Thursday, November 29, 2012

Does Lukoil Enter the Fray for Kurdistan's Oil?

November 29, 2012
BEIRUT, Lebanon Lukoil, Russia's second largest oil company and its second largest producer of oil, has recently bought condensate (very light oil) from Iraqi Kurdistan, notwithstanding Baghdad's position centered around the pivot point that only the central government has the right to negotiate oil deals in all Iraq. For the time being, the Russian company has not been the target of any economic reprisals by Baghdad and it maintains intact its desire of developing Iraq's southern oil fields.

Currently, Lukoil's Geneva-based trading arm, Litasco is the third company that has bought Kurdish condensate. The company has followed the two Dutch companies Trafigura and Vitol, which started their operations in October 2012. According to a spokesman with the Kurdistan Regional Government (K.R.G.) talking with reference to Trafigura's and Vitol's deals, the Kurdish condensate is swapped for refined products with a private Turkish company, with no cash transactions between the involved parties. Given the fact that there are no pipelines between Iraqi Kurdistan and Turkey, Kurdish oil is trucked from Iraqi Kurdistan to Turkey where it is loaded onto cargoes.

Up to now, it's not clear what will be Baghdad's reply to Lukoil's deal, especially bearing in mind that Lukoil was considered by the Iraqi government the most plausible purchaser of ExxonMobil's stake in West Qurna-1 oil field, which is located north of the Rumaila oil field, west of Basra (southern Iraq). ExxonMobil is now in talks for selling its stake in West Qurna-1 because of its energy deals with the Kurdish authorities. Deals that Exxon signed without having previously gotten the authorization from the central government. In fact, Baghdad considered ExxonMobil's Kurdish deals illegal and dismissed the American company's contract for West Qurna-1. Other companies that are facing the ire of Baghdad following their relations with the K.R.G. are U.S. Chevron, Russia's Gazprom and France's Total.

Also Trafigura's and Vitol's deals motivated harsh responses from Baghdad, but according to some Iraqi sources it seems now that this time with Lukoil Baghdad will be obliged to maintain a different stance. In any case, the involvement of both Trafigura and Vitol already means that Baghdad would have serious difficulties retaliating because it depends on these two firms for quite a substantial proportion of its refined oil imports (gasoline and diesel). Not buying from these two companies would immediately imply that Baghdad has to pay much higher prices for similar products on the market. Iraq has an insufficient oil refining capacity and suffers shortages of electricity. For this reason, gasoil is used to generate power. Following the war, internal riots and scarce investments, the country is now forced to import fuel for its energy requirements, and it's nowadays one of the biggest buyers of oil products in the Middle East.

"After checking with concerned parties, we got confirmation that LUKOIL has not purchased any kind of crude for the benefit of the K.R.G." said an official from Iraq's state oil marketer State Oil Marketing Organization (SOMO). Until now, the Iraqi government has not released any comment. Another hint that Iraq's position with reference to these oil deals could be softened is linked to the fact that last week it was announced that SOMO had finalized a term deal with British Petroleum (BP) and Vitol (the latter company is a regular supplier of gasoil to Iraq). The deal was related to the purchase of up to 1.097 million tons of gasoil for deliver in 2013. The two companies are likely to ship the gas either from Bahrain or from Kuwait, two countries where they have term contracts.

Industry sources told Reuters that Litasco had chartered the tanker "Cielo di Napoli" to load about 19,000 tons of Kurdish condensate from the port of Toros at Ceyhan in Turkey. The tanker "Cielo di Napoli" sailed on November 21. Lukoil's trading company won its contract outbidding competing bids from Trafigura and Azerbaijan's Socar and bought the condensate in a public tender (with a $3.00 discount to naphtha prices) thanks the intermediary role played by Powertrans.

The condensate trade with Turkey started last July following an agreement with Ankara. The basic idea was to augment the quantity of refined products (kerosene and diesel) for Erbil. Notwithstanding Ankara's blessing, these truck deliveries were immediately considered illegal by Baghdad. According to Kurdish sources, Kurdistan's export volumes were 12,000 barrels per day in October 2012, but deliveries seem now to have increased and to continue to increase. Obviously, it's a tiny fraction of Kurdish oil in comparison to Kurdish oil exports to Iraq, which following last September's agreement between Baghdad and Erbil were set at 200,000 barrels per day during the last quarter of the year. Iraqi Kurdistan obtained an agreement with Baghdad and was  entitled to receive 17 percent of refined products in Iraq. Trade with Turkey should come under that specific quota.

Summing up, there is no doubt that Vitol's and Trafigura's role is very important with reference to Iraq's fuel imports. But Lukoil's role in Iraq has and according to Baghdad should have in the future a much more relevant responsibility for the development of the country's oil sector. In fact, Baghdad, following the quarrel with ExxonMobil, which had invested into Iraqi Kurdistan, started promoting the takeover of West Qurna-1 by Chinese and Russian energy companies. The American company seems rather to be more interested into the contractual terms offered by the K.R.G. and into pulling out of Iraq's $50-billion West Qurna-1 project. Lukoil's move into Iraqi Kurdistan the Russian company is already one of the largest investors in Iraq could be a real attempt at winning contracts in the semiautonomous region of Iraqi Kurdistan (three governorates out of eighteen for the whole Iraq) without Baghdad's preventive authorization, but especially without losing contracts in the other energy-rich areas of the country.

Energy analysts point out that up to now the difference between Erbil's oil contracts and Baghdad's was very noteworthy for a company's balance sheet and that it was difficult to resist Erbil's calling. And being Lukoil Baghdad's preferred candidate for substituting ExxonMobil in southern Iraq, the company could be successful in signing up to contracts with Erbil's government without real possibilities of economic reprisals with reference to its southern contracts.

In fact, in December 2009, Lukoil together with Norway's Statoil was awarded the rights to develop the West Qurna-2 giant oil field. Lukoil is planning to invest about $25 billion during a timeframe of twenty years. This field according to current estimates should be able to produce 500,000 barrels per day in 2014, and then, in the following years, should raise its production up to 1.8 billion barrels per day. No doubt that it would be difficult for Lukoil to work to another big project like West Qurna-1 replacing ExxonMobil while it is also developing West Qurna-2. In this regard, despite a certain interest toward West Qurna-1, the Russian company last week declared that it would decide about its possible involvement in West Qurna-1 by the end of the year. In brief, the company is taking time. Together West Qurna-1 and West Qurna-2 could be producing around 6 percent to 7 percent of world's oil production.

Having closed the doors of southern Iraq to ExxonMobil and the other Big Oil companies involved in Kurdistan could really jeopardize Baghdad's production targets unless valid and reliable substitutes are found quite soon. The exploration auction held in May 2012, which had very few takers in the licensing round, is a clear reminder that current the technical service contracts (T.S.A.s) offered by Iraq are not so appealing for Big Oil companies, which prefer Kurdistan's production sharing agreements (P.S.A.s). The latter contracts offer to an oil company a defined share of the production, which may be added to the company's balance sheets. Thanks to this, a company's valuation increases and the company may obtain more easily bank loans. The offered share stays the same, either if project costs and/or oil prices move upwards or downwards. Instead, Baghdad's T.S.A.s are not very attractive and companies have to undertake the exploration projects while it is much more difficult to raise debt to finance their operations. In this case, only large companies are able to undertake these projects, but, given the fact that it's possible to find better alternatives on the market, it goes by itself that Iraq's T.S.A.s are not easily subscribed right now. Moreover, the business environment and bureaucracy are less chaotic in Iraqi Kurdistan than in Iraq. In the end, Big Oil's moves in Iraqi Kurdistan are much more understandable and rational than it could appear at first sight.