Restraining the Game-Changer: A Decade of Uneven Development in Iraq Petroleum Sector

14 February 2019

Ahmed Mousa Jiyad, Independent Consultant, Scholar, and BREC Alumni, Norway

The development of the Iraqi petroleum sector during the period 2008-2018 represents, from all related aspects, a distinct phase in the sector and in its role in the national economy. The petroleum sector comprising three different but interrelated sub-sectors through critical forward-backward linkages: Upstream (including exploration, field development and production); Midstream (pipeline, storage, export terminals) and; Downstream (crude refining, gas processing, petroleum product distribution and petrochemicals).


Abstract and Introduction

The development of the Iraqi petroleum sector during the period 2008-2018 represents, from all related aspects, a distinct phase in the sector and in its role in the national economy.

The petroleum sector comprising three different but interrelated sub-sectors through critical forward-backward linkages: Upstream (including exploration, field development and production); Midstream (pipeline, storage, export terminals) and; Downstream (crude refining, gas processing, petroleum product distribution and petrochemicals).

Though the state has been the dominant actor in petroleum sector development, the post 2003 period witnessed grand opening of the sector for International Oil Companies- IOCs. Different contractual modalities, mostly reflecting the peculiarities and realities of each sub-sector, were proposed or adopted to govern the relations with the IOCs.

Thorough and continuing follow-up and research suggest that most of the evidenced development has taken place in the upstream sub-sector, with heavy IOCs involvement in a significant part of proven oil reserves through most prized oilfields.

But the "triple shocks", of collapsing oil prices since June 2014 (economic risks) accompanied by Da"esh (security risks) effects and Kurdistan Regional Government-KRG taking-over some of North Oil Company-NOC oilfields (June 2014-October 2017) (political risks) with the prospect of "lower-for- longer" oil price that prevailed almost a year ago, contributing to continue deepening the fiscal crisis of the state and elevated the "fear-factor" among Iraqi decision makers. That, combining with apparent human, systemic and institutional capacity-gaps limitations (business risks), have resulted in Iraq giving important concessions to IOCs without having tangible benefits in return.

Accordingly, the article would argue that, analytically and empirically, a sub-sector focused policy impacts, negatively, the development in that sub-sector, in the sector itself and on the sector"s contribution to the development of the national economy. That indicates to the absence of well thought, coherent and integrated petroleum and energy policy; and to the "indicative non- mandatory" National Development Plan-NDP. The outcomes would exacerbate structural imbalances, vulnerabilities to external factors and increase dependency on oil revenues, which prohibits desirable structural change, diversification and transformation.

The nature of the topic decides the research methodology. Hence, the article is a multi-disciplinary in its approach focusing on the relevant and important economic, legal, institutional, political economy and geopolitical analytical frameworks and aspects. Also, the article offers evidence-based analysis by relying on official, verifiable and crossed-checked data, information and documentation. Time-series and charts for the ten-years covered period are necessary for elaboration but avoided for space restriction.

The article adopts a holistic view by addressing the three interrelated levels of analysis: micro, sectoral and national, excluding KRG. Throughout the article, many questions were posed indicating the need for further scholarly work and research investigation. Finally, because of my constant follow-up and frequent contributions on Iraqi energy and petroleum sector, this article refers heavily to some of my previous works and publications.

This article comprises two parts and concluding remarks: part one identifies and analyzes the most important milestones in petroleum upstream development while part two provides assessment of successes and failures in the petroleum sector.

Part one

Milestones in Upstream Petroleum Development 2003-2018

Since 2003, upstream petroleum subsector is having many milestones with significant direct impacts on the development of the sector-wide and also on the national economy at different degrees. Some of these landmarks constitute, by their own right, a distinct phase and sometimes overlapping. This part addresses the most important landmarks some of them could shape the development of upstream petroleum for, probably, many decades to come.

First: Ministry of Oil MoUs with IOCs[1]

Between 2004 and end 2008 the Ministry of Oil-MoO had concluded some 40 memoranda of understanding-MOUs with IOCs: including majors, independents as well as minors.

The first step was to formulate a standard text for the MoU, which spells out the structure, the terms of reference governing the signed MoU and its duration and renewal if needed. For each MoU there was one "Joint Steering Committee-JSC" comprises three or four representatives from each side; the names and number of the Iraqi side are known while the corresponding information on the IOC side are not. The role and mission of the JSC is to oversee and insure the full and proper implementation of the related MoU.

Each MoU was signed by the MoO while the other party was either a single company or a consortium of companies or an official entity.

One consortium comprising three companies; three consortia each comprising two companies while the rest represent MoUs with single companies. All MoUs were signed with companies except one, which was signed by the Norwegian Ministry of Energy.

The parties to the signed MoUs belong to 23 countries; the USA has the largest participation with 9 companies, followed by Japan and Norway with 4 each, then China, UAE, UK and Canada has 2 each and one company from each of France, Russia, Holland, Ireland, Turkey, Kuwait, Malaysia, Brazil, Indonesia, Austria, Angola, Australia, Spain, Italy, India and South Korea.

One of each MoU objectives is to conduct "Joint Studies" and for each study there was a "Technical Committee"; again the names, positions, specializations and number of the Iraqi side are known while those for IOCs are not provided. The number and coverage of the joint studies are not unified for all MoUs; some has only one joint study, while many have more.

Another important objective is human capacity development; each MoU offers different opportunities for training, workshops on variety of subjects and programs and for academic degrees.

These MoUs provided various opportunities, both serious and visits, for MoO staff and affiliated companies to interact with their international counterparts after decades of relative isolation. For IOCs, MoUs represent unprecedented and invaluable opining of all archives relating to upstream petroleum in the country that helped IOCs to explore where they would be involved and what they could provide to chart their way towards business objectives in Iraq"s upstream petroleum.

Execution and performance of these MoUs are not similar in delivering stated objective and some were terminated when the related IOC signed contracts with KRG without the approval of the federal Ministry of Oil.

Apparently, eventually outcomes did not correspond to IOCs efforts as their actual involvement in upstream project could tell. Two examples could highlight this: the USA had the largest participation with 9 companies in these MoUs, yet only one, ExxonMobil, has only 32% participation interest in one oilfield. On the other side, Russia had only one company that participated in these MoUs, but Russia has now three IOCs with significant participation interests in four oilfields and exploration blocks.

The same valid also on a company level as the cases of Chevron and Kuwait Energy-KE exhibit. For the MoU signed with Chevron, the three Iraqis in the JSC, headed by the current Minister of Oil-Jabbar Allibi (Luaibi), had a record high of convening meetings outside Iraq (between February 2004 and April 2008 they traveled to London 8 times, to Bahrain 5 times and to the USA twice); Chevron organized 44 training activities (in USA, Jordan, Bahrain, Kuwait and Turkey) attended by 741 Iraqis and held 17 workshops (mostly in Amman) with 139 participants. Finally, Chevron was involved in 15 joint studies. Yet, Chevron did not have a stake in MoO concluded contracts as per the bid rounds.

KE MoU, by contrast, was signed in September 2007 and has one year duration only; the JSC held one meeting only in Kuwait in 2007; the company participated in one joint study only and it provided no training or organized a workshop. Yet, the company has stakes in three MoO signed contracts, including the field it participated in its study!

An important outcome of these memoranda of cooperation is their contribution in the formulation and development of the model contracts for the four bid rounds; they helped the formulation of two year technical support contracts-TSCs, which were devised for implementation by the international oil companies during 2008 and 2009. These contracts focus first on halting the production decline of the major oilfields (Rumaila, Zubair, West Qurna1, Missan and Kirkuk), and then increase production by 400 to 500 thousand barrels per day-kbd. MoO pays for both investment requirements and the IOCs fees to achieve that target. Negotiations on these technical support contracts lasted from the fourth quarter of 2007 to mid-2008 without conclusion because of differences on serious issues (Al-Ammedi 2009).

MoO then reduced the duration of the technical support contracts to one year. After that time they would overlap with the timing of bid rounds. The IOCs refused the one year duration as too short for such contracts. Accordingly, the ministry abandoned the contracts to focus on the bidding rounds.

Based on the previous experience with the technical support contracts and the expected bid rounds the ministry began formulating and drafting the model contracts that would constitute the contractual framework governing the relationship with the IOCs (Al-Ammedi 2009a).

Second, the Accelerated Program and the Symposium for Reviewing Iraq Oil Policy

Intense debate inside Iraq during the period September 2008 to April 2009 focused on the desperate state of the upstream sector, especially in the southern part of the country.

A team of nine senior oil professionals including two former oil ministers conducted in depth survey on the status of the upstream sector. The team visited various locations and sites and held intensive discussions with top management and senior staff there during the period 21-31 December 2008. A final and detailed report was presented to the PM on 12 January 2009. Copy of the report was distributed during the Symposium for Reviewing Iraq Oil Policy held in Baghdad February 27-March 1, 2009.[2]

The first recommendation of the said "report" calls to adopt a program aiming at increasing oil production by some 350-500kbd, and the Symposium endorsed such program, to be executed within two years (2009 and 2010). Two days after the Symposium, the Council of Ministers-CoM[3] authorized a committee comprising the PM, his Deputy, the Ministers of Oil, Finance and Planning, and the Legal Advisor of the PM to review the state of the oil industry and decide on the requested mandates and authorities for the MoO and oil producing companies.

Apparently, the accelerated program was primarily drawn by a former Director General-DG of South Oil Co-SOC and oil ministry and CoM advisor Jabbar Allibi. However, Allibi was removed from been in charge of the program.[4]

Allibi removal had in effect derailed the program and considering the fact that the occupancy of DG position of SOC had changed three times, this had contributed to causing further management instability and worsening deterioration of the upstream operations especially in the south.

Not surprisingly, therefore, to observe the continuous fluctuation of oil production and exports causing serious loss in oil revenues and deepening the financial crisis of the country. Based on official data by the MoO compiled by the author, Iraq did not benefit, as it should have been, from high oil prices because its oil export was sharply declined from a total of 58.8 million barrels-mb to 54.4mb to 49.4mb in July, August and September 2008 respectively, at a time when the average price of the exported Iraqi crude was 118.81$/b, 102$/b and 85.30$/b during the same three months period.

The gradual improvement in oil export revenues during 2009 was a reflection of oil prices upward trend more than oil exports, which kept in regular and sharp fluctuation due to technical capacity constraints and security conditions.

But what is more important was the state of the petroleum upstream sector went from bad to worse and the accelerated programme to at least capture the decline and prevent it from worsening have not succeeded in a sustainable way to insure steady levels of oil production and exports, as the above data indicates clearly. One thought suggests it might be a "deliberate neglect" to justify the opening up of the oil sector before foreign investors- the IOCs.[5]

This might and might not be the case. But judging by outcomes, the above figures clearly suggest mismanagement and lack of vision. Instead of proposing "Grandiose" move by offering more than 80% of Iraq"s petroleum reserves through bid rounds, the MoO could have adopted gradual, feasible and achievable approach starting from rehabilitating the upstream sector moving upwards. Evaluation, selection, prioritisation, sequencing and implementations are fundamental ingredients and preconditions for successful development and testimonies for sound and effective federal petroleum policy.

Third: Conversion of the Contract for Al-Ahdab Oilfield

The production sharing "Development and Production Contract"-DPC was signed 4 June 1997, received endorsements at the time from the Iraqi National Council (parliament) when it was first initialled in 1996 and ratification from the cabinet and revolutionary command council in 1997 before it became effective, but remained idle due to UN sanctions.

The MoO decided to renegotiate the terms in 2006 to convert that PSC into a 20 year service contract; formalised it in late August 2008 in Beijing during a visit by Iraqi Oil Minister, Hussein al-Shahristani, approved by the Cabinet on 2 September 2008 leading to the contract signing on 10 November 2008 in Baghdad.[6]

The significance of this conversion takes many aspects: it marks the first IOC to break ground in Iraq's oil sector since the 2003 US-led invasion; it indicates the type of contract (long term service contract-LTSC not PSC) Iraqi government would accept; it provides the terms, conditions and provisions of such contracts; it highlights the importance of bilateral government-to-government relations or "oil diplomacy" and finally, it establishes the basic first version of the model contract that was adopted latter (but with many modifications reflecting a learning curve) for four bid rounds.

Also this contract offered the Parliament a powerful opportunity to have and consolidate its role in approving the contract and thus establishes a precedence; but regretfully that opportunity was missed due to negligence, incompetence or intentional.

Al-Ahdab original PSC of June 1997 was ratified by law[7] and thus the new converted contract becomes legally invalid unless it is either ratified by a new law or the old law be revoked by a law. The Cabinet decided on the latter option, proposed a draft law and referred it to the Parliament.[8] Instead of insisting on ratify the new contract by a new law, and thus consolidate its role in approving all LTSCs, the Parliament[9] agreed, on 27 March 2011, to the government request and approved an abrogation law!

Fourth: The big-push strategy through four bid rounds

By benefiting from the insights of the MoUs, the status of the accelerated program and the successful conversion of Al-Ahdab contract with lessons learned from it, MoO launched what I considered a fast-tempo big-push strategy (Jiyad 2011).

All existing development and production service contracts and exploration, development and production service contracts were awarded through bid rounds except, as mentioned above, the one relating to Al-Ahdab oilfield.

The four bid rounds followed a similar procedure comprising the following steps:

• Announcement of the fields and exploration blocks offered in the round;

• A request for international oil companies to apply for pre-qualification;

• Specification of the parameters for pre-qualification and announcement of the qualifying companies;

• Preparation of a profile and data package for each offered field or block, and sale of that information to the interested qualifying companies;

• Workshops for the companies to discuss the data package and the draft model contract, and to review the bidding process and parameters. These workshops are usually open for the media and attended by senior officials from the ministry. The fourth bid round was attended also by representatives from local authorities in the areas of the offered blocks;

• The holding of bidding events in Baghdad with full publicity and TV coverage, with the bids being opened and announced in public with full competitiveness and disclosure; and

• Approval of each contract by the Council of Ministers.

The Final Tender Protocol-FTP for each bid round specifies the bidding parameters and the formula for calculating the bidding scores. For the first three bid rounds the bidding parameters were the plateau production target and the remuneration fee, while for the fourth bid round there was only one parameter, the remuneration fee.

For all bid rounds MoO accepted the highest scoring bidder provided the remuneration fee proposed by the highest scorer does not exceed the maximum remuneration fee acceptable. This maximum is disclosed only if the highest scorer"s proposed remuneration fee exceeds the maximum, in order to give the bidder(s) concerned the opportunity to revise their proposed fee downward to that of the maximum remuneration fee. MoO did not disclose the maximum remuneration fee it had set on many occasions when the highest scorer"s proposed remuneration fee was lower than that maximum.

In the case of tied bids, whether the remuneration fees proposed are equal to or less than the maximum set, and where the tie is between a consortium and a single company, the consortium bidder is preferred and declared the winner.

Main features of and developments in the model service contracts are briefly analysed below.[10] This analysis of all versions of the model service contracts identifies the nature and main characteristics of the contracts concluded under the four bid rounds, which were considered as "unknown in the oil industry" when they were introduced (Chalabi FJ 2010:258).

First, each bid round has its own "model contract" reflecting the nature of the offered opportunities and the lessons learned from the previous rounds. From negotiation theory and practice- who sets the agenda impacts the outcome. Thus, the Ministry did well by setting the agenda, i.e., the model contract, and asks the IOCs for feedbacks instead of following Terry Adams proposal.[11]

Second, all the contracts have similar structures in terms of equal number of articles, annexes and addenda, except those for the fourth bid round which have more addenda. Almost all the articles are identical or could be considered as common clauses, except those reflecting the specifics of the field or block.

Third, the contracts could be considered as being in a hybrid category of their own since they include components from production sharing contracts and components from conventional service contracts. Among the main features taken from production sharing contracts are: the long duration; the privileges of first/exclusive rights; the payment of a signature bonus; the R-factor as a sliding scale remuneration fee; and restrictions on sovereignty through consensus-based decision-making within the joint management committees. "Business risk" for IOCs relating to the commerciality of petroleum discovery is covered only by contracts relating to bid round four, which is for exploration blocks.

Fourth, all the contracts are premised upon the principle of take-or-pay/now-or-later even when the government decides to exercise its sovereign rights to curtail production.

Fifth, all payments to the international oil companies (costs and the remuneration fee) are denominated in US dollars, not in barrels or barrels of oil equivalent. This implies that any economic rent (windfall) belongs to the Iraqi side, and the international oil companies do not have any claim on rent in the event of oil price increases. The international oil companies benefit from higher oil prices by expediting the recovery of their capital and operating expenditure and by receiving greater volume in remuneration fees through the operation of the payment caps when there are higher revenues. This, however, also calls for the application of the R-factor, which reduces the remuneration fees.

Fifthly, for each of the concluded contracts there is a carried state partner participation interest of 25% (now reduced for some of oilfield offered under bid rounds one and two) with no up-front payment from the Iraqi side. The international oil companies in the consortium cover, proportionately, this participation until they recover it. The model contract for the fourth bid round does not have a state partner participation interest since the risk of exploration is taken on fully by the international oil companies should there be no commercially worthwhile discovery.

New provisions in the model contract for the fourth bid round

The current version of the fourth bid round model contract exhibits many new components, reflecting the still evolving development of the model contracts and the Ministry of Oil"s learning curve in contract formulation.

A pre-development holding period is introduced, subject to certain rather complex provisions, in the event of an oil discovery. The rationale for this is that Iraq has too much oil to manage if all the contracted fields are developed as planned in addition to the existing production from other fields.

Also for the first time there is a transitional state partner. Initially the state partner is Oil Exploration Co, but once the value of the R-factor exceeds 1 then a new state company takes over the role of state partner. This reflects the different phases of the contracts arising from the distinction between the exploration and development phases, and this distinction lead to the removal of the state partner"s 25% interest, as mentioned above.

The third development is the absence of a performance factor, because with only one bidding parameter (the remuneration fee), and therefore no production plateau target, there is no reason to include the performance factor.

An important fourth new element was introduced to reduce the cost-inflating tendencies of international oil companies. A new term, "cost production", is included to reduce the remuneration fee entitlement in such a way as to induce the international oil companies to pursue cost effectiveness and refrain from exaggerating costs.

The fifth new development is related to the application of take-or-pay/now-or-later principle. The contracting Iraqi oil company"s obligation is confined to 80% of the produced gas if circumstances call for application of the take-or-pay/now-or-later principle. It is worth noting the application of this principle remains as it was in the previous bid rounds in the event of an oil discovery.

The sixth new component is provision for dry gas export, subject to a separate contract and marketing arrangement. This is an option for the international oil companies to pursue, but does not constitute an obligation on them. No such option was or is offered for oil.

Another new provision gives the Iraqi oil company the right to terminate the contract if the international oil companies conclude another contract with any regional or provincial authority without Ministry of Oil approval.

The final new development is the establishment of an infrastructure fund to finance infrastructure projects in the province where the contract area is located. During the term of the contract the contractor will pay 10% of the annual budget for the fund.

It is worth mentioning that each signed contract comprises other detailed provisions, annexes and addendums reflecting the particularities of the related field or exploration block.

The Ministry held four bid rounds between June 2009 and May 2012: the first was for the already producing, known as brown, oilfield; the second was for discovered but not developed, known as green oilfield; the third was for free gas fields and the fourth was for exploration blocks. The outcomes of these four bid rounds can be summarized as follows:

1- Four contracts covering six oilfields were concluded under first bid round comprising oilfields Rumaila, Zubair, West Qurna 1-WQ1 and Missan (comprising three fields of Abu-Garab, Faqa and Buzorgarn). Their combined proven reserves, at the time of contacting, was 33 billion barrels and their combined contracted production plateau target –PPT was 7.335 million barrel per day-mbd;

2- Seven contracts for seven green oilfields were concluded under second bid round comprising West Qurna 2-WQ2, Majnoon, Halfaya, Gharraf, Badra, Najma and Qaiyara. Their combined proven reserves, at the time of contacting, was 33 billion barrels and their combined contracted PPT was 4.765 day-mbd;

3- Adding Al-Ahdab oilfield to the above would give a total PPT of 12.3mbd to be reached at end 2017 and sustained for seven year. They have 67billion barrel of proven reserve; constituting 58% of the country proven reserves at that time.

4- The number of involved IOC