Key fact

Iraq’s output of oil increased to an average 2.75 million barrels a day in the first five months of 2011

Source: Centre for Global Energy Studies

Few executives at international oil companies (IOCs) would have been under any illusion about how difficult working in Iraq would be, after more than 20 years of sanctions, war and neglect. Despite some early successes, efforts to raise production have, as expected, run into problems.

The London-based Centre for Global Energy Studies estimates that Iraq’s oil output rose in the first five months of 2011 to an average of 2.75 million barrels a day (b/d). In 2002 – the year before the US-led invasion – Iraq produced just 1.9 million b/d.

IOCs hitting target is the first sign of success for their strategy, but also highlights Iraq’s growing pains

Attempting to run 11 major upstream oil projects simultaneously has shown the limitations of the country’s infrastructure. It is clear that reaching the 12 million b/d target announced by Baghdad in only seven years will be a huge challenge and will require increasing Iraq’s output capacity by about 1.3 million b/d each year.

High oil production target

Achieving this target would take the country from being the world’s 13th-largest oil producer to rivalling Saudi Arabia and Russia for the top spot. The 12 million b/d figure is the sum of plateau targets from the signed fields, along with production from fields operated by Iraq’s four state-owned entities.

Given the steep investment needed to boost production, the IOCs aimed much higher than had been expected, driven by a desire to recoup their enormous front-loaded capital expenditure in the shortest time.

Reaching this level will require the drilling of 800-1,200 wells each year, using 250-350 drilling rigs at any one time. This particular challenge is set for the five oilfield services companies operating in the country, the ‘big four’ US firms, Halliburton, Weatherford, Schlumberger and Baker Hughes, along with the local Iraq Drilling Company. Mobilising and maintaining drilling rigs in such large numbers within such a short time frame is unprecedented.

Analysts and officials in Iraq are beginning to suggest the expansion plans are running into trouble. Much of this is because the supporting transport infrastructure developments are not yet in place. Even under the best circumstances, London-based consultant IHS Global Insight forecasts that Iraq will only be able to achieve production of 6 million b/d in 10 years’ time.

Some methods used to increase production are also considered unsustainable. According to Ahmed Moosa Jiyad, a former senior economist with the Oil Ministry now based in Norway, the IOCs have hit their 10 per cent targets over the baseline production to invoke cost and fees recovery without ensuring sustainability of the increase.

Jiyad cites the strategy of Italy’s Eni over the past year at the 4-billion-barrel Zubair field. The group plans to raise production to 1.2 million b/d within the next six years and hopes to maintain that level for another seven years. It plans to invest about $20bn in the development of the field over the 20-year term of the contract, which can be extended to 25 years.

In December 2010, Eni announced that production from the field had increased to more than 200,000 b/d, from about 183,000 b/d, when the consortium began field operations in the first quarter of 2010.

“[They will achieve this] by applying short-term mechanical or technical modalities instead of advanced recovery methods,” says Jiyad. “They were debottlenecking at Zubair, reducing pressure and re-perforating. It is not really sustainable – they have some work to do, but it is not going to be done very soon.”

In January, UK oil major BP and China National Petroleum Corporation (CNPC) announced they had increased production to 1.275 million b/d, 20 per cent above the baseline of 1.066 million b/d. This has since fallen to 1.2 million b/d, says Jiyad, confirming his initial fears.

Jiyad argues that he reduced production should disqualify them from recovering costs.

Cost recovery for international oil company

Nonetheless, in mid-May, the first payment to an IOC for cost recovery was made. As part of its payment for oil field development, Baghdad allowed BP to lift a cargo of about 2 million barrels of Basra Light crude oil worth $200m from the Rumaila oil field in the south of Iraq. A similar shipment by CNPC followed on 30 May.

Under its technical service contract, after increasing production at the field by more than 10 per cent in January, BP and CNPC are eligible to receive a remuneration fee of $2 a barrel, as well as recovering capital expenditure investments from the government. The partners are owed $1bn from the Iraqi Treasury, which they also expect to receive in the form of crude.

This is just the start of the payouts. Two other consortiums are due to receive payments. Eni, along with the US’ Occidental and South Korea’s Kogas at the West Qurna-1 field is one. The other is led by the US’ ExxonMobil and UK/Dutch Shell Group at the Zubair field.

With 11 oil fields currently under almost simultaneous development by IOCs, these payments will now start to eat into Iraq’s oil export revenue and state budget. For the IOCs, hitting their 10 per cent production target ahead of schedule is just the first sign of success for their strategy in the country, but it also highlights Iraq’s growing pains.

Iraq’s oil output capacity

There has been speculation that Baghdad plans to cut its oil output target by almost half from 12 million b/d to about 7 million b/d. On the sidelines of the latest Opec meeting in Vienna in June, Oil Minister Abdulkarim al-Luaibi told journalists that his ministry was waiting on the results of a report by consultants, to decide on the extent of possible cuts to Iraq’s oil expansion targets. The plateau targets, which were initially agreed for seven years, could also be extended to 13 or 14 years.

However, deputy prime minister for energy, Hussain al-Shahristani, has denied the reports, saying Iraq has no intention to lower the targets or renegotiate its contracts with IOCs.

Although he has been replaced by Al-Luaibi in the ministry, Al-Shahristani continues to wield considerable power in the oil sector. Even if production targets are cut, Iraq still faces the enormous task of financing and managing the repair and expansion of its pipeline, storage and export terminal network. Given the state of Iraq’s oil transport infrastructure and the rapidly increasing production capacities, getting the oil to export terminals will be another challenge.

The government has to prepare suitable oil pipeline and pumping station capacity for transporting the oil, as well as sufficient capacity for storage and loading facilities at the export terminals. This will amount to several million barrels a day of oil transport and export capacity, and it will need to be in place by about 2017 to keep up with the pace of production increases.

In May, Iraq’s Oil Ministry awarded Canada’s SNC Lavalin an engineering consultancy contract to oversee the first phase of the country’s $50bn planned oil and gas pipeline overhaul. A series of build, operate and transfer contracts for pipelines, pumping stations and storage terminals across the country will be tendered in 2012.

Some progress has been made. Oil Ministry data says about 64.2 million barrels of oil were exported in April. This equates to 2.14 million b/d, compared with 1.93 million b/d in April 2010. But it remains doubtful that Iraq will be able to finance the expansion at a time when oil companies will begin recovering costs for their massive upstream investments.