ANALYSIS: Boom Time in Oil Rich Iraq?

Iraq is establishing itself as a country that may finally be on the point of delivering huge returns on strategic investments. Although major international oil companies (IOC) have been working in the giant fields in the south and also in the fields in Kurdistan, progress has been slow.

This has been for three main reasons:

1. A dilapidated infrastructure which slows the delivery of crude oil to market.

2. The failure to pass an oil law, known in its current draft as the hydrocarbons framework law, which would regulate the oil and gas sector has also impeded progress and created political friction between Baghdad and Irbil.

3. The status of the contracts signed between IOC and Irbil has been the subject of much contention, with Baghdad maintaining the contracts are illegal (although in the last two months we have detected a softening of the hard-line towards this issue).

The absence of a legislative framework has also made IOCs nervous as to the Iraqi government’s intentions, although Baghdad has been at pains to reassure them of the integrity of their contracts. The Ministry of Oil has recently ridden roughshod over calls by some Parliamentarians, specifically the hard-line anti-West Sadrists, to cancel the oil and gas contracts with IOCs.

However, there are clear signs that a political accommodation may be in the cards, and, if that is the case, then Kurdistan and the south of Iraq will become booming business regions of genuine strategic business relevance where significant returns on investment can be made.

The major oil service companies, in particular Nabors, Halliburton, and Schlumberger, are heralding a change in operational emphasis towards exploration, reflecting a generally increasing sense of optimism within the oil
and gas sectors. Major oil service companies have made statements and released results that indicate the oil and gas sector in Iraq is poised for significant growth, both in the South and the North of the country. This report
examines the growth potential.

Analysis

–Current International Oil Company Contracts–

In Iraq, all IOCs are working existing fields on Production Sharing Agreements (PSA), which means the IOC only start to earn a profit once an initial performance plateau has been reached.

For example, in the case of BP and the Chinese National Petroleum Company (CNPC), working the supergiant Rumaila oilfield, they will be investing approximately $15 billion in cash over the 20-year lifetime of the contract. Under the terms of the PSA, there is the need to increase plateau production to 2.85 million b/d in the second half of the next decade.

Once production has been raised by 10% from its current level of approximately 1 million b/d, then BP and CNPC costs will start to be recovered, and fees of $2 a barrel will be earned on the incremental oil production.

In Kurdistan, because of the complexities over the legality of the PSA, Baghdad has only this year reimbursed the IOC the cost of extraction; they still have yet to pay the IOC what is called profit oil.

–Oil Service Company Indicators–

However, the operations the IOCs are conducting are described as workover. This means their core activity is an improvement of existing O&G production through more advanced technology or better extraction techniques.

Service companies, such as Nabors, Weatherford, Halliburton, and Schlumberger, deliver the actual work on the oilfields, and it is to these companies one needs to look to be able to assess the investment viability of Iraq.

Schlumberger has five rigs actively drilling for BP and ExxonMobil, among others, and will have ten in operation by early 2012. It has 450 employees on the ground, and expects the number to double to 900 by the end of 2011.

Nabors clearly sees growth potential. Reuters reported Chief Executive Gene Isenberg stated he expects 18 rigs to be added to the 102 now operating outside North America by the end of this year, with another ten starting to operate in the first half of 2012.

Many of the rigs will be deployed for operations in Saudi Arabia and Iraq, and that can mean only one thing: an increased emphasis on exploration. And the upstream sector is where big margins can be made. The oil service companies are, therefore, in effect signposting the potential development of the oil and gas market in Iraq, both south and north.

–New Opportunities in Iraq–

To set this increase in activity in the upstream market in context, the Ministry of Oil stated on July 27th that the next oil bidding round will be held on the 25th or 16th January 2012. Oil and gas companies are in the hunt for 12 new oil and gas exploration blocks. The Ministry will organise a conference on the next auction in September, following Ramadan.

The level of interest is already very high: there are 45 companies that have pre-qualified for the bidding round, and according to the Director General of the Petroleum Contracting and Licensing Directorate (a division of the Ministry of Oil), there are another 38 companies that have made formal expressions of interest.

The new blocks for exploration are shown below. The majority of the blocs are in the west of Iraq, which has seen the lowest level of exploration in the past. These areas are also close to Al-Qaʼida in Iraqʼs heartlands, and therefore, security of exploration will be – or should be – uppermost in the IOCʼs planning cycle.

The blocks (which are for both gas and oil) are found in the provinces of Anbar, Babel, Basra Diyala, Muthanna, Najaf, Nineveh, Qadissiya, Thi Qar and Wasit.

There is an element of politics here. In the past the Provincial Governments have complained about being excluded from the riches that oil and gas exploration should bring. This selection of blocks includes provinces whose governors have been most vocal on this issue.

A secondary political reason is to ensure Iraqʼs profile as a hugely significant player on worldwide oil reserves map is secured.

In terms of pure production, Iraq, in reality, does not require further exploration. The underlying aim of this exercise is to replenish reserves as result of current production. However, although that is the case for oil, this is not the case for gas.

Iraq needs gas urgently to help increase its ability to generate power. The lack of electricity is a significant problem in all strata of Iraqi society. It even led to the deaths of two Iraqis in riots in Basra last summer.

The development of gas that is not a by-product of crude oil exploration will allow Iraq to have a strategic energy supply that would be insulated from any lowering of oil production as a result of OPEC quota obligations. Iraq currently sits outside the OPEC quotas as the sector matures, but eventually it has signaled its intent to be a fully functioning member of OPEC, and will therefore be bound by its production quotas.

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