Iraq oil industry hangs in the balance

Insight The world will be watching Iraq this week as it broadcasts a unique live auction of oil contracts.

Iraqi police direct traffic as a sandstorm hits Baghdad, closing the city's airport and forcing an auction of the country's oil contracts to be postponed.

The world will be watching Iraq this week as it broadcasts a unique live auction of oil contracts. What is certain is that billions of dollars will be put on the table to develop some of the country's biggest oilfields. But little else is assured. Even nature intervened to delay the bidding, as a sandstorm engulfed Baghdad yesterday and shut down the city's airport. The two-day event, now postponed by one day to tomorrow and Wednesday, is bound to end with a cliffhanger. In the balance is the future of Iraq's oil industry, which is expected to fuel the economic engine behind the country's recovery after decades of war and sanctions.

The auction marks the first time big foreign firms have been invited to Iraq to bid on oil and gas projects since 1972, when the late dictator Saddam Hussein expelled them from the country and nationalised the oil industry. But observers are questioning whether Iraq's tattered oil industry is yet ready for international prime time. The 32 companies shortlisted to bid for 20-year contracts to service fields that have been called "the jewels of the Iraqi oil industry" are not being welcomed with open arms. The contract terms are so tough that profits are in doubt, the companies are not allowed to book reserves or take a share of oil production, and the government is seeking US$2.6 billion (Dh9.54bn) from them in refundable "signature bonuses" to help balance its books.

What is worse, some of the bidding round's domestic opponents, notably including most Iraqi oilfield workers, hold foreign oil producers in the same regard as diamond thieves. That could cause an array of problems, including increased security risks, for foreign operators that are required to work with Iraqi partners and employ a large proportion of Iraqi nationals as field staff. Nonetheless, the auction's participants are likely to include a Who's Who of the world's biggest international oil companies - the likes of Exxon Mobil, Royal Dutch Shell, Total and BP - vying with powerful state-owned concerns such as China National Petroleum Corporation for access to 44 billion barrels of proved oil reserves and 22 trillion cubic feet of untapped gas.

That is roughly a third of Iraq's total proved oil reserves, which are the world's third largest, and nearly 20 per cent of its gas reserves, making this the biggest single auction of oil and gas licences held anywhere in the world. Increasingly squeezed for access to resources, big international oil companies cannot afford to stay away. By establishing bulwarks in Iraq, they hope to better their chances of winning exploration concessions in a country believed to hold more than 200 billion barrels of undiscovered commercially exploitable crude that could eventually put Iraq's reserves ahead of Saudi Arabia's.

"International oil companies are short of reserves and opportunities, and countries control almost 88 per cent of oil reserves. The only real opportunity is Iraq," said Thamir Ghadhban, the chairman of the Iraqi prime minister's advisory board. "Iraq is the big prize in the region," said Raja Kiwan, a Dubai analyst at PFC Energy, a consulting firm. "There's a huge amount of pressure on all international companies looking at Iraq to make sure they have the first foot in."

The atmosphere of the auction promises to be a cross between a game show and Oscars night. After the first contract is awarded, competing companies, which may team up as consortiums, will get a chance to revise the terms of their next bid, but they will have to do so under time pressure, forging new alliances as they go. Individual companies are each allowed to win only one contract as the project leader, and to be a minority partner in another two, which should foster strategic switching. The live TV cameras will ensure maximum transparency, and the potential for drama is high.

Instead of taking weeks or months to evaluate detailed development proposals, as usually happens with other countries' oil licensing rounds, Dr Hussein al Shahristani, the Iraqi oil minister, will announce the contract winners on air, right after publicly opening the envelopes containing the stripped down bids. But for the winners, the risks are enormous. On top of financial uncertainties, they face an unstable security situation in Iraq that is deteriorating ahead of the imminent pullout of US combat troops. With contracts unprotected by a federal oil law, they may be wading into a legal quagmire. They will have to deal with sharp political divisions over whether they should be allowed in the country at all - an issue sure to be hotly contested in Iraq in the run-up to national elections at the end of January. Western-based firms are also looking askance at a process that reduces the government's decisions on who will execute complex, technically challenging energy projects that are vital to Iraq's economic interest to just two numbers: the remuneration fee per barrel, and the production target. They are worried that years of groundwork in Iraq as unpaid energy advisers - time spent since the 2003 US-led invasion on training nationals, conducting field studies and building relationships - could go to waste.

One thing everyone agrees on is that Iraq needs to export more oil in order to pay its mounting bills. The country's crude production of about 2.4 million barrels per day (bpd) is still below the 2.5 million bpd reached before the invasion. With crude prices much lower than last year, that is a big problem for the government, which derives about 95 per cent of its revenue from oil exports. The trouble is, there is no consensus within the country on how to achieve the increase, or on who should be mandated to make crucial decisions on the role that foreign oil companies should play.

The bidding round has set Iraqi parliamentarians against government leaders, the regional government of semiautonomous Kurdistan against the Baghdad central government, and the technocrats and engineers staffing Southern Oil Company (SOC), Iraq's biggest state oil company, against the country's oil ministry. Feelings are running so high that it is a miracle the auction is at last taking place, after months of unexplained delays.

Just last week, Dr al Shahristani was hauled before parliament for two days of questioning on the bidding round. His responses were well enough received to avert a vote of no confidence, which empowered Baghdad to press ahead with the auction. But political rhetoric this past week has been heated, with rival groups exchanging barbs that reflect a web of interconnected sectarian and ethnic conflicts over oil jurisdiction, financial and economic management, power sharing and territory.

"This auction is a violation of Iraq's federal constitution," Nichirvan Barzani, the prime minister of Iraqi Kurdistan, said on the regional government's website. "The proposed oil ministry contracts are not in the best interest of the Iraqi people." Kurdish forces, peshmerga, handle security for the northern oilfields of Kirkuk and Bai Hassan, which are included in the auction despite their location in territory disputed between Baghdad and Kurdistan. The peshmerga have been known to shut down production from the fields over political spats, so companies planning to bid on those fields will pay attention.

Exxon Mobil, one of the contenders for Kirkuk, a giant field containing about 8 billion barrels of remaining reserves that was badly damaged by Saddam-era reservoir mismanagement, was still considering as recently as the middle of this month whether to bid. For its part, Baghdad has refused to recognise more than a score of oil exploration and production agreements that the Kurds have signed with foreign oil companies. Dr al Shahristani has repeatedly called the deals "illegal" and has blacklisted firms doing business with the Kurds from oil projects in the rest of Iraq. Now, Baghdad is pondering whether to disqualify the Chinese state-owned China National Petroleum Corporation and Sinopec from the auction, after Sinopec agreed to acquire Addax Petroleum, a Canadian company pumping oil in Kurdistan.

That would be a risky step for Baghdad, as China is one of the biggest buyers of Iraqi crude. Another critic, Ali Balou, the chairman of the parliamentary oil committee, has vowed that parliament would "totally reject" contracts from the bidding round unless allowed to ratify them: "We will not allow the oil ministry to move ahead, ignoring parliament." Fayed al Nema, who was appointed the director general of SOC just last month, told parliament that under the licensing round, Baghdad would lose control of Iraq's resources. He said the government should abandon its plan to issue long-term contracts, and resurrect an earlier scheme to limit foreign participation in Iraq's oil sector to short-term technical services deals. The bidding round would "put the Iraqi economy in chains and shackle its independence for the next 20 years", he said.

This must be unsettling to the companies preparing to bid. But the final straw could be Iraq's security climate, which has recently taken a turn for the worse after nearly two years of improvement. In the past week, a new wave of violence has left more than 200 people dead, raising concerns about the ability of Iraqi troops to maintain stability as the US withdraws. "How the security situation materialises is of great importance," Ray Irani, the chairman and chief executive of the US oil and chemicals group Occidental Petroleum said in April.

Among other things, rising unrest would push up costs for oil firms venturing into Iraq, requiring them to undertake more measures such as hiring security contractors and building airstrips near remote work sites to keep personnel out of political hot spots. Insurance costs would also soar. Still, companies such as Occidental believe they have little choice. "Anybody serious about being an international oil company over the next few years has to enter Iraq," Stephen Chazen, the company's chief financial officer, told Bloomberg last week.