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Is An Iraqi Production Slowdown Inevitable?

Iraq

A tremendous amount of digital, and real, ink has been spilled on the ongoing oil crash, much of it has been focused on U.S. shale production. Yet, the country that has grown production the most over the last two years, Iraq, has only been mentioned in passing by most observers. Between 2014 and 2016, global oil production grew by 3.3m barrels, 33 percent of that increase, or 1.1m barrels came from a single country: Iraq. If Iraq had maintained its pre-crisis production level of 3.3m barrels, the oil crisis would have been much shallower. Understanding where Iraq’s production is heading is key to understanding where oil prices will go, but like most things, understanding the future requires that you understand the past.

In 2009, six years after the U.S. invasion of Iraq, Iraq undertook a series of licencing rounds for the development of its giant southern oil fields. That was the first-time International Oil Companies (IOCs) had been invited to work in the country since the nationalization of the Iraqi oil industry in 1972. These licencing rounds carried the seed of the recent surge in Iraq’s oil production, but I’m skipping ahead.

Prior to the involvement of IOCs, Iraq’s oil production had been stagnant at around 2.5m barrels, down from a peak of 3.5m barrels reached in 1979. The licencing rounds resulted in the signature of dozens of Technical Service Contracts (TSCs). Between 2010 and 2012, these contracts had no notable impact on Iraqi production as various IOC’s labored to fulfill their contracts, while some stalled in the hope of getting better and more realistic terms. Years of war, neglect and bad management had left most of Iraq’s oil infrastructure in tatters, IOC’s assistance was required to lay new pipelines, build additional storage tanks, erect new pumps and rehabilitate the country outdated and inadequate export infrastructure, this is on top of drilling hundreds of new wells.

Iraq’s infrastructure bottlenecks played a significant role in delaying major increases in Iraqi oil production, despite a large increase in development drilling:

As can be seen from the above graph, completed wells increased by four folds between 2012 and 2014 as compared to the previous three-year period from 2009 to 2011. Up until 2014, the increase in Iraqi production lagged to a large degree the acceleration in the drilling rate. It was only in 2015, 3 years after the drilling surge, that Iraq’s production really took off. The reason for the disconnect between the large increase in drilling and production was the lack of sufficient treatment, storage and export infrastructure to handle the new, often heavier oil supply. Iraq’s inadequate oil infrastructure resulted in quality issues and in turn forced Iraq to curtail production at a number of oil fields.

In May 2015, infrastructure finally caught up with drilling capacity, resulting in Iraq being able to split its Basra oil stream into light and heavy grades, this was made possible after the commissioning of a new Single Point Mooring (SPM) buoys in 2014 and 2015. The light-heavy split generated a significant jump in Iraqi production, and was the key contributor to the increase in Iraqi production and exports in 2015 and 2016.

(Click to enlarge)

Where next?

The 1.1m barrels total increase in Iraqi production in 2015-2016 was the product of an active IOCs drilling campaign combined with a successful debottlenecking and rehabilitation effort to better the country’s oil and water handling infrastructure. The combination of these events, the licencing rounds in 2009, the heavy drilling undertaken in 2012 to 2014, and the infrastructure debottlenecking in 2015-2016 happened at a unique period in history and will not be repeated. This is not to say that Iraq wont increase production going forward, but it will do so at a more moderate pace.

The IEA, in its March 2017 Medium Term Oil Outlook pegged Iraq future production growth at 120K per year:

(Click to enlarge)

(Source: IEA)

The IEA’s modest annual oil production growth target for Iraq seems appropriate in light of the sharp decrease in capital spending by the IOCs (declining from $18B in 2015 to $10.7 billion in 2016) and is currently set at $11.7B for 2017. The reduction in capex can be seen from the halving in Iraq’s rig count from a peak of 96 in June 2014 to 40 as of February 2017:

(Click to enlarge)

(Source: Baker Hughes)

Delayed water infrastructure

One of the major constrains facing Iraq’s oil production growth in the medium and long term is the lack of sufficient water injection infrastructure. As per the IEA Iraq oil and gas outlook (2012), for each oil barrel produced, Iraq needs to inject 1.5 barrels of water. Iraq’s long term goal is to produce over 7m barrels from its southern oil fields, this requires a massive investment in water handling and injection infrastructure.

Iraq’s plan to tackle the water challenge went through several reiterations, in 2010, the initial plan consisted of building the Common Seawater Supply Facility (CSSF), a massive 12.5m barrels seawater transport and injection project carrying water for 100Km from the Arabian Gulf and injecting it into the southern oil fields. However, lack of funding for the $10B project and a conflict with the project manager, Exxon, led to dropping Exxon as project manager and the transfer of the project to the South Oil Company in 2012. The South Oil company planned to proceed in two phases, with the first 5.2m barrels phase initially proposed to come online in 2017 (other reports put first phase at 7.5m barrels with an expected Q2/2018 completion date). In 2014, due to continued delays, phase one was pushed to 2018-2019. By late 2016, with no progress on the CSSF achieved, the project was downsized to 5m barrels in total, split in two phases.

It’s not yet clear when this last scaled down version will be completed, or when it will commence construction. Iraq Oil Report noted in November 2015 that Iraq was negotiating with Exxon and PetroChina on the development of additional, smaller oil fields, in addition to having them mange the water supply project, with a goal of having it functional by 2020. It seems that Iraq has gone full circle and is back talking to Exxon on the construction of the water supply project, and as of March 2017, Iraq is still in talks with them. if the talks conclude successfully, phase one of the scaled down version may come into operation by 2020, however if history is any guide, this date will be pushed up again.

Field by field overview

To better understand where Iraq’s oil production is heading, I will provide a short overview of the key Iraqi oil fields and their near-term production growth potential. The bulk of Iraq’s oil production (3.34m barrels, or 73 percent of total production) comes from eight oil fields (listed below). Once fully developed, these fields will supposedly carry Iraq’s oil production from 4.6m barrels today to 8m barrels at some point in the future. In its World Energy Outlook 2016 the IEA sees Iraq’s oil production reaching 7.1m barrels in 2040, while in its more recent 2017 Medium Term Oil outlook, the IEA sees Iraq’s oil production reaching 5.4m barrels in 2022.

West Qurna-2 (0.425m)

Potential to increase near term production: LOW.

West Qurna-2, operated by Lukoil, currently produces between 0.4m and 0.45m, in line with 2016 levels. Production beyond current levels is expected to get tougher according to operator:

Pumps and water injection will be needed in coming years, and the yet-to-be developed Yamama geological formation, unlike the Mushrif layer that is contributing to today’s output, holds gas higher in deadly hydrogen sulphide.

In 2016, Lukoil was asked by the Iraqi oil ministry to cut its development budget for the field from $2.1B in 2015 to $1.26B, or a 40 percent cut. When development in West Qurna started, the contracted 1.2m barrel long term plateau was supposed to be reached by 2017/2018, there is no sign of this happening as in March 2017, Lukoil expressed a goal of keeping production flat at current levels. Lukoil has not disclosed when it will resume production growth at the field.

As a side note, it might helpful to note that Lukoil spent over $7B dollars between the ratification of the West Qurna-2 contract in 2012 and bringing production to 400K barrels in 2015.

(Click to enlarge)

(Source: Lukoil)

As per the Technical Service Contracts, the Iraqi government is to reimburse IOCs for their development costs, on top of a per barrel production remuneration fee. With current production at around 400K barrels, we can deduce that the per barrel development cost for West Qurna-2 averages about $17K per barrel. This number is close to the $15K per barrel mentioned by Iraqi officials as an average development capex for Iraqi oil fields. In its 2016, World Energy Outlook, the IEA advanced a figure of $10K to $15K per barrel for developing Iraq’s oil fields.

Majnoon (0.215m)

Potential to increase near term production: HIGH.

Majnoon, operated by Shell, currently produces between 200k and 220K barrels, a level that has been sustained since 2014. In 2016, Shell was requested to lower spending from a proposed $1.5B to $855m, while maintaining production at 200K barrels.

In early 2017, Shell signed a $210m contract with Halliburton, with the aim of increasing production to 400K barrels within three years. Majnoon does not require pressure support (water injection) until it reaches its 1m barrels plateau target, accordingly, Majnoon should provide annual production growth of 60K to 70K barrels per year over the next three years.

Zubair (0.4m)

Potential to increase near term production: LOW.

(Source: Iraq Oil Contracting Office)

(Click to enlarge)

Zubair, operated by ENI, currently produces 400k barrels. In 2012, ENI signed a contract with Weatherford to increase production at the field to 550K barrels. During the execution of the contract a dispute arose between the two companies. The dispute was eventually resolved in 2H-2016 and the contract was concluded, apparently without reaching the 550K target. As of Q3/2016, ENI mentioned that they were in negotiations with the Iraqi government on new fiscal terms, and have not provided additional clarity on increasing near term production.

The long-term production plateau agreed with the Iraqi government for Zubair is 850K barrels. According to both Platts and the IEA, Zubair requires pressure support to reach and sustain its production target, hence without progress on additional water injection infrastructure, its unlikely that Zubair will contribute to near term production growth.

Halfaya (0.2m)

Potential to increase near term production: HIGH.

Halfaya, operated by CNPC has been producing 200K barrels since 2014. Initial development plans called for Halfaya to produce 400K barrels by the end of 2016, however these plans have been delayed to 2018, if achieved, Halfaya would be the first field to reach its long term plateau target.

Rumaila (1.45m)

Potential to increase near term production: LOW.

(Click to enlarge)

(Source: Iraq Oil Contracting Office)

Rumaila, operated by BP, the workhorse of Iraqi oil fields, currently produces 1.45m barrels, this is up from 1m barrels in 2009, but still below the 2.1m barrels long term target plateau. This sizable increase was achieved after BP drilled 240 new wells, and renovated Qarmat Ali water injection plant, thus increasing water injection from 60K barrels in 2013 to 900k barrels today. Rumaila has a 17 percent natural decline rate and requires constant water injection to maintain its production.

In Mid-2016, BP, contracted with Amec Foster Wheeler to undertake studies to sustain and eventually expand Rumaila oil production. It’s worth noting that the Iraqi government had asked BP in 2016 to lower its investment budget at the field from $3.25B to $2.48B. Considering the maturity of the field, and its fast natural decline rate, additional growth at Rumaila is unlikely without substantial investments in additional water injection infrastructure. Related: Putin Says Russia Will Become World’s Top LNG Producer

In its, 2017 Medium Term Oil Outlook, the IEA signalled the need for additional water supply projects for Iraq to achieve its production targets, Rumaila was one the fields mentioned by name:

Iraq’s prized southern oil fields will not come close to achieving their full potential - and an official
target of 6 mb/d by 2020 looks unattainable - unless a long-delayed project to supply water gets off
the ground. Baghdad has scaled down the planned mega-project, reducing its scope from 7.5 mb/d
to 5 mb/d to be brought on in two stages. Until then, alternative sources will have to suffice at
mature fields such as Rumaila, Zubair and West Qurna-1.

West Qurna-1 (0.47m)

Potential to increase near term production: HIGH.

(Source: Iraq Oil Contracting Office)

(Click to enlarge)

In Feb 2017, West Qurna-1 production reached 470K following the installation of a 300K barrels water injection unit, this is not materially different from where production stood in 2013, the reason for the lack of production progress was the lack of water injection facilities which caused a sizable dip in production in 2014. Earlier this year, Bloomberg reported that production at West Qurna 1 is expected to increase to 600K by mid-2017. The recent progress seems to be tied to the construction of a new oil production station by the operator, Exxon.

West Qurna-1 long term production plateau is set at 1.6m barrels, the expected increase to 600K barrels in production this year remains a far cry from the targeted level. Achieving the long-term plateau target will necessitate the construction of a much more robust water injection facilities.

Garraf (0.1m)

Potential to increase near term production: MEDIUM/LOW.

Garraf, located currently produces 100K barrels according to the operator, Petronas. The agreed upon long term plateau rate for the field is 230K. In May 2016, Japex, partner in the project, indicated that Garraf is expected to reach its 230K production target in 2019, subject to approval of the Iraqi oil ministry.

Badra (0.08m)

Potential to increase near term production: HIGH.

Badra, operated by Gazprom, currently produces 80K barrels, this is up from 67K barrels in 2016. Gazprom contracted production plateau for the field stands at 170K barrels, its not clear when would that be achieved. Nonetheless, Gazprom did indicate last year that the field could potentially reach 115K barrels in 2017.

Other minor fields

Iraq has a host of other smaller fields at various stages of development such as Luhais, Nasiriya, Tuba, Nahr Bin Umar and Artwi, these fields collectively produced 237K barrels as of late 2015, the target production level set by the Iraqi government for these fields is 345K barrels.

Production from the north of the country, which includes both legacy Kirkuk production and KRG production is currently set at 700K. Production from the north is unlikely to increase materially in the near term due to a host of financial, geological and geopolitical issues constraining further development in this region.

Based on the above tally, Iraq has a line of sight to increase production between 500K and 600K barrels over the next 2 to 3 years. This increase equates to between 200K and 300K growth per year, this is slightly faster then the IEA expected annual increase of 120K per year, but substantially below the 1.1m barrels increase witnessed during the last 2 years. It’s worth noting that additional delays in the construction of water injection projects and the sizable decrease in the rig count could cancel out some of the growth should production decline in some of the pressure supported fields.

Finally, financing production growth with oil at $50 a barrel is a vastly different proposition for Iraq than when oil prices averaged $100 a barrel. The fact that Iraq must pay up for development costs, rather then share them with the IOCs puts the initial capex burden on the Iraqi government. Iraq has been experimenting with changing the terms of the contracts and moving closer to production sharing model, but no such contracts have been signed yet.

A brief look at the rest of OPEC

Iran

The second country to experience rapid production growth recently is Iran. Following the removal of nuclear sanctions, Iranian production increased by 1m barrels from 2.85m in 2015 to 3.81m in Q4/2016, thus regaining its pre-sanctions production level. It’s worth noting that Iranian production was declining for five years prior to the sanctions taking effect in 2012:

(Source: IEA)

The reason for the decline in Iranian production prior to the sanctions is the advanced age of Iranian oil fields, roughly 50 percent of Iranian oil production comes from fields that are over 70 years old. Going forward the IEA expects Iranian crude production to grow at 50K barrels per year (80K per year if we are to include condensate and NGLs) a trickle compared to the 1m barrels increase following the sanctions removal.

If Iran is successful in attracting foreign capital, its production growth may accelerate later in the decade, however with the Trump administration in power, investing in Iran is a risky proposition for most IOCs.

GCC countries

Saudi Arabia, UAE and Kuwait maintain approximately 1m barrels in observable excess production capacity, the lion share of this excess capacity is held by Saudi Arabia. The GCC countries have historically used their excess capacity tactically, in contrast to the rest of OPEC, which have always produced flat out.

The GCC countries will likely increase their oil production once the OPEC cuts expires, however to avoid another large build up of inventories, its probable that the GCC countries will ease their return to the market.

It’s useful to note that within this group, only the UAE is building meaningful additional capacity of 370K barrels between today and 2022.

Africa

Algeria, Angola, Gabon and Nigeria are not investing in additional capacity. The only member with potential excess capacity is Nigeria, which is currently producing at 200K barrels below its potential due to the ongoing conflict in the Niger Delta. Related: Why An OPEC Deal Extension Won’t Lift Oil Prices

Libya, could theoretically produce an additional 1m barrels given enough time and resources, but for that to happen the country needs to achieve political stability, and to repair the extensive damage to its production and export infrastructure. The civil strive in Libya makes it impossible to make an informed forecast as to where that country production is heading.

Latin America

The situation in Venezuela is very fluid, and the country appears to be at the edge of a precipice, in this context its hard to have confidence in the IEA production outlook for Venezuela which calls for a gentle annual production decline of 20K barrels per year. Venezuela presents a true black swan for supply as the country descends into chaos. A total breakdown in Venezuela could remove up to 2m barrels from the market in short order. By all means, even without a total breakdown, due to lack of funds and bad management, the country is likely to experience accelerated production declines for the foreseeable future.

Ecuador, the second smallest OPEC producer, with 570K barrels of production has stopped paying its bills to the service providers, such situation is unsustainable for any extended period of time, without fulfilling its payment obligations, production in Ecuador is likely to decline in the coming months and years.

Conclusion

The large increase in Iraqi production in 2015 and 2016 was mostly a one-time event, and will not repeat going forward. A more modest 120K to 250K barrels annual growth in Iraqi production is more likely, such measured growth rate wont have the same nefarious impact on oil prices as the surge in Iraqi supply had in 2015 and 2016. The upcoming slowdown in Iraqi oil production growth, along with the imminent slowdown in Iranian production growth, paints a vastly different picture of OPEC’s ability to grow production in the near term. With 2.5m barrels of the 3.3m barrels increase in global production coming from OPEC in 2015 and 2016, a slowdown in OPEC’s production growth in the coming years will have a material impact on the oil market balance post the OPEC cut.

The amalgamation of the factors discussed in this article signal a slowdown in OPEC’s annual production growth from 1.25m barrels in 2015/2016 to 500K-600K in 2018/2020, if this forecast proves accurate, shale oil production will need to ramp up relatively quickly in the coming years to keep the market well supplied, and especially so as the impact of lower oil prices starts to erode Non-OPEC long term supply later in the decade.

By Nawar Alsaadi for Oilprice.com

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