BP: Iraq Oil Deal is Start of Something Big

The June 30 auction in Baghdad for development rights to oil and gas fields in Iraq has been portrayed as a dud. That's understandable. After all, the Iraqis managed to award only one of the eight fields up for bid.

But the .125 batting average is somewhat deceptive. The field the Iraqis did award, Rumaila, is a monster, producing 960,000 barrels per day now—nearly half of Iraq's current output. The winners, BP (BP) and China's CNPC, plan to bring the field to plateau production of 2.85 million barrels per day within six years. That would make it one of the most prolific fields in the world. However, the companies may have deliberately made high estimates so as to try to win the contracts.

While the fiscal terms are demanding, BP is enthusiastic. In an interview, the company's exploration and production chief, Andy Inglis, said the deal gives BP "a presence in the Middle East working on the biggest" Iraqi field.

BP Has a Plan BP thinks the Rumaila deal, which is not yet signed, will give it first-mover advantage that can be parlayed into other Iraqi projects. BP also thinks it understands Rumaila well, having originally discovered the field in the 1950s and having worked on it with the Iraqis during the past five years. BP also thinks Rumaila closely resembles the giant Samatlor field in western Siberia, which it has successfully managed through its TNK-BP Russia subsidiary. Finally, through CNPC the partners will have access to a Chinese supply chain to bring in the low-cost equipment needed, including onshore drilling rigs. An Iraqi state company will have a 25% stake, while BP and CNPC will share a 75-25 split of the rest.

Inglis said BP already has a plan for Rumaila. It will include modernizing, such as drilling new wells, renovating old ones, adjusting the level of pumps, and investing in and optimizing the massive water injection programs needed to maintain pressure and boost production.

A lot could go wrong. Rumaila will stretch the companies' resources and capabilities. And there are huge risks that come with working in Iraq, including security and political hazards. Many Iraqis, among them oil-field workers and some officials, don't want foreign oil companies working in their fields. BP and CNPC will have to soothe such concerns if they are to succeed.

Tough Terms for BP Considering the risks, the financial rewards will not be all that great. BP will be working under a service contract that in simple terms provides for payment of $2 per barrel for the oil BP produces above an agreed baseline—believed to be current production, adjusted by a 5% yearly decline rate for output. BP and CNPC initially bid for a $3.99-per-barrel payment, but the Iraqis persuaded them to reduce that. A consortium of ExxonMobil (XOM) and Malaysia's Petronas (PETR.KL) offered the Iraqis a higher target—3.1 million barrels per day—but walked away from Iraq's tough terms. BP will be penalized if it does not hit its 2.85 million-barrel target.

In an indication of how stiff the terms are, Edinburgh consultants Wood Mackenzie estimate that the BP consortium will receive fees amounting to only 1% of the estimated $1.2 trillion total revenues from the project. An additional 4% or so will go to recovering the $10 billion to $20 billion investment and costs required over the 20-year life of the contract. Wood Mackenzie figures the value of the project to the consortium is just $3 billion. "This is quite modest for a field which should produce 16 billion barrels at least," Wood Mackenzie says.

BP points out that the terms are not so different from those on offer for some other projects in the region. In Abu Dhabi, for instance, BP is paid $1 per barrel. Inglis says the deal, which has not been finalized, will give BP a stable supply of what he calls "long, flat barrels" over a substantial period of time.

In the Same League as the Saudis From the Iraqi point of view, getting Rumaila under way comes close to making the bid round a success. Rumaila is Iraq's flagship field. If BP hits its targets, it will nearly double Iraq's production, to the 4 million barrel-per-day range, over the next seven years. That would likely make Baghdad a major player in OPEC and the organization's No. 2 producer after Saudi Arabia.

One other aspect of the bid round was encouraging for the Iraqis. The top production targets bid by the international oil community on the six oil fields on offer add up to 8.2 million barrels per day. If achieved, that level of output would put Iraq in a rarefied league with Saudi Arabia as a major oil exporter.

Potential is one thing, of course, and actual production is another. Since the overthrow of Saddam Hussein in 2003, Iraq has had close to zero success in raising its production, meaning it has missed out on oceans of cash it could have gained from recent high oil prices. On several of the fields in the bid round a huge gap emerged between the remuneration the companies were willing to accept and what the Iraqis wanted to pay. Both sides, but perhaps especially the Iraqis, have some serious thinking to do if Iraq's oil and gas program is to move forward.

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