Three Conditions Needed for a Surge in Iraqi Oil

Recent reports highlight the enormous reserves of oil in Iraq and the potential for them to be exploited in the relatively near term, potentially impacting the onset of Peak Oil. From an investment viewpoint, I focus on the period ending in 2015, largely discounting whatever might come thereafter. In that time frame, Iraqi production increases are more limited and political risks are still hard to assess.

That said, one must tentatively conclude from recent events that foreign contracts are likely to be let and production is likely to increase significantly during the next six years. These events are:

- relatively free recent elections,

- the likelihood of a continuation of the present government for the immediate future, thus suggesting that ongoing negotiations with foreign oil companies will continue and reach a conclusion, and

- the apparent willingness of the U.S. to proceed toward withdrawal of troops suggest that Iraqi is becoming capable of keeping order within its borders.

Here is a summary of two recent reports:

An Oil & Gas Journal (1/19/09) article, “Iraq’s Oil Prospects Prospects Face Political Impediments”, notes that Iraq’s proved reserves are 115 billion barrels, of 80 fields only 15 have been partially developed, the 7 largest fields contain 2/3rds of total reserves proven to date, and it’s potential reserves are 215 billion barrels, possibly the largest of any country in the world. Finding cost is a fraction of a dollar per barrel and estimated finding and development costs are between $1.50 and $2.25 per barrel, among the lowest in the world.

Iraqi production reached 3.5 mb/d pre-invasion and is currently about 2.5 mb/d. Contrasting that with the current 12.5 mb/d potential production claimed by the Saudis and their peak 10 mb/d production gives some perspective to the Iraqi potential.

How quickly could Iraq boost production? It would seem that three conditions must be met.

First, Iraq must settle on a model for obtaining the required technology and skills from foreign operators. Iraqis see the state oil company model all around them and thus may be reluctant to allow private exploitation. On the other hand, Iraq may not have the funds to pay contracting firms to do all the work without giving them an incentive. So a viable business model must be determined and negotiated.

Second, Iraq is a founding member of OPEC, which is currently restricting production. It seems clear that Iraq would be constrained from increasing their exports for some time to come. Such a constraint might not prevent them from starting exploitation activities, but it could depress the value of equity incentives they might need to provide to contractors, as discussed above. It may be necessary for the global economy to show signs of recovery before OPEC will lift export quotas, which could be a year or two from now.

Third, Iraq must secure its territory from any substantial risk of terrorist interference with oil production. Such security seems to be emerging, but complete assurance may require a working agreement with Iran which might take some time to negotiate.

In sum, it seems likely that the start of expanded oil production in Iraq may be 2 - 4 years into the future. Iraq claims to aim for production of 6 mb/d by 2013. On the other hand, the O&G piece states that it would take Iraq 15 - 20 years to reach a sustainable output of 10 mb/d. If 15 years are required and 3 years are required before the effort begins, and if the goal is an increase of 7.5 mb/d that suggests a take-up rate of about 400kb/d per year.

Taking all the above into account, and assuming that security turns out not to be a problem, it suggests the following median case (not best or worst) rate of increase beyond the current 2.5 mb/d of production:

2009: 0

2010: 0

2011: 0

2012: .4 mb/d

2013: .8 mb/d

2014: 1.2 mb/d

2015: 1.6 mb/d (about half the increase that Iraq claims it wishes to achieve)

Comments

[ROLEX18:]

Even without Iraq there is more than enough Oil OPEC is willing to sell, when price of CL will go down to 20-30$ soon, the OPEC will pump even more. The game rules changed, now it is " I can sell it even cheaper " environment. The bubble was nice at 147$ and will stay in our memories, but for biggest Oil/Gas producers it is bubble even at 40$, they are more than happy to sell their only asset they have, otherwise imagine all Oil/Gas executives and millions of employees unemployed, without their status, without other options.They can't just close the pipe or a offshore drilling platform, the show must go on.

Feb 04 10:20 AM

[longoil:]

Your third condition that will be the most challenging.

Without US presence, a power vacuum will be created and Iran will quickly annex Iraq and control all Iraqi oil production. The current Iraqi government is too weak to control the infighting between Sunni, Shiite and Kurdish factions. Iraq is a country that was artificially drawn up by the British after the collapse of the Ottoman empire. Unfortunately, it seems it can only be held together by a dictator or an occupying force.

Feb 04 01:35 PM

[Ferdinand E...:]

Nice comment, Rolex18. Sell the only asset they have, and eventually be left with nothing. There are/were a couple of OPEC members willing to play that game, but perhaps not any more, and even if there are it won't make any difference when the oil price starts increasing again - although I don't think that I will discuss why.

As usual, this is an excellent article, but there is one thing that 'might' be implied in it that I will NEVER believe, which is that the Iraquis cannot develop their oil economy without foreign guidance. Yes, given what has been happening in that country the last 5 or 6 years, or maybe longer, a few foreign firms might be useful for raising oil output, but Iraqui engineers and managers are quite capable of running the show without foreigners looking over their shoulders.

Feb 05 09:41 AM

[mauritius:]

i'm not following the logic of rolex18's argument. it would make sense in an environment where the private oil majors such as exxon had the largest reserves, but they don't, the nationalized oil companies do. why would they be "more than happy to sell their only asset they have" at current prices. with all those princes on the payrolls, and the teeming masses to keep a lid on with a myriad of social problems, i would suspect they would need much more than $40 a barrel. getting back to the article, it fails to mention the domestic use aspect of production. it would seem to me that yes iraq will be producing more, but also consuming more. mutqada al sadr, and his followers, and others in charge now don't seem to be the people you should be exploiting, stealing their resources, why they live in abject poverty. in addition regarding point number three, i believe that the sunni-shia problem is far from over, throw in the kurds, turkey, and iran, you get instability for a long time.

Feb 05 12:34 PM

[bleese:]

most of the gas wells drilled recently have been closed in, waiting for better prices. This will not happen until their is new thinking about what is next in the line for reducing oil consumption.

Feb 05 01:20 PM

[Grampa Jim:]

Many thanks, Jim. Very helpful for a perspective on Iraq's place in the oil supply picture.

Feb 05 02:19 PM

[chistletoe:]

Many astute oil engineers have suggested that all of OPEC's reserves started to become wildly overstated, beginning with the founding of OPEC, having the motivation that "proven reserves" impact the assigned quota,
and continuing to become further and further from the most probable
likelihood as time goes on.

Is there any reason to believe that Iraq's situation is different from the others?

Is there any reason to suspect that the people now reporting the reserves might have similar bias to the people reporting weapons of mass destruction a few years ago?

If the market is depending on an increase of oil production from Iraq, could it be setting itself up for a rather painful disappointment?

Feb 04 09:48 AM