Iraq’s oil: the sale begins

Iraq is a treasure chest of black gold, and now it’s offering contracts to foreign firms for the first time since 1972. But terms and conditions apply, says Cris Sholto Heaton.

Why is Big Oil so excited about Iraq?

Iraq is the world’s biggest untapped prize for oil firms, claiming to have 115 billion barrels (b/b) in proved reserves, plus large areas of the country that have not yet been properly explored. In terms of proved reserves, it ranks third behind Saudi Arabia (which claims 264 b/b) and Iran (138 b/b), but with a crucial difference.

Saudi Arabia remains off limits to foreign firms, with all oil extraction being done by state-owned Saudi Aramco. And the majors dare not invest in Iran while relations are so poor between Tehran and Washington. Iraq, on the other hand, is throwing open its doors. The government has just offered oil contracts to foreign firms for the first time since it nationalised the industry in 1972.

Who’s in the frame?

Almost every heavyweight in the oil business. Finding new reserves elsewhere in the world is becoming increasingly difficult and costly and oil firms are desperate to get access to the Middle East’s giant, low-cost reservoirs, where lifting costs can be as low as $1.50 a barrel. Iraq is an opportunity that can’t be passed up, so Western firms such as ExxonMobil, Royal Dutch Shell and BP, along with China’s Sinopec and Russia’s Lukoil, have shown interest in the six oil fields and two natural gas fields. However, there are plenty of obstacles between the majors and a steady flow of cheap oil.

What sort of obstacles?

Political uncertainty, for one. Oil firms remember Kuwait’s plans to revitalise its industry in the late 1990s, when officials insisted the contracts didn’t need parliamentary approval. Ten years on, the deals are still bouncing between committees. The Iraqi oil ministry is similarly insisting that parliament won’t need to vote on these deals, which reflects ongoing bad blood between oil minister Hussain al-Shahristani and many politicians.

Some nationalists oppose the new contracts outright, arguing that Iraq should rebuild its industry without foreign aid. Critics say the ministry has been too slow to boost production. At around 2.4 million barrels a day, this is still below pre-war levels, creating a budget crisis this year. The Kurdish Regional Government (KRG) of semi-autonomous northern Iraq agrees that the pace of development has been too slow. It’s been offering its own deals to explore northern Iraq since soon after the 2003 war.

Why haven’t majors invested there?

Shahristani says the Kurdish contracts are illegal. So only small firms such as DNO and Addax Petroleum are willing to get involved, with bigger operators holding back for fear it would disbar them for competing for bigger prizes outside Kurdistan – even though the type of contracts the KRG offers are much more attractive than the ones the central government proposes.

What’s wrong with the contracts?

Oil firms prefer production-sharing agreements (PSAs), where they receive a percentage of profits from the fields. This lets them earn more as production and oil prices increase. However, what’s on offer this time are service contracts, in which the company is paid a fixed fee for operating the field. For firms such as Sinopec, this makes less difference, as the national interest of gaining access to oil reserves outweighs commercial considerations.

But these types of contracts are unpopular with Western majors because they’re not profitable enough. In fact, only one of the bidders accepted the Iraqi oil ministry’s terms inthis week’s televised auction, which was described as “a fiasco” by Rochdi Younsi at Eurasia. “It shows the discrepancy between Iraq’s expectations and what companies were willing to offer.”

So will the majors just give up on Iraq?

Not a chance. Iraq has 9% of global proven reserves plus huge exploration potential – and still wants to up production by more than 60% from the fields on offer. This contract round should be just the first of many; firms will hope for better terms later.

And they’re right to be cagey – history suggests there’s a big risk attached to accepting poor deals in the hope of achieving better terms later. Until the 1950s, the Seven Sisters (the leading Western oil firms) demanded 50% of profits when investing in the Middle East. Then in 1957, Italy’s Eni (then a small group desperate to boost its position) accepted just 25% on an Iran deal. With the 50/50 principle broken for the first time, the majors’ bargaining power collapsed.

If they now agree to service contracts in Iraq, the majors risk consigning PSAs to history. This may be inevitable; with most of the world’s remaining oil concentrated in a handful of countries, the majors have little negotiation room and are likely to end up as service providers, not partners. But they’ll want to forestall this for as long as possible.

How much oil does the Middle East have?

Of the world’s proven oil reserves, 60% were held by Middle Eastern countries as at the end of 2008, according to BP’s latestforstall review. World Oil and Gas Journal puts the region’s globalshare at 55%.

But the accuracy of these figures is unclear. They’re based on data provided by the countries, which is not externally audited. There’s little incentive to ensure these figures are accurate; indeed, as Opec production quotas are based partly on reserves, there’s every reason to exaggerate –and the suspiciously stable reserves figures for most of the Middle East over the last ten years suggest this may be the case.

Some analysts have argued that real reserves are much smaller than claimed; yet it’s also possible that the quantity of untapped oil could be much higher, given the number of under-explored prospects in these countries.