February 6th, 2013

The Nassiriya Challenge

 

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It’s unique, it’s challenging and it’s complex, but Iraq’s oil ministry seems determined to make the first upstream-downstream integrated project in Nassiriya a reality. What’s more, forget the $ per barrel fee that was the basis of all previous service contracts. On this one, investors will make a return on their investment from a percentage of the revenues Iraq will rake, pretty much like the “profit oil” concept in production-sharing contracts, but in cash not in kind.

Previous efforts to sell the Nassiriya refinery project under an investment scheme – together with three other refineries – have failed to attract investors. Now, by bundling the Nassiriya oil field development with the refinery into one integrated project under one contract, the ministry is making the last remaining oil fields to be offered to foreign companies the prize for any consortium willing to undertake the refinery project. The twist is that the field developer gets paid from the sale of refined products to the Iraqi government, not from producing oil. In fact it’s synonymous to a revenue-sharing model as opposed to a production-sharing one.

This is the first time such an integrated project is offered in the region. Saudi Arabia tried more than a decade ago to offer integrated projects of upstream gas exploration with power and desalination plants under what was known as the Saudi Gas Initiative, but the scheme failed to take off. The two components were too difficult to reconcile and gas blocks were retendered on their own.

Based on previous studies conducted by foreign oil companies and 3-D seismic carried in the past two years by the ministry’s own Oil Exploration Co (OEC), Nassiriya oil field is estimated to contain more than 4 billion barrels of oil in place. It came on stream in 2009 and currently produces about 35,000 b/d. The ministry is targeting a plateau of 300, 000 b/d from the Mishrif reservoir (26o API) – and possibly Yamama at a later stage – with an equal nameplate capacity for the associated refinery.

The concept of the Nassiriya integrated project is very simple. And yet, drawing up an economic model for such project is very complex and challenging. “It’s similar to any of the contracts signed in the second bid round for developing green fields, but instead of building gas processing facilities as part of the field development contract, the developer will build a refinery”, one ministry official tells me. That’s the easy part – notwithstanding the scale of investment needed which according to industry estimates could be $4-5 billion for the field development and $8-10 billion for the refinery construction.

The parameters of the new model contract are completely different from the existing one as it integrates two cost recovery processes in two separate phases starting with a proportional recovery and later switches to 100% recovery until all capex is paid. On top of this, remuneration or profit is paid as a percentage of the revenue from products sale after costs are deducted. For now, the only bidding parameter being considered by the oil ministry is one based on the investor take, i.e. the percentage of remaining revenue, most probably subject to a ceiling.

But make no mistake: what you get for the field development in terms of cost recovery, will be contingent on progress on building the refinery, not the opposite. And profit taking, i.e. remuneration, only starts once refined products reach the market.

The model is still under development by the ministry’s Petroleum Contracts & Licensing Directorate (PCLD). The latter is planning to engage potential investors who qualify for the project for feedback before the terms are finalized.

Based on the current preliminary thinking, here is how the project should work:

The development of the field will be carried out in parallel with the construction of the refinery. Recovery of cost and payment of remuneration will be based on throughput i.e. barrels of refined products produced. However, as the commissioning of the refinery could easily lag behind the field’s start of production – by at least two years – the developer will be able to start recouping his cost for the field development and the refinery construction from the incremental oil produced, but only in proportion to the progress made in the construction of the refinery. The closest the refinery gets to commissioning, the biggest the ratio of the costs he can recover for both the upstream and downstream spending. Whether a ceiling for the cost recovery, or for the amount of oil produced allocated for this will be introduced, is still subject to debate.

Based on the existing FEED (Front-End Engineering & Design) carried out by Foster Wheeler on behalf of the ministry, the refinery will be completed in two phases, each phase consisting of one train of a 150,000 b/d capacity, allowing for early start of remuneration payment as the first products hit the market, but only up to 50% of the cost recovery. The full cost recovery commences with the completion of the second train or when the construction of the refinery is declared 100% complete.

The refined products will be dedicated for local consumption, not for export. However, calculation of the revenue for the purpose of remuneration payment will be based on international prices of refined products, not the subsidized price of products sold on the local market. It is then up to the Iraqi government to decide when and how to phase out subsidies as it sees fit.

The first draft model contract will only be finalized after a March workshop in which companies, developers, and investors will be able to present their suggestions and proposals to ministry officials in one-on-one meetings that are designed to be brain-storming sessions aimed at maturing the model. At least, that is the intention.

The qualification process for companies is still ongoing as new downstream companies join the foray and integrated companies who previously qualified for the upstream bid rounds are required to update their submissions to qualify for the integrated project. The last deadline for submissions is February 28. The expectation is that the setting up of consortia – the ministry’s preferred format for bidders – will follow in earnest.

If this new venture succeeds, the Nassiriya refinery will be the first to be built in Iraq since the mid-1980’s. Not only should it cut refined products imports that have plagued its market and burdened its budget since 2003. More importantly, it would introduce at last better quality products to the Iraqi local market where 82 octane (and below) is the norm for locally produced gasoline.

The View from Baghdad