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Simon Watkins

Simon Watkins

Simon Watkins is a former senior FX trader and salesman, financial journalist, and best-selling author. He was Head of Forex Institutional Sales and Trading for…

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The Real Reason Big Oil Is Giving Up On Iraq

West Qurna

News last week that U.K. oil super-major, BP, is working on a plan to spin off its operations in Iraq’s supergiant Rumaila oil field into a stand-alone company had an extremely familiar ring about it to those who have been in the oil markets business for a while. It was exceptionally reminiscent of the withdrawal of the U.K.-Dutch oil super-major, Royal Dutch Shell (Shell), from Iraq’s supergiant Majnoon oil field in 2017 and also of its withdrawal from Iraq’s supergiant West Qurna 1 oil field in 2018. Each of these announcements also bore a startling similarity to U.S. super-major ExxonMobil’s (Exxon) recent announcement that it too wants to get out of West Qurna 1 and to its withdrawal from the Iraq’s crucial Common Seawater Supply Project (CSSP) some time ago. The answers to what is actually causing this mass exodus of Western firms from Iraq are laid out below.  The real answers bear little relation to the official reasons given at the time for the withdrawal of these companies from Iraq, as OilPrice.com’s shrewd readers might well have already construed. In Shell’s case, the official reason for its withdrawal from both Majnoon and West Qurna 1 was that such moves were in line with its overall plan to restructure its global business, following its takeover of BG Group, involving a US$30 billion asset disposal programme and a focussing on gas development. The reason given by various BP sources for its creation of a completely standalone separate entity operating in Iraq – ‘ring-fenced’ is another word for it – is that it will allow BP more flexibility to invest in low-carbon energy by enabling it to reduce its spending on oil and gas. ExxonMobil, for its part, long ago gave up bothering to come up with any official reason why it wanted nothing to do with Iraq. 

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Is the reason why so many Western IOCs are exiting Iraq the endemic corruption that permeates any sector of Iraq in which there is money to be found, as has been consistently highlighted by OilPrice.com? Partly it is that, with little change to the overall rotten layers of business and political dealings in the country that have been characterised by the highly-respected independent international non-governmental organisation, Transparency International (TI) in various of its ‘Corruption Perceptions Index’ publications, in which Iraq normally features in the worst 10 out of 180 countries for its scale and scope of corruption. “Massive embezzlement, procurement scams, money laundering, oil smuggling and widespread bureaucratic bribery that have led the country to the bottom of international corruption rankings, fuelled political violence and hampered effective state building and service delivery,” TI states. “Political interference in anti-corruption bodies and politicisation of corruption issues, weak civil society, insecurity, lack of resources and incomplete legal provisions severely limit the government’s capacity to efficiently curb soaring corruption,” it concludes. Staggeringly, even Iraq’s own Oil Minister back in 2015 (and later Prime Minister) - Adil Abdul Mahdi – stated that Iraq “lost USD14,448,146,000” (that is over 14 ‘billion’) from the beginning of 2011 up to the end of 2014 as cash “compensation” payment to international oil companies. To put this into some sort of understandable perspective: if this amount in dollar bills was laid end to end then it would stretch from Earth to the Moon nearly six times over. 

In many cases, these payments have been disguised to Western IOCs by the Iraqi authorities under a key clause relating to Article 12.5 of Iraq’s standard long-term service contract (LTSC). This asserted that compensation related to reduced oil production levels was allowed for three reasons: first, in order to minimise associated gas wastage; second, for any failure of oil and gas transporters in receiving net production at the transfer point through no fault of the contractor or operator; and/or third as a result of the government itself imposing such a reduction. In turn, according to Article 12.5, compensation payments could be made in three ways: a revised field production schedule, extension of the duration of the contract, and/or actual cash payments to IOCs. Related: It’s Too Late To Avoid A Major Oil Supply Crisis

However, as highlighted at the time by Ahmed Moussa Jiyad, former senior economist with the Iraq National Oil Company and now an independent development consultant, from the basis of the standard LTSC contracts, there were two additional elements that factored into the US$14 billion-plus of lost income over just a three-year period. First, the incremental production above the base-line production, and second the ‘net’ remuneration fee. There is a lot of suppositional and highly subjective mathematics involved in these calculations but suffice it say that based on base line production, minus a natural rate of decline of 5% for each year then the remuneration contracts for the 10 fields covered by the LTSCs awarded in the first round of bidding would have given a simple average of US$2.50 per barrel. In practice, though, the weighted average of the remuneration fees was around USD1.90 per barrel, leaving US$0.60 per barrel unaccounted for. 

“What this meant for various Western oil companies was a two-fold risk,” a senior oil and gas industry figure who works closely with Iran’s Petroleum Ministry told OilPrice.com. “First, although it was not clear exactly where these extra payments were going, there was nonetheless a risk that if they were found out to be ending up in the pockets of officials then there would be a huge reputational damage to the company involved, however unwittingly, and second, it meant that the compensation that companies were actually receiving was much less than they had signed up for, and their margins were already very tight,” he said. “What this would mean for a company such as Shell [although there is no suggestion that Shell or BP or ExxonMobil knowingly engaged in any improper activities at all in Iraq], is that it was receiving actual compensation fees per barrel of US$1.25 per barrel for Majnoon and US$1.70 per barrel for West Qurna 1 whereas it had been expecting US$1.39 per barrel for Majnoon and US$1.90 per barrel for West Qurna 1, based on the headline compensation figures given in the contracts,” he added. Similarly, he underlined: “Exxon found that a lot of hurdles suddenly started to arise in projects connected to the CSSP, such as the lack of approval of contracts for service work, or for permits to build out infrastructure needed for pipelines and drilling wells, and for something as simple as obtaining visas for workers and customs clearance for vital technical equipment.” 

Corruption, though, is not the only reason for the mass exodus of Western IOCs from Iraq. The other major factor is that China, especially, but also its partner in Middle East affairs, Russia, with the two countries already effectively in control of almost everything worth having in Iraq’s oil and gas sector and working on gaining power over everything that remains. A prime example of this was that even before Exxon said that it wanted out of West Qurna 1, China was already dominant at the site, not only through the 32.7 per cent stake held by PetroChina - the listed arm of CNPC - but also through the gradual acquisition of a range of huge supposedly ‘contract-only’ awards made to Chinese companies for work on the field.

These most recently included the US$121 million engineering contract to upgrade the facilities used to extract gas during crude oil production to the China Petroleum Engineering & Construction Corp (CPECC) that was exclusively highlighted by OilPrice.com in this very regard. Exactly the same ‘contract-only’ model was also used in the Majnoon oil field exited by Shell, with two game-changing contracts signed: one with China’s Hilong Oil Service & Engineering Company to drill 80 wells at a cost of US$54 million and the other with the Iraq Drilling Company to drill 43 wells at a cost of US$255 million. In reality, it is China that is in charge of both, having given the funds required to the Iraq Drilling Company as a ‘fee’ for its own participation, according to the Iranian and Iraqi oil industry sources.

Complementing this power shift to China that has been underway in earnest ever since former U.S. President Donald Trump started to scale back the U.S.’s on-the-ground presence in the Middle East is that the new standalone company that will now hold BP’s interest in Iraq’s Rumaila oil field will be jointly owned by China National Petroleum Corporation (CNPC). This China state corporate oil proxy already had a 46.4 per cent stake in Rumaila – with BP holding 47.6 per cent and the remaining 6 per cent held by Iraq’s State Oil Marketing Organization – although the new stake split is unknown as yet. 

By Simon Watkins for Oilprice.com

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