Iraq’s oil sector enjoyed a resurgence in 2012, breaking pre-war oil production records and elbowing rival producers aside to claim second spot in the ranks of Opec producers. Baghdad’s energy strategists have reason for caution, however, as they survey longer-term prospects for the country’s critical economic sector.
Iraq’s Oil Ministry is preparing to scale back the ambitious production targets it set out in 2009. Back then, it had drafted technical service contracts (TSCs) with foreign oil companies, reducing the target from the original 12 million barrels a day (b/d) anticipated by 2017 to 8-9 million b/d, over a 2017-20 time frame.
The move to downgrade its targets reflects widespread industry recognition that the original targets are neither achievable nor desirable.
The vaunted ambitions for the 12 TSCs are falling by the wayside well ahead of the 2017 deadline, as oil companies confront insurmountable infrastructure blockages that will render agreed production plateau targets (PPTs) unattainable. Reports that some majors are seeking to amend tough contract terms should surprise no one; there is a distinct cooling of oil company appetite for Iraqi risk.
In late 2011, US oil major ExxonMobil signed an exploration deal with the Kurdistan Regional Government (KRG), effectively sabotaging its own position as leader of the West Qurna 1 field project in the south of Iraq with Baghdad. Since then, no international oil companies (IOCs) have stepped forward to take up its vacated 60 per cent stake in the project, which is envisaged to hit a PPT of 2.3 million b/d by 2017.
I wouldn’t be surprised if the bigger players with larger targets are … trying to see what they can renegotiate
Jessica Brewer, Wood Mackenzie
More significantly, oil majors are seeking changes to the terms of their contracts. Russia’s Lukoil was the first to wring significant amendments to the terms of its TSC at West Qurna 2. The firm signed an agreement with Baghdad on 17 January 2013 to scale back production targets to 1.2 million b/d from the 1.8 million b/d it had originally committed to reaching by 2017. Lukoil, in turn, formalised the acquisition of the 18.75 per cent share in West Qurna 2 that Norway’s Statoil vacated last year, committing to extend the contract by five years to 25 years. The production plateau will be 19.5 years, over the previous 13 years. Although the remuneration fee is understood to have remained the same, speculation suggests the Russian firm may also be granted concessions on taxes.
Lukoil chiefs are pleased with the changes. Company president Vagit Alekperov said the risks emerging in the course of implementation of the project were “considerably reduced” as a result of the renegotiation.
The UK’s BP may be next in line, negotiating new terms at the southern Rumaila field, where it committed to raising output to 2.85 million b/d by 2017, from 1.35 million b/d now. MEED understands that BP has been in discussions with Iraqi officials with a view to reducing the PPT rate, with options ranging from 1.8 million b/d to 2.2 million b/d.
Any decision on contract changes will invariably be influenced by the government’s need to share the reduction in output across the 12 contract areas. “BP operates one of the larger fields [Rumaila], which along with West Qurna 1, might see a slightly bigger reduction than some of the others,” says Jessica Brewer, analyst at UK energy consultancy Wood Mackenzie. “It just depends on what methodology the government uses to make the decision on who receives what new targets.”
As yet, nothing has been confirmed, but if one set of terms are revised, it opens the door for others to try to renegotiate their own contracts. Oil Ministry officials are already in discussions with UK/Dutch Shell Group and Italy’s Eni about reducing targets at their Majnoon and Zubair fields. Shell’s 1.8 million b/d PPT could see a cut similar to Lukoil’s.
“I wouldn’t be surprised if the bigger players with larger targets are … trying to see what they can renegotiate given the constraints with exporting more crude,” says Brewer.
Impetus for reform
Oil companies may have to offer something in return for lower PPTs. “Given the problems reported with agreeing investment in pipelines and export infrastructure, it seems that IOCs investing in the south of Iraq are seeking to defer the output targets in their contracts,” says Bill Farren-Price, director of consultancy Petroleum Policy Intelligence. “And the justification for that is that the plateau production can be extended further.”
Oil firms contend that lowering the PPT will extend the life of the fields, granting Iraq a more substantial long-term endowment.
There are other incentives oil companies can offer to help sweeten the deal. BP, for example, has proffered North Oil Company short-term help at the struggling Kirkuk field, which is only pumping 270,000 b/d. The UK oil major believes it could double capacity at Iraq’s oldest producing field.
Revising contract terms is no easy task, but with IOCs eyeing tough penalties under clauses that link remuneration to performance, the impetus for reform is strong. With TSC terms geared to generating relatively small earnings on high volumes, the failure to engineer speedy production increases has removed much of the commercial incentive for oil firms to stick with the letter of the agreements signed in 2009.
Many of the delays in reaching production targets are caused by inadequate infrastructure and export capacity – areas beyond the immediate remit of the oil companies. According to Wood Mackenzie, southern export infrastructure constraints will cap 2017 production at about half the original targeted output.
The government’s failure to upgrade oil infrastructure in tandem with field development has punched a big hole in their plans. Although the PPT targets are aligned to the fields’ potential, “above ground” constraints were not factored into the equation.
The Iraq Crude Oil Export Expansion Project enabled exports through Basra to reach 2.35 million b/d in 2012, but onshore bottlenecks have limited exports beyond that level. The failure of the government to invest in the upgrade of the pipeline network, pumping stations and the onshore Fao terminal has hampered export performance. Some work is ongoing, but the upgrade that will enable production to fill the expanded offshore export capacity of 5.4 million b/d will take about five years to complete.
“There is also this issue of not having enough storage space, so whenever there’s a weather outage at offshore terminals the fields have to partially shut in, as there is nowhere for them to put the oil in the meantime. It’s quicker to shut in than it is to bring it back on line,” says Brewer.
Developing infrastructure may be an area where oil companies may offer assistance. “The big field developments are the oil companies’ main priority, but they may want to get more involved in some of the infrastructure if they can, just because it gives them a greater chance to export more oil,” says Brewer.
Reconfiguring previously agreed contract terms on the TSCs will also have to pass other tests, even if government and oil firms are in agreement over the need to scale back on PPTs.
“These contracts are cost-plus deals, not production-sharing contracts,” says Luay Khateeb, director of the Iraq Energy Institute, and an adviser to the Iraq parliament on oil affairs.
“If the government lowers the production plateau, this will affect the IOCs’ take. Therefore, if the IOCs are not remunerated with adequate upside, they will eventually increase the cost at some point, or farm-out like other unhappy IOCs,” he adds, referring to StatOil and ExxonMobil, which have withdrawn from the south.
The political context will be critical. While there are no significant challenges policy-wise as the current administration remains in control at the federal level and provincial level parties are supportive of the ruling parties in Baghdad, this may change in the run-up to elections.
Politicians may even be able to find a better excuse to interfere in these contracts.
“These contracts are the product of a transparent bidding process and are all based on two key parameters: the production plateau and the remuneration fee. Any changes to these two factors will render these contracts non-transparent and possibly illegal,” says Khateeb.
Should the political climate turn against them, oil companies have some weight they could wield. ExxonMobil’s migration to Kurdistan, relinquishing its significant stake in West Qurna 1, is one example the IOCs can use in talks with officials. This demonstrates to Baghdad the folly of insisting on tough terms when more agreeable fiscal conditions are on offer in Iraq’s autonomous Kurdish provinces.
But it seems unlikely many others will follow ExxonMobil. For foreign national oil firms such as Malaysian Petronas and China’s CNPC that signed up to oil contracts with Baghdad, Iraq is regarded as a strategic asset to ensure security of supply, rather than a money-making venture. The poor earnings prospects are less important to them than the IOCs. And for the IOCs, the southern TSCs may offer low value now, but are seen as strategic positions that could yield opportunities decades down the line.
The outcome of the wave of contract negotiations will go a long way to shaping Iraq’s chances of realising its potential as the world’s fastest-growing oil producer. Last year was important in registering progress after the missed opportunities of the post-2003 period. Oil production averaged 2.9 million b/d in 2012, enabling Iraq to add another 600,000 b/d to its exports. An increase of 500,000 b/d is targeted for 2013.
12 million b/d: The original Iraq oil production target set in 2009 for an anticipated 2017 deadline
8-9 million b/d: The revised Iraq oil production target to be met over a 2017-20 time frame
b/d=Barrels a day. Source: MEED