Middle East tricky energy triangle

Baghdad's and Erbil's oil-output plans are entwined with political differences and Ankara's strategy to diversify energy sources

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The ashen fabric of Iraqi life over the past few years has had at least one bright thread running through it: the oil sector has gone from strength to strength.

Today, on the face of it, the prospects look good. Earlier this year, Iraq added 10bn barrels to its oil reserves, raising them to 153bn barrels. Now the country is about to go one step better. Oil minister Jabar al-Luaibi told the Iraq Energy Forum 2017 in Baghdad in April that a further 15bn barrels would be added by 2018.

In this same period, he continued, oil-production capacity would rise from around 4.4m barrels a day to 5m b/d. Some Iraqi officials are daring to suggest that this figure could reach 9m b/d by 2040.

The recent achievements of the Iraqi oil industry are especially significant because they were recorded when parts of the sector faced major setbacks. During the Islamic State (IS) surge in 2014, some of state-owned North Oil Company's fields were defended by Kurdish fighters and remain in their hands. Only small volumes of oil from Baghdad-controlled fields have been exported through Turkey—via infrastructure established by the Kurdish Regional Government (KRG), even though Baghdad regards the Kurds' independent exports as illegal.

Impressive as the recent expansion of southern Iraqi oil-production capacity has been, the country still has a lot of catching up to do—in the aftermath of decades of war and international sanctions. Pedro Van Meurs, head of the Van Meurs Corporation and an energy fiscal expert, told the Baghdad conference that compared to other Opec countries, Iraq's "reserve/production ratio is high. This means that on a relative basis, the level of Iraqi oil production has been too low during the last few decades." He added that to fully benefit from its oil resources Iraq needed to "find ways to strongly increase oil production during the coming decade".

Southern Iraq focus

In seeking to increase output capacity in the post-Saddam Hussein era, the focus has been on the oilfields and export infrastructure of southern Iraq. After decades in which Iraq's total energy sector was run by the state, the government in 2009 invited International Oil Companies (IOCs) to bid for technical-service contracts (TSCs) to develop major producing fields and new ones.

West Qurna 2 (today producing 400,-000 b/d) was in the latter category and the successful bidder was Lukoil. The company's head of Middle East upstream, Gati al-Jabouri, told the Baghdad conference that two-thirds of Iraqi oil production in 2016 (3.1m b/d out of 4.6m b/d) was from the seven IOC-operated fields. At the same time, "almost half of the new or added production capacity since 2010 has come from these fields, so the value that IOCs have brought to Iraq since 2010 is significant".

400,000 b/d West Qurna 2 oil output today

For Iraq to maintain the current production capacity level and grow it, Jabouri said, huge financial investments would be needed—in the order of $124bn over the coming 18 years. In Jabouri's view, the development of Basra's export infrastructure thus far had been "a great success for Iraq" but needed to be followed by "more investment in storage tanks at Fao and other facilities for exporting". But he added that the installation of single-point mooring buoys for loading oil tankers had "truly enabled Iraq to export the growth in its oil production and has set it on a good pace for the future".

Ensuring that the expansion of storage and export facilities is matched by growing production capacity in southern Iraq is another challenge. As Jabouri told the Iraq Energy Forum, "a key bottleneck is the delay in the common seawater project for water injection into oil wells". In his speech to the conference, oil minister Luaibi admitted that the project had been "delayed for five or six years" but added that the ministry was putting the last touches for a scheme that will eventually have the capacity to produce 10m-12m b/d of water.

BP, operator of the Rumaila field, has pointed to water problems representing one of the biggest difficulties there. The company's Iraq manager, Zaid Elyaseri, said that "despite all the challenges, we've been able to reach 1.44m b/d and have produced 3bn barrels since 2010". He added that "increasing water injection had been the main theme" in this success. Injection increased from 60,000 b/d to 0.9m b/d between March 2013 and October 2016, following the renovation of the Qarmat Ali water-treatment plant and related facilities.

Sharing burdens

Aside from technical and operational issues, the IOCs represented at the Iraq Energy Forum voiced dissatisfaction with some of the terms under which they were working. Abd Malik Jaffar, Petronas's Iraq manager, spoke of the need for "regulatory clarity and win-win contract terms" that reflected the interests of the operators. Abdulla al-Qadi, head of exploration and production at Crescent Petroleum, said that oil-price volatility "minimises the risk appetite" of IOCs, adding that "the sustainable way of developing projects in Iraq, especially in the oil and gas industry, is through joint public-private partnerships". These would enable the resource holder and operator to "share the risks and the burdens through good times and bad".

Lukoil's Jabouri said that remunerations for IOCs represented less than 0.5% of Iraqi revenue, adding that "the majority of investment projects in Iraq demonstrate low rates of return, in the low single digits" so it was "critical that contracts are adhered to in full" by the government. The current state of affairs was having "a negative impact on Iraq's competitiveness to encourage and find new foreign investment coming into the oil sector". To attract more investment Iraq should "improve the terms for companies and look at ways to ensure that future growth of production is matched by normal economic returns for companies".

Responding from the conference floor, former oil minister Thamir al-Ghadhban indicated that Iraq, too, was unhappy with the present arrangement, but for

different reasons. He agreed that "contractual terms should be respected, but these service contracts create problems because they don't protect the government in a low-price environment. Because whatever you spend, we pay you. Secondly the IOC has no incentive to cut costs." He went on to describe international operators as "expensive", delivering oil "at a high cost in terms of capital cost per barrel, as well as operating cost".

Finding a balance

For his part, Jabouri pointed out that in return for being paid back immediately for capital expenditure, the IOCs were forced to accept very low levels of remuneration. He said Lukoil earned $1.15 for a barrel of oil produced "which is actually $0.56 after taxes and other deductions. And that's nothing. So we need to find a right balance."

In a later presentation, van Meurs also agreed that there was more work to be done on terms and conditions, saying that the "current TSCs don't align the interests of Iraq and the contractors. Iraq takes 100% of the revenues remaining after cost recovery and payment of remuneration". On the other hand, "contractors receive more remuneration oil and more total oil if costs are higher. As a result, there is no incentive for the contractor to be efficient." Cost control procedures, he concluded, were cumbersome and the contracts "make it difficult to increase rapidly oil production under favourable international conditions for Iraq".

So exploiting the likely 168bn barrels of reserves under the ground in Iraq—and keeping the bright thread of oil looking vibrant—will require the crossing of contractual hurdles as well as technical ones. All this assumes that Iraq as a whole remains politically stable and secure and that Baghdad-Erbil relations stay calm, particularly after the defeat of Islamic State in Mosul.

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