Country Focus: Iraq’s New Dawn

Iraq’s potential as an oil producer or as a market for contractors and sub-contractors is not in doubt. Proven oil reserves were 115 billion barrels at the end of 2010 according to BP’s last Annual Statistical Review, which the Iraqi Oil Ministry recently increased 143 billion. Harry T Holzman Jr, the man put in charge of estimating Iraq’s reserves by the US Army, thinks 230 billion barrels is realistic.

Realising this potential relies on Iraq’s oil industry undergoing nothing short of a transformation unprecedented in scale and speed in extremely difficult circumstances.

The Iraq Oil Ministry’s ambitious production target of 13.5 million barrels of oil per day (bpd) by 2017 has been undermined by the IEA and prominent industry figures, including BP CEO Bob Dudley, who said in June that, by 2017, “five or six million barrels is maybe a more realistic level.” 1.3 million bpd of Iraq’s 2.5 million bpd national output comes from BP’s Rumaila field in the south.

“Iraq is still insecure,” states the US Special Inspector for Iraqi Reconstructions’s April Quarterly Report to Congress. “The current government is unsettled, and leading parliamentarians are speculating on the possibility of early elections.”

The report notes the seismic shift that is due to come later in the year when the last US troops draw down, leaving Iraqis to largely police and negotiate reconstruction themselves.

Unlike the rest of the global exploration and production business, where ‘deeper, further, unconventional’ is the new mantra, getting hydrocarbons out of the ground is not the challenge in Iraq. “There are four types of business risk for international oil companies: exploration, technical, market, and cultural/political,” says Carter Andress of security and services firm AISG.

Whatever the production figures, Iraq is slated to grow rapidly. A recent Citibank study, quoted by the US Government’s latest Special Inspector General for Iraqi Reconstruction’s quarterly report to Congress (SIGIR), Iraq has among the best opportunities for growth in 2011 and is among the top five national growth prospects worldwide to 2050.

The International Monetary Fund predicts 12.2% GDP growth in 2011 and 11.1% in 2012. However, unemployment remains high, with unemployment among young men a problem at 40%.

2011 has already been a landmark year for the upstream industry in Iraq. BP has become the first international oil company to be paid for its investment in the memmoth south oil fields. The supermajor took payment in kind from the Rumaila oil field that it operates by way of a 2 million barrel tanker lifted in May. Shell and Lukoil are soon to follow.

Progress at Rumaila bodes well for international oil companies that have invested heavily in other south Iraqi fields. BP, in partnership with China’s CNPC, hit its 10% production uplift target in December 2010.

The question then, is not whether companies can find opportunities in Iraq, but whether the environment – legal, political, cultural, business, or physical – will let them do so.

Law and Politics

Iraq still lacks satisfactory hydrocarbon laws. A draft legal framework was completed in 2007. Progress has been stymied over a range of political issues, since then, not least over the revenue sharing arrangements between the various provinces of Iraq and the semi-autonomous Kurdistan.

“It is worth remembering what is at stake here,” says Anthony Franks, a Senior Strategic Analysis Consultant at The Soufan Group. “The proper management of one of the world’s largest oil reserves; only last week al-Shahristani stated that Iraq may raise proven oil reserves by 21% once reserves in Kurdistan were added.”

The hydrocarbons law has progressed in recent weeks, having been passed from the Oil Ministry to parliament.

Passing the oil framework law is becoming increasingly urgent, as MPs who are alarmed at the Oil Ministry’s willingness to plow on with awaring contracts seek to ban further oil and gas deals before the law is approved.

“I want to put an end to this vicious circle,” says Adnan Janabi, chairman of the parliamentary oil committee, according to the Iraq Oil Report. “The way to end [legal and constitutional problems] is to press everybody to get our act together and enact the oil and gas law.”

Regardless, the Oil Ministry has since initialed the long-awaited $12 billion gas deal for Shell and Mitsubishi to capture 700 billion cubic feet per day of gas currently flared from the southern oil fields, despite this being specifically mentioned in Janabi’s moratorium proposal. The project aims to greatly increase the feedstock for power generation for both oil companies and the national grid.

Accompanying the framework law is a law to re-establish the Iraq National Oil Company, which would vertically integrate upstream, transport, downstream and marketing functions under a cabinet-level executive. It is not yet known whether INOC would include Kurdish assets.

At the time of writing the amended framework law is with the cabinet for approval and the INOC law has had its second reading in parliament.

Once the laws pass (and assuming they do), companies will see their existing contracts regularized and be able to invest in Iraq with certainty.

2011 could be the year when this finally happens, in time for the 12 contract-strong fourth bidding round, slated for 25th or 26th of January 2012.

“The catalyst for rapid opportunity exploitation will undoubtedly be the ratification of the hydrocarbon law,” says Franks. “As soon as there is binding legislation in place, we believe that the oil sector will see significant growth, and more players will seek market entry.”

Staying secure

Security has generally improved markedly in Iraq over the last three years, though it remains a top priority. Any company operating in the country needs to include security as a necessary cost to business.

In a recent Reuters interview, Brigadier Moussa Abdul-Hassan, chief of the south oil police, said Iraq is barely capable of protecting its vital oil infrastructure and could falter if its oil police do not get enough manpower and sophisticated security equipment soon.

“With the expansion of oil work in the south, from drilling hundreds of oil wells to building oil facilities, we need to boost the number of troops and update our equipment to be fit for the job,” Hassan told Reuters.

With government’s security competence in doubt, and the drawdown of US troops uncertain, companies must invest privately to close any gap.

“Security is a major factor for any company operating in Iraq, however things have improved dramatically,” says Mike Douglas, CEO of logistics firm SKA-Arabia. “We are now adopting a much lower profile in terms of how we manage our security. SKA is very much focused on developing a local national solution and this is helping to lower costs in many cases.”

However, the last two months have seen an upswing in attacks on oilfield assets and high-profile targets. As a result of this type of activity, the Economist’s Intelligence Unit found that 64% of executives questioned believed that it was still too dangerous to do business in Iraq at present.

“The key for security now – and even more so in the future – is relationships with local police and the military,” says Andress. “Iraqi security forces are very much present and effective throughout the country” and local police “can identify and deal with threats much better than any Western security element will ever be able to do.”

AISG is an American-owned design/build construction firm, with the first Iraq Ministry of Interior license issued to a non-Iraqi private security company. The firm has completed $400 million of projects in Iraq since its founding in Baghdad in March 2004 without default.

AISG has around 800 staff in-country, and is responsible for operating and maintaining all facilities for 7,000 US soldiers and State Department personnel at six bases in Basra including the port of Umm Qasr and Safwan Iraq-Kuwait border crossing.

The firm also provides security, life support, training and life support services for international oil services companies and the US Chamber of Commerce delegations in Iraq. 

“The barriers to entry into the Iraq marketplace for foreigners include security overhead,” Andress explains. “If a company is not prepared to carry that load out the next year or so, then they are not ready for the market and should wait out the current security situation.”

Aditya Dalvi, Operations Manager at Lakeshore Engineering Services, a construction, environmental, and bulk fuels firm that has invested heavily in Iraq, says that hiring locals is key.

“Our private security division includes local Iraqi personnel on their security team rather than a team comprised solely of expats,” Dalvi explains. “With six years’ experience in Iraq and a large regional network, we have had a better experience with using a team that includes local Iraqi personnel.”

Security and services contractor Unity Resources Group says the upcoming transitional period as US troops drawdown will require continuous management and evaluation.

Whilst both US and Iraqi governments have been tight-lipped on the issue of US troop immunity from prosecution, URG says it is probably at the heart of negotiations on drawdown.

Kurdistan questions
No appraisal of Iraq is complete without emphasizing that, for the oil & gas upstream businesses, the country is effectively two nations in one.

While Baghdad has concentrated on awarding huge contracts to IOCs, Kurdistan has seen a rennaisance in drilling by independents, with mixed results: RAK Petroleum has struck promising wells, yet Sterling Energy has underperformed.

The logistics and business environment is also very different, says Eliska Hill, General Manager of Chapman Freeborn’s Dubai office.

“Over the last few years, the differences in working in Central Iraq and Kurdistan have become clear for the logistics industry,” she says. “The general safety of the region has allowed for greater development of the infrastructure of the airports, and this in turn has attracted the Western carriers to the area.”

“The airport authorities of Erbil and Suleymaniah have been very proactive for cargo also, and eased restrictions that have hampered Baghdad’s growth,” adds Hill.

Yet the most fundamental difference between Iraq and Kurdistan day to day is security. “The differences [between south Iraq and Kurdistan] are enormous,” says Franks.

“Kurdistan is, compared to the other regions of Iraq, largely safe,” explains Andress. “There are dangerous areas – e.g. Mosul and Kirkuk – but by and large the operating environment is benign and extremely welcoming. South Iraq is open for business, but the infrastructure, both business and logistical, is still being developed. Kurdistan is a much more modern and connected environment.”

Bureaucracy

Iraq generally is a strictly controlled business environment, and bureaucracy remains too prevalent and too slow to allow optimum development. Local knowledge and good relations with officials are the most important factors in getting things done.

According to Franks, industry contracts below $20 million in value do not need official approval. Contracts between $20 million and $50 million need approval from a joint management committee, and contracts over $50 million require Oil Ministry approval.

Franks understands contracts in the south are now going through the South Oil Company in a bid to speed project awards.

“The process for obtaining Government approvals at any level is extremely complex,” says Douglas. “However with over eight years’ experience operating in Iraq, we are well positioned to understand problems and overcome obstacles.”

Unity Resources Group says requirements for approvable contracts include details of personnel, equipment and vehicle registrations and monthly update reports. URG says there are additional nuances with operating in the Kurdish Region, Central Region and Southern Region which requires considerable experience to ensure compliance with national, regional and provincial requirements.

AISG emphasise the importance of local hires and relationships. “If you approach the Iraqis with Iraqis, as at the end of the day the IOCs are going to need to employ almost exclusively host nation locals, then you’ll find – as we do – that local regulatory consent for projects is pro forma within the context of Iraqi law,” Andress explains.

Charles Ellinas of management, engineering and development consultancy Mott MacDonald agrees. “The key thing is to be prepared to go and establish a local presence, have local offices and employ Iraqi staff.”

However, bureaucracy will still stifle the ability of businesses to grow, and companies have to price this in.

“It is complex and long-winded to obtain long-term multi-entry visas, which has in turn impacted upon the ability of oil companies to manage their human resource base effectively,” says Franks. “To obtain a visa, there is the need to fill out eight separate documents, two of which are in Arabic. The process can take over three weeks.”

Dalvi also cites visas as a business issue. “At times, obtaining a visa can take only a few days; at other times, obtaining a visa can take as long as three weeks.”

Obstacles to climb

Added to the above challenges is the state of the business environment in Iraq, which companies admit has to improve to spur needed investment.

In its 2010 Doing Business Report, the World Bank ranked Iraq in 153rd place out of 183, a ranking out of keeping with the country’s huge potential.

Iraq still lacks an adequate banking sector, with local banks unable to provide services to IOCs and larger services firms. The government is addressing this, though it is unlikely the finance sector will capitalise sufficiently to meaningfully support the industry anytime soon.

As a result of developing state of the Iraqi business environment, preparation is paramount. “Any company looking to enter the Iraq market should first take time to study the situation on the ground and to understand the complexities of how things are done”, says Douglas.

Demonstrating social responsibility works, says Franks. “Companies need to give as well as take,” he says. “Companies that have a demonstrable record or policy of Corporate Social Responsibility will be the companies that do well.”

“Lessons must be learnt. Engaging with local communities and tribal elders will be critical in avoiding local delays and strife,” agrees Ellinas.

Corruption

At the top, the Iraqi cabinet is generally regarded as scrupulous. According to the Iraq Oil Report, as Oil Minister Abdul Kareem Luaibi exited parliamentary discussion about the oil laws last month, a Basra MP handed him an application for a family member to obtain approval for a new petrol station petrol station. Luaibi declined.

However, “corruption rem-ains a serious issue in Iraq,” says Franks, and takes many different guises. Iraqis are resigned to paying ‘baksheesh’ to secure preferential treatment, whether that be to avoid a traffic offense, expedite bureaucracy, or bribe an official to secure employment for a family member.

In its 2010 Bribery Survey, Transparency International states that 56% of respondents interviewed in Iraq stated they had paid a bribe to local government officers, mainly to expedite paperwork.

It would be naïve to consider doing business in Iraq without devising a strategy on how to deal with corruption and bribery. While “the tide is slowly turning,” says Franks, “bribery and corruption is frankly endemic. Corruption might not be an intractable problem, but it is certainly an enduring one.”

With a drive for stricter anti-corruption legislation that carries international implications – the UK’s Bribery Act 2010 being the most recent and stringent example – oil & gas companies that cannot benefit from the heedless approach of state-backed players such as China’s CNPC need to be vigilant against the expectation of bribes and treat corruption as a serious business risk.

Going for growth

With IOCs, oilfield services giants and major independents vying for work, and significant costs before entry, southern Iraq looks like a maturing market. However, it remains early days, and companies need to prepare for the barriers to entry.

“There are numerous oil service and logistic companies trying to enter the market in southern Iraq, but unless they are careful in how they approach market entry, Iraq could be a very expensive business mistake,” says Franks.

“The old military saying that failing to plan is planning to fail is never truer than in complex environments, and Iraqi is most certainly a complex environment.”

The stakes may be higher in the next auction round of oil fields, as the government is likely to open up more challenging fields for development. To mitigate risk firms need to partner with local Iraqi companies, to ensure they get a local ‘social’ license to operate (see ‘Getting Cultured’ on page 26).

Embracing local communities mitigates risk. “A crucial element to our success lies in local talent that we’ve mentored through our apprenticeship program and the strategic partnerships we’ve made with extremely reliable local companies throughout the region,” says Dalvi, yet staffing is an issue.

“There are many Iraqis with oil and gas experience available, but they need training, particularly in terms of quality and safety, to bring them up to date with current industry standards and IOC expectations,” Dalvi explains. This issue encompasses every aspect of recruitment ranging from difficulties with references and a lack of skilled personnel and project management resources to training and safety.

Lakeshore already has mobile batch plant and construction equipment mobilised in Iraq in order to self-perform construction activities, reducing the cost and time needed to complete projects.

Mott MacDonald has been active in Iraq for more than 50 years and has completed over 1,000 projects in the country since 2003, from transport to health, power and water. The company is supporting international oil companies in the development of oil fields in the south, where projects include asset surveys, refurbishment of dilapidated oil infrastructure.

“To date our emphasis is on investing to establish longer term business,” explains Ellinas. “Our recent move to Iraq Energy City near Basra is a tangible sign of our strong commitment to the energy future of Iraq.”

MIS – a Sharjah-based fabrication and services company recently acquired by Lamprell – is building a significant presence in Iraq, with their progress in winning work there to date cited by analysts as a reason for Lamprell’s purchase. The company is registered in both Iraq and Kurdistan under respective joint ventures.

MIS operates its Sunbelt safety division in Kurdistan, and is planning construction of a 50,000 square metre fabrication facility there. The company will hire Iraqi staff and is committed to training and mentoring.

In addition, MIS is about to open a new fabrication facility near Basra. The company has plant fabrication, land rig, project management and safety training amongst its expanding offering in-country.

Logistics

While Iraq’s business environment is improving, the physical landscape will always be unforgiving. Temperatures peak at over 50 degrees Celsius in summer, water is scarce, and the national infrastructure is weak, despite an average daily reconstruction spend of $17 million by the US government since 2003.

While they may seem secondary issues, cooling, water and power are at the heart of producing hydrocarbons. They are also security issues: the fewer trips a tanker needs to make, the less chance it will be intercepted, the fewer disturbances there are to the population, and so the easier it becomes to do business.

“Water and power – and especially the fuel to generate power – are becoming major issues and as the Iraq economy starts to develop very fast the resources are simply not easily available for private companies,” says Douglas. “These are two of the areas in which SKA is working to provide solutions”.

SKA-Arabia offers a range of transport and logistics solutions to companies in Iraq that need to move fuels and personnel securely. The company is investing over $15 million in constructing a 20,000 metric tonne fuel storage facility in the port of Khor Al Zhubair and a $5 million 70,000 square metre warehousing and logistics hub at the Safwan Iraq – Kuwait border post.

The government has been criticized over poor domestic energy policy. A typical Iraqi still only enjoys four hours of electricity a day. In order to be sure of sufficient power, engineering companies such as Mott MacDonald have resorted to installing dozens of generators, each by an oilfield asset.

Until the Shell and Mitsubishi gas project is online Iraq has to import oil and gas at a cost of billions of dollars a year. This has given rise to a hasty gas pipeline deal with Iran to acquire sufficient gas for domestic power generation. The $365 million pipeline will be ready by 2014 – only two years before the nearby Iraqi Mansuria fields are scheduled to come on stream.

The Kurdish authority has fared much better on power generation, with Ahmad Ismail Saleh, a charismatic and passionate Kurdish poultry tycoon, investing millions in two new gas-fed power plants in Erbil and Sulaimaniya, supplied by Khor Moor gas from Dana Gas. Saleh is investing in a third liquid fuel plant at Dohuk which is due to come online later this year.

Lakeshore is currently buying truckloads of water and getting it shipped to their project site and Project Management Office (PMO), says Dalvi.

There have been successes in improving access to water. In 2008 AES Arabia refurbished a water plant near the Al Zubair petrochemical facility in Basra that had fallen into disrepair. Under a contract from UNICEF and the DFID, AES refurbished the plant to provide 24,000 cubic metres per day of treated water.

“It is difficult to see how these shortages will be resolved in the short term, other than through temporary fixes,” says Ellinas. “There are plans to overcome these in the longer term, such as the Common Seawater Supply project, the Southern Iraq Gas Utilisation project, and so on, but implementation takes time”.

Transport is clearly a vital – and costly – consideration for companies, whether moving personnel, equipment or fuel. Providing diesel for power generation has kept SKA Arabia busy. The firm is expanding its storage and distribution infrastructure offering and enjoys a current monopoly on commercial helicopter transport.

Hill reports increased demand for Chapman’s private jets, as these offer same-day return flights to Basra and Baghdad.

“The pressure is on to create safe transport networks,” says Hill. “We have been consulting on a variety of rotary projects over the last twelve months.
Cost is an important part of infrastructure investment criteria”.

Prospects

Whilst the challenges remain significant, and the pace of production gains is likely to undershoot government targets, Iraq is has opportunities for the those who prepare and adapt.

“The potential to achieve high levels of production is undoubtedly there,” says Ellinas. “Exxon, Shell and BP, among others, have committed billions of dollars and, in many ways, the future of their respective positions in the oil industry on successfully developing Iraq’s southern oilfields,” says Andress. “The IOC commitments ensure that failure to exploit Iraq’s oil reserves is highly unlikely”.

It is also worth remembering just how far Iraq has come since ‘Mission Accomplished’ in 2003.

“After over eight years on the ground I remain optimistic that production will increase; despite all the problems, I have seen the Iraqi people’s great ability to overcome adversity,” says Douglas. “However Iraq is not for the faint hearted. Only companies with the flexibility to overcome the obstacles will succeed in this environment”.

Getting cultured

Anthony Franks is a senior strategy advisor at The Soufan Group, an international strategic consultancy, which provides information and analysis to the oil and gas industry. He explains why understanding local culture is so important to getting business done in Iraq.

Part of risk mitigation and management in Iraq is cultural and social. Companies need to be aware of the social, economic, political and security issues that underpin day-to-day operations in Iraq. Oil and gas companies should be aware that the Islamic view of the oil sector does not necessarily sit comfortably with a Western capitalist view.

Big oil’s view is – naturally and necessarily – about profit. In Iraq the economic theories of Mohammed Baqir al-Sadr, Iraq’s most highly regarded Shi’a cleric of the last century, still have resonance.

Sadr sought to create an economic model which had social justice as its central goal. The oil sector is therefore at the very heart of this theory and in part helps to explain the extraordinary loyalty and devotion to duty of the Iraqi oil engineers who have nursed a fragile and dilapidated infrastructure for the last 25 years of neglect. Their achievements in Iraq are extraordinary.

Any company will therefore need to thoroughly research not only the metrics of their business plan, but also social and cultural nuances that must be equally well understood if they are to prosper.

And to make life that little more complicated, each region of Iraq has a distinct personality of its own: therefore the best way to mitigate risk is by a carefully coordinated process of gathering information on where a company intends to operate, followed by a calibrated stakeholder engagement plan to meet politicians, business and tribal leaders of significance and to establish an early rapport with these key individuals.