Friday, June 28, 2013
BEIRUT,
Lebanon — Production sharing contracts (P.S.C.s) between international oil
companies (I.O.C.s) and the Kurdistan Regional Government (K.R.G.) continue to be
signed notwithstanding the opposition of Iraq's central government, which instead signs
only technical service contracts (T.S.C.s). Baghdad affirms that it alone has the
right to negotiate and sign energy deals for the whole Iraqi territory, the K.R.G. included. Since
U.S. ExxonMobil entered the K.R.G.'s energy sector in October 2011 — at that
time the company acquired six exploration blocks — other major I.O.C.s have been
investing in the semi-autonomous Kurdish region. 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), which
together have invested more or less $20 billion.
CHEVRON'S AND TOTAL'S RECENT ACTIVITIES IN
THE K.R.G.
Approximately
ten days ago Chevron and Total respectively announced that they had increased
their activities in the K.R.G. In specific, on Monday, June 17, through a statement issued from Erbil, Chevron announced that it had signed an exploration deal — the third with Kurdish authorities — in relation to the Qara Dagh field. This
block is located in the southern part of the K.R.G. and totals about 860 square
kilometers (or 332 square miles). "Chevron will acquire an interest in and
operatorship of the Qara Dagh block production sharing contract from the
Kurdistan regional government," the company said in the statement.
The U.S. company was awarded the exploration deal last January, while, in July 2012, it had already acquired from India's
Reliance Industries Ltd. an 80 percent stake in two blocks two (called Rovi and Sarta, with the
related operational control) located north of the city of Erbil.
Almost in the same days, Total expanded its presence in the K.R.G. In fact, having purchased an 80 percent stake in the Baranan block (with the K.R.G. owning the remaining 20 percent), south of the city of Suleimaniya, Total now has four assets in the country. This block (a.k.a. K9) had been previously held by the Canadian oil and gas company Talisman Energy until it decided to hand over the acreage last year. In 2012, the French company purchased a 35 percent stake in the Harir and Safen exploration blocks in the Erbil-controlled territory, while at the same time it owns a minority interest in the Taza exploration block in the Kurdish province of Suleimaniya.
In dealing with Baghdad, the
position of Chevron and that of Total in are different. In fact, if on the one
side, the American company does not have any energy stake in central and southern Iraq,
on the other side, the French company owns a stake in the Halfaya oil field in
southern Iraq. In this regard, since last year Baghdad has warned Total requesting that it cancel or freeze its contracts with Erbil unless it wants to
be forced to relinquish the Iraqi asset. Up to now, the company has continued
to operate in the K.R.G. and in Iraq. The only measure implemented by Baghdad has been banning the two companies from future contracts in Iraq. Then, two events have changed the picture. First, last March Total was preselected with six other companies with
reference to a call for bids in an oilfield in Nassiriya, in southern Iraq and second,
still in March, ExxonMobil announced its
intention of increasing its investment in its West-Qurna-1 oilfield (a $50
billion investment) located in southern Iraq. From this two events, it's possible to understand that
Baghdad does not have the upper hand. Indeed, it goes by itself that
replacing big companies of the likes of
Total or ExxonMobil it's not an easy task.
WHY
INTERNATIONAL OIL COMPANIES ARE CHOOSING THE K.R.G. INSTEAD OF IRAQ?
In order to understand what is
happening in Iraq and the K.R.G. at the level of energy deals, the real question
to be answered is: Why are I.O.C.s all flocking to the K.R.G.?
There are three main reasons for the I.O.C.s interest in Iraqi Kurdistan:
A)
The presence of abundant energy reserves — Current Kurdish data speak about 45 billion barrels of oil, i.e.,
one-third of Iraq's proven reserves (proven reserves are those with a 90
percent certainty of being produced at current prices with current commercial
terms and government consent, known in the industry also as 1P) which are
estimated at 150 billion barrels. In other words, quantitatively (not
qualitatively because Erbil has heavier oil) the K.R.G. could be another Libya. In
addition to oil, the K.R.G. has from 3 to 6 trillion cubic meters (TCF) of potential gas reserves, as recently underlined in London by the minister of natural resources of
the K.R.G., Ashti Hawrami, at the Iraq Petroleum Conference 2013 organized by C.W.C., a company
specialized in the dissemination of the energy and infrastructure knowledge.
The Minister of Natural Resources of the K.R.G., Ashti Hawrami
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I.O.C.s invest where there are energy resources
and — especially considering the supermajors — they are accustomed to
investing in so-called difficult countries and harsh environments. For
instance, Lebanon — a troubled country whose recent history has always been entangled
with Syria's (in the latter country there is an ongoing civil war,
if not something more because of the external actors, which are involved in
the warring operations within and outside the country. Up to know, there have
been only sporadic spillovers of Syria's civil war into Lebanon) has recently
been able to attract for the prequalification phase of its offshore gas exploration contracts forty-six I.O.C.s.
B) Security
and a safe business environment — The K.R.G. with no doubt offers now more security and a safer
business environment (for instance: a modern and open investment law and a
progressive hydrocarbons (oil and gas) law for the Kurdistan Region) than those present in Iraq.
Moreover, during the last years Erbil has been able to implement progressive
economic policies and to increase its government transparency. "The K.R.G.
also remains committed to the criteria and goals of the Extractive Industries Transparency Initiative (E.I.T.I.) and last year submitted a full report on production and revenues",
said Dr. Hawrami still at the Iraq Petroleum Conference 2013.
On the other hand, Iraq is a volatile
and unstable country, where the Shia-led government had struggled to restore order
until an increase of U.S. troops in late 2007 was able to push insurgents and
militia out of the cities and provinces that they were trying to conquer. The
row with the K.R.G. about the disputed territory, and in specific about the destiny
of the ethnically mixed city of Kirkuk (around 1,000,000 inhabitants, although the figures are disputed, the population should consist of one-third
Turkmen, one-third Kurds and one-third Arabs) with its hydrocarbon
riches (the city sits on the second largest oil field in Iraq), has
continually threatened to derail the peace progress. As a result, insurgents in
Iraq continue using violence in order to undermine the government. And according
to the United Nations (U.N.), May 2013, when more than 1,000 people were
violently killed, has been the deadliest month since the sectarian slaughter of 2006-07.
C)
The K.R.G.'s P.S.C.s are more attractive for I.O.C.s than Iraq's T.S.C.s — Let's now examine the two different
typologies of energy contracts used respectively in Iraq and the K.R.G.
C1) Baghdad's
T.S.C.s — Since 2008, Iraq's Ministry of Oil has tried to redevelop its energy reserves by bringing in
the country top-notch foreign technology. And it has done so through a series of technical service
contracts (T.S.C.s) in four bidding rounds (these service contracts have taken also other names
like Development and Production Service Contracts or Exploration and Production
Service Contracts, but the basic assumptions are quite similar). In practice, with 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. The companies have no right to lift, market or
book reserves, plus they bear all the capital expenditures and financial risks.
Contracts linked to the first three
bidding rounds, held in 2009, 2009 and 2010, had for the I.O.C.s an economic return that was
not as high as expected and later some of the
companies tried to renegotiate or to cancel the contracts. In fact, the fees per barrel were as low as $1.15 to as high as $7.50. Plus, the fees
were additionally reduced by a 25 percent fully carried state participation and
by a 35 percent income tax. In the end, the government take in some cases was as high
as 99 percent. Moreover, the barrel per fee was reduced by up to 70 percent as the R factor increased
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). For instance, ExxonMobil
from the assigned supergiant West Qurna-1 (which is now producing about 500,000
barrels per day) earns $1.9 per barrel. The profit for the company is substantially fair, but the problem is the produced quantity. In fact, to
recoup 30 to 35 percent of its initial investment it should produce 2 million
barrels per day, which is not doable now. Plus, as an additional hurdle, the
companies that signed these contracts have become entangled with bureaucratic
hurdles.
Summing up, the first three licensing
rounds obtained mixed results for Iraq. According to some commentators, the
first one was initially a failure with only the supergiant Rumaila oil field (17
billion barrels) awarded. Only through subsequent negotiations in the following
year it was possible to award three fields that initially had not been not awarded:
Zubair (4 billion barrels), Maysan (2.5 billion barrels), and West Qurna-1 (8.7
billion barrels). Through these additional negotiations it was redressed a licensing round that at
the beginning had raised many questions and doubts. The second and third bidding
rounds almost completely awarded their blocks even if bidding was in a certain
way feeble. The only really important exception was in the second round the
unsuccessful assignment of the East Baghdad oil field (8 billion barrels). But it
this regard — and this supports Baghdad's decisions — it should be
noted that at least with reference to the first three rounds the fields on
offer were all pertaining to discovered areas (some of these were supergiant
fields with more than five billion barrels of oil reserves). And this meant that the
risk for the companies was very low.
The fourth bidding round (oil and gas)
was held in 2012 and it was a complete failure. In fact, the dissatisfaction
of I.O.C.s with the terms proposed by Iraq was well shown last year when this
fourth energy auction ended with very few foreign investors bidding for the
blocks. The result was just 3 blocks awarded out of 12 on offer (and 8 blocks did
not even receive any bid).
Why such a negative result? If the
previous three licensing rounds had offered rights to immediately start production raising output at large- or medium-sized sites with proven reserves, the fourth round instead involved areas with undetermined levels of hydrocarbons. Besides,
in the fourth round there was a new formula to calculate the fee per barrel. In practice, IOCs would have been paid the fee per barrel on the remaining
production after having deducted costs (for instance, if total production was 1
million barrels and the contractor had spent $300,000 on a subcontractor, it
would later receive payment only for the remaining production, i.e., 700,000
barrels). In the coming months Iraq will organize the fifth licensing round for oil exploration (ten blocks). It appears now that probably Baghdad will
ease its contractual terms in order to lure consistently I.O.C.s and avoid another
failure.
C2) Erbil's P.S.C.s — In Iraqi Kurdistan the oil and gas contractual terms are quite different. Today's contracts date back to
the compromises included in Iraq's Constitution of 2005. In specific, Erbil
asserts that the Constitution gives it full authority to sign P.S.C.s with reference to future oil and gas fields (these
are fields not yet discovered when the Constitution was signed eight years ago),
shared authority for the existing fields, and the right to export hydrocarbons
produced within the K.R.G. borders. On the other side, Baghdad has a completely different
view: All fields (existing and future) are supervised at the central level, the government retains the right to approve or reject any future P.S.C. and Baghdad
must have full control over oil and gas exports. In order to try to overcome
this impasse and given the long-dated incapacity of legislating the much needed
Federal Oil and Gas Law, the K.R.G. in 2007 passed the Oil and Gas Law of the Kurdistan Region. Since then the K.R.G. has entered into P.S.C.s with I.O.C.s. Baghdad
has immediately considered these contracts completely illegal and has refused to pay the K.R.G. the
full value of the oil produced in Iraqi Kurdistan. Baghdad has been paying as a reimbursement only part of the cost
oil to the I.O.C.s working in Iraqi Kurdistan.
Following this move Erbil has not had the economic resources to pay the I.O.C.s and has retaliated halting production from the K.R.G. It's important to know that based on their share of the Iraqi population, the K.R.G. is supposed to get 17 percent of national revenue. When last March 7, 2013, the federal government passed the 2013 Budget Law the agreed-upon allocation for the K.R.G. was $3 billion short of what Erbil expected. And the direct consequence of this federal law was the K.R.G. "Law of identifying and obtaining financial dues to the Kurdistan Region — Iraq from federal revenue", a.k.a. the Financial Rights Law of April 2013. The aim of the law was to create a mechanism for the assessment of the amount Baghdad owed to Erbil and, especially, and for the definition, within the framework of Iraq's Constitution, of a remedy if the central government did not pay. This remedy meant direct exports of oil and gas produced in Iraqi Kurdistan. Currently, the K.R.G. Ministry of Finance affirms Baghdad's debt is as high as $20 billion of which $4 billion belongs to the I.O.C.s operating in the K.R.G.
With
P.S.C.s a contractor in general carries out all the investments and performs
management implementing all the technical and operating services under the
control of a state agency (many times a national oil company (N.O.C.)). Here the big
difference with service agreements is that a contractor receives a share of
production to recover its costs (cost oil). Subsequently, the I.O.C. will
split the remaining production (profit oil) with the government to get its
profits. Summing up, in a P.S.C. the overall
economic rent consists in general of five components:
1) Bonus
(government share),
2) Royalty
(government share),
3) Government's
Profit Oil (government share),
4) Taxes
(government share) and
5) Contractor's
Profit Oil (contractor share)
If it's
true that the majority of the economic rent goes to the hosting government,
it's also true that the contractor has the possibility of recovering all its
costs (Exploration Costs, Development Costs and Operating Costs). In fact,
Article 25.3 of the K.R.G. P.S.C.s format says that:
Subject to the provisions of this
Contract, from the First Production in the Contract Area, the CONTRACTOR shall
at all times be entitled to recover all Petroleum Costs incurred under this
Contract, of up to [ ] percent ([ ]%) of Available Crude Oil ...
Plus,
at the same time, in addition to recovering its costs, the contractor is entitled
to obtain profit Oil. In fact, Article 26.2 of KRG's PSC says that:
From First Production and as and when
Petroleum is being produced, the CONTRACTOR shall be entitled to take a
percentage share of Profit Crude Oil and/or Profit Natural Gas, in
consideration for its investment in the Petroleum Operations, which percentage
share shall be determined in accordance with Article 26.5.
Why
the K.R.G. is proposing P.S.C.s. is another good point to be raised. The reason is
both based on economic and political assumptions. Erbil believes that
economically speaking it has to develop its own economic agenda. Being linked
to Baghdad means proceeding with a very slow pace and with unreliable economic
gains postponed to future times. Iraq does remain now in dire conditions with
huge security problems associated to a sectarian civil war that continues up to
today and does not seem to abase. With reference to the energy sector, a
national hydrocarbons law to date has not been passed and Iraq's bidding rounds,
based on T.S.C.s, have been quite a failure. Moreover, Turkey is very interested into
Erbil's energy riches and could be the customer permitting the K.R.G. to export its oil and
gas. In other words, P.S.C.s with a more balanced revenue sharing mechanism, could be the
right tool for developing in a fast manner a sector that until a few years ago (2006)
had been practically nonexistent. I.O.C.s have flocked to the K.R.G. without many doubts. If improved economic conditions will permit Erbil to create an
independent state is another thing. But surely in Erbil many officials do not have
positive ideas about Iraq's future. "Iraq is going to hell. If we cannot
live together we must talk about something else. We Kurds are not part of the
conflict between Shia and Sunnis. But if there is a fire in the house next
door, it will burn you too in the end. And there is no fireman" said in an
interview Fuad Hussein, an adviser to the president of the K.R.G., Massoud
Barzani.
CONCLUSION
To
conclude our analysis of these two types of oil and gas contracts it should be
underlined that there is no energy ontract that can really fit all the working
possibilities. In fact, every contract suits different economic conditions, and
it's important to strike a fair balance between I.O.C.s and the hosting state. A T.S.C.
could be an acceptable contract when companies 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). In this regard, Iraq's first three licensing rounds (and also the contracts related to fields not awarded with the first licensing round, which only later were awarded through private negotiations — see for instance West Qurna-1) have very tight
conditions, but with the right amount of produced barrels (permitting a company
to recoup its incurred costs) could well be profitable for the involved I.O.C.s.
Things of course change if we consider areas with unproved reserves. In such a
case, it's clear that contractual terms have to change if a government wants to
avoid a bidding failure as Iraq's fourth oil and gas licensing round.