The oil majors BP Plc. (NYSE:BP) and Exxon Mobil (NYSE:XOM) seem to be playing the growing dispute in Iraq between the Kurdistan regional government [KRG] and the central government quite differently. Exxon angered the central government by signing a more lucrative exploration agreement with the KRG and is in the process of wrapping up its operations in Southern Iraq. On the other hand, BP is sticking with the central government honoring its earlier agreement to develop Rumaila, Iraq’s largest oil field. In fact, recently it even agreed to develop the Kirkuk oil field, which lies in the swathe of land over which the Iraqi central government and the KRG are locked in a dispute. While Exxon is betting on higher control of the KRG over its oil reserves and exports, BP is sticking to its rather stable stream of cash from the central government, in the hope of better terms on future deals. However, both of them face huge operating risks in a country that holds ~10% of the global oil reserves [Statistical Review of World Energy 2013, bp.com].
The Growing Dispute Over Oil
Disagreements over the control of Kurdish oil reserves and export revenues is at the heart of a larger dispute between the Iraqi central government and the KRG. The central government believes that the semi-autonomous Kurdistan region has no legal authority to export oil or sign production agreements with oil companies. While the KRG maintains that Iraq’s constitution gives them the right to do so, and has already signed contracts with a number of multinational companies, including Chevron, Exxon and Gazprom.
The Iraqi Kurdistan used to rely on a pipeline controlled by the central government to export its oil, as it does not have the required infrastructure to do so. However, since Baghdad denies the KRG the right to independently strike oil contracts, it has withheld most of the payments which the oil companies were promised by the regional government. As a result, the Kurds stopped using the Kirkuk pipeline for exporting oil last December. This not only put the oil companies operating in the region in a difficult situation, but it also stymied the development of the region’s abundant oil reserves.
But there is a ray of hope for the companies that have flocked to the semi-autonomous region in increasing numbers, in defiance of the central government. The Kurds are almost done with laying a new pipeline that will be able to carry the Kurdish oil directly to Turkey. It will have an initial capacity of exporting around 300,000 barrels of oil per day and is expected to become operational during the fourth quarter.
However, the central government has asked the KRG to link their new pipeline to the main government pipe at a metering station near the Turkish border, so that they can know the amount of oil being exported out of Iraq. It has also threatened to refuse the region’s 17% share in the federal budget if the KRG tries to bypass the central authorities and starts operating an independent oil pipeline. In a nutshell, there is no end in sight currently for this growing dispute between the two governments [Iraq Threatens to Cut Revenue to Kurds Over Pipeline, bloomberg.com].
KRG Offering Better Returns
The technical service contracts awarded by the Iraqi central government prevent oil companies from reporting their share of the production volume, which is a closely watched metric in the investor community. These contracts also do not allow the companies to gain from higher oil prices, which makes the return on these projects look less lucrative compared to the ones governed by production sharing contracts. Moreover, infrastructure bottlenecks, red tape and payment delays further reduce the rate of return on such tightly priced agreements. As a result, despite significant production ramp-up potential, there is little incentive for oil companies to develop the oil fields in southern Iraq.
On the other hand, exploration companies have been lured to sign contracts with the KRG as it has offered attractive production sharing contracts, which allow companies to report their share of production volumes and gain from higher oil prices. The better security environment in Kurdistan also makes the region more lucrative to companies intending to set up local operations.
Despite these advantages, the risk of future amendments or the tightening of agreement terms is inherent to pursuing any deals with the KRG, as the central government does not recognize the validity of such regional contracts. There is also a risk of missing out on any lucrative deals with the central government in the future. Moreover, oilfields in southern Iraq hold proven reserves and are under a development process while there are exploration risks associated with the Kurdish agreements involving new acreage.
Exxon Betting On The Risky Kurdish Agreements
After Exxon’s contract with the KRG to explore six blocks in the semi-autonomous region was made public towards the end of 2011, the central government banned the oil major from participating in future rounds of bidding to develop new oil fields and removed it from the lead role in developing a multi-billion dollar water injection facility in southern Iraq. Voices within the government also threatened that Exxon could lose its contract to develop the massive West Qurna I field unless it relinquished its plans to explore Kurdistan. Towards the end of last year, Exxon informed the Iraqi central government of its wish to sell its entire stake in the West Qurna I development project.
The West Qurna I field is one of the largest conventional oil fields in the world, with estimated resources of around 8 billion barrels. Exxon entered into a technical service contract with the Iraqi government in 2010, to boost the production rate from the field to ~2.8 million barrels per day (MMBD) from ~0.25 MMBD. The field is currently producing over 0.5 MMBD and is expected to reach a level of 0.6 MMBD by the end of the year [Exxon Looks to Sell Part of Iraqi Project to PetroChina, wsj.com].
Last month, the Iraqi oil minister announced that Exxon Mobil will be selling out more than half of its stake in the West Qurna I project to China’s biggest energy firm, PetroChina and Indonesia’s Pertamina. The deal reflects Exxon’s declining interest in the project due to lower returns as well as ongoing issues with the Baghdad government. Going forward, the company might sell its residual stake in the project as well [Minister: ‘West Qurna 1 deal imminent’, upstreamonline.com].
BP Sticking With Relatively Stable Cash Flows
On the other hand, BP did not bid for any blocks in the Kurdistan region, honoring its long-term agreement with the central government to develop Rumaila that stipulated oil companies from entering into any pacts with the KRG. In fact, recently, it even signed a letter of intent to develop a disputed oil field in Kirkuk. This could potentially result in a long-term contract for the company similar to the technical service agreement that governs its operations at Rumaila [Iraq signs deal with BP to revive northern Kirkuk oilfield, reuters.com].
Although Kirkuk holds prospects of a relatively stable cash flow stream for BP, it falls in a swathe of land over which the Iraqi central government and the KRG are locked in a dispute. The KRG has opposed Baghdad’s deal with BP and maintained that any such deal would be unconstitutional as long as the dispute over sovereignty of the province continues. (See: BP Agrees To Develop A Disputed Field In Iraq)
Despite their different strategies, both the companies face huge uncertainties in Iraq, as the two governments are nowhere close to an agreement on a vast array of issues discussed above. While Exxon is betting on the KRG being able to manage its own oil reserves in the future without being dependent on or liable to the central government. BP is betting on the central government’s tightly priced service contracts in hope of better deals in the future. The best-case scenario for both the companies would be if the KRG gets a conditional control over its oil reserves in return for the central government’s control over the Kirkuk oil field. On the other hand, an armed conflict would be the worst-case scenario as it would hamper investments in both the regions and will not benefit either of the private players.
Disclosure: No positions