Opportunities for world-class petroleum contracts in the Middle East

The balance of power between oil-rich countries and petroleum companies appears to be shifting. Governments in the Middle East must take heed.

The aim of a good oil contract, from a government point of view, should be to maximise the value to the country. Hasan Jamali / AP Photo

The Second World War was drawing near, Sigmund Freud was still alive, space travel and nuclear power were just science fiction, and oil sold for US$1 per barrel, when Sheikh Shakhbut of Abu Dhabi signed a concession agreement with Petroleum Development Trucial Coast.

That concession, signed in 1939 - now Abu Dhabi Company for Onshore Oil Operations (Adco) - will expire shortly. The world can change unimaginably during the long lives of oil contracts. Now the balance of power in the never-ending tussle between oil-rich countries and petroleum companies may be shifting again - and Middle East governments need to take heed.

In the late 1990s, prices briefly dipped to $10 per barrel, and major producers from Russia and Venezuela to Iran, Saudi Arabia and Kuwait contemplated the once-unthinkable step of opening up their fields to foreign investment.

Then followed a lean decade of high oil prices and scarce opportunities. Leaders such as Hugo Chávez, Vladimir Putin, the Alaskan governor Sarah Palin, the UK finance minister George Osborne and Australia's Kevin Rudd sought to raise taxes on the oil industry.

Oil prices are still high. But an important set of new agreements are on the way in the Middle East. Iraq has signed a number of mega-deals to boost production to 6 million barrels per day or more by the decade's end, and is launching further exploration bids. Abu Dhabi's Adco concession, working to increase output to 1.8 million barrels per day, is set to expire next year, with the two major offshore concessions up in 2018. Post-revolutionary Libya will also seek new investment.

The region offers tough terms. Abu Dhabi famously pays its concession partners just $1 per barrel produced, and the Iraq auctions also yielded bids about $1 to $2 per barrel - an effective tax rate of 98 to 99 per cent. In Libya, the government takes more than 90 per cent of the profits. In well-run but high-cost Norway, by contrast, the tax rate is 78 per cent.

The aim of a good oil contract, from the government's point of view, should not be to squeeze the last fils from the private oil company: it should be to maximise the value to the country.

Excessively heavy or inflexible taxation destroys value. Badly-designed fiscal systems encourage companies to inflate their costs, and discourage them from exploring or developing more costly resources.

Oil companies also generate value for the host country in less tangible ways - employing and training local citizens, introducing advanced technologies, developing indigenous supply chains and supporting businesses.

This is seen clearly in the United States. Tax breaks and research and development support led to the breakthroughs in shale gas which have made North America self-sufficient in gas, and are now boosting oil production.

Oil companies today have other options. If they do not find attractive contracts in the Middle East, they will go to North American and Chinese shale oil and gas, Brazilian deep-water, and new exploration frontiers in East Africa and the eastern Mediterranean.

What is the solution? The region's oil producers need a flexible, profit-based system of taxation, allowing the oil companies to operate at their best, without handing them easy money. Instead of simply accepting the lowest bid, they need to value a company's technical capacity, environmental record and contribution to developing citizens and the wider economy.

And they need to attract a diverse ecosystem - from supermajors and Asian and Russian national oil giants, to smaller companies with the nimbleness to exploit unconventional resources, new exploration concepts and marginal or mature fields.

Such systems do exist - Australia and Norway are good examples. Seventy-five years on the region has the ideal opportunity to devise world-class petroleum contracts for the 21st century.

Robin Mills is the head of consulting at Manaar Energy, and author of The Myth of the Oil Crisis and Capturing Carbon.