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Pump It Up: The Development of Iraq’s Oil Reserves

By Vivienne Walt Monday, Dec. 07, 2009

Walking the line: Iraqi police patrol a vulnerable oil pipeline feeding a southern refinery
Nabil al-Jurani / AP

In the spring of 2003, more than a million people marched through the streets of cities across Europe and the U.S. to rail against U.S. plans to invade Iraq and oust Saddam Hussein. Amid the chants for peace was an angry accusation: the war was merely a grab by Western companies for Iraq’s vast oil reserves.

Nearly seven years on — and after more than 4,600 Americans and tens of thousands of Iraqis have been killed — Iraq’s natural resources are only now emerging as spoils of war. As U.S. troops prepare to withdraw from the country next year, some of the world’s biggest energy companies, among them ExxonMobil and Royal Dutch Shell, are racing to lock up multibillion-dollar deals with officials in Baghdad that will allow them to exploit the country’s giant oil fields. The deals will not only allow Big Oil to return to Iraq for the first time since Saddam nationalized the industry in 1972. By modernizing a production system wrecked by conflict and embargoes, Iraq’s exports could also get a huge boost, putting the country’s parlous economy on firmer footing and allowing Iraq to take its place as an oil power almost equal to Saudi Arabia. (Watch a video about the gas shortage in Iraq.)

Not just the fortunes of one war-torn country are at stake. Researchers believe that Iraq’s untapped oil reserves total at least 115 billion barrels — the third largest in the world. When fully developed, Iraq’s oil industry could significantly boost global crude supplies and even bring down oil prices. Tapping Iraq’s oil is an industry event of historic proportions, says Alex Munton, a Middle East analyst at global energy consultancy Wood Mackenzie. “There are very few examples in history you can point to and say, ‘A similar thing happened there,’ because there really have not been any,” he says. After a flurry of initial oil field – development deals were completed in November, Munton said, “Iraq’s future has just changed, absolutely.”

Until recently, that change looked like it might never happen. Last summer, Iraq’s government hosted an auction for eight large oil and gas fields at Baghdad’s high-end Al-Rashid Hotel. There, oil executives from the U.S., Europe, Russia, China and South Korea paraded on stage and dropped their bids into a sealed box, in a ceremony broadcast live on Iraqi television. It was meant to be grand theater, but proved a p.r. failure for Baghdad. Just one bid succeeded: it was submitted by a partnership between Britain’s BP and China National Petroleum Corp. (CNPC) for production rights to southern Iraq’s giant Rumaila field. Other companies abandoned the process after Iraqi officials refused to pay more than $2 for each barrel produced above a certain threshold. (Instead of leasing the fields to operators and receiving royalties for every barrel of oil sold, Iraq is retaining ownership of production. In essence, the government is employing oil companies to develop the fields, paying them by the barrel.)

The auction’s failure was due in part to the government’s inflexibility. Baghdad is under pressure by Iraq’s feisty oil unions and politicians, who have accused leaders of aiming to sell the country’s riches on the cheap to gain a little short-term relief for the economy. Oil executives argued they should be paid as much as $3.99 a barrel — nearly double the government offer — because of the risks involved. Operating in Iraq means investing billions in an unstable country where foreign oil workers are routinely kidnapped and insurgents have blown hundreds of holes in pipelines. Rochdi Younsi, until last month the director of Middle East and Africa for the Eurasia Group in Washington, told TIME that the auction was “a fiasco and embarrassment,” saying that the government “thought oil companies would do absolutely anything to get into Iraq.”

The government may have been right all along. After months of sticking to their demands, oil companies now are agreeing to Iraq’s $2-a-barrel offer. In mid-November, Italian oil executives from ENI flew to Baghdad to sign a deal on Zubair, a southern Iraq field with about 4.1 billion barrels of reserves. ENI plans to pump about 1.1 million barrels a day from Zubair in partnership with California-based Occidental Petroleum and South Korea’s Kogas. ENI was quickly followed by ExxonMobil and Royal Dutch Shell, which agreed to produce about 2.3 million barrels a day in another giant field called West Qurna. Combined with BP-CNPC’s anticipated output from Rumaila, “those three fields alone would be about 6% of total oil production in the world” when output targets are reached, says Munton, the Wood Mackenzie analyst. (See pictures of the Exxon Valdez disaster.)

The catalyst for the flurry of agreements appears to be the BP-CNPC deal, Iraq’s first international oil contract in nearly four decades. The British and Chinese companies won the right to drill for 20 years in what is believed to be one of the world’s four largest fields with potential reserves of about 65 billion barrels. Though it will earn only $2 a barrel, BP says it aims to keep expenses down by using low-cost Chinese labor and equipment. The group promised Iraq’s government that it will nearly triple the field’s output from 1 million barrels a day to about 2.8 million barrels a day in just seven years. “We see this as the beginning of a long-term relationship,” BP’s chief executive Tony Hayward said in a statement.

For oil companies, establishing similar relationships with Baghdad could prove crucial, and highly profitable. As oil supplies dwindle in places like the North Sea and Gabon, companies are desperate to book new reserves — and Iraq, which unlike Kuwait or Saudi Arabia is incapable of producing its oil without foreign know-how and investment, is up for grabs. Unlike huge new finds off Mexico, Brazil and West Africa, many Iraqi fields were mapped years ago — some by the same companies now negotiating new contracts — and so will not require lengthy exploration before pumping can begin.

Fresh from a trip to Baghdad, Yves-Louis Darricarrère, who heads global exploration and production for the French energy giant Total, told TIME in early November that oil executives all feared being left out of the rush. “Iraq is extremely important for the industry and for world supply,” he said. Even though Total dropped its bid in June for one of Iraq’s fields, it is now considering several others on offer in a second round of bids, which Iraq’s government has scheduled for mid-December; Iraqi oil officials say they expect about 45 companies to compete for 15 fields. Says Darricarrère: “It is difficult for any major oil company not to be in Iraq.”

But being there won’t be easy, either, due to daunting technical and other challenges. Iraq’s oil industry has limped along for years on creaking old equipment, patchwork pipeline networks and decayed, rusted port facilities; Saddam-era sanctions largely prevented the industry from upgrading to state-of-the-art equipment. The country produces just 2.5 million barrels a day, down from 2.8 million barrels before the U.S. invasion and a sharp drop from its high of 3.7 million barrels in 1979, when Saddam boosted production to finance his calamitous war with neighboring Iran. A government adviser recently told Britain’s Independent newspaper that only about one-third of the 1,400 wells in southern Iraq are functioning. Oil Minister Hussein Shahrastani estimates it will cost about $50 billion to upgrade infrastructure needed to produce Iraq’s target of 6 million barrels a day by 2017. “Iraq’s oil industry is in a dire state,” says Samuel Ciszuk, Middle East energy analyst for the consultancy firm IHS Global Insight in London. “Decades of war, brain drain, political instability and underinvestment have all depleted what was there.” When foreign oil companies finally start working Iraq’s fields, they will face a critical shortage of local engineers, geologists, managers and almost everyone else they need, since previous generations of professionals have left the country. (Read “Why Iraq’s Oil Law Remains Deadlocked Three Years On.”)

While stability is returning, this relative peace is fragile. Iraqi officials and oil executives have rushed to sign contracts before national elections scheduled for January, since no one knows whether the current government will remain in power. Shahrastani is under fire from opposition politicians, who are complaining of widespread corruption and mismanagement in his ministry. In addition, oil contracts signed during the past five years with the Kurdistan Regional Government, whose three semiautonomous Iraqi provinces until recently exported about 100,000 barrels of oil a day, have been declared illegal by Baghdad, forcing Kurdish leaders to halt exports in October.

Indeed, battles over how to carve up Iraq’s oil revenues between the country’s bitterly divided ethnic groups have stopped parliament from signing a national hydrocarbon law originally drafted in 2006. After previously insisting that they would not do business in Iraq without a legal framework governing central issues such as revenue-sharing, oil executives now are resigned to the fact that it may be years before a law is forthcoming.

Neither companies nor government officials want to wait any longer to kick-start production. The Iraqi people are impatient for economic relief, and since more than 90% of Iraq’s budget comes from oil revenues, nothing seems to offer more hope than the arrival of Big Oil. “We still have a long way to go to build the country,” says Ahmeh Jasim, 56, a real estate agent in Baghdad. “Without these companies it is very hard to have a proper oil sector.” For most Iraqis, the drilling cannot begin soon enough.

— with reporting by Ben Lando / Baghdad

Read “The Reasons Behind Big Oil Declining Iraq’s Riches.”

(See pictures of Iraq’s revival.)

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