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.
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Source: The
Independent
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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).
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.
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.
Conclusion
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".
