Iraq: China’s Breakthrough

29 August 2008

China this week became the first country since the overthrow of Saddam Hussein to clinch an oil deal with Iraq, by reviving the first of a series of contracts signed by the previous Iraqi regime under new terms dictated by new realities. The service contract for development of the Al-Ahdab field, which includes a mix of old production sharing elements and new service contract terms, sets a ceiling for any development terms to be offered by Baghdad in the future. The deal also presents a challenge to the Kurdistan Regional Government’s production sharing agreements (PSA).

China National Petroleum Corp.’s (CNPC) new 20-year service contract preserves some of the attractions of its 1997 PSA, but both sides offered concessions to bring negotiations launched last year to a conclusion, Iraqi sources told Energy Compass.

CNPC managed to preserve its 75% stake in the new joint venture, while state North Oil Co. (NOC) will hold the remaining 25%. NOC’s contribution will take the form of assets and local costs. This marks a success for the Chinese, given that the new long-term service contract model being developed by Iraq’s oil ministry for its first licensing round is likely to stipulate a 51% stake for the state, up from the 25% announced on Jun. 30. The model contract is currently being finalized with help from UK consultants Gaffney, Cline.

One reason Iraq compromised on the equity split is that — unlike the six oil fields offered in the bid round — Al-Ahdab is not producing. Four wells were drilled there in the late 1970s and early 1980s, but the field was never developed. Located 60 kilometers south of Al-Kut, it forms part of the central oil fields, which also include East Baghdad and Balad.

Investment under the new service contract is put at some $3 billion, compared with the former 22-year PSA’s price tag of $660 million for capital expenditure and a further $600 million for operating costs. Iraqi sources say the Chinese firm argued during the negotiations that the investment cost for Al-Ahdab needed to be five times the old estimate, while the oil ministry pitched a threefold increase. CNPC also asked for security costs to be included in the figure.

While accepting CNPC’s proposed investment value, the ministry succeeded in increasing the peak production rate from the original 90,000 barrels per day to a new 110,000 b/d target. An initial three-year development phase will bring 25,000 b/d on stream — potentially in 2011-12 — after which the 20-year term kicks in. Once the full target is reached, levels should be sustained for at least six years. The field was discovered in 1979, with reserves estimated at around 1 billion bbl.

Under the terms, CNPC will recoup its investment according to an agreed sliding scale. This fee will be based on an “R” factor, calculated as total revenues divided by total costs. Payment will be as high as $6 per barrel in the early stages of development, when production is low and spending high, but would gradually fall to about $3/bbl once production hits the targeted plateau. Total remuneration will be linked to an internal rate of return of about 18%. Operating costs will be financed from production.

In time, CNPC will cease to be the operator, with responsibility moving to a joint operating company. That handover will be triggered either by CNPC recouping all its costs or the R factor reverting to one, whichever occurs first. A joint management company will also be set up at the beginning of the contract term, for the period when CNPC is sole operator.

Sources say the oil ministry had been under pressure to conclude an agreement with CNPC since late last year, when Iraq’s electricity ministry awarded a contract to China’s Shanghai Heavy Industries to build a $940 million power plant in the Shiite-dominated Wasit province — which will be fueled by crude oil from the nearby Al-Ahdab field. The first of the plant’s four 280 megawatt units is due to be ready in about three years’ time, coinciding with the field’s start-up. About 15,000 b/d, or 60% of the initial production, will be required then. The plant will later run on associated gas from Al-Ahdab, supplemented from other gas sources at southern oil fields. In all, it is estimated that the 1,120 MW plant will require about 350 million cubic feet per day of gas, far above Al-Ahdab’s expected supply.

Compass Points

• SIGNIFICANCE: China has made a clear breakthrough in clinching the first major oil deal in Iraq since the overthrow of Saddam Hussein, advancing its sometimes controversial global quest for upstream assets. But the Al-Ahdab service contract falls short of the generous terms negotiated in the late 1990s, when it also became the first country to reach an oil deal with sanctions-era Iraq. Other companies currently renegotiating old deals include India’s ONGC, state Petrovietnam and Indonesia’s Pertamina.

• CONTEXT: The oil world has changed since the 1990s, and companies must compromise on contractual terms in the contest for limited upstream opportunities. Since the overthrow of Saddam Hussein, resource nationalism has been mounting in Iraq — as elsewhere — forcing Baghdad to drop the PSA model for field developments. While CNPC managed to preserve some elements of its old contract, Baghdad’s open tender for six producing fields is expected to offer fewer sweeteners.

• NEXT: Watch next for a decision on the fate of short-term technical service contracts. Royal Dutch Shell and a partnership of Chevron and Total have submitted revised proposals for one-year deals, following Exxon Mobil. But in Beijing this week, Iraqi Oil Minister Hussein al-Shahristani cast further doubt on their prospects, suggesting that the chances of signing deals are getting slimmer by the day. While the cabinet supports the deals, the oil ministry is said to be lukewarm.

By Ruba Husari, Dubai

(Published in Energy Compass August 29, 2008)

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