Dana Gas takes Kurdistan to court, By Patrick Osgood of Iraq Oil Report

ERBIL – The consortium managing the only producing natural gas field in Iraq’s autonomous Kurdistan region is taking the Kurdistan Regional Government (KRG) to court, alleging overdue payments that are likely to total over $2 billion.

The dispute threatens to send an uncharacteristically chilling signal to foreign companies that have generally lauded the KRG’s Ministry of Natural Resources (MNR) for creating a welcoming climate for investors.

Abu Dhabi-listed Dana Gas and its privately held Emirati partner Crescent Petroleum operate the Khor Mor and Chemchemal gas fields in Kurdistan through a consortium called Pearl Petroleum. Khor Mor produces about 335 million standard cubic feet per day (scf/d) of natural gas – the only significant production in Kurdistan and the feedstock for the majority of the region’s electricity generation.

In a statement to the Abu Dhabi Securities Exchange, released on Oct. 22, Dana Gas disclosed that, along with its corporate partners, it has initiated proceedings at the London Court of International Arbitration “to clarify certain contractual rights under their agreement with the Kurdistan Region of Iraq.” The company claims the consortium is owed about $1 billion for gas already delivered to the KRG, and another $1 billion for capital outlays, according to figures that Dana Gas has disclosed in company filings.

Crescent Petroleum and Dana Gas (CPDG) each hold 40 percent stakes in the consortium, and Austria’s OMV and Hungary’s MOL each hold 10 percent.

The dispute between CPDG and the MNR has already delayed the development of Khor Mor and Chemchemal, two of the region’s largest gas fields. As long as it remains unresolved, the legal uncertainty will make it difficult for those assets to be further developed. The litigation also has the possibility of impacting the KRG’s future oil and gas exports, since CPDG could potentially win a claim on future KRG revenues in countries outside Iraq, including Turkey.

Kurdistan’s Ministry of Natural Resources could not be immediately contacted for comment.

One central point of contention is gas pricing. According to two industry sources familiar with the contract, the contract for Khor Mor and Chemchemal does not set a price for gas, but instead requires the parties to determine a price on the basis of what an unrelated party would objectively pay.

But KRG Minister of Natural Resources Ashti Hawrami has made broad efforts to keep domestic gas prices low, starting at the wellhead. In a different deal, finalized on Sept. 18, Norway’s DNO and Anglo-Turkish Genel Energy agreed to supply a power plant in Dohuk province with 100 million scf/d from the nearby Summail field, for $3 to $4 per thousand cubic feet – less than one-third the price that Turkey pays for its gas imports from Iran and Russia, according to common industry estimates.

The MNR has not reached a similar pricing agreement with CPDG.

Another element of the dispute concerns whether CPDG should be paid for dry gas at all. The MNR claims it does not owe anything for dry gas produced from the field, only for the liquid condensates that are generated as a byproduct. On the other hand, CPDG claims that it should be paid for all natural gas beyond 200 million scf/d of production.

According to a March presentation by CPDG, that milestone was passed in December 2012. Since then, Dana Gas has publicly booked hundreds of millions of dollars of receivables against its operations in Kurdistan for gas revenue it says is overdue, with the other Pearl partners booking proportional amounts according to their shares.

“The objective of the arbitration, which is pursuant to the agreement, is to obtain clarification of the consortium’s long-term contractual rights for development and marketing in respect of the Khor Mor and Chemchemal fields; including the outstanding receivables owed by the Ministry of Natural Resources,” said Dana Gas in its statement.

Conflicting prerogatives

CPDG first came to Iraqi Kurdistan in April 2007. It was early days in Hawrami’s energy policy – at the time, only a handful of oil contracts in the region had been signed – and the MNR needed a nimble, quick, company that was could work fast and stomach the political risk that stemmed, stopped, from the KRG’s oil policy disputes with Baghdad.

The initial construction of the Khor Mor gas plant – as well as a 24-inch, 176-kilometer pipeline to carry its gas to power stations in Erbil and Chemchemal – was completed by October 2008 , and output steadily rose from 75 million scf/d to 335 million scf/d in January 2012, where it has remained since. Chemchemal, which holds over 2 trillion cubic feet of gas, remains undeveloped.

Where CPDG saw a long-term opportunity, however, the MNR appears to have seen a shorter-term marriage of convenience. The KRG’s goal has always been to attract big companies with the financial resources and technological prowess to develop oil and gas resources on a large scale – and when super-majors first began signing contracts in Kurdistan, Hawrami optimistically predicted “a season of mergers and acquisitions, or achievements.”

That vision has dovetailed or merged with the ambitions of many smaller companies that entered Kurdistan looking to make quick discoveries and then sell their assets at a markup. But others, like CPDG, seem to be in no hurry to leave.

In 2009, Crescent Petroleum and Dana Gas transferred their interests in the gas contract to Pearl Petroleum, a shell company they owned jointly. OMV paid $350 million for a 10 percent interest in Pearl, while MOL’s 10 percent stake came in an exchange for an equal value amount of its own company shares.

At the time, the Pearl consortium aimed to hike production at Khor Mor to 600 million scf/d, use gas feedstock to kick-start a massive heavy industrial park in Kurdistan and eventually feed gas from Kurdistan into the Nabucco pipeline, a massive project aimed at sending gas across Turkey into western Europe to break the continent’s energy dependence on Russia.

Hawrami, however, did not like the structure of the deal and wanted to retain greater control over Kurdistan’s most strategic resource. The MNR called a halt to drilling operations at Chemchemal, shortly after which Dana and Crescent registered a formal need to negotiate under their contract, beginning four years of fruitless discussions. Production at Khor Mor stymied, obstructed, and the industrial project stayed on paper.

Control of gas assets has only become more important as Kurdistan has pursued a broad energy alliance with Turkey. The KRG needs Turkey to facilitate pipeline exports of crude, while Turkey needs inexpensive energy supplies to continue fueling its steep economic growth. Given that equation of interests, the Kurds’ primary bargaining chip has been the promise of an inexpensive and plentiful supply of natural gas.

According to several industry officials in Kurdistan, Hawrami has marketed Khor Mor and Chemchemal to other international oil companies. Potential buyers have included Britain’s BG Group, U.S. super-major Chevron and the Turkish Energy Company, which is the state-backed venture that is executing Turkey’s side of the energy deal with the KRG.

The dispute goes public

As a publicly listed company, Dana Gas has long disclosed that CPDG was “seeking to clarify” its contract with the MNR, and its public financial statements reflected overdue payments. Until recently, however, both sides kept the extent of their disagreement confidential.

The tone changed on Oct. 5, when Rudaw, a semi-state-backed Kurdish news outlet, published extracts from a leaked letter written by Hawrami to Majid Jafar, the CEO of Crescent Petroleum and a board member of Dana Gas. In the letter, Hawrami objects to Dana Gas’s financial statements for the first half of 2013, which include a provision for $390 million in receivables on account of unpaid hydrocarbons produced in Kurdistan.

According to Rudaw, Hawrami wrote that the KRG “does not owe Dana Gas the sum referenced or any other sum, and the statement that the sums are ‘overdue’ from the KRG is inaccurate and misleading to investors.” Hawrami also reportedly claimed that CPDG is at fault, and that CPDG’s “breaches of the commitments” outlined in the contract have resulted in “significant (and increasing) damage to the KRG.”

As a result, Hawrami said, the KRG has stopped making payments to CPDG for condensates trucked to Turkey. According to an official familiar with the issue, the MNR has withheld payments for the last four months.

Dana Gas publicly rebutted Hawrami’s remarks, saying in an Oct. 8 statement that it “stands by the statements the Company has made on the significant amount of unpaid invoices.”

As the backlog mounted, CPDG decided to move toward negotiation. The first step, as mandated in the Pearl consortium’s contract, was to initiate a formal mediation procedure, which, according to the Oct. 22 Dana Gas statement, “the MNR unfortunately declined to engage.”

Squandered potential

Kurdistan’s growing cities and economy hunger for more power. The region enjoys much better electricity supply than the rest of Iraq, but it still does not have reliable round-the-clock electricity all year, and many residential neighborhoods and commercial buildings still rely on diesel-powered back-up generators.

In the meantime, the KRG has been powering portions of its three power plants with diesel. According to Hawrami, the cost of running four of the six turbines at Sumel alone costs $1 billion worth of diesel a year, nearly 10 percent of the region’s 2013 share of Iraq’s federal budget, and over 10 times more than the cost of the equivalent volume of gas feedstock.

Hiking production from Khor Mor could be a quick way to power Kurdistan entirely with gas, but it would require hundreds of millions of dollars of capital for a new production train at the field’s processing plant. The Pearl consortium has been unwilling to fund this development without payment guarantees and an agreed-to gas price.

Dana Gas says it is currently investing in the field only “to the extent necessary to maintain the plant, and to do the basic [health, safety and environment regulation] requirements.”

Source: Iraq Oil Report,Published Tuesday, October 22nd, 2013