Oil Supply Surge, Price Drop in Iraqi Auction

Washington, 19 March 2010 (Oil & Gas Journal )

Iraq’s December 2009 auction of rights to develop 60 billion bbl of crude oil reserves in 10 fields will lift the country’s production to 9.6 million b/d by 2017 if several major obstacles can be overcome, a new Energy Policy Research Foundation Inc. (EPRINC) report concluded.

“By any standard, the Iraqi auction represents a major event in the history of the world oil market: It is the largest single transfer of reserves into the production stream since the beginning of the petroleum era,” the report maintained, saying the supply effect might lower oil prices enough to strain alternative fuels.

The report suggested that, although a wide range of external and internal threats and more traditional obstacles could derail Iraq’s prospects for a massive crude oil production increase, the prospect that it could send a supply shock into world markets can no longer be dismissed.

Expanded Iraqi production also could prevent a price spike if production outside the Organization of Petroleum Exporting Countries drops over an extended period, according to the report.

“In this scenario, the role of Iraqi supplies may be more of a brake on rising prices than a catalyst to a lower price path,” it explained. “In any case, the Iraqi auction clearly opens the door for a careful review of the conventional wisdom on the outlook for oil prices over the next 20 years.”

Under the new contracts, companies have committed to bring 9.6 million b/d online by 2017, which with production expected from fields not covered by the auction would meet the Iraqi government’s expectations for 12 million b/d. The EPRINC report assumed companies will be able to achieve only 50-75% of the targeted levels by 2017 but included scenarios under which total Iraqi production would approach or exceed the 12-million b/d benchmark by 2020.

The scenarios, it said, “clearly raise the potential for downward price adjustments in crude oil against a range of business-as-usual cases.” Several likely price outcomes, it added, “may also place alternative transportation fuels into severe financial distress.” Biofuels with economics marginal while crude oil prices are $80/bbl would require additional subsidies, “which may not be easily obtained in an era of ‘fiscal fatigue.’”

The US Energy Information Administration estimates Iraq’s reserves at 115 billion bbl, third behind Saudi Arabia and Iran. “However, credible estimates . . . suggest Iraq contains over 200 billion bbl of recoverable reserves and potential reserves of over 400 billion bbl,” EPRINC’s report indicated. It is available online at www.eprinc.org/pdf/EPRINC-Iraq-FirstLook.pdf.

Moving quickly

The unprecedented scale of the Iraqi government’s commitment and the project-management experience of many of the companies winning technical service contracts provide potential for field development to progress quickly, the report said. “Some of the difficult political issues have been met in the auction decision and process; others are being met, if grudgingly, by the very large and unexpected revenues which will be distributed to all Iraqi provinces on an equal per capita basis,” it said.

“The pitched rhetoric between the Kurdish government and the central government has softened, but substantial areas of disagreement remain,” it continued. “In line with their historical pursuit of autonomy, the Kurds have initiated and want to pursue a separate energy enclave. Under the proposed revenue distribution structure from the central government, the Kurdish government would receive 17%. It would be a great deal of money, much greater than the Kurds are likely to achieve from their regional oil development program.”

Other risks include the absence of a comprehensive law justifying the legal framework for the auctions, resolution of the Kurdish-Arab struggle for Kirkuk and oil and gas resources in Kurdistan, and Iraq’s outstanding debt with Kuwait, Saudi Arabia, and the United Nations.

“Several major oil companies, who chose not to bid, could not get comfortable with the lack of clarity on performance conditions of the contracts, stability of the tax regime, and the large carried interest of the Iraqi national oil company (approximately 25%) in the fields won by the bidders,” the report added.

Other problems include security, delivery of rigs, the handling of water for secondary recovery, and completion of government projects to upgrade pipelines and ports.

“None of these uncertainties are insurmountable, but resolving all these issues is critical if the Iraqis are to move forward on the ambitious production program,” the report said.

New ground

Besides scale, the auction broke new ground in two crucial ways, the report said. It would be the first time so many development projects of this size are started simultaneously with identical target completion dates. And the auction represents the first major break from the prevailing oil industry structure in almost 40 years.

EPRINC observed that since many producing countries began to nationalize their oil resources in the 1970s, multinational oil companies have had limited ability to explore for or develop reserves in those countries, particularly around the Persian Gulf. “The Iraqi auction will stand as an action that marries the interests of oil companies and of a government which controls a very large reserve base,” the report said.

“With its action Iraq has established a format for reserves development which leapfrogs the models of the other major Gulf oil producers—a transparent contractual arrangement that offers international companies an acceptable return on investment.”

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