Iraqi police officers protecting oil installations secure an oil pipeline.

Big Oil is between a rock and a hard place over new investments in Iraq. Although the Iraqi government held a three-day symposium in mid-February in Istanbul as part of an attempt to allay the fears of the 32 energy companies vying for the eight new exploration licences to be let this summer, the risk-reward assessment in Iraq remains as difficult as ever.

With Iraq’s reserves of more than 100 billion barrels, the country offers significantly easier pickings than other, more expensive, options like offshore and deepwater sites. The BBC even reported one Western diplomat in Baghdad as saying Iraq was “emerging as the only truly functioning democracy in the Arab world.” The reality, however, is that Iraq’s political future remains deeply uncertain. The political and personal safety considerations remain key issues for the oil companies. The risk inherent in committing to any kind of agreements without an agreed oil law defining the framework for foreign company investment, presents a major headache for long-term investment prospects. Recognizing this, the Iraq Oil Ministry introduced several sweeteners during the meeting in Istanbul. But they also upped the ante by saying that companies who win contracts to have staff on the ground starting operations within six months – or face the consequences. Mahdy al-Ameedi, deputy director general of Iraq’s petroleum contracts and licensing directorate, told reporters in Istanbul, “If any oil company has been awarded a contract and it doesn’t mobilise and perform activities on the ground within six months from the effective date, the contract will be terminated.”

Iraqi energy ministers are hoping the new contracts will result in an increase in oil output of 1.5 million barrels per day, a 60 percent increase over the current 2.5 MMbbl/d. While the oil majors fear missing out on Iraq’s potentially massive oil and gas reserves, the current reduction of spending budgets in the wake of the slump in oil prices has heightened further the sense of risk which, as one senior executive told Reuters, is “scaring the hell out of international oil companies.”

A root cause of disquiet is the flat-fee payment basis of the proposed contracts. The oil companies would prefer the usual share of the profits arrangement. When Iraq launched the current round of bids for exploration and production licences in January 2008, oil prices were around $90 a barrel. Since then, even as oil prices have plummeted, the Iraqis have toughened the terms. With operational licences set to last for 20 years, the oil companies are concerned over the lack of an oil law that fixes the legal parameters. Not surprisingly they would prefer to have get-out clauses written in should the current political realities lead to a lack of authority and control down the line. Four international companies, BASF, BG Group, Anadarko Petroleum, and Premier Oil, have already dropped out of the race, deciding the risk-reward balance was not in their favour. But Russia’s Lukoil, China’s top oil company CNPC – both backed by government funds – together with Turkish Petroleum, are all reportedly considering joining the race.

In Istanbul, the Iraqis worked to bolster confidence by relaxing the incremental production targets. The contract model now allows for a five percent decline in production rate after initial baseline targets have been met. This is important as oil companies on a flat-fee arrangement would only receive payment from output above the current baseline rate. A natural decline would inevitably mean a significant drop in income, or even no income at all.

In addition, the unit ownership balance has been changed. Iraq will now own a 25 percent stake in the new infrastructure units, with the oil companies owning the other 75 percent. The original deal called for a 49-51 percent split. The changes will mean a far quicker return on investment for the foreign oil companies.

The oil companies have until March 6 to give the Iraqi Oil Ministry feedback on the new contract proposals before the IOM issues the final model contracts in April. With bids due by late May/early June the eight contracts are expected to be awarded by the end of June. All of which will make the second Iraq Oil and Gas Summit on May 13-14 in Houston an interesting affair. Companies will doubtless want to keep their cards close to their chest. However, it may also provide a platform for the energy companies to lobby the Iraqis to further soften their terms. But there is one aspect senior oil company executives might like to factor into their strategic decision-making over Iraq: Iran.

The Iran Factor

The lack of stability and factional violence in Iraq, much of it aimed specifically at disrupting energy infrastructure and Iraq’s oil and gas revenue, has been instigated internally by Sunni factions and, externally, by Iran-proxy Shia militias. In an under-reported development highlighted recently, the Tehran Times gave a strong indication that Iranian-sponsored violence in Iraq may be set to end. According to the Tehran paper, as recently as February 13, Iranian foreign minister Manouchehr Mottaki briefed reporters on a trip to Basra that he was drawing up a new “road map” for relations with Iraq. Chief among Iranian desires, he claimed, is the need for “energy cooperation with Basra.” According to the report, this has already led to the signing of a new oil deal which will see Iraqi crude transferred to Iran’s Abadan Refinery with refined oil products making the return journey. Mottaki also spoke of Tehran and Baghdad jointly exploiting oil fields and, as regards Basra, “informing Iranian investors of the great potential for investment in this city.”

According to Mottaki it is the increasing handover to Iraqi officials that has prompted the new ‘road map’. One might suspect, however, that it has more to do with Iran’s rapidly failing economy and its increasingly desperate need to expand commercial, trade and energy ties with whoever it can. While none of this will allay security fears, the prospect of an Iran with a real stake in Iraq’s energy sector may at least remove one area of concern over the safety of staff.

Cashing in?

The Iraqis clearly appear to be in a hurry to get some deals done. The big energy companies, meanwhile, appear reluctant to pick up the tab for the fledgling Iraqi democratic enterprise, by risking a great deal for, at least in the short-term, small returns. Prospective bidders from Russia, China and India, all have the advantage of the financial safety net government cash in the guise of sovereign wealth funds provides. But with global oil prices likely to recover, perhaps dramatically, in the coming years, it is easy to see the entrepreneurial spirit associated with all new frontier oil exploration kicking in – with some of the world’s biggest energy companies deciding to put down their markers in the high-stakes Iraq energy game.