Monday, November 25, 2013

Shell's Majnoon Oilfield and the Company's Other Operations in Iraq


November 25, 2013
BEIRUT, Lebanon —  When last summer Iraq's Ministry of Oil accused Anglo-Dutch Royal Dutch Shell (R.D.S.) of more than $4.6 billion of lost revenues (with an aggregated loss of production amounting to 44 million barrels of oil) in relation to the company's operations in the Majnoon oil field in southern Iraq, one might have expected a possible stop to additional new ventures of R.D.S. in Iraq. Instead, the Anglo-Dutch company is currently closing a preliminary deal with Iraq for a $11 billion petrochemical complex. Considering the unrest that Iraq is currently experiencing, this Shell's additional involvement in the country is good news. This month French-American Schlumberger and U.S. Baker Hughes, two oilfield service providers have stopped their operations in Iraq as a consequence of the religious protest at the British Petroleum-operated Rumaila oilfield. Until now, R.D.S. has not experienced social unrest at the Majnoon oilfield, which is its most important operation in the country. 
After closing this deal, R.D.S. will be involved in Iraq in four relevant operations:
  1. Investing in the $11 billion petrochemical Nebras complex.
  2. Collecting gas from southern oilfields.
  3. Being the junior partner at the West Qurna-1 oilfield. 
  4. Being the operator at the Majnoon oilfield.
Let's now examine these four operations R.D.S. has in Iraq, giving of course more attention to the Majnoon oilfield.
The preliminary deal for this petrochemical complex is an important step for R.D.S. because it marks for the company the first major investment in Iraq's downstream sector. The downstream sector refers to refining crude oil and processing and purifying natural gas, as well as marketing and distributing products derived from crude oil and natural gas. Baghdad and R.D.S. are close to signing a heads of agreement—sources say that it's a matter of few weeks. Still in relation to this project, in April 2012, the company had already signed a memorandum of understanding for a feasibility study for a factory to produce the plastic building block ethylene.
This project is called Nebras, which means "beacon of light." If accomplished it will be part of Iraq's investments aimed at establishing a petrochemical industry in the country. In fact, recent estimates explain that Baghdad wants to find $35 billion to $50 billion hoping in the end to produce 10 million tons of petrochemical products per year. One of the main positive points of the go-ahead for Nebras complex is that thousands of jobs might be created. According to Shell's country chairman, Hans Nijkamp, for every job in the complex there would be 162 outside the plant. 


Exactly two years ago, in November 2011, Shell signed a $17.2 billion deal with Iraq for collecting and processing natural gas from three of Iraq's giant southern oilfields—Rumaila, West Qurna-1 and Zubair. For this purpose, the Iraqi government created the Basra Gas Company (B.G.C.), participated by Iraq's South Gas Company (51 percent), R.D.S. (44 percent), and Japan's Mitsubishi Corporation (5 percent). According to the deal, this 25-year-long joint venture has first to collect, treat, and process raw gas and then to sell it and the associated products, such as, condensate and liquefied petroleum gas (L.P.G., is a flammable mixture of hydrocarbon gases and it's used as a fuel in heating appliances and vehicles), domestically and, if production exceeds the internal demand, also abroad.
At the time of the signing, southern Iraq produced around 1 billion cubic feet (BCF) a day of associated gas, but of this amount, some 700 million cubic feet (MMCF) were flared, which meant wasting millions of dollars of the country’s resources. Associated gas was normally flared, or burned off, but, of course, given the dire energy needs in Iraq, Baghdad does not want to waste it anymore. Apart from a positive economic impact from supplying additional energy, collecting natural gas means reducing greenhouse gas emissions.
The joint venture started its operations last May. Shell and Mitsubishi have a 35 percent tax on their profits. According to the released data, this project is the world's largest gas-flare reduction project. Under the signed contract the B.G.C. has to sell the processed gas to the state-owned South Gas Company. The planned target for this project is to process 2 BCF per day from a current amount of 400,000 MMCF. Iraq's current proven reserves of gas are estimated at 128 TCF, but, adding also the probable gas reserves, the total amount could reach the value of 325 TCF. 

BACCI_Oil_and_ Gas_Reserves_Definition_Nov_2013

Shell is the junior partner at the supergiant West Qurna-1 oilfield located 50 kilometers north-west of the city of Basra, in southern Iraq. West Qurna-1 owns 8.7 billion barrels, and by the end of 2013 current production should reach 600,000 barrels per day (bbl/d). The main partner of this twenty-year service contract is U.S. ExxonMobil (60 percent), Iraq's Oil Exploration Company (25 percent) and R.D.S. (15 percent).
It is possible that, in the next months, Exxon will sell part of its stake to appease its tense relations with the government in Baghdad. In fact, in October 2011, ExxonMobil entered the Kurdistan Regional Government (K.R.G.) energy sector acquiring six exploration blocks, and, with this move, it upset Baghdad, which considered—and still considers today—those deals as plainly illegal. In addition to this, Baghdad immediately menaced to strip Exxon of the West Qurna-1 contract, if the U.S. oil company did not relinquish its operations in the K.R.G. ExxonMobil at the end of 2012 had expressed the intention of selling all its stake, then, in the spring of 2013, it announced the intention of increasing its investment in West Qurna-1, while recently (summer 2013) it seems that the company wants now to sell more than half of its 60 percent stake. Petrochina could buy a 25 percent stake of West Qurna-1 and Indonesia's Pertamina a 10 percent stake. Considering the new quotas, Exxon would still maintain a 25 percent stake. 

Iraq’s Oilfields Map — Source:

West Qurna-1 was part of the first Iraqi licensing round (2009, with the bidding and award of the contracts in June 2009) and it was not initially awarded. Only some months later, in October 2009, the consortium led by Exxon (and including Shell as junior partner) was awarded the oilfield (with final signature in January 2010). In practice, in the months after the auction, what later became the winning consortium accepted a reduced fee per barrel in comparison to what previously it had offered on the day of the failed auction for West Qurna-1. In fact, the Exxon-led consortium initially had requested a fee of $4 per barrel, but after some months it accepted a $1.90 per barrel. Something similar happened to the British Petroleum-led consortium for the Rumaila oilfield (also on offer through the same licensing round) although in this case the field was awarded immediately (the only field in the first licensing round awarded as a direct result of the auction out of eight) in the July 2009 auction for a fee of $2 per barrel. What happened later was that the contract was renegotiated in the following November with an improvement to the contractual terms for British Petroleum (BP). (For more information see: BACCI, A., BP Continues Investing in Iraq. With T.S.C.s the Devil is Always in the Detail(s) (October 2013).


The production plateau when the Exxon-led consortium signed the contract was 2.325 million bbl/d, and in November 2010 it was raised to 2.825 million bbl/d thanks to the discovery of new reserves. Behind this plan there was the necessity for the Exxon-led consortium to increase productivity in a fast manner in order to recover costs. To get to this point it was necessary to drill new wells, revamp old ones, and proceed with water injection projects. Now that the Iraqi government is revising the production plan for all the southern oilfields—reductions have already been agreed upon for the two oilfields Zubair (in May 2013) and West Qurna-2 (in January 2013)—ExxonMobil and its partners are discussing about reducing the plateau production from 2.825 million bbl/p to 1.8 million bbl/d.  

Majnoon is one of the supergiant southern oilfields, which are crucial for Iraq in order to at least double its oil output, which hovers now around 3 million bbl/d. The operator is Shell with a 45 percent stake, while Malaysia's Petronas and Iraq's Ministry of Oil have respectively a 30 percent and 25 percent stake.
Majnoon, which owns more than 13 billion barrels, is located in Basra Governorate in southeast Iraq60 km northwest of the port city of Basra. The field, which was discovered in 1975, extends northward toward Maysan Governorate. It's long approximately 52 kilometers, and it's wide 15 kilometers. Its territory lies for the most part under man-made islands in the Hawizah Marshes (these are a Ramsar area under the aegis of the U.N.), close to the Iranian border.
Historically, France's Total had shown a certain interest for this field since the 1990s. At that time, it signed a never implemented agreement with President Saddam Hussein for developing the field. Later, in 2002, President Hussein annulled this agreement. In 2007, Total signed together with U.S. Chevron an agreement to explore the field. When after the Second Gulf War, Iraq started auctioning its oilfields, Majnoon was then part of the ten oilfields auctioned in 2009 through the second post-war licensing round. The result of the second bidding round was partially positive because only three oilfields were not awarded. In fact, for them no bids were submitted (quite relevant was the non assignment of the Baghdad oilfield holding 8 billion barrels). Shell and Petronas beat a rival bid from Total and China National Petroleum Corporation (C.N.P.C.) and signed a 20-year service contract for the Majnoon oilfield. With reference to the signed contract, the two companies should receive $1.39 per barrel, and, at least initially, the target was to increase oil production to a plateau of 1.8 million bbl/d by 2017. Shell started in 2012 some talks with Baghdad with the aim of reducing the targeted oil production to 1 million bbl/d.
When the winning consortium took possession of the oilfield, oil production was at 46,000 bbl/d—it's important to underline this number out of a 13-billion-barrel oilfield. Subsequently, in September 2011 production almost doubled reaching 75,000 bbl/d, but huge problems emerged in 2012. At that time, the maximum production was 54,000 bbl/d because of some pipeline constraints, but, in reality, the average field production was around 18,600 bbl/d. In June 2012, started a shutdown to bring online new production facilities.
The Majnoon oilfield at reservoir level is not particularly difficult to be worked on by so qualified a company as Shell. “There is some hydrogen sulfide, but we can cope with that. The difficulties lay mostly elsewhere,” affirms Davesh Patel, operations and asset manager for Majnoon. In fact, the real difficulties lay out of the ground. And many were the problems that that the consortium has faced in the last months. Among them:
  • Infrastructure limitations—The existing 28-inch pipeline was not able to satisfy the requirements of an increased production. The delay in the construction of the pipeline was probably one of the reasons forcing the consortium to miss the 2012 target of 175,000 bbl/d. Last year, Shell asked Iraq for a waiver to start recovering costs, if Majnoon had not meet its first commercial production target by year-end (pushing on the fact that Iraq could fail to provide an export route to handle Majnoon's output), but this request was rejected. Iraq stressed the point that dues would be paid only after first commercial production (F.C.P.). The construction of a new pipeline was quite controversial because in 2011 Iraq, Shell and Petronas awarded Dubai-based Dodsal Group a $106 million contract to build a 79-kilometer (50-mile) pipeline from the Majnoon oil field to a crude storage depot near Zubair in southern Iraq. The problem was that the Ministry of Oil discarded the deal on the basis of high costs and handed over the task to an affiliate to the Ministry of Oil. China Petroleum Pipeline (C.P.P.) was then contracted for building part of the pipeline.
  • Mine-clearance activity—The oilfield is located close to the Iranian border and, considering the history of that area (first the Iran-Iraq War and then the First Gulf War), there are still in place many explosive war remnants.  A relevant mine-clearance activity has to be implemented in order to ensure safe oil operations. As of fall 2013, more than 14,000 explosive remnants have been cleared.
  • Delays at customs—Shell is still very concerned about the complex and long customs procedures. As an example, the company is very concerned about being successful in securing enough rigs to drill the 1,000 wells planned for its Majnoon oilfield. HansNijkamp,Shell’scountrychairman Mr. Nijkamp recently said, “Unless we work together with the Iraqi government and fix these port systems and customs, you will not see the ramp-up the Iraqi government is targeting with production.” Summing up, importing goods takes a lot of time and also securing visas for sub-contractors requires an excessive amount of time. This is a problem common to all the companies which have to import goods from abroad into Iraq.
  • Bad weather conditions—During some months in 2012 weather conditions were inclement and partially hampered the development activities. It's worth remembering that in those months oil exports from both Kuwait and Iraq were disrupted for inclement weather (storms and high winds). As a result, Basra terminals consistently reduced exports.

Technician on his way back from daily routine check. Majnoon Oil Field — Central Processing Facility — Source: Shell MENA Magazine Nov. 2013
Last summer the Iraqi Ministry of Oil addressed a letter to R.D.S. strongly complaining that the field in the summer of 2013 was still shut down and the production had stopped since July 1, 2012, after Shell's request to perform the rehabilitation of the existing surface facilities. The ministry continued explaining that the rehabilitation was supposed to be completed by January 1, 2013, and that in July 2013 Shell neither resumed production nor, as a consequence, was able to achieve soon the F.C.P. Last but not least, the government accused Shell of not handling well the associated natural gas produced at the field, increasing economic losses (not selling this gas was considered as a lost revenue) and producing environmental damages for Iraq.
With no doubt the company never thought of experiencing so many a problem at this oilfield. In relation to the company's 2013 development program, output was scheduled to rise over 200,000 bbl/d over 2013, and now it's possible to affirm that this target has been reached. In fact,  last October, the production of the Majnoon oilfield rose to 175,000 bbl/d, which is the established F.C.P.—this is a very important target because it's the level from which the consortium may start to recover costs. Now, according to Baghdad, current production should be around 200,000 bbl/d, which is approximately the agreed-upon target for 2013. 
What will happen in the future in Iraq—and in this country also a few months is a long period—is not clear (let's think of the current unrest and the tensions with the K.R.G.). All this said, it's possible to affirm that R.D.S. is implementing in Iraq important and diversified oil and gas operations, of which the Majnoon oilfield is the crown jewel. The company has decided not to invest in the K.R.G., and this strategy of being focused on Iraq proper only is permitting R.D.S. to be one of the main players in Iraq.
Some tensions between an energy company and the host country are part of the normal development of big business ventures (and those of the energy business certainly are) in which delays may always occur for many unforeseen reasons. So, it should not be a surprise that an additional new contract has recently been signed between Shell and Baghdad, and that, only a couple of months after a summer ridden by tense relations between Shell and the Ministry of Oil, the company has been able to reach the planned production target, partially catching up with the previously missed deadlines.

Sunset at Majnoon oilfield — Source: Shell MENA Magazine Nov. 2013

Tuesday, October 8, 2013

BP Continues Investing in Iraq. With T.S.C.s the Devil Is Always in the Detail(s)

October 8, 2013

BEIRUT, Lebanon  The political relations between the Kurdistan Regional Government (the K.R.G.) and Iraq proper with reference to the development of hydrocarbons remain tense and difficult. When in September 2013, U.K. British Petroleum (BP) inked a letter of intent to help Baghdad to develop the Kirkuk oil field, another element of friction was added to the whole picture. What has been going on in Iraq including Iraqi Kurdistan since the summer of 2011 is a positioning game between international oil companies (I.O.C.s) in order to operate in specific swaths of territory where there are consistent hydrocarbon resources. Historically, the relations between Erbil and Baghdad have always been difficult, and oil and gas hunting in the area is again pitting at loggerheads the K.R.G. and Iraq, which are offering to the energy company two different types of contracts: production sharing contracts (P.S.C.s) for Erbil technical service contracts (T.S.C.s) for Baghdad.     

The Current Situation in Iraq and the K.R.G.
This positioning game had its inception when the American oil supermajor, ExxonMobil decided to start negotiating drilling contracts with the K.R.G. In this way the American company bypassed Baghdad's authorization. In fact, Baghdad affirms that it alone has the right to negotiate and sign energy deals for the whole Iraqi territory, the K.R.G. included. Erbil insists that the Constitution of Iraq allows it to agree to contracts and as a result to produce oil independently of the central government. In October 2011, ExxonMobil entered the K.R.G. energy sector acquiring six exploration blocks. Since then, given the better contractual terms on offer in the K.R.G., other major I.O.C.s have been investing in the semi-autonomous Iraqi Kurdistan. Presently, there are in Iraqi Kurdistan around fifty international energy companies (among them four big names: U.S. ExxonMobil and Chevron, France's Total and Russia's Gazprom Neft), which have invested more or less $20 billion. 

Source: The Independent

One point that should be clear is that I.O.C.s go where they deem to find profitable opportunities for their business  only wildcatters may follow a partially different logic. And I.O.C.s (and especially Big Oil) have the necessary economic, managerial and technical requirements that give them the leverage for investing also in very difficult environments  which could be difficult both with reference to the required technical skills for recovering oil and gas and/or for the political situation of the involved area.  

Now, according to the location of their investments in the K.R.G. and Iraq, I.O.C.s have three different possibilities:

A) Investing only in the K.R.G. (U.S. Chevron),
B) Investing only in Iraq proper (U.K. British Petroleum and Royal Dutch Shell and Italy's Eni),
C) Investing in both the K.R.G. and Iraq (U.S. ExxonMobil, France's Total and Russia's Gazprom Neft).       

BACCI -The-Most-Important-Energy-Companies-in-the-KRG-and-Iraq-Oct.-2013

The third possibility mentioned above places I.O.C.s in a sort of limbo because Baghdad does not accept and consider completely illegal that I.O.C.s invest in the K.R.G. without its authorization. In retaliation for their K.R.G. investments, Baghdad has menaced these companies of outstripping them of the right to invest in Iraq proper if they do not stop their K.R.G. operations. On the Erbil side there are no problems if I.O.C.s are investing both in the K.R.G. and in Iraq proper, unless the operations deal with that strip of land which is disputed between Erbil and Baghdad.  

In specific, it seems now that ExxonMobil will sell its stake in the WestQurna-1 oil field one of the biggest world's conventional oil fields with 8.7 billion barrels in southern Iraq favoring the company's investments in the K.R.G. "Exxon has decided to scale down, based on our request. We have asked Exxon to scale down on the West Qurna and they have decided to sell" said Iraq's deputy prime minister for energy affairs, Hussein al-Sharistani. He also added that, for the time being, ExxonMobil would continue to be the operator of the field. The possible purchasers of ExxonMobil's stake could be PetroChina and Indonesia's Pertamina.   

BP's Letter of Intent for Kirkuk Oil Field
One of the companies that decided to stay on Baghdad's side is BP, which has recently, in early September, signed a letter of intent with Iraq's central government to revive Kirkuk  oil field. Already in January 2013, the two sides had signed a preliminary deal for developing the same field. This letter of intent is important because it permits BP to operate in the area disputed between Erbil and Baghdad. According to local sources, this letter of intent refers to an 18-month deal for offering consulting services. At the same time, it could be considered an interlocutory step, like the basis for negotiating a long-term development contract. In this regard, it's already evident that Iraq would like to move in the 18-month timeframe to signing a T.S.C., while BP would like to obtain better terms than the those of the T.S.C. it is has already signed in southern Iraq.

The major center of the disputed area is the ethnically mixed city of Kirkuk, which is claimed by Kurds, Turkmen and Arabs  and to a certain extent all buttress their claims according to different historical accounts. In an attempt to "Arabize" the area of Kirkuk in the 1970s, Saddam Hussein's regime forced over 250,000 Kurdish residents to relinquish their homes to Arab people. Well before Saddam Hussein played these in-Stalin-style forced deportations, according to the 1957 census Kirkuk was 40 percent Iraqi-Turkmen, 35 percent Kurdish and less than 25 percent Arab. The huge importance of Kirkuk is linked to the fact that it sits on the giant Kirkuk oil field, which as of 1998 owned around 10 billion barrels of oil. 

Given its importance, neither Baghdad nor Erbil wants to renounce to Kirkuk's area. To give a sense of this: BP's operations will develop just west of the ExxonMobil's developed area. And of course every initiative which involves the disputed area always sparks objections: if, on the one side, Baghdad has always opposed whatever hydrocarbon operations is carried out in the K.R.G. without its permission, on the other side, Erbil has always stood against any hydrocarbon operation in the disputed area like, for instance, BP's new involvement. "No company will be permitted to work in any part of the disputed territories including Kirkuk without formal approval and involvement of the K.R.G." affirmed in September a spokesperson for the K.R.G. Ministry of Natural Resources. 

Then, on Wednesday, October 2, 2013, Arif Tayfur (Kurdish), the deputy of the Iraqi Parliament speaker, strongly criticized Iraq's Ministry of Oil for signing the letter of intent with BP. In specific, he affirmed that the agreement was illegal because it violated Art. 140 of the Iraqi Constitution, which says:

Second: The responsibility placed upon the executive branch of the Iraqi Transitional Government stipulated in Article 58 of the Transitional Administrative Law shall extend and continue to the executive authority elected in accordance with this Constitution, provided that it accomplishes completely (normalization and census and concludes with a referendum in Kirkuk and other disputed territories to determine the will of their citizens), by a date not to exceed the 31st of December 2007.

The goal of the Article 140 is clear: Normalizing the situation in Kirkuk and the other disputed areas, bringing back Kurdish inhabitants, repatriating to central and southern Iraq the Arabs brought in to Kirkuk by the Saddam Hussein's regime and, most importantly, conducting a new census and then a referendum permitting the inhabitants to decide whether they want Kirkuk to be annexed to the K.R.G.      

Moreover, Mr. Tayfur requested that the Iraqi minister of oil, Abdul Karim al-Luaibi and the deputy prime minister for energy affairs, Hussein al-Sharistani took "into account the sensitive circumstance in the country and to refrain from concluding contracts and agreements with foreign Petroleum companies and control resources of the people, especially in the disputed areas as differences still exist around these areas".

Kirkuk Oil Field and BP's Role
Presently, Baghdad needs a qualified partner to revive an oil field that in the last years has experienced an important output decline. According to local sources, this letter of intent refers to an 18-month deal to offer consulting services. At the same time, it could be the basis for negotiating a long-term development contract. The British company will be working with reference to the Baba and Avana geological formations. Instead, Kirkuk's third formation, Khurmala is controlled by the K.R.G. and is developed by the Iraqi Kurdish KAR Group

This field was discovered by the Turkish Petroleum Company in 1927 and then seven years later, in 1934, the Iraq Petroleum Company (I.P.C.) started production. At that time  it's seems impossible in today's Middle East 12-inch pipelines brought oil from Kirkuk to Haifa and Tripoli (Lebanon). Today's oil production is moved through the Kirkuk-Ceyhan Pipeline.   

It's manifest that it's really premature to speak about possible future contractual terms when it's still unknown how complex the field is and what kind of intervention it necessitates. It seems that at the beginning of this collaboration for the Kirkuk oil field BP will pour in up to $100 million with two main and specific goals:

A) Stopping the decline of the field. At this time the Kirkuk field produces more or less 280,000 barrels per day (bbl/d) when in 2001 the production was around 900,000 bbl/d. The production has slumped by 70 percent and now Baghdad would like to increase it to 600,000 bbl/d in five years. 
B) Obtaining a clear assessment of the field's potential. At present, some engineers believe that bad reservoir management  like injecting water and dumping unwanted crude and chemicals into the field since Saddam Hussein's years, could have seriously if not permanently damaged the field. In specific, due to fuel oil re-injection, a big problem is oil viscosity, which complicates extraction and of course increases the costs.      

Why Did BP Decide to Invest Only in Kirkuk? One Simple Reason: Rumaila Oil Field
BP decided to increase its presence in Iraq because it has under contract the development of the super-giant Rumaila oil field ($30 billion oilfield project), which is located in southern Iraq, approximately 20 miles from the border with Kuwait. This field is considered the third largest oil field in the world. It's estimated to hold 17 billion barrels, i.e., 12 percent of Iraq's oil reserves, which are estimated at 143.1 billion barrels and it produces 1,400,000 bbl/d (data of June 2013). Iraq owns the field, which is subcontracted to BP and China National Petroleum Corporation (C.N.P.C.). BP is an operator of the project with a 38 percent stake, while C.N.P.C. holds a 37 percent stake and Iraq's State Organization for Marketing of Oil holds a 25 percent stake. The latter company is the Iraq's government representative.  
BP and C.N.P.C. operate in Rumaila under a 20-year T.S.C., the Iraq Producing Field Technical Service Contract (P.F.T.S.C.) and, according to the initial terms, after having reached an initial output target they recover a remunerated fee of $2 per barrel  (one important consideration is that BP's initial offer was $3.99 per barrel). Interestingly, ExxonMobil also bid for this contract, but its price of $4.80 per barrel was evidently much higher. At the end of 2009, BP sources affirmed that BP had a rate of return (ROR) on the Rumaila investment of 15 to 20 percent. A subsequent study by Deutsche Bank, a German bank, put the return even higher, at 22 percent. If BP has this ROR with a fee of $2 per barrel it is indeed doing a good business.  

On the technical side, Rumaila is really a good asset for BP. When the company entered the field after the 2009 contract, the oil field was in a shocking state of affairs like all Iraq's petroleum industry following its nationalization (completed in 1972), the Iran-Iraq War (1980-88), the First Gulf War (1991) and the Second Gulf War (2003) but notwithstanding this, the field was producing approximately 1 million bbl/d. Part of this result is linked to the field's simple geology. In fact, the presence of a natural water aquifer is capable of maintaining the reservoir pressure constant. Thanks to this oil may flow at an high rate. 

Considering this situation, it goes by itself that, at least for now, for fear of a possible retaliation by Baghdad, BP will not look for new upstream opportunities in Kurdistan, although it's worth mentioning that according to industry sources, Air BP is participating to a tender to supply fueling services at an airport in Erbil. On the other side, for Baghdad, Rumaila is the most important asset because it is the most important field of southern Iraq, the part of country that produces more than 67 percent of Iraq's total oil output.

BP Accepted a $2 Per Barrel Fee, but Is This the Real Final Fee?
A technical service contract (T.S.C.) is an agreement negotiated between a government entity and an operating or service company. The goal is to perform exploration, development and/or production services for fees and recovery costs, but with the important caveat that the oil company does not own the right of booking reserves. With Iraqi T.S.C.s, I.O.C.s get only a small contribution per barrel while Iraq has full control and ownership of the resources and companies have no right to lift, market or book reserves, plus they bear all the capital expenditures and financial risks.

Obtaining $2 per barrel is remarkably a low price for BP. Especially, if we consider that the fee is additionally reduced by a 25 percent fully carried state participation and by a 35 percent income tax. Moreover, in Iraq according to the implemented T.S.C.s, the barrel per fee may be reduced by up to 70 percent as the R factor increases from 0.0 to 2.0 (the R factor is a sliding scale that employs a ratio of two numbers to determine a rate. In the oil and gas business the most common R factor is obtained dividing cumulative revenues by cumulative costs).

But there is a logic behind this contract and this logic supports Baghdad's decisions. Companies prefer P.S.C.s, but T.S.C.s could be acceptable contracts when I.O.C.s have to work in an environment where there are proved reserves and/or where the real activity is just related to a previously exploited field (for instance, a redevelopment activity). Rumaila is a well discovered area with huge oil reserves and this means that the risk for BP is very low. All this said, with a $2 fee per barrel many analysts questioned the profitability of the investment for BP ,especially with a boasted ROR around 20 percent.

Three months after the auction the Rumaila contract was privately renegotiated between the Iraqi government and the winning consortium BP/C.N.P.C. The slide below shows the five most important contractual modifications. 


As U.K. Platform Group underlines:

The effect of these changes is to transfer the most significant risks from BP/C.N.P.C. to the Iraqi government, making the contracts considerably more attractive to the companies. In all of these changes, it is the Iraqi side that loses out. As a result of the enhanced compensation provisions, the Iraqi government could find itself paying BP/C.N.P.C. (and likely other companies) even when it is not earning oil revenues to offset those payments. Meanwhile, the changes undermine the Iraqi ability to ensure that it achieves value for money, and that oil is developed in the national interest.

It's not the purpose of this analysis to decide whether the implemented renegotiation is good or negative for the Iraqi government. Of course, it should be better if  contract were implemented exactly as they were awarded and not with substantial modifications after just three months. Instead, what happened was a rebalancing of the contract where in the end what the consortium was getting was not anymore $2 per barrel, but much more, although this plus was given with different means. As Eni's C.F.O., Alessandro Bernini pointed out in 2009, with reference to another renegotiated contract related to the Zubair oil field, "we accepted $2 because, basically, the fiscal terms are different now.” Moreover he added that the renegotiated terms with a remuneration fee of $2 were equivalent to the pre-bid terms at a fee of $4.50. A similar renegotiation happened as well for two other southern oil fields: West Qurna-1 (ExxonMobil/Shell) and the above mentioned Zubair (Eni-led consortium). In West Qurna-1 the renegotiated fee was $1.90 from an initial bid of $4 and for Zubair $2 from $4.80. The terms of the reductions implemented in West Qurna-1 and Zubair are very similar to Rumaila's.  

In Rumaila a Contract Renegotiation Was Implemented but Is It Really Positive for Iraq?
With no doubt Rumaila's contract renegotiation has given to BP an improved contract guaranteeing the company to be paid also if the government did not receive oil revenues to offset its payments. As for the renegotiated contract the following five events:

A) a potential OPEC quota imposed onto Iraq,
B) a potential infrastructure risk,  
C) less Iraqi oversight for project expenditures, starting only over $100 million,
D) potential security, political and natural risks and
E) absence of liability for reservoir damage

do not change anymore the economic profitability for BP, but they exclude now its liability. It is worth asking whether for Iraq it was not preferable signing a simple T.S.C. with an increased fee per barrel on behalf of BP in order to have an evenly split between BP and the Iraqi government liability in the occurrence of one or more of the five points mentioned above. The five mentioned events may well happen during a twenty-year contract, and currently a potential risk infrastructure is already having a relevant impact as well as some security risks.

Iraq's Poor Infrastructure and Contract Renegotiations in Light of an Iraqi Oil Production of 9 million bbl/d (if Not a More Advantageous 6 to 7 Million bbl/d) 
It's quite notorious how southern Iraq does lack oil storage capacity so that delays or weather-related interruptions to loading tankers force a company to curtail production. And if reducing production is fast, lately reincreasing it is a long operation. This is just one single example of the infrastructural gaps present in today's Iraq. 

Since December 2012 BP has been trying to renegotiate the terms of its Rumaila contract with Baghdad. BP is facing difficulties in ramping up oil production to the plateau level of 2.85 million bbl/d by 2016 as requested according to the 2009 contract, although if the difficulties were related to one or more of the five mentioned points, BP should always be paid. The company would like to cut the initial plateau of 1 million bbl/d. 

It's quite possible that in the near future there will be an agreed-upon plateau reduction between BP and Baghdad because the latter is lowering the plateau levels in all its production fields in southern Iraq (it has already implemented a renegotiation of the plateau with Italy's Eni for Zubair and with Russia's Lukoil for West Qurna-2) in line with the new overall country target of 9 million bbl/d in 2017, before the target was the unreachable level of 12 million bbl/d. This level was probably unattainable for at least three main reasons (of course assuming that there would not be any security risks more than the average security risks in the area):

A) the big infrastructural gap existing in Iraq,
B) a possible collapse of the oil price as a consequence of pouring into the market 12 million bbl/d,
C) the reintroduction of an OPEC quota for Iraq.

Iraq does not have an OPEC quota following the sanctions from 1990 to 2003 and the instability witnessed by the country following 2003. All this said, traditionally Iraq's quota was matching Iran's and was something less than 4 million bbl/d before the invasion of Kuwait in 1990. A higher quota could be expected to compensate the country's hardships but thinking of a quota higher than 6 million bbl/d is very difficult. And six million is exactly half the production that in 2009 Iraq was planning to produce by 2017.      

The basic idea of this article was to show that, in a competitive process, oil companies make bids based on their evaluation of the risks and the rewards of the project on offer. No big company implements any deal without a careful assessment of the pros and the cons involved in the operation. The Rumaila contract well suits this idea. Similarly, as a consequence to economic considerations, linked mainly to more profitable contractual terms it was quite normal that some I.O.C.s deemed interesting to invest in the K.R.G. where productions sharing contracts (P.S.C.s) were, and are, on offer. Booking reserves and profiting from a high oil price are two relevant incentives for P.S.C.s. But again, generalizing that companies want only P.S.C.s is too simple a way of thinking. Also T.S.C.s, if structured in a balanced manner, could be profitable for I.O.C.s.

The Rumaila contract also shows us that when in the energy field two heavyweights like BP and the government of Iraq do business together there is ample room for continued negotiations. It's difficult to arrive at rupture points between such two parties ,and there is a lot of negotiating activity conducted behind closed doors, which hardly ever reaches the headlines. In Rumaila, it's possible that there will be a reduction of the plateau of production probably in the direct interest of both parties. And if BP could gain more profits not reducing the plateau and applying the five liability exemptions, it's presumable that there could be for the British company other profit-generating opportunities with Iraq in the long term in Rumaila or in other locations (for instance, in Kirkuk?). In other words, you may lose something on one side, but you may gain something else on another.             

For next December 19, the Iraqi oil industry is planning to auction the giant Nassiriya oil field (4 billion barrels of oil) located as well in southern Iraq (part of the project includes the construction of a 300,000 bbl/d refinery). According to released information, the terms of this contract will be different than those of the previous T.S.C.s. First of all, operators will not have a state partner and no signature bonus will be paid. When production begins, the investors will be offered a share in the project revenues and the ministry will pay recovery costs from the date of the commencement of work. Investors will have to pay 35 percent taxes on profits like in the previous rounds.

With no doubt this revised T.S.C. could be a positive step forward after the failure of the Iraqi fourth bidding round and the complains that Baghdad has been receiving in these last years with reference to the the slim margins oil companies have been obtaining (See for more details: BACCI, A., Chevron and Total Continue Investing in the K.R.G. A Brief Analysis of Baghdad's T.S.C.s vs. Erbil's P.S.C.s).
A contract to be successful needs to be balanced among the involved parties. When it's possible to strike such a balance then normally a contract is signed. And contracts need to be completely understood in order to have a clear assessment of their profitability. Simple formulas, like T.S.C.s or P.S.C.s, many times do not provide the whole picture. The devil is in the detail(s) in a negative and/or positive meaning. And with oil contracts sometimes it's more appropriate to use the other older idiom: "God is in the detail".