Friday, June 28, 2013
BEIRUT,Lebanon— Production sharing contracts (P.S.C.s) between international oilcompanies (I.O.C.s) and the Kurdistan Regional Government (K.R.G.) continue to besigned notwithstanding the opposition of Iraq's central government, which instead signsonly technical service contracts (T.S.C.s).Baghdad affirms that it alone has theright to negotiate and sign energy dealsfor the whole Iraqi territory, the K.R.G. included. SinceU.S. ExxonMobilentered the K.R.G.'s energy sector in October 2011 — at thattime the company acquired six exploration blocks — other major I.O.C.s have beeninvesting in the semi-autonomous Kurdish region. Presently, there are in IraqiKurdistan around fifty international energy companies (among them four bignames: U.S. ExxonMobil and Chevron, France's Total and Russia's Gazprom), whichtogether have invested more or less $20 billion.
.jpg "Chevron and Total Continue Investing in the K.R.G. A Brief Analysis of Baghdad's T.S.C.s vs. Erbil's P.S.C.s. (2)")
CHEVRON'S AND TOTAL'S RECENT ACTIVITIES INTHE K.R.G.
Approximatelyten days ago Chevron and Total respectively announced that they had increasedtheir activities in the K.R.G. In specific, on Monday, June 17, through a statement issued from Erbil, Chevron announced that it had signed an exploration deal— the third with Kurdish authorities — in relation to the Qara Dagh field. Thisblock is located in the southern part of the K.R.G. and totals about 860 squarekilometers (or 332 square miles). "Chevron will acquire an interest in andoperatorship of the Qara Dagh block production sharing contract from theKurdistan regional government," the company said in the statement.The U.S. company was awarded the exploration deal last January, while, in July 2012, it had already acquired from India'sReliance Industries Ltd. an 80 percent stake in two blocks two (called Rovi and Sarta, with therelated operational control) located north of the city of Erbil.
Almost in the same days, Total expanded its presence in the K.R.G. In fact, having purchased an 80 percent stake in the Barananblock (with the K.R.G. owning the remaining 20 percent), south of the city ofSuleimaniya, Total now has four assetsin the country. This block (a.k.a. K9)had been previously held by the Canadian oil and gas company Talisman Energy until it decided to hand over the acreage last year. In2012, the French company purchased a 35 percent stake in the Harir and Safen exploration blocks in the Erbil-controlled territory, while at the same time it owns a minority interest in the Taza exploration block in the Kurdish provinceof Suleimaniya.
In dealing with Baghdad, theposition of Chevron and that of Totalinare different. In fact, if on the oneside, the American company does not have any energy stake in central and southern Iraq,on the other side, the French company owns a stake in the Halfaya oil field insouthern Iraq. In this regard, since last year Baghdad has warned Total requesting that it cancel or freeze its contracts with Erbil unless it wants tobe forced to relinquish the Iraqi asset. Up to now, the company has continuedto operate in the K.R.G. and in Iraq. The only measure implemented by Baghdadhas been banning the two companies from future contracts in Iraq. Then, two events have changed the picture. First, last March Total was preselected with six other companies withreference to a call for bids in an oilfield in Nassiriya, in southern Iraq and second,still in March, ExxonMobil announced itsintention of increasing its investment in its West-Qurna-1 oilfield (a $50billion investment) located in southern Iraq. From this two events, it's possible to understand thatBaghdad does not have the upper hand.Indeed, it goes by itself thatreplacing big companies of the likes ofTotal or ExxonMobil it's not an easy task.
WHYINTERNATIONAL OIL COMPANIES ARE CHOOSING THE K.R.G. INSTEAD OF IRAQ?
In order to understand what ishappening in Iraq and the K.R.G. at the level ofenergy deals, the real questionto be answered is: Why are I.O.C.s all flocking to the K.R.G.?
There are three main reasons for the I.O.C.s interest in Iraqi Kurdistan:
A)The presence of abundant energy reserves— Current Kurdish data speak about 45 billion barrels of oil, i.e.,one-third of Iraq's proven reserves (proven reserves are those with a 90percent certainty of being produced at current prices with current commercialterms and government consent, known in the industry also as 1P) which areestimated at 150 billion barrels. In other words, quantitatively (notqualitatively because Erbil has heavier oil) the K.R.G. could be another Libya. Inaddition to oil, the K.R.G. has from 3 to 6 trillion cubic meters (TCF) of potential gas reserves, as recently underlined in London by the minister of natural resources ofthe K.R.G.,Ashti Hawrami, at the Iraq Petroleum Conference 2013 organized by C.W.C., a companyspecialized in the dissemination of the energy and infrastructure knowledge.
.jpg "Chevron and Total Continue Investing in the K.R.G. A Brief Analysis of Baghdad's T.S.C.s vs. Erbil's P.S.C.s. (3)") |
The Minister of Natural Resources of the K.R.G., Ashti Hawrami |
I.O.C.s invest where there are energy resourcesand — especially considering the supermajors— they are accustomed toinvesting in so-called difficult countries and harsh environments. Forinstance, Lebanon— a troubled country whose recent historyhas always been entangledwith Syria's (in the latter country there is an ongoingcivil war,if notsomething more because of theexternal actors, which are involved inthe warring operations within and outside the country. Up to know, there havebeen only sporadic spillovers of Syria's civil war into Lebanon)has recentlybeen able to attract for the prequalification phase of its offshore gas exploration contracts forty-six I.O.C.s.
B) Securityand a safe business environment— The K.R.G. with no doubt offers now more security and a saferbusiness environment (for instance: a modern and open investment law and aprogressive hydrocarbons (oil and gas) law for the Kurdistan Region) than those presentin Iraq.Moreover, during the last years Erbil has been able to implement progressiveeconomic policies and to increase its government transparency. "The K.R.G.also remains committed to the criteria and goals of the Extractive Industries Transparency Initiative (E.I.T.I.) and last year submitted a full report on production and revenues",said Dr. Hawramistill at the Iraq Petroleum Conference 2013.
On the other hand, Iraq is a volatileand unstable country, where the Shia-led government had struggled to restore orderuntil an increase of U.S. troops in late 2007 was able to push insurgents andmilitia out of the cities and provinces that they were trying to conquer. Therow with the K.R.G. about the disputed territory, and in specific about the destinyof the ethnically mixed city of Kirkuk (around 1,000,000 inhabitants, although the figures are disputed, the population shouldconsist of one-thirdTurkmen, one-thirdKurds and one-thirdArabs) with its hydrocarbonriches (the city sits on the second largest oil field in Iraq), hascontinually threatened to derail the peace progress. As a result, insurgents inIraq continue using violence in order to undermine the government. And accordingto the United Nations (U.N.),May 2013, when more than 1,000 people wereviolently killed,has beenthe deadliest month since the sectarian slaughter of 2006-07.
C)The K.R.G.'s P.S.C.s are more attractive for I.O.C.s than Iraq'sT.S.C.s— Let's now examine the two differenttypologies of energy contracts used respectively in Iraq and the K.R.G.
C1) Baghdad'sT.S.C.s— Since 2008, Iraq's Ministry of Oil has tried to redevelop its energy reserves by bringing inthe country top-notch foreign technology. And ithas done so through a series of technical servicecontracts (T.S.C.s) in four bidding rounds (these service contracts have taken also other nameslike Development and Production Service Contracts or Exploration and ProductionService Contracts, but the basic assumptions are quite similar). In practice, with T.S.C.s, I.O.C.sget only a small contribution per barrel while Iraq has full control andownership of the resources. The companies have no right to lift, market orbook reserves, plus they bear all the capital expenditures and financial risks.
Contracts linked to the first threebidding rounds, held in 2009, 2009 and 2010, had for the I.O.C.s an economic returnthat wasnot as high as expected and later some of thecompanies triedto renegotiate or to cancel the contracts. In fact, the fees per barrel wereas low as $1.15 to as high as $7.50. Plus, the feeswere additionally reduced by a 25 percent fully carried state participation andby a 35 percentincome tax. In the end, the government take in some cases was as highas 99 percent. Moreover, the barrel per fee was reduced by up to 70 percentas the R factor increasedfrom 0.0 to 2.0 (the R factor is a sliding scale that employs a ratio of twonumbers to determine a rate. In theoil and gas business the most common R factoris obtained dividing cumulative revenues by cumulative costs). For instance, ExxonMobilfrom the assigned supergiant West Qurna-1 (which is now producing about 500,000barrels per day) earns $1.9 per barrel. The profit for the company is substantially fair, but the problem is the produced quantity. In fact, torecoup 30 to 35 percent of its initial investment it should produce 2 millionbarrels per day, which is not doable now. Plus, as an additional hurdle, thecompanies that signed these contracts have become entangled with bureaucratichurdles.
Summing up, the first three licensingrounds obtained mixed results for Iraq. According to some commentators, thefirst one was initially a failure with only the supergiant Rumaila oil field (17billion barrels) awarded. Only through subsequent negotiations in the followingyear it was possible to award three fieldsthat initiallyhad not been not awarded:Zubair (4 billion barrels), Maysan (2.5 billion barrels), and West Qurna-1 (8.7billion barrels). Through these additional negotiations it was redressed a licensing round that atthe beginning had raised many questions and doubts. The second and third biddingrounds almost completely awarded their blocks even if bidding was in a certainway feeble. The only really important exception was in the second round theunsuccessfulassignment of the East Baghdad oil field (8 billion barrels). But itthis regard— andthis supports Baghdad's decisions— it should benoted that at least with reference to the first three rounds the fields onoffer were all pertaining to discovered areas (some of these were supergiantfields with more than five billion barrels of oil reserves). And this meantthat therisk for the companies was very low.
The fourth bidding round (oil and gas)was held in 2012 and it was a complete failure. In fact, the dissatisfactionof I.O.C.s with the terms proposed by Iraq was well shown last year when thisfourth energy auction ended with very few foreign investors bidding for theblocks. The result was just 3 blocks awarded out of 12 on offer (and 8 blocks didnot even receive any bid).
Why such a negative result? If theprevious three licensing rounds had offered rights to immediately start production raising output at large- or medium-sized sites with proven reserves, the fourth round instead involved areas with undetermined levels of hydrocarbons. Besides,in the fourth round there was a new formulato calculate the fee per barrel. In practice,IOCs would havebeen paid the fee per barrel on the remainingproduction after having deducted costs (for instance, if total production was 1million barrels and the contractor had spent $300,000 on a subcontractor, itwould later receive payment only for the remaining production, i.e., 700,000barrels). In the coming months Iraq will organize the fifth licensing round for oil exploration(ten blocks). It appears now that probably Baghdad willease its contractual terms in order to lure consistently I.O.C.s and avoid anotherfailure.
C2) Erbil's P.S.C.s— In Iraqi Kurdistan the oil and gas contractual terms are quite different. Today'scontracts date back tothe compromises included in Iraq's Constitution of 2005. In specific, Erbilasserts that the Constitution gives it fullauthorityto sign P.S.C.s with reference to futureoil and gas fields (theseare fields not yet discovered when the Constitution was signed eight years ago),shared authority for the existing fields, and the rightto export hydrocarbonsproduced within the K.R.G. borders. On the other side, Baghdad has a completely differentview: All fields (existing and future) are supervised at the central level, the government retains the right to approve or reject any future P.S.C. and Baghdadmust have full control over oil and gas exports. In order to try to overcomethis impasse and given the long-dated incapacity of legislating the much neededFederal Oil and Gas Law, the K.R.G. in 2007 passed the Oil and Gas Law of the Kurdistan Region. Since then the K.R.G. has entered into P.S.C.s with I.O.C.s. Baghdadhas immediately considered these contracts completely illegal and has refused to pay the K.R.G. thefull value of the oil produced in Iraqi Kurdistan. Baghdad has been paying as a reimbursem*nt only part of the costoil to the I.O.C.sworking in Iraqi Kurdistan.
.jpg "Chevron and Total Continue Investing in the K.R.G. A Brief Analysis of Baghdad's T.S.C.s vs. Erbil's P.S.C.s. (5)")
Followingthis move Erbilhas not had the economic resources to pay the I.O.C.s and has retaliatedhalting production from theK.R.G. It's important to know that based on their share of the Iraqi population,the K.R.G. is supposed to get 17 percent of national revenue. When last March 7, 2013, the federal government passed the 2013 Budget Law theagreed-upon allocation for the K.R.G. was $3 billion short of whatErbil expected. And the direct consequence of this federal law was the K.R.G. "Law of identifying and obtaining financial dues to the Kurdistan Region —Iraq from federal revenue", a.k.a. the Financial Rights Law of April 2013. Theaim of the lawwas to create a mechanism forthe assessment of the amount Baghdad owedto Erbil and, especially, and for the definition, within the framework of Iraq's Constitution, of aremedy if the central government did not pay. This remedy meant direct exportsof oil and gas produced in Iraqi Kurdistan. Currently,the K.R.G. Ministry of Financeaffirms Baghdad's debt is as high as $20 billion of which $4 billion belongs to the I.O.C.s operating in the K.R.G.
WithP.S.C.s a contractor in general carries out all the investments and performsmanagement implementing all the technical and operating services under thecontrol of a state agency (many times a national oil company (N.O.C.)). Here the bigdifference with service agreements is that a contractor receives a share ofproductionto recover its costs (cost oil). Subsequently, the I.O.C. willsplit the remaining production (profit oil) with the government to get itsprofits. Summing up, in a P.S.C. the overalleconomic rentconsists in generalof five components:
1) Bonus(government share),
2) Royalty(government share),
3) Government'sProfit Oil (government share),
4) Taxes(government share) and
5) Contractor'sProfit Oil (contractor share)
If it'strue that the majority of the economic rent goes to the hosting government,it's also true that the contractor has the possibility of recovering all itscosts (Exploration Costs, Development Costs and Operating Costs). In fact,Article 25.3 of the K.R.G. P.S.C.s formatsays that:
Subject to the provisions of thisContract, from the First Production in the Contract Area, the CONTRACTOR shallat all times be entitled to recover all Petroleum Costs incurred under thisContract, of up to [ ] percent ([ ]%) of Available Crude Oil ...
Plus,at the same time, in addition to recovering its costs, the contractor is entitledto obtain profit Oil. In fact, Article 26.2 of KRG's PSC says that:
From First Production and as and whenPetroleum is being produced, the CONTRACTOR shall be entitled to take apercentage share of Profit Crude Oil and/or Profit Natural Gas, inconsideration for its investment in the Petroleum Operations, which percentageshare shall be determined in accordance with Article 26.5.
Whythe K.R.G. is proposing P.S.C.s. is another good point to be raised.The reason isboth based on economic and political assumptions. Erbil believes thateconomically speaking it has to develop its own economic agenda. Being linkedto Baghdad means proceeding with a very slow pace and with unreliable economicgains postponed to future times. Iraq does remain now in dire conditions withhuge security problems associated to a sectarian civil war that continues up totoday and does not seem to abase. With reference to the energy sector, anational hydrocarbons law to date has not been passed and Iraq's bidding rounds,based on T.S.C.s, havebeen quite a failure. Moreover, Turkey is very interested intoErbil's energy riches and could be the customerpermitting theK.R.G. to export its oil andgas. In other words, P.S.C.s with a more balanced revenue sharing mechanism, could be theright tool for developing in a fast manner a sector thatuntil a fewyears ago (2006)had been practically nonexistent. I.O.C.s have flocked to the K.R.G. without many doubts. If improved economic conditions willpermit Erbil to create anindependent state is another thing. But surely in Erbil many officials do not havepositive ideas about Iraq's future. "Iraq is going to hell. If we cannotlive together we must talk about something else. We Kurds are not part of theconflict between Shia and Sunnis. But if there is a fire in the house nextdoor, it will burn you too in the end. And there is no fireman" said in aninterview Fuad Hussein, an adviser to the president of the K.R.G., MassoudBarzani.
CONCLUSION
Toconclude our analysis of these two types ofoil and gas contracts it should beunderlined that there is noenergy ontract that can really fit all the workingpossibilities. In fact, every contract suits different economic conditions, andit's important to strike a fair balance between I.O.C.s and the hosting state. A T.S.C.could be an acceptable contract when companies have to work in an environmentwhere there are proved reserves and/or where the real activity is just relatedto a previously exploited field (for instance, a redevelopment activity). In this regard, Iraq's first three licensing rounds (and also the contracts related to fields not awarded with the first licensing round,which only later were awardedthrough private negotiations— see for instance West Qurna-1) have very tightconditions, but with the right amount of produced barrels (permitting a companyto recoup its incurred costs) could well be profitable for the involved I.O.C.s.Things of course change if we consider areas with unproved reserves. In such acase, it's clear that contractual terms have to change if a government wants toavoid a bidding failure as Iraq's fourth oil and gas licensing round.
