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Energy Development in Iraq Faces Political Obstacles, but Could Prove a Boon for China

By Jason Simpkins
Managing Editor
Money Morning

Global oil majors interested in Iraq’s huge energy reserves continue to be derailed by that Middle Eastern nation’s political and ethnic divisions – despite recent increases in security.

So far, China has been the most successful at sidestepping Iraq’s blurry bureaucracy. And that presents an intriguing potential view of the future: Should the war-torn nation’s political web ever become untangled, the world’s second-largest oil consumer (China) could end up being the premier player in one of the world’s largest oil-producing nations.

Iraq has the world’s third-largest proven petroleum reserves, according to the Energy Information Administration (EIA). But while the country boasts proven petroleum reserves of 112 billion barrels, the EIA estimates that up to 90% of the country remains unexplored. Only 2,000 wells have been drilled in Iraq, versus approximately 1 million in the state of Texas alone. Iraq would easily have another 100 billion barrels of oil buried beneath its uncharted territories.

For more than a year now, major oil companies have been bidding on exploration-and-development projects in the nation’s fledgling oil sector.  But political rifts and ethnic divides have hampered any real progress in developing the country’s resources.

“Politics – international, domestic, ethnic and party-based – has dominated every aspect of discussions of Iraq’s post-invasion oil development,” the Middle East Economic Survey (MEES) said in its weekly newsletter.

“Given the size of the potential revenues at stake this was probably inevitable,” the survey stated. “But in the end the oil development itself and by extension that of Iraq’s economy, will probably suffer.”

Developing the energy sector is crucial to Iraq’s economy, as 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).

Unfortunately, the country has been locked in a political stalemate that pits Iraq’s parliament against Iraq’s prime minister, Nouri al Maliki. While Prime Minister Maliki and members of his cabinet insist that Iraq’s constitution does not require energy deals to get parliamentary approval, many outspoken members of parliament disagree. 

That has made it very difficult for Iraq’s oil ministry to court long-term investment with the kind of favorable terms it would like to get from foreign oil majors, despite the fact that there is significant international interest.

Political Shell Game

The company that’s currently adrift in the choppy waters of Iraq’s political scene is Royal Dutch Shell PLC (RDS.ARDS.B). Shell signed a $4 billion deal with Iraq’s oil ministery that gave it the rights to process and market natural gas from the country’s southern Basra province.

But that deal was put in jeopardy last week when Jabir Kalifa Jabir, secretary of Iraq’s parliamentary oil-and-gas committee, said the pact was “illegal” because it didn’t go through parliament.

“This is bad for Iraq’s economy. Under the contract Shell has monopoly rights to all gas in Basra and the south. This is not right,” Jabir told Reuters.  “We are going to do everything we can to revoke this deal and to push Shell out

Jabir also criticized the deal for its failure to prioritize domestic supply. The agreement gave Shell the right to sell the gas at international prices, he said. So if Shell sold the gas domestically, Iraq would have to pay Shell international prices and then subsidize the price to industry and power users

“There are fears Shell will just take the gas and export it rather than meeting increasing local demand,” Jabir said.

Jabir’s criticisms also underscore local concern about the influence of Western oil majors in the country’s energy sector.

The arrangement with Shell and the so-called greater oil licensing round – the approach that Iraq uses to solicit bids from foreign oil companies – have been highly controversial already because many critics believed they were unduly influenced by the United States and Britain, two countries that have occupied the country after toppling Saddam Hussein in 2003.

Even Hussein al-Shahristani, Iraq’s top oil minister and a staunchly pro-federalist backer of Prime Minister Maliki, has exhibited such nationalistic fervor.

“We do not see the necessity to have anyone sharing the Iraqi people’s oil,” al-Shahristani said last year. “The Iraqi oil will remain under complete Iraqi control under the auspices of the national oil company once it is established.”

A Canada-educated nuclear scientist and chemical engineer, al-Shahristani spent 11 years in Abu Ghraib prison for refusing to help Saddam Hussein build a nuclear weapon.

A Growing Opportunity for China

Ethnic feuds, political strife, underdeveloped infrastructure, and a lack of domestic support have left most Western oil majors “unimpressed” by the prospects awaiting them in Iraq, MEES’ said. And at prices of less than $50 a barrel (it closed yesterday at $45.88), crude oil currently offers very little market incentive for these companies to risk large sums of capital.

But while Western oil majors are backing off from Iraq, Chinese companies continue to pour in.

At a time when low commodity prices have most global players standing pat, China has been scouring the globe, buying companies and cutting deals. China’s objective: To lock up suppliers of key commodities – including crude oilMoney Morning reported earlier this year.

Iraq is a key part of that ongoing strategy.

China was actually the first country to sign an energy deal with Iraq in the post-Saddam era. China National Petroleum Corp. (CNPC) last yearagreed to a $3 billion deal to develop the Ahdab oil field, 100 miles southeast of Baghdad.

The CNPC deal, according to Jabir, is every bit as invalid as the deal struck with Shell. However, he also made it clear that the parliamentary committee would prioritize revoking the Shell deal before turning its attention to CNPC’s deal, which is viewed as being less damaging to Iraq’s economy.

“If you have a deep wound on one hand and a cut on the other, you deal with the wound first,” Jabir said.

Chinese companies are ideally suited for projects in Iraq, because they have a shorter history, less experience, and fewer business opportunities than their larger Western counterparts.

And they are eager to gain ground.

Also, China took no part in the U.S. military endeavors in Iraq earlier this decade, avoiding what MEES termed “nationalist suspicion of foreign involvement in the country’s oil sector.”

With the hope of placating parliament, Iraq’s oil ministry has asked some of the larger Western oil majors to form international teams with smaller global competitors. That way, Iraqi fields would have access to the more-advanced technologies of Western firms, but without igniting domestic concerns about control of Iraq’s resources.

Also hoping to placate parliament, Shell is in advanced talks with CNPC and China Petrochemical Corp. – China’s two biggest state-owned oil companies – to bid jointly for oil licenses in IraqReuters reported.

“We indeed have had discussions about bidding,” Shell Chief Executive Officer Jeroen van der Veer said in Beijing, according to Reuters. “Chinese companies for certain are part of the bidding partnerships.”

The Kirkuk oil field in northern Iraq is widely believed to be the site of any potential joint venture between the Anglo-Dutch oil group and one or both of the Chinese companies. It’s also one of the fields cited by MEES as a possible liability for Western oil partners.

“The 10-billion-barrel Kirkuk field, which straddles the border between central government and Kurdish Regional Government (KRG) areas has, despite the size the reserves, attracted relatively little interest,” the MEES report said.

Money Morning Investment Director Keith Fitz-Gerald said last year that China – which is also pursuing energy resources in the Sudan –would doggedly pursue the energy resources needs to sustain its growth, regardless of any social or political upheaval.

“It’s a virtual certainty that China will maintain this policy going forward,” Fitz-Gerald said. “My contacts in China and Africa have told me point blank that China’s leaders ‘don’t care about human rights or nukes or hostile governments. What matters is anyone who provides oil to China no matter what the rest of the world thinks’.”

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