Tuesday, 16 September 2014

Iraqi oil from propaganda to reality

A series of revisions to production targets will result in lower oil output from Iraq than originally planned.

On 4 September, Iraq reached an agreement with BP and the Chinese oil company CNPC to lower the planned production target for Rumaila, the country’s largest oil field. The agreement is not a one-off—it is part of a series of revisions to the targets that had been originally agreed on with international oil companies in 2009. The revisions will lead to a sharp fall in Iraqi oil output relative to the original unrealistic plans.

The BP/CNPC deal does not come as a surprise. For months international oil companies have been negotiating lower production targets for the fields they run. ExxonMobil agreed with the Iraqi government on a lower production target for the West Qurna-1 field. Lukoil did the same for West Qurna-2. Likewise for Eni and CNPC, the operators of Zubair and Halfaya, respectively. Only Shell is yet to agree with the Iraqi government on a new output target for the Majnoon field. It is lobbying for a reduction from 1.8 million barrels per day (mb/d) to only 1.o mb/d, but the Iraqi government is holding out for 1.2 mb/d. (The table below provides a summary of the original and revised production targets by field.)

Such broad revisions to the original agreements indicate a flaw in the way the contracts had been awarded. The process involved oil companies submitting bids specifying: (1) production target (the peak level of output the company would eventually produce from the field); and (2) remuneration for developing the field and reaching the target. Iraq then chose the bids with the highest production targets (since they result in more revenue) and lowest fees (less cost). But as pointed out by James Hamilton, these auctions encouraged oil companies to exaggerate production targets in order to win the contracts. Once awarded, they began negotiating lower targets to move from “propaganda to the reality”.

What does the new reality hold for Iraq? The path of future Iraqi oil production will be significantly lower than originally planned. Instead of producing 11.0 mb/d from the six fields listed in the table above by 2020, Iraq has to settle for only 7.2 mb/d. And even this target looks overly optimistic. To achieve it, Iraq has to be more stable and efficient in the next six years than it has been in the last five.

The production loss is even bigger if we include the fields of Qayara and Nejma, which were projected to add 230 kb/d by 2020. Sonangol, the Angolan company which had won the contract to develop them, pulled out of the country in February due to deteriorating security situation. The fields are now under the control of the Islamic State of Iraq and al-Sham, and there is little hope for production growth from either of them.

Finally, while BP/CNPC were not alone in negotiating a revised production target, the agreement unusually included raising their shares in Rumaila. BP’s share increased to 47.6% and CNPC’s to 46.4%, while Iraq’s stake was reduced to 6%. Iraq had previously maintained a 25% share in all oil fields, and it is not clear whether this reduction is unique to the BP/CNPC agreement or if it also applies to the other revised deals. Iraq might be moving from propaganda closer to reality, but transparency is still in short supply.

Monday, 1 September 2014

Who controls Iraq’s oil?

The conflict in Iraq is unlikely to materially reduce oil production but could lead to a significant slowdown in its growth.

The International Energy Agency has released the full text of its monthly Oil Market Report. The report raises interesting points about the current state of Iraqi oil production, some of which I discuss below.

                                 Source: International Energy Agency

1. Iraqi oil production continues unabated, despite the ongoing violence. Officially, Iraq's daily oil production averaged 3.1 million barrels per day (mb/d) in July. Oil fields in Kirkuk pumped 0.16 mb/d; the Kurdish Regional Government (KRG) produced 0.31 mb/d; with the southern fields responsible for the remainder of production at around 2.65 mb/d. 

2. By capturing Kirkuk, the KRG has doubled the production capacity under its control to around 0.85 mb/d. However, logistical constraints and political/legal disputes with the central government in Baghdad has kept production at half capacity.

3. Logistically, the KRG does not have the infrastructure to refine or export additional oil production. Fighting around Baiji has resulted in the closure of Iraq’s biggest refinery—with 0.3 mb/d capacity. Furthermore, the Kurdish private pipeline, which has been used to transport independent Kurdish exports, can accommodate current Kurdish exports but very little on top of that.

4. The dispute with Baghdad over independent oil exports has made it difficult for the KRG to find international buyers. Of the six KRG cargoes which have left the Turkish port of Ceyhan since May, only one has managed to offload its contents—at the Israeli port of Ashkelon. Another cargo is a subject of a legal dispute before a US court between Baghdad and the Kurds. The rest are still in limbo.

5. The Islamic State of Iraq and al-Sham (ISIS) has added Ain Zahla and Batma to its existing portfolio of oil fields, which consists of Najma, Qayara, Himreen, Ajeel and Balad. This means that ISIS controls 80 thousand barrels of daily oil production in Iraq alone—equivalent to 2.6% of the total official Iraqi output (including the KRG).

6. Oil production and smuggling has been reportedly providing ISIS with $2 million a day. These reports are not backed by hard data but they seem plausible if we assume that ISIS is producing at 50% of capacity (40 kb/d) and selling crude at half price ($50 per barrel). It also means that losing the oil fields could deal a significant blow to ISIS by depriving it from a valuable source of funding.

7. Southern oil accounts for 85% of Iraqi production and all official exports. Southern production and export facilities are quite distant from the conflict zones in the north and west of the country, and have been immune from sabotage. In the short term, violence is likely to have limited impact on Iraq’s ability to pump and export oil.

8. In the medium term, violence could have quite a negative impact on oil production and exports. First, the general deterioration in the country’s security situation could lead to a disruption in foreign investment and missing out on ambitious production targets. Some companies, such as BP and ExxonMobil, have already withdrawn non-essential staff. Second, trade partnerships are likely to be tested, with China and India—the largest importers of Iraqi oil—pre-emptively looking for supply alternatives