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.

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