More palatable Iraqi terms possible

Lower oil prices have hit Iraq much harder than the core Mideast Gulf producers.

Although Iraq is almost a Mideast Gulf country geographically, and although it enjoys abundant reserves that are relatively cheap to produce, lower crude prices are hitting its capacity development plans in a big way. But lower prices that are a bane to Iraq could turn out to be a boon to the foreign companies developing its nine largest fields.

Unlike its Mideast Gulf Arab neighbours, Iraq did not take proper advantage of the windfall that higher oil prices gave all producers from 2010 until the middle of last year. Poor governance, financial mismanagement and corruption have left Iraq with hardly any financial buffer that would allow it to ride out a year or two of lower oil prices without making radical spending cuts.

The Isis-led insurgency has connived, so to speak, with lower oil prices to intensify Iraq’s financial woes by significantly boosting government spending on its armed forces and pro-government militias. “The bill for fighting terrorism is high,” an Iraqi government official tells Argus.

Unfortunately for Iraq, the first casualty of the financial crisis gripping the country is its upstream oil sector — the very industry that Iraq is relying on to gradually boost its revenue and provide the funds it needs to develop its economy.

Iraq’s financial crisis is so dire that it is defaulting on payments to the foreign companies developing its nine largest fields. The companies are meant to be paid in crude of equivalent value to the cash they are owed in cost recovery and remuneration fees for new output.

Iraq’s oil ministry is inviting foreign companies to renegotiate their service development contracts at the large fields in southern Iraq, and is hinting that it is offering better terms that would change the service contracts into something more like production-sharing agreements (PSAs).

But PSAs would be unpalatable to the Iraqi parliament and to the public at large, and the oil ministry is stressing that it has no intention of converting Iraq’s technical service agreements with the foreign companies into PSAs. But it is considering ideas such as linking the profit that oil companies make to the price of oil, rather than paying them a flat $/bl fee for incremental production as it does now.

The technical service agreements worked well for Iraq when crude prices were around double today’s levels, but they expose the government to price risk rather than the foreign companies.

Yet oil companies prefer this sort of price risk to acting like contractors that earn fixed fees, as they do now in Iraq. They see this as more akin to the PSA model than to the technical service agreement model. And they hope that introducing a price risk element into their deals in Iraq will allow them to book reserves and production.

The foreign companies hope that the system of cost recovery under which they invoice the Iraqi oil ministry for their development costs and await reimbursement will change into a system that sees them getting paid directly out of the revenues of their respective projects. That too would make their contracts look more like PSAs.

The foreign companies that entered Iraq’s upstream in 2009-10 were not keen on the stringent terms Iraq was offering at the time, nor were they happy about being treated like contractors rather than partners. But the oil price fall could well turn out to be their lucky break in Iraq.

For more information, please contact OilBlog@argusmedia.com