A Brief Look At Lukoil's Operations In Iraq And Why The Company Will Not Be Affected By Violence

Jun.25.14 | About: PJSC Lukoil (LUKOY)

Summary

Russia's Lukoil has been developing what will soon be one of the largest oil fields in the world, West Qurna-2 in Iraq.

The nation of Iraq is in the midst of sectarian violence between the national government and a Muslim fundamentalist group.

This violence has caused several oil companies to evacuate the country.

The violence has been so far focused in the north and central areas of the country but Lukoil's field is in the south.

Thus, the risk to Lukoil is not particularly high at this point, but could get that way if ISIS expands the fighting to other areas.

One of the biggest news stories in the past few weeks has been the renewed unrest in Iraq as the nation's two Muslim sects have greatly increased their violence against each other. While this is clearly terrible on any level, this is an investment site and so this article will focus on the impact that this violence could have on your investments. For energy investors, the impact could be significant.

The reason that this violence could have an impact on an energy investor's portfolio is due to the size of Iraq's oil fields. Iraq has the third largest conventional oil reserves of any nation in the world, after Saudi Arabia and Iran. Conventional oil is much cheaper to produce than unconventional oil such as the various shale plays around the world. Due to the war in Iraq over the past decade though, Iraq's oil fields are somewhat less developed than their counterparts in Saudi Arabia or Iran. Thus, Iraq's oil fields represent the largest and best remaining source of cheap oil in the world.

This has caused many oil companies to move into Iraq in order to develop these resources. For example, in 2010, ExxonMobil (NYSE:XOM) signed an agreement with the South Oil Company, one of Iraq's state-owned oil firms, to redevelop the West Qurna-1 field. Royal Dutch Shell (NYSE:RDS.A) (NYSE:RDS.B) is a minority partner in this project. Chevron (NYSE:CVX) has been expanding into Iraq's Kurdistan region while Statoil (NYSE:STO) is involved in the project to redevelop the West Qurna-2 field in southern Iraq.

It has not only been Western oil companies that have been involved in redeveloping Iraq following the U.S.-led invasion of the country in 2003. Russia's Lukoil (OTCPK:LUKOY) has also established a significant presence in the war-torn country through its operator stake in the West Qurna-2 field (Statoil is a partner in this project).

The West Qurna-2 field is one of the richest conventional oil fields in the world. The field is estimated to contain approximately thirteen billion barrels of oil.

Source: Lukoil

Lukoil has laid out a rather ambitious plan for bringing this field to a productive state, a process which was undoubtedly made easier by the fact that the field was producing oil prior to the invasion of the country. Lukoil discusses this development plan in detail on its web page.

  • The first phase of the project involved the construction of the field's main production site, a Central Processing Facility capable of processing 400,000 barrels per day. This facility was constructed with the assumption that it would start out by producing 120,000 barrels per day and would eventually be ramped up to its 400,000 barrels per day maximum. The first phase of the field's redevelopment has also involved the drilling of 48 wells as of March 2014 along with five well pads and a 126 MW Gas Turbine Power Plant. Lukoil also constructed a 100 km long export pipeline to the large Tuba Tank Farm along with multiple asset roads. All in all, this represents a tremendous capital investment in order to produce oil from this field.
  • The second phase of the project will be the full-scale development of the nearby Mishrif oil field. This will increase the total production of the project to 550,000 barrels of oil per day.
  • The third and final phase will further increase the production from the West Qurna-2 project. According to Lukoil, this will increase the site's total production by another 650,000 barrels of oil per day. That would bring the total production from this field up to 1.2 million barrels of oil per day.

Lukoil has already completed the initial stages of the first phase of this project. On March 24, 2014, the company began producing 120,000 barrels of oil per day from the field. This has since been increased to approximately 200,000 barrels per day. The start-up of this production was prior to the recent escalation of violence in the Middle Eastern country. So, how is Lukoil responding to the recent violence as what has been the overall impact to the company?

Many of the oil majors that are active in Iraq have begun to evacuate their respective employees from the country. For example, Russian Television reports that ExxonMobil has pulled approximately 20% of its staff out of the country. BP (NYSE:BP) has evacuated all non-essential staff from its Rumaila field located in the southern part of the country. The various Chinese oil companies that are active in Iraq have also been considering pulling some of their combined 10,000 employees out of the country. Unfortunately and surprisingly, this article does not state whether or not Lukoil has followed the example of many of its peers at this time. However, we can find the answer to this question by checking other sources. According to Reuters, Lukoil has not evacuated the country at this time due to the fact that its operations are located in a still calm region of the country.

This certainly makes sense. As the map above shows, Lukoil's operations are located in the southeastern corner of Iraq, close to the Iranian border. However, the violence that has been occurring is focused in the north and center of the country.

Click to enlarge

Source: Russian Television

Thus, Lukoil's massive Iraqi operations have thus far not been affected by the violence in the country.

There is no guarantee that this will continue to be the case, however. ISIS is determined to seize control of the whole of Iraq and the Levant. Thus, it seems reasonable to assume that the group will expand the fighting to the area where Lukoil's fields are unless the group is prevented from doing so. ISIS has already shown that it will target the country's oil fields, as the Associated Press reported that the group laid siege to Iraq's largest oil refinery a few days ago. Should the militants target the West Qurna-2 field, then Lukoil will most certainly lose, at least temporarily, some or all of the 200,000 barrels of oil per day that are currently being produced there.

Fortunately, the Iraqi government has taken some steps to ensure the security of the country's oil fields. The primary step taken by the government is to station police forces at the country's various fields. To this end, a total of 100,000 police forces have been assigned to protect the fields. Unfortunately, we do not know how many of these police officers are stationed at West Qurna-2 but it is presumably a sizable number given the size of the field.

Thus, Lukoil's presence in Iraq does not appear to be threatened by the recent surge of violence in the country. At least, this is true in the near-term. Should the violence escalate further or expand outward from its current concentration in the northern and central part of the nation then the company may be forced to suspend or delay its development plans for the West Qurna-2 field which would clearly have an adverse impact on Lukoil's forward growth. As already discussed, such an occurrence would also result in the company losing the revenues from its 200,000 barrels per day of current production in Iraq.

Disclosure: The author is long BP, STO. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

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