Iraqi Government to Invest US$2.5 bil. in Five Core Output-Raising Technical Service Contracts

Luring the Giants

Iraq's Oil Minister, Hussein al-Shahristani, has been preparing his government to allocate up to US$2.5 billion for five TSCs, each at one of Iraq's largest producing oilfields. The TSCs are planned to add 100,000 b/d of production capacity to each of the five fields and will run for a short two-year period, according to senior Iraqi Oil Ministry adviser, and former oil minister, Thamir Ghadban. It is hoped the contracts will be signed early next month and "there is a rough estimate that it could cost about US$400 million to US$500 million per field," Ghadban told Reuters in an interview, adding that "between US$2 billion and US$2.5 billion over two years…should be paid by the government to companies." As Global Insight reported recently, the Iraqi government is working out a framework where the companies could receive their pay in crude as well as trying to reach some guarantee that the TSCs will be converted into long-term production-sharing agreements (PSAs), when a national oil law so allows.

The TSC framework—allowing companies to come in and undertake development and production activities under a fee-based framework, instead of being able to book reserves like under a PSA set up—is being adopted because the Iraqi government has failed to push a national oil law through parliament. With Iraq lacking any regulatory framework for private participation and investment in its oil sector, allowing TSCs under the old pre-2003 invasion laws is the only tangible option left for the government in order to obtain know-how and new technologies. Iraq's own state-owned operators have suffered from a long and disastrous “brain drain” and the remaining workforce have missed decades of technological development in the oil industry because of the long period of under-investment under the former regime, as well as wars and sanctions.

As Iraq, five years after the 2003 invasion, has managed to lift its oil production to pre-war levels, mainly by restoring above-surface production infrastructure and securing the northern Kirkuk-Ceyhan pipeline export route from sabotage, new technologies are needed to obtain further incremental rises. Reservoir management programmes need to be launched, new wells need to be drilled, and many existing wells need workovers. Enhanced oil recovery (EOR) schemes need to be put in place and much of the infrastructure—some of it dating back to the 1930s-50s—should be exchanged for modern technologies.

A comprehensive licensing round to hand out TSCs for most of Iraq's oil fields is under way, with more then 70 IOCs having registered themselves for pre-qualification The prolonged negotiations with the majors over the first five pilot contracts seem to have delayed the pre-qualification process for up to another month, however, from an original planned date of late March. This licensing round is, however, being spearheaded by the issuing of the first five TSCs for Iraq's largest fields to five of the world's largest majors, with each of the contracts being expected to result in the incremental output rise mentioned by Ghadban above. The rather small cost per contract is evidence of the comparatively small investments needed to secure production rises in Iraq; an alternative view is that it represents over-optimism on behalf of the Oil Ministry.

Glorious Future, Gloomy Present

Although Iraq has managed to restore oil production to its pre-invasion levels recently—levels that were very low as a result of international sanctions and under-investment—the lack of progress on almost any of the more complex issues facing the hydrocarbons sector is staggering. Apart from the lack of a proper legal framework, the Iraqi Oil Ministry has failed to invest anything in the acquisition of new technology, completely relying on IOCs to bring that to the table when international investment gets under way. Investment has, however, not been secured, as the national oil law has stalled in parliament for over a year and become a hotly contested issue between the country's leading factions.

Under the TSCs, the government will have to pay upfront fees for new technology being implemented and, although many of the majors have been running goodwill training courses for Oil Ministry personnel, technology transfers take time and require well-functioning organisations to be successful. The total price tag of US$2.5 billion for the five two-year contracts adding 500,000 b/d of production does not sound in any way comparable to other enhanced oil recovery, drilling, workover, and production infrastructure projects internationally, especially when taking globally spiralling contracting and raw material costs into the equation. On top of that, the companies will need to be compensated for their extensive security arrangements, further lifting their operational costs, and, lacking an oil law properly regulating their rights and obligations, the companies will be cautious to make any substantial financial outlays themselves without being reimbursed.

Outlook and Implications

The history of miscalculation and over-optimistic targets emanating from the Oil Ministry over the past few years has, unsurprisingly, failed to build confidence among industry executives about the majors' ability to operate in Iraq. A shaky legal situation exposes the companies to every major change of political direction and the contentiousness of the drafted oil law further undermines any guarantees from the current government of the TSCs being converted to PSAs further down the line.

The security situation in Iraq is another serious problem still to be overcome. Although the violence levels have been falling sharply, this has been attributed to the U.S. Army surge, which is set to be wound down by mid-year, when the additional U.S. troops will be sent home. The majors will want to evaluate the ensuing security situation before risking their personnel and assets, as well as the resulting political climate following the creation of several new armed Sunni factions, which the Shi'a-dominated government might try to incorporate into the national security forces. The U.S. presidential election in November 2008 will be another big worry, with the possibility of an eventual U.S. withdrawal being viewed with great uncertainty.

Iraq probably offers the largest and most easily accessible hydrocarbon opportunities anywhere in the world for the majors, and they are naturally keen not to miss out on contracts being signed. Under the TSCs they will, however, not gain stakes in the reserves; hence, lowering their willingness to take risks. An incremental production rise of 500,000 b/d is clearly feasible, although previously aired Oil Ministry hopes that this should be reached by end-2008 seem over-optimistic. So does the US$2.5-billion price tag, which indicates a failure to understand Iraq's operating difficulties as well as the globally inflated costs of construction, technology, and know-how, which will needed to bring production at the five key fields up to international standards.

Additional Reading:

Iraq: 14 March 2008: Iraq's Oil-Contract Awarding Schedule Seen to Slip Again

Iraq: 5 March 2008: IOCs to Receive Crude as Compensation Under Provisional Iraqi Service Contracts

Iraq: 5 March 2008: Oil Minister Expects Additional 500,000 b/d of Iraqi Production Onstream Before End-2008

Iraq: 19 February 2008: Over 70 IOCs Register Interest for Iraqi Major Oilfields' Tenders

Iraq: 8 February 2008: Shell Tempts Iraq with Floating LNG Plant Proposal

Iraq: 1 February 2008: Shell Works on Iraq Gas Master Plan, Exports, but Needs Oil Law

Iraq: 25 January 2008: Oil Minister Airs Hopes for 400,000 b/d of Added Iraqi Oil Production in 2008

Iraq: 3 January 2008: Oil Ministry Looks to Pre-Qualify Foreign Bidders for Iraq Oil Licensing Round

Iraq: 30 November 2007: Oil Ministry Outlines Strategy; Eyes 1-mil.-b/d Iraqi Output Boost by 2010