Iraq: The year of transfer?

Five years on, the US-led occupation of Iraq faces renewed violence in Baghdad's Sadr City and the once pacified city of Basra. In March and April 2008, Iraqi security forces have become ensconced in battles with militia in both cities.

Amidst this unrest, the country's oil ministry has taken the important step of qualifying thirty five international oil companies (IOCs) to bid for its first post-war licensing round (see table below for qualifying IOCs list), which it hopes to launch in May 2008.

Source: Iraq oil ministry's Petroleum Contracts and Licensing Directorate

The qualified IOCs will be bidding mainly for the provision of technical services aimed at enhanced oil recovery, updating technology and field redevelopment, rather than exploration and will be doing so before the fiscal and legal framework for working in Iraq has been settled.

Despite this significant advance in turning around the fortunes of Iraq's oil industry, the reality is that a safe operating environment in Iraq remains a distant prospect.

However, the US military 'surge' launched in February 2007 has met with some success, improving the security situation and facilitating a rise in Iraqi crude production (see chart on Iraqi monthly oil production), which has in turn bolstered the government's finances.

In Q1 2008, the total oil production for the country averaged 2.4 million b/d, close to 250,000 b/d higher than the 2007 average of 2.181 million b/d.

This figure is some way short of the 2.85 million b/d average achieved in the final three months before 2003's US-led invasion and still remains far below the country's potential (see chart on Iraqi oil production).

The substantial increase in the average daily production rate from Iraq's northern oilfields, including the giant Kirkuk field, climbed to a post-war high of 619,000 b/d in March, up 180,000 b/d from the previous month, Iraqi ministry of oil figures obtained by Platts showed. But this is still substantially below the pre-war average of 870,000 b/d.

Exports from the north averaged 320,000 b/d in March 2008, 74,000 b/d lower than February, and 1.598 million b/d from southern Gulf terminals, 56,000 b/d higher than in February.

Iraq's oil ministry figures also showed that production from southern fields fell to 1.796 million b/d in March 2008 from 1.905 million b/d during February.

It is unlikely that production will increase in the southern fields from current levels of 1.9 million b/d, due to the need for incremental work of drilling and of reservoir management, which would take months to implement under present circumstances and is largely dependent on the ongoing security situation.

The March 2008 figures also showed that Iraq exported 1.918 million b/d, down from 1.936 million b/d in February.

Iraq's potential too big to ignore

Investing in a factionally, ethnically and regionally riven country in which institutions and the rule of law are weak and which depends on an outside force for its stability is never going to look like a great proposition, but IOCs know that Iraq's potential is simply too big to ignore.

Iraq offers world class hydrocarbon resources that make it perhaps the last bastion of 'easy oil' on earth open to foreign investment. Proven reserves are estimated at 115 billion barrels of oil with low extraction costs.

Tariq Shafiq, director of Petrolog and Associates, and a member of the team charged with drafting Iraq's subsequently amended petroleum law, estimates the finding and development cost of Iraqi oil at just $0.5-$1.0/barrel and the operating costs at $1-$2/barrel, although costs may be inflated by security requirements and rising oil field equipment prices.

As a result, it is not surprising that a large number of companies contested to be qualified in the first post-war licensing round. Iraq represents such a big opportunity that IOCs cannot afford not to be involved.

Technical service contracts (TSCs) represent a foot in the door, with the possibility of much more lucrative exploration and production ventures in the longer term.

According to the Centre for Global Energy Studies' (CGES) recent study, Hydrocarbon exploration and field development in Iraq, new known fields in Iraq could support a plateau of 3.8 million b/d in addition to current output of about 2 million b/d, but this will not be realized soon.

Iraq's current production export facilities can handle up to 3.5 million b/d. This implies that a rise in existing output could be accommodated, but realizing the long-term potential of Iraq's reserves - output between 6-9 million b/d - would require major investment in new export infrastructure.

CGES forecasts Iraqi output of 2.146 million b/d in 2008, rising to 2.385 million b/d in 2009 and 2.692 million b/d in 2010 (see table on Oil production and export forecasts).

An important caveat is the contribution of the northern oil fields, where security issues have reduced capacity to 30-40%.

An improved security situation could result in an increase in production of 500,000 b/d, says CGES. An additional factor will be the success of service contracts negotiated with the majors.

In the north, capacity is not a problem so long as the security of the Iraq-Turkish crude pipeline can be maintained. In the south, the current export system and the Gulf terminals are barely sufficient to export at current levels.

Raising export capacity here from it's present level of around 1.7 million b/d to 3.0 million b/d would require the development contracts to include the rehabilitation of Sea Lines and the Khor Al-Amaya export terminal, the installation of extra storage tanks and pumping units, as well as pipeline system development, including the upgrading and completion of the second internal strategic pipeline (see map of Iraqi oil infrastructure).

Security environment the key element

While the lack of a settled fiscal and legal regime governing oil contracts in Iraq represents a major uncertainty, as does the ability to improve internal infrastructure, the security environment remains the key element in whether technical service agreements can be translated into real action on the ground

The negotiations for oil contracts are likely to be conducted outside of Iraq, mainly in Jordan. As there will be practically no security risks during this process for international oil companies (IOCs), the question is what will the Iraqi political and security environment be like post-2009?

In December 2007, the US military warned that despite a drop in violence, there is still no place in the country that is safe from attack by extremists.

"We have made no projections of peace at hand. We realize that security is very fragile and that at any moment any attack could occur at any place in Iraq," military spokesman Rear Admiral Gregory Smith said.

With a drawdown expected in US troop levels from summer 2008 and possibly a more radical change in US policy hinging on the year's US presidential election, companies will have to consider whether the recent improvements in security represent more than just a holding operation.

The US government has been relatively upbeat in its assessment of progress in stability and security in Iraq over the course of 2007, but there can be little doubt that the country remains in a highly fragile state.

Assessing the US Department of Defense's latest report on Measuring Stability and Security in Iraq, Anthony Cordesman of the Washington based Center for Strategic and International Studies had some serious reservations about recent progress.

Cordesman argues that Iraq's stability will require years of sustained US effort, writing that "2008 cannot be a decisive year in building stable accommodation, only a beginning."

Despite some legislative progress, Cordesman says "there are no timelines, for tangible action to either legislate major progress towards accommodation or to actually implement it."

Referring to the Department of Defense's assessment of internal tensions, and highlighting the weakness of Iraq's central government, he writes, "there remains a strikingly unrealistic contrast between the regional tension . . .and the data on provincial security transition assessment.

The provinces shown as "transitioned" or "ready for transition" are all either under the de facto control of the Kurdish Pesh Merga or competing Shi'ite factions in the south, and not transitioned to real world Iraqi Security Forces (ISF) responsibility or central government control.

This highlights a critical apparent gap between the plans for accommodation and the plans for developing the ISF."

Threats to security and stability

These concerns appears to be borne out by current events. The southern city of Basra saw an outburst of renewed violence at end-March as the ISF took on local militias in an attempt to control the city.

This battle is a major test of the reconstituted Iraqi army and the central government's ability to impose control on virtually lawless areas of Iraq.

In Baghdad, clashes have been reported between Iraqi and US forces and militants of the Mehdi army, led by Shia cleric Moqtada Sadr, who has called for a campaign of civil disobedience.

This raises the question as to whether the US military surge has had anything but a temporary impact on security.

A major success, according to the US Department of Defense has been the 'tribal awakening movement' or 'Concerned Local Citizen' ('CLC') program, which is proving "crucial to the counter insurgency effort."

Cordesman notes this is a critical risk area for 2008, arguing that the unplanned Sunni uprising against Al Qaeda has been the real key to improvements in security.

Any cuts in US forces will increase the dependence on the success of the CLC program.

The US Department of Defense itself recognizes the importance and risks attached to the CLC program, writing in its report, "the slow pace of integrating the CLC members into Government of Iraq institutions, lack of alternative employment and fears by the Maliki government that these forces may return to violence or form new militias are of concern

. . . Shi'a extremist and criminal activities have become growing threats to security and stability as the role of insurgents and Al Qaeda in Iraq wanes. The conflicts among communal groups for political power and resources continue."

It would appear that as nearly all foreigners in Iraq are currently either military or paramilitary personnel, the US surge has engendered a false sense of security. Iraq's regional and ethnic divisions are only being held at bay.

If IOCs do start work on the ground, there will be a much larger number of less well-protected foreign targets.

It would be very difficult for long-term service contracts to be run remotely or by proxy with contracting companies.

If security cannot be guaranteed then major foreign investment in Iraq's oil industry is unlikely. It is possible that IOCs will take on more risk than they might normally assume because of the size of the oil resources at stake.

In addition, they are well aware that competitors, in particular state-owned Asian oil firms, have shown a larger appetite for risk in other countries.

With a drawdown of US forces in sight, discussions on a new licensing round may prove of little significance, if Iraq's central government cannot bring the regions under its control.

IOCs will be keen to keep the door to Iraq's oil riches open, but will be unlikely to commit resources until a safe operating environment can be established.

Given that the prospect of an improved security situation remains a medium to long-term prospect, this suggests there will be no rush to conclude negotiations taking place in the calm provided by Jordan.

IOCs qualify for bid round

Iraq's oil ministry has qualified thirty five international oil companies (IOCs) to bid for its first post-war licensing round, which it hopes to launch in May 2008.

The list (see table for qualifying IOCs list), compiled by the oil ministry's Petroleum Contracts and Licensing Directorate and obtained by Platts, includes US and European oil and gas majors as well as Russian, Chinese, Korean and Japanese companies.

More than 120 international companies submitted expressions of interest and the ministry document says some would be considered for future licensing awards.

"The Petroleum Contracts and Licensing Directorate will continue updating the process of qualifying companies, especially those that did not pass, by updating their information with the view to allowing as many as possible of the IOCs to participate in the next Licensing Rounds (following the First Round)," the document states.

The list excludes companies such as Austrian OMV and Norway's DNO, which angered Baghdad by concluding production-sharing agreements with the Kurdistan Regional Government on the basis of a hydrocarbon law approved by the Kurdish parliament without central government approval.

The Iraqi oil ministry in Baghdad decided to forge ahead with the further development of Iraq's oil fields without waiting for a federal hydrocarbon law, which has failed to win the approval of all three main sectarian groups in Iraq, the Shi'ites, Sunnis and Kurds.

Iraq's oil reserves, estimated at 115 billion barrels, are second only to Saudi Arabia's. But much of the country remains unexplored and its producing fields are suffering from a lack of investment as a result of decades of war and UN sanctions.

Iraq's oil production averaged 2.181 million b/d in 2007, oil ministry figures obtained by Platts showed. This is below the average 2.8 million b/d achieved in the final three months before the US-led war of 2003 and far below the country's potential (see chart on Iraqi oil production).

The Iraqi oil ministry is negotiating separately with foreign oil companies on short-term technical service agreements as a stop-gap measure to boost production capacity from major producing fields.

It had hoped to sign agreements with multinationals in April but the talks appear to have stalled as the oil majors sought to link the Technical Support Contracts (TSCs) to longer-term contracts.

No agreement on Production Sharing Agreements (PSAs)

Iraqi oil minister Hussein a-Shahristani said April 21 that he still considered invalid oil production-sharing contracts awarded by the Kurdistan Regional Government (KRG) unilaterally because they did not conform with a draft federal law and had not followed rules of transparency.

The KRG has been at odds with Baghdad over the validity of oil contracts entered into between the Kurds and international oil and gas companies, as well as other issues such as whether or not the northern oil city of Kirkuk belongs in the autonomous Kurdish region.

"No, we do not accept them," Shahristani told reporters when asked to comment on whether the two sides had now reached an agreement over the contentious issue of whether contracts awarded by the Kurds without Baghdad's approval are valid.

"The contracts have to comply with the draft law," Shahristani said, adding that the award of exploration and production contracts should follow a transparent process and public tenders rather than direct negotiations with companies.

"Regarding the hydrocarbon (oil and gas) law, both sides agreed on the following principles: all ongoing negotiations will be within the framework of the constitution; the KRG and Baghdad have agreed they will start with the previously negotiated, February 2007 draft hydrocarbon, as the basis of the new draft law to be submitted to parliament," said a statement issued by KRG prime minister Nechirvan Barzani and posted on the KRG's official web site.

Shahristani said that the draft law was with the Iraqi parliament and he could not say when it would be approved. "It is with parliament," said the oil minister.

The draft has been held up due to disagreements over the final version submitted to the house of representatives between the country's three main factions - the Shi'ite Muslims, the Sunnis and the Kurds - over how to divide up Iraq's oil wealth, estimated at 115 billion barrels of proven reserves.

The KRG said that a revised draft law, a revenue-sharing law and other related documents would be submitted to parliament as a package.

"Once agreement has been reached, the laws concerning oil and gas, revenue sharing, the Iraqi National Oil Company, and the restructuring of the oil ministry will be submitted as one package," the KRG statement said.

KRG Prime Minister Nechirvan Barzani issued the statement following recent meetings with Iraqi federal government officials in Baghdad.

Barzani met Iraqi prime minister Nouri al-Maliki on April 12 for talks on differences between the two on the national hydrocarbon law, the status of the Peshmerga, the Kurdish security force, and the status of a referendum on the northern oil city of Kirkuk.

"Our meetings in Baghdad were marked by a positive feeling of cooperation and progress," Barzani said in the statement.

The KRG argues that the regional hydrocarbon law that it passed last August complies with the constitution and served as the basis for 15 production sharing agreements it has signed to date with 20 international companies.

Shahristani has warned oil companies doing business with the KRG they risk being banned from operating in the country and these companies were excluded from a list of 35 international companies that have qualified for an oil and gas bid round it plans to issue in May.

The Iraqi oil ministry in Baghdad decided to forge ahead with the further development of Iraq's oil fields without waiting for a federal hydrocarbon law.

Iraq's oil production averaged 2.181 million b/d in 2007, oil ministry figures obtained by Platts showed. This is below the average 2.8 million b/d achieved in the final three months before the US-led war of 2003 and far below the country's potential (see chart on Iraqi oil production).

Much of the country remains unexplored and its producing fields are suffering from a lack of investment as a result of decades of war and UN sanctions.

Baghdad is also negotiating separate technical service agreements (TSCs) with oil majors to boost production capacity in the short term until it awards longer term contracts.

The Iraqi oil ministry had hoped to sign the TSCs with multinationals in April 2008 but the talks appear to have stalled as the oil majors sought to link the TSCs to longer-term contracts.

Shahristani said the contracts are still being negotiated and suggested agreement was not imminent. "It will take some time," he said, speaking on the sidelines of the 11th International Energy Forum in Rome.