Iraq pushes for fresh oil expansion
Despite hurdles, energy sector ambitions abound
Despite the campaign against Islamic State (IS), the strain on the federal budget, the crippling of some oil and electricity assets, the Opec quota, and the unresolved dispute between Baghdad and the Kurdish Regional Government (KRG), 2017 brought success for Iraq's energy sector. Oil production stabilised at around 4.4m barrels a day, higher than in 2016. Some new export capacity came on stream in the south. Electricity generation reached 15 gigawatts for the first time. Thanks to higher oil prices, Iraq's crude export revenue last year came in at $60bn—its highest in three years.
The government wants to build on this platform and the plans are ambitious. Oil output capacity may reach 5m b/d by end-2017 and the Ministry of Oil (MoO) is now targeting 6.5m b/d by 2022. A fifth licensing round is imminent. Baghdad wants to replace the federally controlled portion of the Iraq-Turkey Pipeline (ITP), which has been heavily damaged in recent years, building a new link to Fishkabour at the border with Turkey. It plans to revive exports to Jordan and possibly through Saudi Arabia. And a host of refinery projects, including repairing the 310,000-b/d-capacity Baiji refinery, are on the slate—the government is targeting processing capacity of 1.5m b/d by 2022. That would more than end costly fuel imports and allow for significant exports. A new law, passed by parliament on 5 March, would re-create Iraq National Oil Company and give it sweeping powers over a lot of this.
Yet like the blast walls and roadblocks that still cripple traffic on Baghdad's streets, the hurdles in the way of this vast energy-growth plan are many. No one can even reliably predict who will head Iraq's government after the parliamentary elections on 12 May, let alone who will steer its energy sector. Among the energy investors Iraq will need, perceptions of hostile contract terms, opaque rules, snarling bureaucracy and a depth of graft that has left Iraq ranked as the 11th most corrupt country in the world are also strong headwinds.
Prospects for near-term increases in capacity are good. At the CNPC-operated Halfaya oilfield, close to the border with Iran in Maysan province, production is scheduled to double to 400,000 b/d the end of 2018. Other fields in the province, some operated by Cnooc, are also in a modest growth phase.
But the 5m-b/d target for end-2018 depends on an agreement with the KRG (and more flouting of the Opec quota—see below). The recapture of Kirkuk oilfield and its Avana Dome, along with the Bai Hassan field, from Peshmerga forces last year shut in about 280,000 b/d of oil that had been flowing through the KRG's 700,000-b/d pipeline to Turkey. So, this output would need to resume. Iraq and Iran recently signed a deal to truck oil from Kirkuk to an Iranian refinery in Kermanshah, but the volumes envisaged are negligible, at around 60,000 b/d.
Settling the Kurdish question won't be easy—even if both sides now have much to gain from an agreement. Iraq wants an outlet for its northern crude and the KRG is broke and needs federal funding to help it pay salaries, if not its mounting debt pile. In late February, prime minister Haider al-Abadi said an agreement had been struck to resume oil exports and "resolve differences later". But the block hasn't been lifted; and since then the federal government has begun a lawsuit against the KRG to stop it independently selling output from the region, which is now running at around 328,000 b/d.
The coming parliamentary election complicates matters. Abadi's tough stance on the Kurds since their September 2017 independence referendum has won him support elsewhere in Iraq, say politicians in Baghdad. That referendum, and the Kurdish debacle at Kirkuk, have also opened splits within the KRG itself, making it difficult for the region's leaders to agree a common stance vis-à-vis Baghdad—recent street protests against the government in Erbil probably weaken its position further. Still, the best hope for a breakthrough may come if Abadi is forced to rely on Kurdish support for his Shia bloc after the election.
The longer-term target of 6.5m b/d depends on building new export facilities, fixing other midstream constraints, and making Iraq more attractive to outside investors. In the north, the government wants Kirkuk's output capacity to rise by 260,000 b/d to 700,000 b/d. BP has provisionally agreed to handle this, and Russia's Rosneft, which has assets in the KRG, may join it. But the project lacks a timetable. Reports of IS's reappearance in the town and nearby underline the security risk. And reaching the target depends on rehabilitating the federal portion of the ITP. The government has talked of signing up a contractor to build a new 1m-b/d pipeline to Fishkabour, where it would link to the 1.5m b/d portion of the ITP in Turkey; but progress is scant.
The south has other midstream hurdles. A fifth single-point mooring facility has been added to the export infrastructure around Basra, giving evacuation capacity of about 4m b/d. But exports had already reached more than 3.5m b/d at the end of last year. Even if Iraq expanded its refining capacity to account for all domestic fuel consumption (it amounted to 760,000 b/d in 2016), the 6.5m-b/d target for 2022 would imply southern exports of around 5m b/d. Questions continue to arise about the sanctity of older pipelines running into the Gulf, too—some of them are thought to have corroded; and a link to the Khor al-Amaya terminal was shut in February to repair a leak. At some stage, it may need replacing.
To relieve the pressure on the south, Iraq wants to reopen a 1.7m-b/d pipeline through Saudi Arabia to a port north of Yanbu on the Red Sea. Thamir Ghadhban, a former Iraqi oil minister and advisor in Baghdad, has lobbied for the idea. But the pipeline has been closed for crude since 1990 and used in Saudi Arabia to transport gas. Despite Riyadh's recent efforts to curry influence in Iraq, its championing of supply restraint from fellow members and its own cannibalising of the infrastructure suggest its reopening isn't imminent.
Another 1m-b/d pipeline, from Baghdad to Aqaba in Jordan, has also been in the works for years. The government in Jordan recently approved the project and it's thought the route would now pass south of troublesome parts of Anbar province. Nonetheless, despite repeated reports that construction had started or was imminent in recent years, a firm schedule has yet to appear.
Fundamentally, oil-output growth also depends on companies willing to keep investing in Iraq's upstream and on the success of the megaprojects in the south. Investor enthusiasm will be tested in a forthcoming licensing round (bids were due as Petroleum Economist went to press). But even if the export capacity can be freed up, more expansion from the supergiant fields around Basra must overcome some other obstacles.
The Common Seawater Supply Project (CSSP), a plan to supply water for reinjection at the southern oilfields, is now well behind schedule. It has also been scaled back from original plans for 12m b/d of water supply to 5m b/d, broken into two phases. ExxonMobil and CNPC have been negotiating the project since 2015, but with no outcome. The government says it has now shortlisted five companies to bid on it, but even if a deal is struck quickly it's unlikely to be operating before the early 2020s. The CSSP is needed not just to sustain growth but to offset decline rates, which are steepening at some fields.
Its timing, like that of the other export-infrastructure projects, will determine the pace of expansion in the south. So too will negotiations underway between the government and the international oil companies developing them. The original plateau production targets, part of Iraq's plan to reach nationwide output of 12m b/d, have been repeatedly revised lower (see table).
That some investors have soured on the technical-services contracts (TSCs) they agreed in the south is no secret. The TSCs pay a per-barrel fee (taken in oil), but allow for expenses to be recouped on a quarterly basis. As Iraqi oil-export revenue sank with the oil price in 2015-16, the government was unable to pay the bills sent by the IOCs. Things have improved since then, but neither the government nor the contractors are happy. Baghdad thinks the expense claims were too high (including, for example, Dubai office costs) and demanded they be lowered. The IOCs argue that if Baghdad won't meet the expense claims, they can't produce as much oil. One of them, Shell, is now exiting its 45% operating stake at the 220,000-b/d Majnoon oilfield and its 20% position in the Exxon-operated 440,000-b/d West Qurna Phase 1. In early April, Petrofac and Anton Oilfield Services signed up to replace Shell in Majnoon.
The contract niggles were all supposed to be fixed by now. Since the payment problems of 2015-16, the government has repeatedly said it would listen to proposals from IOCs. But the rise in the oil price seems to have lessened Baghdad's urge to compromise. The terms on offer for the 5th licensing round (see box) seem just as irksome to investors.
In general, the government's sluggish approach to agreeing deals, whether adjustments to existing ones or new contracts, is another bug-bear. "There was a lot of enthusiasm and energy—and a lot of potential project and export financing—coming out of the Kuwait conference," Douglas Silliman, the US ambassador to Baghdad, told the recent Iraq Energy Institute's forum in the capital. "But Iraq must move now to capture that enthusiasm and unlock that financing before it disappears." He said one American company had told him a week earlier that it had finally tired of waiting for the government to finalise its contract.
"Why would an international oil or gas company—or an Iraqi investor, for that matter—put hundreds of millions or billions of investment dollars into a high-risk, low-reward country?" Silliman asked. "The answer is, they will not, and do not." The MoO was starting to understand this, and the "lack of profitability of the traditional TSC". But a new model "must come quickly to be of most benefit to Iraqis who have suffered years of war against IS".
The same could be true of the downstream, where Iraq's plans are also aggressive—but likely to be hampered by investors' wariness of a country rife with contractual and physical risk. Processing capacity is thought to be around 500,000 b/d at present, but the government wants another 280,000 b/d of throughput added by year-end and for total capacity to reach more than 1.5m b/d by 2022, including allowing for 500,000 b/d of exports. It offered a list of refinery projects needing investment in the prospectus for the recent donor conference in Kuwait that, if implemented, would account for most of the capacity growth (see table). Oil minister Jabbar al-Luaibi says investment in the projects would amount to $4bn.
It's a salutary aim, because Opec's second-biggest oil producer remains a net importer of fuel-paying about $2.5bn a year to buy it. Total oil consumption included diesel and gasoline use of about 240,000 b/d; but this should rise quickly as the economy expands and activity picks up in recently liberated parts of the country.
But finding downstream investors won't be easy. The southern projects, especially the 300,000-b/d refinery planned for Fao, will be most attractive, given their security and proximity to export facilities. Total and CNPC have negotiated with the government over the 150,000-b/d Nasiriya refinery project and a 70,000-b/d expansion of the Shuaiba refinery near Basra is already underway. But the most critical project, rehabilitating the 310,000-b/d Baiji facility, will be tricky. It's said to be under the control of paramilitary groups involved in recapturing the refinery from IS last year. The government, which treats these forces as quasi-official members of the security apparatus, may be the most likely investor. This might also be the case for the planned 150,000-b/d refinery in Anbar, one of Iraq's least-secure provinces.
Iraq will stick with the Opec cuts, for now
Fuad Masum, Iraq's president, feels the "need to support the deal to cut crude oil supply". Iraq's prime minister, Haider al-Abadi, says his country will stick with the cuts. Iraq's oil minister, Jabbar al-Luaibi, says he agrees with the cuts and Opec must only decide whether to extend them for three or six months. Thamir Ghadhban, the senior oil advisor to the Iraqi government and a former oil minister, says the cuts should stay and Iraq is an "active member" of the group.
The unanimity from Iraq's top brass is easy to understand. Thanks to Opec's efforts in engineering a price rise, Baghdad's oil revenue in 2017 was its highest since 2014. If prices hold their level, the budget may run a surplus this year.
But things aren't as straightforward as you'd think. Iraqi production should rise this year as the Halfaya project ramps up. Any deal between the Kurdistan Regional Government (KRG) and Baghdad could be expected to lift total output almost immediately by another 300,000 barrels a day or so. All told, Iraq still plans to increase oil production this year, to 5m b/d, part of a medium-term target to reach 6.5m b/d.
To the ballet box: parliamentary elections in May could bring a new phase of growth
In no month since the Opec+ deal was agreed in late 2016 has Iraq fully complied with its Opec quota of 4.36m b/d (see Fig 1). Exports have trended upwards, too. Only because of the dispute with the KRG has Iraq maintained a semblance of cooperation. Not that this is acknowledged in the official production data Baghdad sends to Opec, which have landed precisely on the quota number for months. Even the secondary sources are thought to underestimate Iraqi production by at least 100,000 b/d, according to people familiar with on-the-ground data.
Opec's secretary general, Mohammed Barkindo, was in Baghdad again for the Iraq Energy Forum in late March to meet with senior Iraqi officials. It suits no one in Opec or Iraq to expose the country's non-compliance. The success of the Opec+ deal, which has almost eradicated the global surplus, is an outcome of Saudi supply restraint, Venezuela's collapse and strong demand.
And, insisted Ghadhban in an interview with Petroleum Economist, Iraq plans to develop capacity, not supply—"there's a difference between capacity and production". That will be news to investors whose profitability depends on production increases. Needful of oil revenue to fund its reconstruction, Baghdad can't keep promising upstream expansion while pretending it will stick to quotas it hasn't heeded much anyway. The Opec+ deal has been convenient for Iraq—lifting prices during a period when production growth had involuntarily stalled. But, "at some point soon, the Opec deal won't make any sense for Iraq," says one source.
New licensing, new terms
As oil prices sank in 2015, the technical-services contracts (TSCs) Iraq signed with IOCs to develop the big southern oilfields added to the pain. The fees paid to the firms, typically taken in oil, didn't move with the oil price; and the contracts allowed IOCs to reclaim expenses each quarter. The expenses had mounted, so the call on the government's budget did too, soaking up cash needed elsewhere. The IOCs had long complained about the TSCs. But now both sides were hurting.
Iraq's government promised to revamp the terms ahead of a 5th licensing round, even while it has also been renegotiating plateau-production targets with the producers who signed contracts in the earlier auctions.
The new bid round is imminent—due as Petroleum Economist went to press—but the contract terms remain vague. Fearing the political paralysis that's likely to follow parliamentary elections on 12 May, the government was releasing new contract terms on 13 April. Two days later, companies were being asked to bid. Investors weren't impressed with the haste.
Among the changes to terms that are known is that remuneration will now be based on the oil price, shifting the market risk from the government to the investors. Bids will also be based on profit share not, as before, on remuneration fee. There will be considerably more oversight of IOC spending, and what's allowed to be claimed.
That last point is a sore one for investors. The government rightly complained about IOCs charging Baghdad for running costs that included offices in Dubai. IOCs, who initially saw the almost-real-time repayment of expenses as critical to the projects' net-present value, griped about how slowly Baghdad approved their claims. They say the government promised to streamline this process, but has instead just beefed up the red-tape.
The proof of this pudding will be in the bidding. The long-list of prequalified companies-about 26 strong-includes those automatically added because they were already operating in Iraq. But it seems unlikely that Exxon or Shell, for example, will participate. Both have downsized their Iraqi presence. Lukoil, another producer, was prominent in criticising some of the new terms when they were presented in Baghdad in late March. Intriguingly, the UAE's Dana Gas was added to the list recently, despite its holding assets in Iraqi Kurdistan. This may suggest Baghdad has ended its embargo of companies that signed what it considers to be illegal contracts in the Kurdish region.
The assets on offer include onshore exploration blocks near Kuwait and offshore in the Gulf, as well as fields, such as the promising Sindbad, along the border with Iraq. Development of those assets might depend on some kind of unitisation deal or agreement with Tehran. Iraq's Ministry of Oil has previously talked about cooperating in the upstream with neighbouring countries.
"The whole process has been rushed," says one senior Iraqi oil analyst. "It's all part of the election campaign. Companies have 24-48 hours to submit bids based on contracts they haven't tested on assets they barely know. Without a solid fiscal regime, it's going to be very difficult to sign up." The best hope for licensees might be from among smaller companies lacking access to the south, he added.
This article is part of an Report series on Iraq. Next article: Iraq's rebuilding project