq in 2003, ousting the regime of Saddam Hussein, international oil companies have been itching to return to the country from which they were banished in the early 1970s. However, it was another six years before Iraq launched its first post-war bidding round for oil and gas licenses in a televised public auction in June this year.

To the surprise of many, given the immensity of the resources on offer, the high-profile event was a flop. The government awarded only one of eight long-term oil and gas development contracts, which together offered access to more than 40 billion barrels of oil equivalent of reserves. One gasfield did not attract a single bid and most of the offers submitted by teams of foreign companies to develop six of Iraq’s biggest oilfields and another gasfield were hastily withdrawn after the government responded with miserly counteroffers.

Only BP and China National Petroleum Corporation (CNPC), which teamed up to bid for a 20-year contract to boost output from the biggest Iraqi oilfield, Rumaila, agreed to the tough government terms – an offer to pay the companies just $2 for each extra barrel produced, before taxes and other compulsory payments that would claw back about $1 per barrel. Not surprisingly, it took more than four months of haggling over the fine print for the final version of the contract to be signed at a ceremony on November 3.

Among those frustrated by the slow rate of progress was the US oil tycoon T Boone Pickens, who last month showed a fair amount of gall when he told the US Congress that American companies were “entitled” to some Iraqi oil.

Still, events were in motion to reach more agreements. Even before the deal to nearly triple output from Rumaila was in the bag, another big contract was announced and a third soon followed.

A consortium led by Eni of Italy agreed on November 2 to raise the production capacity of the Zubair field in southern Iraq by 930,000 bpd for remuneration of $2 per barrel. Three days later, a partnership between the biggest US and European oil companies, respectively ExxonMobil and Royal Dutch Shell, signed an initial accord to boost output from southern Iraq’s West Qurna oilfield by more than 2 million bpd for $1.90 per barrel. They beat a rival team led by the Russian company Lukoil to the deal.

By Iraqi government and industry estimates, Rumaila contains 16 billion barrels of remaining proved oil reserves, placing it among the top 10 world oilfields. West Qurna and Zubair respectively hold about 9 billion and 4 billion barrels of recoverable oil.

The Rumaila reserves alone are larger than the total oil reserves of the OPEC exporter Algeria. Peak production of 2.85 million bpd from the field would be close to the current output capacity of Abu Dhabi.

“The speed at which companies that participated and lost in the first ever bid round … reversed their positions and accepted the Iraqi oil ministry’s stiff terms took many, including within Iraq, by surprise,” wrote Ruba Hasari, the Baghdad-based editor of Iraq Oil Forum, a website focused on the Iraq oil industry and its politics.

Low Iraqi remuneration offers, together with legal and political uncertainties swirling around the contracts and the still-unsettled national security outlook, had originally seemed too daunting for even the biggest oil companies to stomach. Furthermore, the foreign firms were being offered technical services contracts, not the much-preferred production-sharing agreements that would have allowed them to book reserves.

So what persuaded some of the most sophisticated players in the global upstream oil and gas industry to change their minds? Details of the deals have been leaking out, providing some clues.

One key change, says Samuel Ciszuk, the Middle East energy analyst with the consulting firm IHS Global Insight, is that the government agreed to tax only the “profit oil” of the operating companies. Originally, Baghdad had wanted a 35 per cent tax on all oil sales.

Another change was that the oil ministry tinkered with its contract model, introducing incentives for producers to increase production to as high a level as possible. That encouraged some of the unsuccessful bidders from the June auction to come back with revised output models that made more economic sense.

“The tax change dramatically altered the companies’ project economics,” Mr Ciszuk said in a research note. “The relaxation of Iraqi operational control also served to make companies less fearful of red tape and bureaucratic delays.”

Even so, the scale of investment required to achieve the envisaged capacity jump within the targeted six to seven years represents a formidable challenge. BP and CNPC have reportedly agreed to spend $15bn on Rumaila. The Iraqi oil minister, Dr Hussain al Shahristani, has estimated the total investment needed over the life of the project at $50bn, evenly split between capital spending and operating costs.

Further oil development deals could be in the offing as Baghdad plans to hold a second licensing round next month, but this could point to problems.

“Iraq does not have the ability to absorb such major development in such a short time, nor is it likely that the global oil services sector has the capacity to expand Iraqi capacity to more than 6 million to 7 million bpd without putting severe strain on resources, costs, and quality project delivery,” the Middle Eastern Economic Survey warned in a recent analysis.

For Baghdad and international oil firms, timing is of the essence. Ahead of Iraqi national elections scheduled for mid-January next year, Nouri al Maliki, the prime minister, and Dr al Shahristani wanted to show they had a viable plan for putting economic development back on track. Faced with a possible change of government in Baghdad, Big Oil needed to get a foot in a temporarily open Iraqi door.

While plenty of political opposition exists in Iraq to the return of foreign oil interests, analysts now say it would be a bold government that would derail such massive investment commitments made on terms so favourable to Baghdad.

Foreign companies were concerned about a situation in which they agreed to undertake large investments swiftly, only to be faced with “losing their contracts and potential expropriations by those parliamentarians who brand their entry into Iraq illegal”, Mr Ciszuk said. Under terms of their final contract, “BP and CNPC only need to deliver a 10 per cent production increase at the Rumaila field within the first three years at an estimated investment commitment of $300 million in the first 33 months, making it possible for the firms to gauge the political climate in Iraq with some accuracy” before spending more heavily.

“At least it gives the consortium a chance to defer the risk during the fist critical period,” he said.

Offsetting the potential for investment delays, foreign firms may be feeling more urgency to stake out positions in Iraq. Consortiums participating in the second auction are expected to “aim high” with their bids, “since no more fields are likely to be offered for development by foreign companies for a long time to come”, Ms Husari predicted.

What all are aware of is the vast potential for further oil and gas discoveries in Iraq, which could offer more lucrative development opportunities than those currently on the table. Its energy resources were underexplored 40 years ago, when the former Baathist regime came to power, and that remains the case today. The 115 billion barrels of proved Iraqi oil reserves – the third-largest reserves in the world – are just the starting point for what could yet turn out to be a world-class oil rush.

However, there are already losers, most notably the three northern Iraqi provinces comprising the semiautonomous Kurdistan region and the foreign companies developing Kurdish oil and gas resources. Baghdad and the Kurdistan regional government are at loggerheads over resource jurisdiction and the prospect of big production increases from the southern fields will remove any urgency for Baghdad to compromise with the Kurds on the issue. Territorial claims to the northern city of Kirkuk and its large nearby oilfield form another potentially explosive area of conflict.

Security remains one of the biggest concerns of foreign companies operating in Iraq and Kurdish frustrations could still boil over to upset Iraqi oil development plans. At the very least, the Kurds may be expected to continue to block the passage of a long-awaited federal oil law for Iraq, which foreign oil firms hoped would put their somewhat dicey contracts on firmer legal ground.


tcarlisle@thenational.ae