A shorter version of this article was published in the The Independent on Sunday, 5 July 2009

The auction of Iraqi oil production licences last week was truly historic – not least because it was the first such exercise ever to be broadcast live on television. Over 30 companies were expected to compete for 8 contracts, with bids rejected and revised and consortia reshuffled, all in front of the cameras. In effect the Iraqis had set up a high stakes reality TV show, with oil minister Hussain al-Shahristani in the role of Sir Alan and company executives as the desperate wannabes. Some of the bidders feared it would degenerate into an unseemly scramble, and with good reason.

The prize was a bit more valuable than an apprenticeship. Iraq not only holds the world’s third biggest official reserves at 115 billion barrels, but its giant fields are uniquely underexploited, following three decades of war, sanctions and insurgency. “Iraq is the last big, low cost play in conventional oil anywhere in the world”, says Bill Farren-Price, a Middle East expert and Energy Director at Medley Global Advisors. The licence round was meant to raise Iraqi oil production from 2.4 million barrels per day to 4 mb/d, and with so much to fight over, the Iraqis seem to have assumed the working title for their gameshow was “I’m An Oil Company, Get Me Into Here!” But that’s not quite how it turned out.

One by one the companies dropped their sealed bids for each of the fields into a Perspex box, and then the government announced what it was actually prepared to pay. At that moment, according to a source in one of the bidding companies, “there was a collective dropping of jaws around the table”. Just one contract was awarded and 7 failed, as the bidding exposed a massive gulf between the expectations of the companies and the government. Several observers branded the process a farce.

The contracts were designed to increase the output of some of Iraq’s biggest fields by rewarding the successful bidder for every barrel produced above a set target. But the companies wanted between 2 and 10 times more than the government was prepared to pay. To work on the Bai Hassan field, for instance, ConocoPhillips demanded $26.7 per barrel, whereas the government offered just $4/bbl – compared to a global market price of around $70. After failing to reach agreement, almost 30 oil companies, including Exxon, Shell, Total, and China’s CNOOC and Sinopec, simply walked away. The industry was left to work out who were the real winners and losers, and why Iraq had played such hardball.

One reason may be that Iraq was just as desperate as it assumed the companies were. The government needs tens of billions of dollars for reconstruction, yet its income, which is 95% dependent on oil revenues, has shrunk in line with the plunging oil price – down from $147 per barrel last July. This put enormous pressure on Mr Shahristani to squeeze the oil companies as hard as possible. If so, the tactic backfired spectacularly.

The oil minister also faced fierce opposition from MPs and unions opposed to foreign involvement in Iraq’s oil industry, and apparently felt the need to act tough. “Shahristani has checkmated the critics who were accusing him of giving away the family silver”, says Bill Farren-Price, “but he has also overplayed his hand”.

The solitary contract was won by BP and China’s CNPC to produce oil at the giant Rumaila field near the Kuwaiti border that provides almost half Iraq’s current output, although some argue they may come to regret it. The consortium initially tendered $3.99 per barrel, but then halved its bid to meet Iraq’s maximum offer. “I am surprised they were beaten down”, says Farren-Price, “it looks pretty marginal at $2”. Rumaila was also the first contract to go under the hammer, before the scale of the walk-out was known, leaving BP as the only supermajor to take the plunge.

BP has promised to almost triple production at Rumaila from 1 million barrels per day to 2.85 mb/d, but the consortium may struggle to deliver, not least because of the chronic violence. While security has improved, the auction came on the same day US troops pulled back from Iraqi cities and a car bomb that killed 27 people. Staff and infrastructure managed by foreign oil companies are almost certain to be targeted by the remaining insurgents and al-Qaeda.

More fundamentally, the reservoirs of Rumaila may have been permanently damaged by the effect of international sanctions imposed from the Iraqi invasion of Kuwait in 1990 until 2003. The sanctions denied Iraq access to essential chemicals and high tech equipment, and meant that water injected into the fields to maintain pressure was untreated and unmeasured. According to a series of reports produced by experts for the UN Security Council around the turn of the century, this threatened to halve the amount of oil recoverable from some reservoirs. One report concluded: “Poor oilfield husbandry has already resulted in an irreversible reduction in the ultimate recovery of oil from individual reservoirs. Crisis management will continue to exacerbate the permanent loss of huge reserves of oil.”

But BP is unlikely to have bought a pup, since the company was part of the group that discovered Rumaila in 1953, and has been analyzing its geology under an agreement with Iraq since 2005. Chris Skrebowski, consulting editor of the Petroleum Review, takes a more positive view: “Even if the reservoirs have been damaged, this is a 15 billion barrel field. And BP has earned goodwill with the government for future licence rounds, and stolen a march on the competition. This is a brilliant stroke”.

The companies that walked away may be mystified by the outcome of this week’s auction, but none admitted regret about not folding to Iraqi pressure. The rejected bids have been referred to the cabinet for reconsideration, there is another bigger licence round to come, and Iraq desperately needs to attract outside capital and expertise to upgrade its crumbling oil infrastructure. In the circumstances the industry clearly feels it can play hardball too. “The message from the industry is that they weren’t prepared to treat these early fields as loss leaders for potential access down the line”, says one source among the supermajors.

If the international oil companies regard this week’s effective boycott as a line in the sand, the fact they took part in the auction at all shows how far they have already retreated. Traditionally the IOCs have insisted host countries sign production sharing agreements (PSAs) that give the companies a share of the profits and part ownership of the reserves, which helps bolster their share price. But the agreements on offer this week were service contracts paying only a flat fee for producing the oil with no equity stake. The IOCs were tendering not as all powerful multinationals, but as hired help. What this week’s gameshow demonstrated was that even in their reduced circumstances, the contestants still have cards to play, and that means the show will be back for a second series.

1 Comment

  • As you rightly say, this first bidding round was about establishing a partnership with the Iraqi Government. The fact that BP know this field particularly well is relevant, but more relevant will be the way they manage the task and demonstrate a long term commitment and a will to work with the local communities and contractors. That will set the standard for renewed oil and gas operations in Iraq by western companies. BP deserve their prize.

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