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Will Shell’s Gas Gamble Pay Off?

Supermajor Royal Dutch Shell has decided to divest its Iraqi oil assets in a move to focus on its future in natural gas.

The industry giant is seemingly breaking from its oil heritage to head full speed into the “Golden Age of Gas.” Shell’s decision to leave Iraq’s upstream oil assets is not without risk, however, as the market for natural gas is even more oversupplied than it is for crude oil.

Reuters reported the move first, based on a letter from the Iraqi ministry of oil, followed by a confirmation from Shell. The Dutch heavyweight indicated to the press that its oil asset divestment in Iraq is in line with its strategy to focus more on natural gas and downstream activities.

Shell’s current 45 percent stake in the Majnoon oil field will be relinquished in “due course,” officials stated. The company also indicated that the Iraqi Ministry of Oil formally endorsed the proposal. While a timeline for the divestment has yet to be agreed upon, Iraqi officials already indicated that Shell Iraq will now focus mainly on the Basrah Gas Company and the Nebras Petrochemicals Project.

For Iraq, Shell’s strategy change is a slap in the face. The decision will likely lead to a delay in production within the field, further constraining Iraq’s widely published production target of 5 million bpd by the end of 2017. Sources put current production at Majnoon at 235,000 bpd, with a target of 400,000 bpd in 2020.

While both sides have reiterated that the Shell decision isn’t based on a political conflict or increased risks in the country, analysts suggest that the ongoing disagreement on production specifics between the Iraqi government and IOCs may be partially to blame. Baghdad has yet to agree to establish Production Sharing Agreements, even though Iraq-Kurdish operations are already based on them.

An open disagreement on contract terms seems to be the official cause for Shell’s decision. Baghdad has placed harsh conditions on all of its contracts, seemingly targeting even higher revenues. This is in contrast to the IOCs, which target a quick return on their own investments.

Others have stated that Baghdad added performance penalties to the Majnoon remuneration fees in May, which could have sped up Shell’s decision. Also, some say that Shell wants to divest its West Qurna-1 field, which would be another blow for Iraq. Related: Supermajors Prepare For A Permian Bidding War

It is no coincidence, however, that Shell took the decision at a time when Iraq is under severe stress. The growing possibility that the country is poised for a new internal conflict due to the Kurdish independence referendum on September 25, in addition to the ongoing conflict between Iraqi forces and Daesh within the country, could be the straw that broke the camel’s back.

Another possibility for Shell’s decision to leave Iraq may stem from its desire to move into Iran.

Recently, Shell presented plans to develop the major offshore Kish gas field in Iran. The proposal was handed over by Shell vice-president Hans Nijkamp to his Iranian counterparts at the national Iranian Oil Company. Both sides of the agreement signed an MOU to develop the field in December 2016, and last month, Shell had already submitted proposals for the development of the Azadegan and Yadavaran oil fields in southern Iran.

Azadegan, a giant oil reservoir at the Iran-Iraq border, has been signaled out as the first oilfield to be tendered within the framework of the Iran Petroleum Contract—the country’s new, more attractive contractual model for implementing upstream petroleum projects.

Shell is taking an immense risk in leaving a very prolific oil region (Iraq) for a still-disputed oil and gas producer under international sanctions. Iran’s future is still undecided, as Washington still seeks to put much more strict sanctions on Tehran or even revoke the current JCPOA agreements.

If the Trump Administration puts new sanctions or totally blocks any business with Iran, Shell will be hit hard. The Dutch major will not only have relinquished prolific oil reserves, potentially holding more than 18 billion barrels, but will also have to end its involvement in Iran if it doesn’t want to be hit by U.S. sanctions, as well. Based on its listing and involvement on the U.S. Stock Exchange and assets in the U.S., the risks of an enormous negative fallout due to its Iranian operations seem to be much higher than would have been the case by staying in Iraq.

In addition, Shell will have to face the consequences of its dealings with Iran. The Arab countries will not look favorable to any renewed or increased cooperation with an IOC supporting Iran’s future. The company’s gas gamble could have a significant impact on its Arab influence. Saudi Arabia, the UAE and Egypt, all important for Shell’s gas ambitions the coming years, could become a no-go area.

On the sidelines, Russian and Chinese oil companies and investors are watching in amusement. If Shell leaves Iraq’s oil fields, its former assets will likely be taken over by Rosneft, Sinopec or CNOOC. The Dutch gas move could lead to an increase Russian-Chinese grip on a vast portion of Arab crude oil reserves. Related: Does Russia Really Need The OPEC Deal?

Where Stalin did not accomplish his goal of building a Russian Crescent of Influence in the Middle East, Russian oil and gas companies may very well succeed. From Iran to Syria, Russian majors will rule the desert.

Next time, Shell advisors should watch Arab media sources, read between the lines and keep an eye on Washington before making a decision. A gas-fired future could be interesting, but profit margins on crude oil, and a sustainable financial stability of the company should be the main cornerstones for all rational decision-making processes.

Iran’s attractiveness could be one of the famous fairy tales told to children since the time of Princess Shahrazad. The Majnoon decision (Majnoon means stupid in Arabic) could be step or two down the road, after the debacle for the Dutch oil on Abu Dhabi’s ADCO concession.

By Cyril Widdershoven for Oilprice.com

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