Western Oil Majors Reluctantly Return to Iraq

Exxon Mobil Corp. (NYSE: XOM) and Royal Dutch Shell PLC (NYSE ADR: RDS.A, RDS.B) on Thursday won the right to develop Iraq's West Qurna-1 oilfield.

The agreement is the third such deal this year, which means Iraqi oil production could increase at a faster pace than previously expected and potentially lead to a drop in oil prices.

Iraqi officials earlier this week finalized an agreement with BP PLC (NYSE ADR: BP) and China National Petroleum Corp. (CNPC). Policymakers also reached an initial agreement with a consortium led by Italy's Eni SpA (NYSE ADR: E) that will develop the Zubair oil field.

The latest deal gives Exxon and Shell the right to increase production at Iraq's West Qurna-1 oilfield, which is believed to hold about 8.7 billion barrels of oil reserves. The field is already producing about 279,000 barrels per day (bpd), and Exxon and Shell will be paid $1.90 for every additional barrel of oil they can produce from the field.

Many Western oil producers – including Exxon, Shell, and Eni – walked away from bidding on Iraq's oilfields in June dissatisfied with the terms that were being offered. Exxon had originally asked for $4 for every extra barrel of oil produced, while a consortium led by Russia's OAO Lukoil wanted $6.49 a barrel. Even CNPC proposed $2.60 a barrel.

However, all of these companies have resumed bidding on Iraq's unstinted fields, and most are agreeing to terms below $2 per incremental barrel, which was the benchmark set by BP and CNPC in their bid for the Rumaila field.

Rumaila is the largest of Iraq's six oil fields on offer to foreign and state-owned companies with 17.7 billion barrels of proven reserves. Under terms of the 20-year contract, BP and CNPC have six years to boost the field's production to 2.85 billion bpd.

Eni, and its partners, Occidental Petroleum Corp. (NYSE: OXY) and Korea Gas Corp., have agreed to increase production at Zubair from its current level of 190,000 bpd to 1.125 million bpd within seven years. They also will be paid $2 a barrel for the extra oil they produce, after insisting on $4.80 a barrel as recently as June.

Iraq's enormous potential and rising oil prices – which have surged more than 12% since June 1 – are most likely the reasons behind Big Oil's change of heart. At some 115 billion barrels, Iraq's reserves are the third largest in the world.

Rumaila, Zubair, and West Qurna alone could triple Iraqi production from the current level of 2.5 million bpd  in less than a decade, according to Iraqi officials. Analsyst believe that added production could lead to a dip in oil prices.

"If Iraq and the international oil companies are able to bring these projects on,"

David Kirsch, an analyst with Washington consultancy PFC Energy told BusinessWeek, "it certainly would eliminate concerns that global production is going to peak any time soon."

It could also put the Organization of Petroleum Exporting Countries (OPEC) in a difficult situation. Iraq is a member of OPEC but has been exempted from quotas as it attempts to recover from the United States' 2003 invasion. Crude oil export revenue represents about 60% of Iraq's gross domestic product (GDP) and 89% of government revenue, according to the International Monetary Fund (IMF).

As Iraq's oil producution increases, members will start to call for that exemption to be withdrawn.

"As prospects increase for Iraq to approach prewar [oil production] levels … the issue of reincorporating Iraq into OPEC's system of production targets will quickly re-emerge as a topic for negotiations," PFC said in a report. "The process of reaching a negotiated settlement could add further friction to what will already be a difficult process of managing oil markets during the global economy's weak recovery."

At its December 2008 meeting in Algeria, OPEC agreed to reduce production by 4.2 million bpd to put a floor under plunging prices. While some member nations — notably Iran and Venezuela — have allegedly violated that limit, it has generally been adhered to.

News and Related Links:

• Money Morning:
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• Money Morning:
  Energy Development in Iraq Faces Political Obstacles, but Could Prove a Boon for China

• BusinessWeek:
  Why Oil Majors Are Coming Back to Iraq

• Money Morning:
  Oil Prices Gaining Momentum as OPEC Keeps a Lid on Production