First Upstream Bidding in Iraq Disappoints

Nightmarish Result

The first upstream bidding round yesterday got off to a dispiriting start immediately, as only two bidding consortia—ExxonMobil with Petronas, and BP with CNPC—submitted bids, and these were far from matching Iraq's minimal production cost requirements and therefore had to be rejected immediately. The companies were given until later in the day to revise their bids, in what quickly turned out to be the standard in a sequential bidding round that was televised in order to demonstrate the maximum level of transparency.

In the end, only Iraq's huge Rumaila field was awarded; a BP/CNPC consortium came back with a revised bid just matching the government maximum production cost of US$2/b, after the companies had halved their own initial bid. BP and CNPC will receive about US$800 million per year between them in revenues for the project if they meet targets—before overheads, but after project costs—a somewhat paltry sum given the companies' size and the dimensions of the project, with doubts rife in the market over whether this will be enough to produce a profit. With the second field up for grabs, the undeveloped Mansuriya field in the restive Diyala province, not receiving a single bid, it was becoming clear that the expectations at the Iraqi Oil Ministry of a rush of supermajors and NOCs with an international appetite fighting over each field no matter what terms Iraq would offer were deeply misplaced. Most fields received only one bid, and in most cases even the lowest revised IOC/NOC bid proved to be far from reconcilable with the tight margins offered to the bidders by the Iraqis. Only the giant West Qurna (phase one) contract and Zubair saw some competition between bidders, although even here the distance between the government's expectations and what bidders were prepared to offer proved impossible to bridge.

Painted Into a Corner

Domestic political pressure from a highly resource-nationalistic population, coupled with increasing pressure on the Oil Ministry to raise the state's revenues radically over the past year, has led to the terms offered by Iraq being harsh. The nation's vast oil reserves—officially set at a proven 115 billion barrels—place it third in the world, but there is also a realisation that it remains dramatically underexplored and is quite likely to see massive future discoveries being made. This knowledge has emboldened the Iraqi leadership to seek the best possible terms when inviting investors and has created a notion that IOCs, shut out from most new sizeable developing areas and reserves, would be willing to agree to almost any terms just to get access to Iraq's vast volumes.

Today Iraq's Oil Minister Hussein al-Shahristani will start counting the cost of that miscalculation, as complete havoc is wreaked on his ministry's development plan. While it has been suggested that the Iraqi cabinet will have a look at the lowest bids submitted by the bidders and see if it can, after all, agree to them, the great divide between what companies have offered and what the government has demanded will make it hard for the government and Oil Ministry to agree without exposing themselves to strong domestic criticism for bowing to the companies' terms. If sideline bilateral talks are initiated with each of the lowest-bidding consortia, the government would also expose itself to entering just that kind of old-fashioned back-room oil deal that its transparency initiative had tried to tackle, inviting even more criticism. Ironically, this would also raise the political risk for the bidders further, given that their deals would enjoy even less legitimacy in the eyes of most Iraqis.

At the same time Iraq's oil production development strategies are in tatters, with no clear "Plan B" visible. The Rumaila field is now the only field that will see a concerted development strategy being applied, while the Oil Ministry and the Iraqi national oil industry still lack the necessary capabilities, skills, and technological know-how after decades of mismanagement, conflict, and brain-drain to mount an expansion programme even remotely similar to what would have been the case if the bidding round had been successful.

Outlook and Implications

Al-Shahristani is set to come under significant political pressure now, as he has previously been severely criticised for having neglected all easy repairs and developments of Iraq's producing oilfields over the past one to two years and having focused completely on preparing the licensing round. Iraq will have to rethink its general strategy in order to bring in development and will now have to address some of the bidders' fundamental grievances in order to at least get the second licensing round under way. This will also entail trying to facilitate the political process in the country to pass a national oil law and reduce the legal ambiguity that any oil contract in Iraq would experience at present. Given the fractured politics, this is no mean feat, but is surely necessary, together with taking a far more realistic view of what profit margins and risk/reward ratios it needs to offer prospective bidders to attract badly needed investment into the country.

The Iraqi opposition to foreign oil and gas investment will in the meantime become even more emboldened, with Ali Hassan Balou, the chairman of parliament's Oil and Gas Committee today telling media that he was going to challenge the legality of the Rumaila deal reached with BP and CNPC—a statement that had been expected given his previously voiced intentions. The confusion over whether or not the parliament has a role in the ratification of the contracts and whether it can stop them will now be tested, as will BP's and CNPC's willingness to actually commit financially at these levels of uncertainty. Their win makes sure that the issue of foreign hydrocarbon investment will feature in the campaign for the February 2010 parliamentary elections.

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