KRG Lambastes Iraqi Service Contract Framework, Casting Crucial Oil Law Unity in Doubt

Differing Views

Ashti Hawrami, natural resources minister of the KRG, yesterday told the World Petroleum Congress newsletter that the service contracts the Iraqi government was aiming to strike with IOCs to develop Iraq's major producing fields were "likely to fail…We don't encourage these contracts. It is not in the interest of Iraq or in the interest of the companies". Hawrami continued to claim that the Iraqi government's favoured contract model would result in slow development and "trillions of dollars" in lost oil revenue, and would contravene the Iraqi constitution.

While the lack of a national legal framework for the oil sector—as well as sufficient security—has hampered central and southern Iraq's oil development, the autonomous Iraqi Kurdistan region last year passed its own oil law, enabling IOCs and NOCs to take up exploration and production (E&P) acreage under production-sharing agreement (PSA) contracts. The region has been successful in luring more than 20 companies of varying size—albeit no majors—as it has been in its interest to secure international investment in exploration and build up a domestic revenue stream. Basing its unilateral action on its interpretation of the Iraqi constitution—in itself a hazy-worded compromise between Iraq's main factions—the region has nevertheless continued to be dependent on the passing of a national oil law, given that it remains impossible for Iraqi Kurdistan to export its crude production without consent from Iraq's Oil Ministry, which controls all available routes as well as the relations with the region's neighbours.

Study Says…

In yesterday's interview, Hawrami unveiled the results of a study commissioned by the KRG, in which international law firm Clifford Chance and consultant Pedro van Meurs reach the conclusion that there is "no doubt" that the contract model now being favoured by Iraq "would be a real tragedy" for the country, as it "completely misaligns the interests of the investor and the host government in terms of cost efficiency". Criticising the lack of incentive inherent in the TSC contracts, the report says that the service agreements pay the companies equal amounts regardless of the outcome of the contracts, making them unwilling to take technical risks, question Iraqi oil industry presumptions, or even introduce their most advanced technological solutions into the projects, so as not to unduly expose proprietary solutions.

The report also appeared to criticise the lack of transparency in the direct negotiations held for the initial no-bid contracts between the Iraqi oil ministry and a number of oil majors and IOCs. The oil ministry had been careless in giving the companies exclusive access to reservoir data for the fields they were in talks about, giving them a competitive advantage over other IOCs in the forthcoming bidding round, the World Petroleum Newsletter reported Hawrami as saying.

"It's a Trap"

Hawrami did not mince his words, summarising the report by saying that IOCs risked being blamed further down the line as the contracts failed to deliver the widely intended production capacity increments. "It's a trap, you've been waiting for five years; wait another five" he advised IOCs in the newsletter. Production levels of "7 million, 8 million, or 9 million b/d" would not be achieved by offering oil companies "lousy contracts".

He did not rate the chance of Iraq's parliament passing the contract framework as particularly high, as it will not maximise revenue from Iraq's resources, which—according to the KRG reading—is required by the Iraqi constitution. Emphasising the need for a national oil law to be passed before the tendering round goes ahead, he finished by saying that "anyone sensible will not sign, if you do not have a legal framework it will end in tears".

IOC Scepticism over Short-Term Agreements

Meanwhile, Total's chief executive, Christophe de Margerie, said that while the company was still in talks with the Iraq Oil Ministry to take on short-term TSC contracts on one of the fields later to be included in the licensing round together with Chevron, "2009 is probably too short a time frame to carry out major investments". Calling the contracts "transitory" he said this was all the majors could do given the security problems that remain in the country, Agence France-Presse (AFP) reported.

Total, Chevron, ExxonMobil, BP, Shell (in conjunction with BHP Billiton), and a consortium consisting of U.S. midsize Anadarko, the United Arab Emirates' Dome and Swiss-Dutch Vitol, have all been in direct talks with the Iraqi Oil Ministry over no-bid stop-gap pilot contracts to get development started on the six oilfields later to be tendered in the licensing round. The development was due to be conducted under a model TSC contract negotiated with the companies—later to be applied more widely—for a two-year term. The government's inclusion of the fields in the June 2009 tender has, however, slashed the term to less than one year, probably cutting the eventual hoped-for increment of 500,000-600,000 b/d from the contracts by far more than half. In fact, as Global Insight wrote yesterday, there are grounds to doubt whether the short-term contracts will be agreed in any form close to what has been discussed at all, as de Margerie's statement can be read to indicate.

Outlook and Implications

It is in the KRG's fundamental interest to get its contract framework—within which it has signed up a large number of IOCs committing E&P investment to the region—confirmed under a national oil law, in order to get access to export routes and be able to monetise its resources (under the proposed national revenue-sharing agreement). Hence it is looking increasingly fearfully on the central government's move away from advocating PSA-based solutions to preferring TSC-based IOC involvement. The KRG has sufficient power and representation in the Iraqi parliament to make it very hard—if not impossible—for the Iraqi government to pass an oil law without its support, and the gist of the scathing criticism delivered by Hawrami should probably be interpreted as a KRG threat to halt any anti-PSA oil law.

The Iraqi government will not be able to sign up IOCs for any long-term contracts in Iraq without an oil law being in place. This puts the KRG in a better position than it has been in for the last couple of months, when development on its earliest producing assets had to be de facto suspended as there was no way of marketing any output that exceeded the small domestic KRG demand. Now, the Iraqi government has committed to clarifying the legal and technical details of the tendering round by September, giving it three months at the most. If it fails to do this, it risks delaying the June 2009 tendering round, for which companies must submit bids by the end of March next year.

Delays to the round would further undermine the already-low legitimacy and trustworthiness of the scheme, perhaps opening the way for more frank and open negotiations about the oil law from the central Iraqi government's side, and leading to a clarification of the KRG oil laws' status.

Related Articles

Iraq: 1 July 2008: Iraq Outlines 2009 Oil Licensing Round; Short-Term Contracts Called into Question

Iraq: 23 June 2008: Six More IOCs Prequalify for Iraqi Service Contracts Bidding

Iraq: 10 June 2008: Companies Pushed to Sign Contracts as Iraq Unable to Raise Production Alone

Iraq: 29 May 2008: BP and ExxonMobil Submit Service Contract Proposals to Iraqi Oil Ministry

Iraq: 14 April 2008: Oil Ministry Pre-Qualifies 35 Companies to Bid for Oil-, Gas-Development Contracts

Iraq: 16 May 2008: Iraqi Oil Ministry Concludes Technical Talks with IOCs, Requests Final Proposals

Iraq: 30 April 2008: Violence Still Too High for IOCs to Invest, Iraqi Oil Ministry Report Says

Iraq: 17 April 2008: Government Says Deal Has Been Reached with Kurds over Iraqi Oil Law

Find out more about Same-day Analysis