Analysis: BP’s crude payload from Rumaila oilfield

Payback Time

Iraq has started paying BP and CNPC for their work on its Rumaila oilfield, the mainstay of Iraqi crude production over the past few decades, allowing BP to lift a cargo of around 2 million barrels of Basra Light at a value of over USD200 million.

The cargo was, according to trading sources speaking to Reuters, set to leave southern Iraq last Saturday (14 May) and will be followed soon by a cargo lifted by BP’s partner CNPC, with yet another BP cargo allocated for lifting in late May or early June, according to Reuters’ sources.

The payment comes after BP and CNPC hit—and exceeded—the original 10% increment over the baseline production target at the turn of the year and were therefore due their USD2 per incremental barrel produced remuneration fee, as well as recovery of their capital expenditure (capex) investments in the development project.

It is understood that BP and CNPC by now are owed payments of about USD1 billion from the Iraqi Treasury, which they are expected to receive in kind, in the form of crude, under the technical service contract (TSC) signed for the Rumaila field.

At the beginning of the year, BP and CNPC reported boosting Rumaila production by as much as 20% above the baseline of 1.066 million b/d to 1.275 million b/d. Since then, however, output has been running at just below 1.2 million b/d, raising questions and fears over the occurrence of early reservoir problems on the field, which saw significant mismanagement and overproduction during the past three decades of war, instability and international isolation.

As IHS Energy has said, it is more likely that the initial boost—achieved largely by quick repairs and infrastructure debottlenecking—is giving way to more detailed development work, including an accelerated installation of electrical submersible pumps (ESPs) and workovers of existing production wells, which includes having to take some of the old producing wells offstream while work is ongoing.

Consequently, all existing production facilities will not be able to work at full tilt while the break-neck speed development continues—targeting a 2.85-million-b/d production capacity by 2017 and potentially a 1.5-million-b/d output capacity by the end of this year. BP holds a 38% operating stake in the Rumaila TSC, with CNPC partnering on 37% and Iraq’s State Oil Marketing Organization (SOMO) holding the remaining 25%.

Averting a Strike

Meanwhile, protests are increasingly spreading among Iraqi oil workers, who over recent days have threatened to stage blockades against foreign workers on Iraqi oilfields and organise strikes on production facilities.

The protests stem from discontent over pay for oil workers that are still working for the Iraqi state oil industry, who are seeing their salaries severely lag behind those of their colleagues who have been seconded to work for IOCs developing a host of Iraqi oilfields under TSCs awarded over the past two years.

IOCs have, when taking over the operations of Iraqi oilfields, immediately hiked salaries for the workers there, as well as launch bonus incentive schemes, which the underfunded state-entities have been unable to replicate.

The worker action, which reportedly also planned to target the Eni-operated Zubair field and the Shell and Total-operated Majnoon field, was seemingly averted through negotiations, although so far the Iraqi government response to the oil unions has been to call any action illegal and threaten severe security crackdowns and prison terms for those involved.

Whether the Oil Ministry will be able to fund imminent pay increases is doubtful, although precedents from other Middle East and North African countries over the past few months suggest that the region’s governments are increasingly willing to pay off dissatisfied workers in order to stave off wider threats of popular unrest.

Outlook and Implications

When entering Iraq, IOCs were well aware of the potential problems and popular backlash from hiring a lot of foreign workers and instilled a strategy of prioritising local hires and training Iraqis in order to lift their technical competence level, which had been severely eroded over decades of international isolation.

Hence the foreign workers present in Iraq now can be said to fill a gap that Iraqis are unable to fill, although this, as always, is something that is hard to convey. As protests and discontent spread through the workforce of Iraqi state oil companies, it is natural that the presence of foreign experts will also be seized upon by the protestors, although the irony is that any excessive IOC hiring of Iraqi engineers and skilled workers will immediately hit the operational capability of the state oil companies, whose pool of skilled workers is starting to run very thin.

That would, in turn, damage the oil infrastructure projects for which the Iraqi state industry is responsible for executing further—and they are already running late—with the risk of leaving the IOCs with shut-in production capacity at their upstream projects due to deficient pipeline or export terminal capacity, in due course.

Focusing of Minds?

The suddenly rather dense-looking oil cargo payment schedule will eat into the oil export earnings of Iraq, at a time when its budget continues to be over-stretched and it is struggling to finance, not to mention project-manage, much of its badly needed reconstruction across the country’s remaining sectors.

BP and CNPC are only the first companies to start collecting their fees and recover their capex among a growing list, with the Zubair consortium—Eni, Occidental (Oxy) and KOGAS—and West Qurna-1’s ExxonMobil and Shell all too having reached the payment threshold.

As capex investment will continue to escalate swiftly—well before resulting in higher oil production rates—Iraq’s state budget will see its net oil export income to the state budget come in at a much lower rate, a factor that might create a political backlash if not managed carefully by the Iraqi government.

Iraqi oil contracts lack the roof for capex cost recovery per year that are found in many other jurisdictions, and the pressure to repay investments for the break-neck development programme aiming for a 12-million- b/d production capacity—regardless of how incredulous the 2017 target is—is likely to start focusing the minds of the Iraqi government.

As IHS Energy has repeatedly said, a downgrade of the contracted production plateaus at some point in the coming two to three years is not unlikely, especially as there is reason to doubt the global demand for the 12-million-b/d Iraqi production capacity and as the country can ill afford the luxury of maintaining a swing production capacity akin to Saudi Arabia’s, before being properly rebuilt.

With all of Iraq’s megafield development projects running virtually simultaneously, there will be massive capex investments over the coming years for IOCs to recover before the added production capacity comes onstream.

With a government budget already under pressure, cutting Iraq’s output growth targets to more realistic levels is probably the easiest way to handle this problem, although it will require partial renegotiations of the oil contracts.

So far, the downscaling of Iraq’s targets has been a politically sensitive issue, but as costs will start to escalate, a government-initiated downgrade could well be portrayed as a responsible and prudent set of policies—if handled properly—vis-à-vis the Iraqi population.

If mishandled, however, the potential cut in net government revenue from all oil investments being recovered could well fuel a political backlash against IOC pay, with negative popular pressure on the oil companies and their contracts creating unpredictable consequences.