Storm clouds threaten Iraq’s striking oil revival, By Guy Chazan

When it comes to the world’s rising oil powers, none has risen quite as quickly – and with such profound implications for global crude markets – as Iraq.

Ravaged by decades of war and sanctions, Iraq’s oil industry is making a remarkable recovery. Production has rebounded strongly thanks to big investments by western majors in the country’s long-neglected southern oilfields.

 “We see Iraq as one of the countries that will be making the most significant contributions to world oil supply over the next 5-10 years,” says Jessica Brewer, Middle East research analyst at energy consultancy Wood Mackenzie.

By any measure, the comeback is striking. Iraq’s oil production has increased by 1m barrels a day since 2002, the year before the US invasion, to about 3m b/d. Last year it hit a crucial milestone when it overtook Iran to become Opec’s second-biggest producer after Saudi Arabia.

And the trend is set to continue. The International Energy Agency says Iraq’s output will more than double to 6.1m b/d by the end of the decade.

But storm clouds could threaten Iraq’s revival. Bottlenecks are undermining continued production growth: weak government institutions mean contracts for crucial infrastructure projects are not being awarded quickly enough. A deficit of skilled workers is dogging the industry.

“There are a lot of issues that are out of the western oil companies’ hands, such as Iraq’s infrastructure constraints,” Ms Brewer says. “There is a shortage of pipeline, storage and pumping station capacity.”

As a result, the big ramp-up in output seen between 2010 and 2012 has now stalled. The continuing stand-off between Baghdad and the Kurdish regional government has not helped, and neither has the increase in sectarian violence.

Iraq’s revival began after it signed a clutch of service contracts with international oil companies late last decade. As part of the bidding process, the majors committed themselves to hitting certain plateau production rates: combining these would give Iraq total capacity of 12m b/d by 2017, a huge number.

The majors won’t risk huge investments in oil that might not make it to market because of export bottlenecks

– Western consultant

In the past four years, the westerners have moved in in force, deploying manpower and technology to revitalise production across the badly battered south. BP partnered China’s CNPC in Rumaila, one of the world’s largest oilfields. ExxonMobil signed up for West Qurna-1, Royal Dutch Shell for Majnoon and ENI for Zubair.

The companies were initially gung-ho. But the infrastructure challenges, the worsening security and the poor returns on their contracts – they receive a fee of just $1.15-$2 per barrel – have made them more cautious about pouring more money in.

One western consultant says: “The majors are entering a period of very large spending decisions as they move to full field development. But they won’t risk huge investments in oil that might not make it to market because of export bottlenecks.”

As a result of such challenges, the government has now acknowledged that the 12m b/d by 2017 is unrealistic. Luay al Khateeb, head of the Iraq Energy Institute, says: “Iraq was trying to achieve in seven years what took the Saudis 70 years.”

Bowing to the inevitable, Baghdad is now renegotiating many of its contracts with foreign oil companies, and is considering reducing the combined production plateau from 12m b/d to 9m b/d by 2018 while at the same time extending the plateau period.

Iraq was trying to achieve in seven years what took the Saudis 70 years

 So far, Russia’s Lukoil and ENI have both managed to revise their deals: talks with Shell, Exxon and BP are moving painfully slowly. Some of them have argued that the per barrel remuneration fee should be increased, to take into consideration Iraq’s tough operating climate.

The IEA worries that even the 9m b/d target could be overambitious. It says $125bn of investment will be needed over the next five years to achieve that – yet in 2011 Iraq’s energy sector attracted only $9bn.

Analysts say more progress could have been achieved – both with the contract revisions and the infrastructure improvements – if Iraq was not so distracted by its constant political crises and the worsening security situation.

Despite all their private grumblings about poor returns, unrealistic targets, pipeline problems and geopolitical instability, the majors still have great deals in Iraq and are there for the long haul, Mr al Khateeb says.

“They signed up for producing fields, supergiants with billions of barrels of oil,” he says. “And Iraq is the last place on planet Earth where you can still produce cheap oil.”

 Financial Times, July 8, 2013 3:05 pm