Oil Minister Gives June Ultimatum to Majors, as Iraqi Oil Law Progress is Held Up

Results by Flexing Muscle

Hussein al-Shahristani, Iraq's oil minister, has threatened to drop those technical service contracts (TSCs) for which majors do not submit their proposals by a new end-June deadline, instead proceeding without their help with the development of the fields. This measure is clearly directed at the group of oil majors that, for some months now, has been negotiating to sign up to a batch of spearheading TSC deals, each valued at US$500 million and aiming to add 100,000 b/d of production capacity to each respective field in a six- to 12-month period. A total of five of Iraq's largest fields are on offer among the first tranche of contracts, and the oil minister had originally hoped to add 500,000 b/d of production capacity as early as the end of 2008. The timetable has, however, been slipping: first hopes were for a signing early in 2008; this was put back to the end of March, and is now being seen as happening at best by mid-year. This means that work on the projects will hardly have started by the end of the year, and results will not be visible until well into 2009.

Hitting the National Capacity Ceiling

Given the timetable slippage, the oil minister's frustration is understandable, though his comments to Dow Jones and Reuters yesterday on the sidelines of an oil and gas conference in Italy, saying that Iraq's Oil Ministry—through its regional production companies—would undertake the development independently of the majors should the TSCs be dropped, sound more like rhetorical posturing. Al-Shahristani acknowledged in comments aired by Dow Jones that the know-how and technical capabilities of the majors would facilitate the process of increasing Iraq's production capacities greatly, although he added that Iraqi workers had already increased production capacity by around 500,000 b/d in the past year. They were capable of continuing to do so, the Oil Minister was certain.

The question of whether they are capableis relevant, however, as this is far from clear. While groups of Iraqi oil personnel have received training and support from the majors over the past few years, the collective workforce has suffered a disastrous rate of "brain drain", as the Oil Ministry's regional offices and production companies—like the rest of the government structures, but perhaps with some more diligence given the institution's centrality to Iraq's revenue flows—have been purged along ethnic and sectarian lines. The global shortage of oil engineers has further lured large numbers to join the Iraqi diaspora and take on lucrative assignments abroad. Furthermore, decades of Iraqi underinvestment, conflict, and isolation have left the industry far behind on a technological level, meaning that a learning curve to deploy, install, and operate technology and expertise several generations more advanced that what is currently being used will be time-consuming to scale without IOC assistance.

Iraq has managed to repair the infrastructure destroyed and damaged in the last war and in the civil infighting, as the U.S. army surge instated higher levels of security. Lifting production capacity further above 2.5 million b/d will, however, mean having to take new technological leaps, and given how rapidly Iraq could lift production by around 500,000 b/d when security allowed repairs to commence, it has been quite telling that the last few months have lacked further substantial production increases. Iraq seems—at least for the short-to-medium term—to have reached the ceiling of what its current in-house capacities can achieve without technical assistance.

Royalty and Windfall Tax

Al-Shahristani also clarified that the coming licensing round, for which 35 IOCs have been prequalified, will use TSC-based agreements as its foundation. The fields offered in the first licensing round following the 2003 U.S.-led invasion will be a second tranche of already-producing fields and "as there is no risk in developing already-producing fields", production-sharing agreements (PSAs) would not be relevant, Reuters reported the oil minister as saying. He did, however, also clarify that a 12.5% royalty tax would be applied through the contracts, as well as a windfall oil tax.

Oil-Law Negotiations Continue

Talks between Iraq's central government and the Kurdistan Regional Government (KRG) from the autonomous northern Iraqi Kurdistan region are ongoing, although issues further removed from the oil law seem to be holding up progress. Issues as wide as the status of the Kurdish defence forces—the peshmerga—and a general delineation of the region's autonomy vis-à-vis the central government are hard to solve, meaning that the oil law again risks becoming stuck among factional disagreements despite its centrality in getting development under way. Nevertheless, a greater understanding between the sides has been confirmed and a serious de-escalation of rhetoric has been noted, with the exception of al-Shahristani again yesterday affirming that the oil contracts signed with IOCs by the KRG are illegal.

As a compromise of sorts over the contracts signed by the KRG is necessary to reach an agreement, and leaked information from the negotiations seems to indicate a greater level of understanding between the sides on this point lately, the oil minister's habitual outburst seems peculiar in its timing. It might reinforce the determination on the KRG side to make his weakened position, and possible departure, conditional to a final oil-law compromise.

Outlook and Implications

Iraq has had a hard time lifting its crude production levels above pre-2003-invasion levels of 2.5 million b/d, since this entails large-scale infrastructure modernisations and the deployment and operation of technology much more advanced then the decades-old equipment used currently in Iraq. As a result, the oil minister's threat to drop latecomers from the initial contracts rings somewhat hollow, although no major will want to upset the goodwill created in the Iraqi Oil Ministry over recent years.

Likewise, the oil minister's notion that there is no risk involved in upgrading producing Iraqi fields and hence TSCs—as opposed to PSAs—are called for is somewhat halting given that the security of recoverable reserves is still outweighed by the political, legal, and physical risks experienced in Iraq. Thus, majors will continue to be reluctant to sign and try to push the deadline further back. Iraqi security in the latter part of the year is a concern, especially if an expected, but delayed, U.S. troop drawdown is implemented. The lack of a legal framework is inhibiting for the companies, and the political insecurity over what legal framework and deal with the KRG is to come, is likewise unsettling. Hence, further large-scale additions of production capacity in Iraq during this year look increasingly improbable.

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