Iraq: Taking politics out of oil

15 August 2008
Overcoming internal divisions will be key to creating a workable strategy for the long-term development of Iraq’s hydrocarbons sector.

For the past five years, Iraq’s energy strat-egy has been primarily defensive, aimed at restoring oil output to its pre-2003 peak of about 2.8 million barrels a day (b/d). The achievement of sustainable exports of more than 2 million b/d through the first of half of 2008, including nearly 500,000 b/d through the northern export pipeline, suggests Baghdad is close to achieving its aim.

But this year is also meant to mark the turning point in Iraq’s hydrocarbons fortunes, when the government finally starts to chart a coherent strategy for the long-term rehabilitation of the Iraqi oil sector.

The results are mixed. The dual-track strategy adopted by Baghdad’s Oil Minister Hussein al-Shahristani to revitalise the sector - comprising bilateral two-year technical service contracts (TSCs) hiking output by 500,000 b/d and an open licensing round to add another 1.5 million b/d over the long term - is already in danger of shedding one strand, with attempts to interest a clutch of oil majors in the service deals so far yielding nothing.

The majors lined up for the TSCs - the UK’s BP, Australia’s BHP Billiton, the US’ Chevron and ExxonMobil Corporation, the UK/Dutch Shell Group and France’s Total - have yet to be persuaded by the service deal model. They say the structure of the service contracts is ill-suited to their particular skill sets.

Unclear fees

Oil company bosses are wary of taking on the risk of working to ambitious production targets to which the fees are not related. Payments are set to be the same for all fields regardless of their output. “Big oil is not interested in short-term commitments without major advantages,” says Thamer Uqaili, a consultant at the UK’s Centre for Global Energy Studies.

Such benefits are not on offer, even if the companies’ participation would have added to the bank of goodwill. The majors have no guarantee that what are essentially bridging measures will represent a first step towards production-sharing contracts (PSCs).

Al-Shahristani’s decision to launch the licensing round - the second part of the oil investment process - has also taken some of the shine off the TSCs.

“Now that there is an open bidding round, companies do not see the point of the TSCs,” says Yahya Said, Middle East director of the US-based Revenue Watch Institute. “Even if the government was able to offer those who come in early via TSCs some advantages in the bidding round, that would have undermined the bidding round.”

The minister announced in mid-July that the bilateral contracts risked interfering with the oil-licensing round, read by many as a signal of the minister’s draining enthusiasm for the deals. Frustrated at the oil companies’ apparent waning interest, Al-Shahristani has also slashed the terms of the TSCs to one year.

There is strong resistance within Iraqi oil circles to the TSC structure. “Iraq’s oil industry is suffering from management and technical difficulties,” says Uqaili. “These short-term deals will have little impact on these issues.”

The stalemate triggered the intervention of Prime Minister Nouri al-Maliki in an attempt to force the pace. In late July, Al-Maliki announced the creation of a new higher council, the National Council for Reconstruction & Development, which will bypass the ministries to focus on strategic projects, including oil. This body will have the power to award contracts and define a single type of contract. It will invite firms to negotiate directly on oil projects.

Field auction

The ministry is bullish that the licensing round, for which 41 international companies are prequalified, will prove more successful than the service contracts. Al-Shahristani announced on 30 June the six oil fields and two gas fields that will be put up for auction, with the ministry preparing a roadshow in London in September. The oil fields are Rumailah, Kirkuk, Zubair, West Qurna, Bai Hassan and Maysan. The gas fields are at Akkas and Mansuriyah.

The long-term contracts are aimed at adding 1.5 million b/d to Iraq’s production capacity by 2013. Bidders will be requested to offer local companies a minimum 25 per cent interest in the consortiums. Contracts are expected to be signed by mid-2009.

The decision to press ahead with a licensing round is not without risk, as the supporting legislation, the Petroleum Law, is in parliamentary limbo. In public, ministers are upbeat about the prospects for the legislation being agreed. Industry & Mines Minister Fawzi Hariri says it should be passed before the end of 2008.

The private view is more downbeat. Pressing on with the licensing round and dispensing with the need for formal legislative backing for PSCs appears to be an attempt to reverse-engineer the process for investing in Iraqi oil and gas. The success or failure of the licensing round may yet determine the future investment climate for Iraqi hydrocarbons.

“The best outcome would be a clear legal framework and an agreement on the strategy going forward,” says Said. “But the next best would be to get on with the licensing round, so long as the process is reasonably transparent and consistent.”

Oil companies are happy to go along with the process, even without the immediate prospect of reserves bookings. But if the licensing round proves to be a blueprint for the future investment regime, the ministry needs to get it right. Some say the bid round’s focus on reinvigorating producing fields, rather than discovering untapped acreage, is the wrong approach.

Dissatisfaction is also evident over the contract structure. A report by oil contract expert Pedro van Meurs, commissioned by the Kurdistan Regional Government (KRG), compares the structure of the licensing round’s proposed risk service contract unfavourably with the KRG’s own PSC model contract, charging it with fundamentally misaligning the interests of the investor and the host government.

Van Meurs’ report, issued in July, says the ministry is encouraging investors to incur and declare higher costs. It says there is no incentive to achieve maximum recovery of oil and gas, and makes a lower recovery more profitable to the oil majors. The net impact would be lower revenues to the Iraqi exchequer.

This timely Kurdish intervention is indicative of the rising tensions between Irbil and Baghdad. The two sides have failed to make progress over the issue of who has the right to grant oil contracts, the main stumbling block to the passage of the Petroleum Law.

The danger is that the wider conflict between Kurdish aspirations to a supercharged form of autonomy and the growing nationalist consensus in the rest of Iraq will make it harder to reach agreement on oil issues.

The KRG has already lodged a complaint about being sidelined from talks on the service contracts, which it says cover locations in northern areas over which the Kurds have territorial claims, and that will ultimately be determined by the proposed referendum on the status of the disputed oil city of Kirkuk.

With Arab-Kurdish antagonisms flaring up after MPs passed a provincial elections bill that seeks to bolster Arab influence in Kirkuk, US ambassador to Iraq Ryan Crocker has been brought in to mediate between the two sides.

The impasse between the KRG and the federal government may be unlocked in time, but this could be linked to the wider political issue of Kirkuk’s status. “The two are related,” says Uqaili. “The Kurds may be using the Kirkuk issue as a test to see what happens over the contracts issue.”

Kurdish Natural Resources Minister Ashti Hawrami has so far stuck to the letter of the constitution to argue that the Kurds have the authority to negotiate contracts independently of Baghdad.

Compromise deal

A compromise deal could yet be patched up without a grand political solution. One thing that may help is that the Kurds have already signed the majority of the oil contracts they intend to: an estimated 28 out of 30 contracts.

“With just two left to sign, this may provide an opening for a deal between the two sides, because if these deals are grandfathered then the new law would not necessarily need to make explicit allowance for regions to sign contracts,” says Said. “They could grandfather the Kurdish contracts and from there on keep the process centralised. It is not ideal, but it is a way of reaffirming the asymmetric position of the Kurds.”

The federal government would in any case find it difficult to unwind many of the Kurds’ oil and gas projects. The latest, a $650m gas-fed industrial complex, Kurdistan Gas City, involves the UAE’s Dana Gas and Crescent Petroleum supplying 150 million cubic feet a day of gas from the Khor Mor field in northern Iraq. This project will feed domestic power generation plants and new gas-intensive industries, and will therefore be insulated from federal government interference, in contrast with the Kurds’ oil export schemes, which may require the explicit consent of the Baghdad authorities.

The ministry’s establishment of new regional oil companies, first in Maysan province and soon in Dhiqar governorate, could give added impetus to the drive of southern Shia regions for resource control, undermining the prospects for reassembling a united national oil company for all of Iraq.

Meanwhile, Baghdad has to focus on its existing opportunities. Resurrecting the TSCs may be asking too much, but Al-Shahristani needs the licensing round to be a success - and to be seen as such. Merely reaching the crude output level that sanctions-wracked Baathist Iraq averaged five years ago will not do.

Iraq’s leaders need to sort out a way for the sector to operate and find a way to take the politics out of management and strategic planning for oil, so that decisions can be taken from a purely technical and commercial standpoint. The country is still a long way from that point.

A MEED Subscription...

Subscribe or upgrade your current package to support your strategic planning with the MENA region’s best source of business information. Proceed to our online shop below to find out more about the features in each package.

Get Notifications