Corporations to control Iraq’s Oil: so how is this meant to work exactly?

As you’ve probably heard by now, control of Iraq’s oil is to be handed over to certain corporations, under what are known as Production-Sharing Agreements (PSAs). These agreements are long term (decades long) deals which give the oil corporations the lion’s share of the profits, and which bind the Iraqis to terms agreed by their current government. Terms which a reasonable person might conclude are not exactly favourable to the Iraqi people.

Here’s the main article in which the story was broken in the English-speaking world, by yesterday’s Indepedent on Sunday.

And Iraq’s oil reserves, the third largest in the world, with an estimated 115 billion barrels waiting to be extracted, are a prize worth having. As Vice-President Dick Cheney noted in 1999, when he was still running Halliburton, an oil services company, the Middle East is the key to preventing the world running out of oil.

Now, unnoticed by most amid the furore over civil war in Iraq and the hanging of Saddam Hussein, the new oil law has quietly been going through several drafts, and is now on the point of being presented to the cabinet and then the parliament in Baghdad. Its provisions are a radical departure from the norm for developing countries: under a system known as “production-sharing agreements”, or PSAs, oil majors such as BP and Shell in Britain, and Exxon and Chevron in the US, would be able to sign deals of up to 30 years to extract Iraq’s oil.

PSAs allow a country to retain legal ownership of its oil, but gives a share of profits to the international companies that invest in infrastructure and operation of the wells, pipelines and refineries. Their introduction would be a first for a major Middle Eastern oil producer. Saudi Arabia and Iran, the world’s number one and two oil exporters, both tightly control their industries through state-owned companies with no appreciable foreign collaboration, as do most members of the Organisation of Petroleum Exporting Countries, Opec.

Critics fear that given Iraq’s weak bargaining position, it could get locked in now to deals on bad terms for decades to come. “Iraq would end up with the worst possible outcome,” said Greg Muttitt of Platform, a human rights and environmental group that monitors the oil industry. He said the new legislation was drafted with the assistance of BearingPoint, an American consultancy firm hired by the US government, which had a representative working in the American embassy in Baghdad for several months.

“Three outside groups have had far more opportunity to scrutinise this legislation than most Iraqis,” said Mr Muttitt. “The draft went to the US government and major oil companies in July, and to the International Monetary Fund in September. Last month I met a group of 20 Iraqi MPs in Jordan, and I asked them how many had seen the legislation. Only one had.”

Blood and Oil

We haven’t yet seen the final bill, which is due to be rammed through this week, but the draft, familiar to the oil majors and the IMF, but not apparently to most Iraqi MPs, contains things which give rise to understandable concern. From the Independent, who have seen a copy of this quasi-secret draft:

“A Foreign Person may repatriate its exports proceeds [in accordance with the foreign exchange regulations in force at the time].” Shares in oil projects can also be sold to other foreign companies: “It may freely transfer shares pertaining to any non-Iraqi partners.” The final draft outlines general terms for production sharing agreements, including a standard 12.5 per cent royalty tax for companies.

It is also understood that once companies have recouped their costs from developing the oil field, they are allowed to keep 20 per cent of the profits, with the rest going to the government. According to analysts and oil company executives, this is because Iraq is so dangerous, but Dr Muhammad-Ali Zainy, a senior economist at the Centre for Global Energy Studies, said: “Twenty per cent of the profits in a production sharing agreement, once all the costs have been recouped, is a large amount.” In more stable countries, 10 per cent would be the norm.

While the costs are being recovered, companies will be able to recoup 60 to 70 per cent of revenue; 40 per cent is more usual. David Horgan, managing director of Petrel Resources, an Aim-listed oil company focused on Iraq, said: “They are reasonable rates of return, and take account of the bad security situation in Iraq. The government needs people, technology and capital to develop its oil reserves. It has got to come up with terms which are good enough to attract companies. The major companies tend to be conservative.”

Dr Zainy, an Iraqi who has recently visited the country, said: “It’s very dangerous … although the security situation is far better in the north.” Even taking that into account, however, he believed that “for a company to take 20 per cent of the profits in a production sharing agreement once all the costs have been recouped is large”.

Immediate Value

So, it appears that the bloody shambles the incompetents in Washington have made of Iraq is turning out to be advantageous for at least some, those oil companies who will obtain PSAs at extremely favourable terms, justified by the risks implied by the horrific security situation in Iraq.

PSAs in which shares are, you will notice, tradable and hence can become the subject of very profitable speculation before a barrel of oil is pumped under their terms. Consider for a moment the value to a speculator of a share in the long-term rights to exploit some of the largest and potentially most profitable reserves of oil left on the planet. These deals are very long term, so the security situation may improve, in which case such shares would become far more valuable as a result, and and a canny speculator can bet profitably against that possibility.

The enormous and rapidly growing (as we use up active reserves) potential value of these PSAs could potentially underwrite, if I’m not mistaken, a hugely valuable speculative market.

In addition, it’s very likely that large additional supplies exist in the relatively unexplored regions, regions which seem to have been of great interest to Cheney’s Energy Task Force. So the potential exists for proving out those fields and radically increasing the reserves controlled by the relevant oil majors (along with their share prices and executive stock options) Those parts of Iraq are lightly inhabited, so at least as far as exploration goes, if not production, the security issue isn’t too much of a worry.

Future Value

Of course, at some point, let’s say in a decade or so, the necessity of actually pumping that oil will start to become overwhelming. It’s the last really big pool of relatively unexploited, easy to access, high quality oil on the planet. There are plenty of places with a very great deal of heavy oil, Venezuela being one obvious example, but that costs so much more to turn into something useful.

Ultimately though, someone is going to want to pump that oil. So the question is, now that they’ve got these deals locked in for a few decades, or rather assuming all this gets rammed through the Iraqi parliament on schedule, just how are they going to actually lift the oil?

Presumably security is a key concern. From the point of view of the oil companies, the motivation is to secure pipelines and infrastructure, but not necessarily to do anything particularly positive about the overall Iraqi security situation unless it happens as a side effect of their primary concerns.

A couple of things now seem very obvious. The US may withdraw troops from the cities, but it’s certainly going to want to maintain large bases from which to deploy its high-tech super weapons in defence of all that precious oil. I also doubt that any of this comes as a surprise to James Baker’s ISG or to Dick Cheney, so perhaps the US debate about Iraq can usefully be interpreted in terms of the specific commercial problem of exploiting Iraq’s oil. An issue that seems to have faded from the mainstream discussions about Iraq, but which is no doubt foremost in the minds of at least some US leaders.

There’s a lot of room for speculation here, and I’d be very interested in any comments on how the oil companies might think this could be best achieved.

A cynical person might for example, look at what happened to the PSAs negotiated after the fall of the Soviet Union with a weak Russian government and which have recently been overturned by Putin’s government, which has just re-negotiated much more more favourable deals now that it’s strong enough to do so.

A cynical person might conclude that from the oil companies point of view, a weak and divided Iraqi government, terrified that if the US doesn’t protect them from their own citizens, they and their families will be tortured to death by angry zealots from a multitude of rival militias, gangs and whatnot, might actually be advantageous to the oil companies, who would therefore have no particular reason to want the overall security situation in Iraq resolved as long as they’re able to lift and ship ‘their’ oil. After all, while their cut remains at 70% of all those hundreds of billions of dollars worth of oil, they can afford to spend a bit on pipeline security and so on. Whereas if the Iraqi government ever became strong enough and the country stable enough to tell them to fuck off as Putin has done recently, they’d be making considerably less money on the deal.

3 Comments

  1. Posted January 11, 2007 at 3:30 pm | Permalink

    any indication how the oil workers are going to take all this?

    On the weakness of the Iraqi government, I’m pretty sure that Afghanistan was the original model for Iraq: commit limited resources to overthrowing the existing regime, do a token constitutional consultation to establish a strong executive and worthless legislature, then hand the reigns over to a semi-authoritarian leader with a proven track record as a US asset, whose success would be assured as the incumbent with a massive monopoly on electioneering resources.

    The weak central government is something that was forced on them, rather than chosen, even if they are now adopting those tactics in response to the new situation. What I can’t see though, given the nature of oil installations (lots of pipelines to protect), how exactly they can secure production without a functioning state apparatus.

  2. Posted January 11, 2007 at 5:35 pm | Permalink

    Well, I don’t see that as an immediate problem for the oil majors, if shares in those PSAs are indeed tradable, they can presumably construct all kinds of financial instruments around them to play with short term. In effect turning them into vast amounts of free money to speculate with.

    Longer term is more interesting I agree. They’ve somehow got to find a way to stabilise the place enough to profitably pump that oil, say within a decade or two, without ending up with a strong government that’ll do a Putin on them and force them to renegotiate the PSAs. A tricky balancing act I’d imagine.

  3. Posted January 11, 2007 at 5:59 pm | Permalink

    I seem to recall that there is some pretty useful stuff on oil workers’ perspectives here.

    http://www.carbonweb.org/showitem.asp?article=57&parent=4&link=Y&gp=3


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