Tough contracts hurt Iraq energy auction: analysts

by Prashant Rao

Note: This article was originally published by AFP on June 1, 2012. It can be found in full here.

BAGHDAD (AFP) – A landmark Iraqi auction for oil and gas exploration blocks was a disappointment because of poor contract terms on offer and a lack of requisite energy infrastructure, analysts say.

The May 30-31 auction, the fourth of its kind to be organised by Baghdad in the past three years and the first to offer acreage for oil and gas exploration since the 2003 US-led invasion, ended with just three deals awarded out of 12 blocks on offer, and eight plots receiving no bids whatsoever.

Iraq’s oil ministry painted the bid round as a success, with one official arguing that a success rate of 25 percent was a “good result.”

Analysts, however, disagreed.

“It was not a success,” said Ruba Husari, editor of www.iraqoilforum.com. “It was not a success because the main aim of Bid Round Four was to find gas and develop it.”

Husari pointed to two key obstacles — poor energy infrastructure in many of the exploration areas, particularly in Iraq’s western desert which is thought to hold gas; and contract terms that required firms to specify how much money they wanted to receive, without knowing how much energy was in the blocks.

“Until you drill, and make a discovery and you appraise that discovery, and until it is declared commercial, you cannot tell how much you want to be paid for that, to make the project feasible,” she said.

“And with that infrastructure, you cannot monetise the discovery because you will only start receiving remuneration once you start producing, and you cannot produce if this infrastructure is not ready.”

Iraq is focused on building up oil pipeline and export-related infrastructure but remains lacking when it comes to gas, with insufficient facilities for extraction, treatment and transport of the resource.

Of the three blocks that were eventually sold, two were in Iraq’s oil-rich south, while none of the exploration blocks along Iraq’s western border received bids.

Blocks were eventually awarded to Pakistan Petroleum, and consortia led by Russia’s Lukoil and Kuwait Energy.

As in previous auctions, Iraq required firms that agree to explore blocks to work under fixed-price service contracts, rather than the production-sharing agreements that are common elsewhere and more popular with major energy firms.

But whereas previous bid rounds offered oil and gas fields that were already discovered and where production needed to be increased, analysts said the uncertainty regarding the level of reserves in exploration blocks offered in the latest sale meant service contracts were particularly difficult to accept.

“The drawbacks were the conditions, as they were only pure service contracts, so they did not have upside potential if they found a big field,” said Manouchehr Takin, an analyst with the Centre for Global Energy Studies in London.

Takin noted that a key issue was also that Iraq specified in the contracts that, were oil to be discovered in any of the exploration blocks, it could require that companies not extract any crude for up to seven years, as the country is already busy ramping up output at several fields.

But while Iraq would not need the production, and indeed may not be able to export such additional capacity in the short-term because of bottlenecks in the country’s export infrastructure, companies were not keen to wait so long to see returns on their investments.

“It is the terms of the contract, compared with other parts of the world, and the restrictions, and the possibility of seven years,” Takin said. “People want to get revenues from their expenditure — they are not happy with just getting back their costs.”

Iraq currently produces about three million barrels per day (bpd) of oil, and exports around 2.5 million bpd, but is looking to increase both figures dramatically in the coming years after awarding several contracts to boost output in the previous three bid rounds.

The country has proven reserves of 143.1 billion barrels of oil and 3.2 trillion cubic metres (111.9 trillion cubic feet) of gas, both of which are among the highest such deposits in the world.

It was that level of reserves which motivated international firms to accept deals paying them as little as $1.15 per barrel of oil extracted from proven oil fields.

Engaging in exploration, however, required a different calculation.

“The Iraqis are working with a service contract model that is not conducive with exploration,” said Alex Munton, an analyst in Edinburgh with energy research firm Wood Mackenzie. “It works with a discovered resource basis, it works with proven reserves.”

“It doesn’t work when the proposition is a significantly more risky undertaking, because you don’t know if you’re going to find anything. If you’re going to spend money on the basis you might not find anything, then the reward side of the deal has to be greater.”

Husari summed up the auction as a “poker game”.

“You cannot gamble on something you don’t know,” she said. “You don’t know what you’re going to find.”

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