Oil Firms ‘plough ahead’ and Ignore Politics to Invest in Iraq’s South

Rumaila, the workhorse of Iraq’s oil industry and its largest producing oilfield, is buzzing with activity as executives, engineers and drillers begin a massive overhaul to nearly triple its million barrels per day output.At the airport in Basra, capital of southern Iraq, officials struggle to process the unprecedented numbers arriving to join the country’s nascent oil boom. Iraq may be struggling to form a new government almost three months after elections, but oil firms chosen to carry out the largest oilfield development projects on the planet are ploughing ahead with investments that could take the country into the elite of global oil producers. And, though the old administration failed to pass a new law to govern an energy sector vital to rebuilding the country after years of war and sanctions, Iraq’s oil industry is booming. “The companies are not going to sit back and just wait,” said Raad Alkadiri of Washington-based PFC Energy. “Iraq’s government has itself encouraged this by saying ‘keep going and the politics will sort itself out” The Rumaila project is the most advanced and was the first Baghdad signed, with BP and China’s CNPC taking it on. Oil Service Company Weatherford International is already up and running on the ground there. It was one of the firms that won part of a $500 million deal to drill wells at the field and already has 300 people working in Iraq. “It’s still very early days,” said Alex Munton of Edinburgh-based consultancy Wood Mackenzie. “But the drilling contract’s in place and the pace of activity so far is an indicator of them hitting the ground running, as they said they would do.” Iraq sits on the world’s third-largest oil reserves and has signed contracts that would boost its output by around 10 million barrels per day by 2017, generating an additional $700 million a day in oil revenues at current prices. Though it may never reach that target and output gains over the next year or so are expected to be much more modest at around 600,000 bpd, the contracts themselves have encouraged companies to move ahead as quickly as possible. To start recuperating investment, oil companies need to boost output at producing fields by 10 percent. From Iraq’s untapped fields, firms have an early target called first commercial output to trigger cost recovery. Hitting the targets fast reduces capital investment exposure to Iraq by allowing oil firms to recycle money already invested. The faster oil firms hit the targets, the faster they can begin recycling investments, reducing the need for new exposure. “The reality is that the quicker you can get to commercial output on these contracts, the quicker you can recover investment and begin receiving remuneration,” Alkadiri said. While the outgoing government failed to pass a new oil law to provide a framework for investment, it said the deals were legal under existing legislation. So far, legal uncertainty has done little to discourage investment, said Hadeed Hassan, a Baghdad-based lawyer for Al-Tamimi & Co, who worked on the deals.  “It’s not enough to stop them,” said Hassan. “They’re already signing subcontracts, they wouldn’t be signing such contracts if they weren’t ready to go ahead and move down south.”

In the political vacuum that has emerged from an inconclusive election, neither leading contender Iyad Allawi nor Prime Minister Nuri al-Mailiki has indicated he would embark on what would be a political nightmare for the oil companies – a full review and overhaul of the deals. Iraq’s take of revenues from the deals is among the highest in the world. It would be hard for the government to squeeze more out of the contracts, oil industry executives say. With so much at stake, a new administration would be reluctant to turn back the tide of activity the contracts has unleashed. Seven years after the US-led invasion, the country is still pumping below pre-war levels. “Iraq has no choice but to move ahead with these contracts,” said Luay al-Khatteeb, of the London-based Iraq Energy Institute. “Any government will honor them, not because they are perfect, but because they have no choice. They’ve already wasted too much time.” Iraq faces huge challenges building the capacity to deal with the size of the oil projects underway. Many of Iraq’s most skilled workers and bureaucrats left the country during the years of sectarian violence after the war. That has left its administration and its national oil company with little capacity to deal with the megaprojects at most of its largest oilfields. Already, oil firms were finding Iraq’s South Oil Company a frustrating partner, industry sources said.

“These are some of the biggest projects on the planet,” said one source familiar with operations in Basra. “And Iraq’s strategic planning capacity is showing the wear and tear of years of decline and brain drain.” Across the administration, efforts are underway to train bureaucrats to handle the surge of activity ahead.  “There is an unprecedented level of activity right now in Basra,” said Andrew Doust, of Coffey International Development, which has been involved in training over 100,000 Iraqi public sector workers since the war. “This will certainly place greater demands on Iraqi systems than they have ever had before.” At Basra airport, the old Iraq is already struggling to deal with the new. People arriving to join the nascent oil boom crowd around a counter for hours staffed by one official approving visas that have already been granted by Baghdad, a consultant who just visited the region said on condition of anonymity. “They can’t even staff and manage properly the one gateway to the country for a few hundred billion dollars,” he said.

William Wakeham, Managing Director of AAIB, the foreign insurance brokers based in Iraq observes that this news shows that international oil companies have taken strategic decisions to position themselves as future key partners in the emerging Iraq, sound in the knowledge that whatever shape the next Iraqi government takes, the economic underpinnings of the economy and the need to expand oil production will remain.

Iraq itself arguably lacks the technical resources and expertise to quickly refurbish existing capacity and to put in place new capacity, at the rate needed for the Governments recently published output targets to be met. Hence the reliance on outside expertise and the volume of contract awards over the last two years.

Whereas the political stalemate creates a degree of uncertainty as to the status of some oil contract awards and whether they will be honoured, renegotiated or cancelled, this risk seams to have been factored in by companies when bids were made and contracts were signed.

Oil and gas companies and their supporting infrastructure and service companies cannot avoid “political risk” totally when investing in Iraq or in other transition economies, however some risks can be mitigated by insurance programmes.

Political risk” insurance gives companies a degree of protection against certain politically based events or conditions that result in a financial loss. These may include politically motivated violence, such as revolution, insurrection, civil unrest, terrorism or war; Governmental expropriation or confiscation of asset, repudiation of contracts, or for example, inconvertibility of foreign currency or the inability to repatriate funds.

Clearly the continuing interest of foreign companies and their preparedness to commit sizable funds into Iraqi projects shows that these types of potential risks are not perceived to be probable enough, or their impact large enough, to halt future investments.

It’s expected that such risks will subside even further once the new political status quo emerges, the new government is formed and when government policies, including economic development policies are given a fresh impetus.

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