Iraq Oil High Hopes and High Risks. Dr. Carole Nakhle

Transcription

1 Iraq Oil High Hopes and High Risks Dr. Carole Nakhle 1. Introduction Good afternoon Ladies and Gentlemen, I am very happy to be invited again to speak at this conference. I see that in the current Iraq War Inquiry, Mr. Tony Blair is being blamed for exaggerating the dangers in Iraq to justify the invasion. Well he did what we all do at times - but I am going to try to AVOID today - namely he overstated the evidence and hoped that the facts would catch up later and prove him right. Unfortunately they didn't. Nevertheless it really would not be an exaggeration to say that the Iraq oil potential puts it right at the top of the producer league. I think it was Mark Twain who cynically defined a big oil find as a liar standing by a hole in the ground. But in modern Iraq his cynicism would have been misplaced. Let us start with the facts on the ground or, I should say, under the ground. With 115bnbbl of proven oil reserves, Iraq has the world's third largest oil reserves after Saudi Arabia and Iran. But these estimates are dated and almost certainly conservative. And of course Iraq s potential should not just be judged in terms of oil. Proven natural gas reserves are estimated to 112 trillion cubic feet, but the country s potential could be much higher. Once Nabucco goes ahead, Europe could be cooking using Iraq gas. The current official goal for Iraq oil production is to reach 4 Mb/d in the next five years. Looking further ahead some officials have mentioned much bigger figures, even exceeding 7Mb/d within six years. This would take the country from its current position of being the world s 11 th oil producer to being the third. Indeed, the deals that have been recently signed and are currently being negotiated would almost triple Iraq's output, with a consequent significant contribution to world s oil supply and 1

2 therefore an impact on oil prices. No wonder OPEC are so interested in the way things are developing in Iraq! It has to be recognised that the subject of oil and gas in Iraq has all along been a tricky and sensitive issue because of the emotive aspects behind it. Back at the time of the US invasion in 2003 there was much talk about blood for oil and myths were vigorously promoted about ripping off Iraqi oil. Not being a politician, I maintain distance from the wilder claims, but being an economist, I focus on the contractual framework for investment in the oil and gas sectors as it is in practice emerging in Iraq. 2. The First Bidding Round On 30 June 2009, Iraq held the country s first licensing round for more than three decades, described by the Oil Minister, Hussein Shahristani, perhaps a shade overexuberantly, as the greatest race on Earth. Two gas fields and six oil fields containing about 37% of Iraq s proven oil reserves were put on offer (43bnbbls). Thirty two companies bid for contracts to develop those fields on offer in a televised auction. But this was no straightforward auction. Bidders were unaware that Iraq had a reserve price. The lowest bids were for a remuneration fee of around $4/bbl. But the Iraqi Government stated at the last minute that all it could accept was $2/bbl and gave bidders just a couple of hours to reconsider their terms. Frantic calls to head office followed - can we accept the take it or leave it offer? It had suddenly become a deadly serious game of nerves. Most of the bidders withdrew at the last moment, saying the terms on offer were unfavourable. Only one field the giant Rumaila oil field, near the southern city of Basra was awarded to BP and CNPC, after Exxon Mobil (who tabled the most attractive offer) turned it down 1. 1 For Rumalia, XOM bid a higher plateau production rate of 3.1Mbp/d compared to BP's 2.85Mbp/d. Because of that the Iraq Government was minded to award the contract to XOM if they could get them to accept $2/bbl. But XOM refused $2/bbl so they turned to BP. 2

3 What actually happened to create this situation? Put simply, the gap between Iraqi perceptions and the risk-reward balance required by the oil industry was just too great for most bidders. BP broke ranks and rescued the Government s strategy thereby changing the game for everybody What was offered? Terms of contract: Service contracts were awarded by competitive bidding. Service contracts typically generate the largest reward for the state; a 90% Government take is not unusual. At the same time they result in difficulties for IOC s in booking reserves, hence their attractiveness for countries with a strong nationalist tendency 2. Duration: The new contract is set at 20 years with the possibility to extend it by a further maximum period of five years 3. State Interest: 25% 4 Cost and remuneration: IOC s will finance 100% of the Capex, Opex and other expenditures (supplementary and training costs) (carry state partner). They get their money back through cost recovery mechanism (but the pace of getting it back is limited to 50% of the revenues attributable to the difference between the base and actual production profile). The lower the actual production and the lower the oil price, the less cost the IOC can recover. Furthermore, no costs can be recovered before production reaches 10% above 2 The types of contracts Iraq used since nationalization, which started in 1972 were limited to technical assistance contracts in the 1970s, production sharing agreements in the 1990s and a service contract called Development and Production Contract (DPC), based on the Iranian buyback contracts, that was introduced in 2000 and remained in place till the fall of the previous regime in Unlike the DPC, with 12 years and a provision for an extension. One can argue that the contract offered in June can be seen as a hybrid model contract, mainly as an attempt by Iraq to compensate for other limitations introduced in the contract. 4 During the early internal negotiations over the government entity stake, Iraqi oil officials debated different options and the earlier version of the contracts considered in late 2008 stipulated the government holds a majority stake of 51% in the project. As oil prices fell from their high of $140+/bbl in mid-2008, adding strains to the state budget, the interest of the state entity was dropped to 25%. 3

4 initial production at the start of the contract. (Unused amounts are rolled forward). Biddable Items: Companies bid on two features of the contract - the maximum remuneration fee and the plateau production target. In the June round, the squeezed down fee offered by the Iraqis of $2/bbl came as a complete surprise on the day. Fixed Signature bonus: recoverable from Service fee soft loans Income tax: Currently at 15% but being increased to 35% (on the Remuneration fee) for upstream sector and contractors. This reduces the headline $2/bbl to a mere $1.30 post tax! The Iraqi Parliament has yet to approve this change. The special tax of 35% also applies to contractors though the boundaries have yet to be defined - a unique arrangement to catch upstream economic rent but very difficult to police given the complexities in determining the boundaries of the tax regime. For example is the grocer selling food to the oil industry a contractor? Does he then become liable to tax at 35%? Interestingly I recall that the British Treasury tried to introduce a higher tax rate for the UK supply chain a couple of years ago. That was at a time when supply chain costs and profits were skyrocketing - the perception being that rent was escaping the tax net in form of high contractor margins. However the UK Treasury gave up on the idea, concluding that it was too complex to implement and police. As it can be clearly seen, these are very tough terms, maybe rightly so, given the size of opportunities being offered. But focusing just on size can be rather restrictive Revised bids Since the June outcome many IOC s have revisited their Iraq access strategy and concluded that they would need to lower their remuneration expectations if they were to be successful. As a result we have seen two very large contracts awarded to consortia led by Eni and XOM in late October and early November, for Zubair and West Qurna fields. They both have swallowed $2/bbl and even $1.9/bbl respectively. 4

5 This leads to the conclusion that perhaps XOM regret not accepting the Rumalia deal when first offered back in June. Eni, along with partners Occidental Petroleum, Kogas and South Oil will invest $10bn to increase production at Zubair field (from 195,000 bbl/d to a plateau of mmbbl/d over the next seven years) have also swallowed the going rate of $2/bbl, but remember this is a mere $1.30 post tax! Nippon proposed to invest up to $8 billion to develop the Nassiriyah oil field in the country's south, along with building a power station and a 300,000 bbl/d refinery. Meanwhile an Exxon-led consortium has secured the West Qurna-1 oil field (with reserves of 8.7 billion barrels). Once again they have reportedly accepted the $1.9/bbl fee. 3. Outcome of the 1 st bidding round: Who was the real winner? Well perhaps this is the wrong way to judge the outcome. In a sense, everybody can be said to have emerged a winner from the process. The IOC s, or some of them, now have a foothold in the most prolific oil province in the world. Iraq stands to benefit from Western technology and management expertise, let alone the flow of tens of $ billions per year in investment. But at the outset, the first bidding round was far from being the greatest race on earth. Yet, thanks to BP and its partner, the perceptions have changed. Iraqis played for high stakes they took a gamble and by all appearances have succeeded. They rightly judged that the competitive instincts of the IOC s are so strong that a hard bargain can be driven. However there are many challenges to overcome before the outcomes envisaged in the contracts are delivered From the Iraqi perspective Prior to the bidding round, the Oil Minister was caught in the middle. Had all contracts been awarded, he would have been attacked for being too generous and accused of squandering the country s oil revenues. Had none been signed, he would have been accused of being ultra-nationalist by not encouraging enough foreign investment. 5

6 But even though just one contract was originally awarded, it was The Biggest Contract. Rumaila field is described as the workhorse of the Iraqi oil industry (with remaining reserves exceed 17 bnbbls. The signature bonus for Rumaila was $500 million). The BP consortia commitment is to almost triple production from the field (from circa 1Mb/d to 2.9Mb/d) within 6 years; making it the world s second largest oil producing field after the Saudi Ghawar field 5. Whether this one jewel in the crown constitutes success or not it could certainly be argued that in practical terms the outcome for Iraq is realistic and sensible. Iraq is just not yet institutionally capable or organised to handle a whole raft of contracts at once. So in practice a slow pace with the big opportunities prioritised is the right pragmatic answer. Viewing what has happened as the first step in a new and strategic policy of oil expansion, it is fair to say that Iraq does seem to have won the first round of the game. Originally, the lowest bid on Rumalia was $3.99/bbl. The June offers for Zubair were in the range of $4.8 to $9.9! As for West Qurma, June offers were in the range of $2.6 to $19.3. The $2/bbl seems to be the going rate, although ironically the remuneration fee should be biddable From the IOC s perspective BP s move changed the rules of the game. The company described its deal as a strategic asset, giving it perhaps first-mover advantages and a foothold once again in Iraq - after having been thrown out of the country in 1972 when Saddam Hussein nationalized the oil industry. The deal also strengthened BP s position in the Middle East and also indirectly gave it greater access to the Chinese market and supply chain. 5 Rumaila is already integral to Iraq's output, contributing nearly half the nation's current oil production of around 2.5Mbp/d. 6

7 But BP s reputation is on the line if the production target is not achieved. Many are asking why did BP accept $2/bbl? Do they know something nobody else knows? Why did Exxon turn it down? 4. Second Licensing/Bidding round The second round of bidding for Iraq's oil contracts is due to take place in the first half of December (11 and 12). This will be the next big test. Will the terms be any better for the second round? And for whom? Based on recent events, a Christmas present for the IOC s looks unlikely. The country has offered 10 blocks with a total reserve of about 41 bnbbl 6. According to Iraqi officials, for the second licensing round, the two biddable parameters - per barrel service fee and plateau production target - will not be the same as in the first round. As the fields on offer are undeveloped, some modification in terms is not surprising. The government is likely to consider a higher per barrel fee than the previous round. Iraq is expected to reveal in advance the maximum service fee it is ready to pay for each project, unlike the first round. The Government will take a quarter stake in the new hydrocarbon contracts. The cash it is seeking up-front will be reduced but the second round bonuses will be non-recoverable (no soft loans) 7. What do companies expect for the next round? What will they do? Are they more desperate now or will they play hard ball? Let s wait and see. 6 Some of the major fields on offer include Majnoon and West Qurna-2 with more than 12 bnbbl of proved reserves in each and the Halfaya field with about 4 bnbbl of reserves. 7 Iraq will seek $1.2 billion in non-recoverable signature bonuses for deals made in a second round of bidding for oil deals (compared with $2.6bn in the June round): the signature bonuses for the East Baghdad, Halfaya, Majnoon and West Qurna super giant fields will be $150 million each), and $100 million each for the other six oil and gas fields it plans to offer. 7

8 5. Conclusion/observations The development of Iraq s world class oil reserves is of great importance both in its impact on the country s economy and in relation to the world s energy supplies in the 21st century. In a previous report, I criticised those who argued that Iraq would be exploited by the big oil companies. In contrast, I said that if Iraq puts in place the right framework, it can do the opposite 8. So far the Iraqi Government has played a skilled and somewhat risky game, offering service contracts with tough fiscal terms on fields in production, quite rightly. The gamble paid off thanks to BP, although it was a close shave. One wonders if the rest of the IOC s are cursing BP. However, the saying goes once bitten, twice shy and the IOCs may be warier next time, which means that Iraqi authorities also need to be more cautious in their immediate future deals and negotiating tactics. Emotions about IOC s involvement and the loss of sovereignty still need to be overcome. It should always be born in mind that investors cannot be pushed too far. Yes, Iraq does offer world class reserves and low cost, but the fiscal arrangement must reflect the right risk-reward balance. The IOCs and their backers have limited resources. Their capital will flow to the most attractive opportunities in their global portfolio, where it looks as though the best balance between risk and reward can be achieved. And let no-one assume that Iraq oil is somehow easy. Of course it is easier than some of the deeper fields being discovered elsewhere but in reality there is now no such a thing as easy oil. All oil fields can benefit from best practice reservoir management, the latest technology, extending field life and improving the economics of marginal projects. 8 Even one other deal would mean $50 to 60bn dollars in additional investment in Iraq, $ billions in additional annual revenue, and tens of thousands of additional jobs. 8

9 The danger is that Iraqi officials might still lack any clear understanding of the minimum IOC operational requirements or of the scale of the logistical challenge ahead. This in turn could create unrealistic expectations on the Iraqi side of what IOC s can deliver. As I began by reminding you the political risks in Iraq are still very high, and still impose heavy additional costs on the companies sending their staff to Iraq. Iraq's oil laws are still vague and with elections scheduled in January, oil policy seems to have become a political battleground. But a central political challenge now facing Iraqis is how to manage all those revenues from oil contracts and that the curse of oil which blighted other countries is avoided. Equally importantly, how will OPEC react when and if Iraq s output begins to climb by millions of barrels a day? What then will be the implications on the global oil supply and global oil prices? How welcome will Iraq, the new big boy on the block, actually be? Ladies and Gentlemen, what we have before us in Iraq is a golden prospect but also a dilemma. On the one hand the story of Iraq s recovery has been so far so good. But on the other hand very large risks and uncertainties abound. The shadows of geopolitical conflict and Middle East political turbulence still stretch heavily over the whole region. There is the familiar story in ancient Baghdad about the young boy Aladdin who found a magic lamp which only had to be rubbed to produce untold gold and riches. Unfortunately the lamp was stolen and from then on he had to use his wits and judgment to make any progress. Well of course there is no magic lamp in real life, either for the international oil companies or the Iraqi people. But both sides can gain if they proceed with patience, caution and realism. And then it could all end up happily, as it did for Aladdinalthough that, of course, was a pantomime story, and this is hard reality. 9