Hanging in the balance

By Lucy Douglas

Following on from last issue’s Special Report into the challenges facing Iraq if it is to reach its ambitious oil output targets, Next Generation Oil & Gas takes a look at the opportunities available in Iraqi Kurdistan, but only if the politics are right.

“Iraq has little in the way of exploration projects in the pipeline, and with no small to mid sized fields, junior companies are unable to tap into this huge market.”
-Simon Ciszuk

Following the removal of US and British troops from Iraq six months ago, speculation quickly turned to the country's vast hydrocarbon wealth and how state firms could best leverage these assets in order to bring the much-needed economic boost to the country plagued by war for much of the last two decades.            

Lucrative though it could be - Iraq has proven reserves totalling 115 billion barrels of crude and 112 trillion cubic feet of natural gas, which will push the country alongside oil-producing giants Saudi Arabia - the country is still plagued by its war torn backdrop and all the challenges that come with that: a wealth of security issues, an under-developed infrastructure of limited capacity, a poor regulatory framework, limited availability of trained personnel and ongoing political instability. This has not deterred companies such as BP and National China Petroleum Company, major players that have been keen to assert their presence in any of the 16 mammoth fields that Iraq opened up to international oil companies (IOCs) in 2009. Nonetheless, the future of IOCs in Iraq has remained shrouded in uncertainty since the general elections in March failed to indicate a clear winner and talks between Iraq's various political factions has been on going in an attempt to establish a government.

A new government and a change in the regulation of IOCs will have significant, potentially crippling, repercussions on the operations in Iraq of international firms, and not least on the activity taking place in the semi-autonomous Kurdistan region of northern Iraq.

Long a region politically at odds with the government of Iraq and once subject to the al-Anfal attack at the bidding of Saddam Hussein, Kurdistan today sees itself as a state integral to a politically and economically united Iraq but largely able to conduct its own affairs. According to the Iraqi constitution revisions in 2005, Iraqi Kurdistan is a recognised federal entity and though active in the 2003 invasion of Iraq, has since enjoyed relative stability. In addition, Kurdistan boasts a significant proportion of the country's oil reserves, making it a highly attractive prospect for international investment.

Indeed, the region has already attracted the likes of Hunt Oil, Murphy Oil, Heritage Oil and Marathon Oil Corporation for development projects. And with good reason. In addition to its resources - proven reserves in Iraqi Kurdistan are somewhere between 20-25 billion barrels - Kurdistan operates with a developed rule of law and compared to Iraq proper is a fairly peaceful region where companies are able to operate easily. 

 "They've been quite successful and even put in their own oil law and attractive upstream investments for exploration," explains Samuel Ciszuk, a Senior Energy Analyst at HIS. "In a few cases we've seen developments. However, what has sort f remained the problem is there is a debate and disagreement with Iraq proper about how much should be divulged to the autonomous region. And of course, one of the main issues is how much control over the oil resource the Kurdistan Regional Government (KRG) should be allowed to have."

The failure in March 2010 to elect a government that suited all parties vying for political rule had a knock on effect for the rest of the year. While the Iraqqiya, National Alliance and Kurdistan Regional Government parties sought to find a resolution to the political deadlock, oil companies have taken the opportunity to develop their operations in the lucrative Iraq market - both in the Shi'a dominated south and in Kurdistan. American firm Marathon announced in October that it had acquired a position in four exploration blocks in Kurdistan, at an initial cost of US$156 million and leaving the company with access to a total 295,000 net acres. The blocks lie northeast and north-northwest of Erbil, two in each location. The northeastern blocks are co-owned with the KRG, at an 80/20 percentage share respectively. "The opportunity offers both near and long term potential to Marathon. With two wells currently drilling in our licence areas, the potential for production as early as 2016 is achievable and we believe a minimum success could yield 50,000 BOEPD by the end of the decade, with total exposure for Marathon of over 400 million barrels of net resources," explains Dave Roberts, Marathon's Executive Vice President of Upstream. 

Therein lies the challenge. Despite Roberts' confidence that discoveries made in the Kurdistan wells will provide some lucrative long-term benefits for the company, the real effects of the Iraq's fragile rule will come into play. While Marathon and other such companies have invested so much into exploration projects in the region, the potential for development will remain cloudy until the political situation is resolved. "The few companies that have developed export capacity in Kurdistan have not been allowed access to export links," explains Ciszuk. "They are still controlled by the central government. So you have quite a few companies exploring but increasingly coming up, I suppose, to a situation where even those who have made discoveries might think twice before they start to invest in developing those discoveries because it looks like they might have their production capacity shut in."

According to Ciszuk, Kurdistan's legal framework for IOC's operating in the region is based on regional oil law whereby acreage is offered and a production sharing agreement implemented between the KRG and the oil company in question. This, he explains, is a different model to the one used in Iraq proper, where the government have looked to offering service contracts which they claim will keep oil wealth in Iraqi hands. "It's just a different perspective because of course, the regions are quite different to some extent," he says. "In Iraq proper, it is not actually about exploring for oil. It's generally taking over existing producing fees, and in some cases existing discoveries."

 Indeed, this seems to be the crux of the dilemma facing the world's major oil producers looking to move into this lucrative market. The economic risks involved in a move into Iraq are significantly lower in the south, thanks to it geological space, and with significantly higher proven fuel reserves, firms looking for a relatively swift return on investment this is an attractive option. However, underdeveloped infrastructure and security still remains a big problem in the country, and entry into the market is still relatively difficult for foreign investors. For Kurdistan on the other hand, its comparatively open nature is its primary attraction for IOCs, and the on-going political confusion surrounding the country's oil has left firms tentatively relying on a suitable outcome in order to make their investments worthwhile.

"One solution is, of course, an agreement whereby Iraq proper will say, 'We have this autonomous region, and they will continue to be autonomous like this and they will have their separate oil law and continue on these lines and be able to export crude,'" highlights Ciszuk. Certainly, the situation remaining as it is will be a logical resolution to suit the firms operating in the region. However a host of issues, not least multiple-entry visa requirements for personnel and the customs procedures for equipment imports, need to be resolved in order for operations to develop smoothly. On top of this, personnel security remains a major issue in Iraq, and is proving costly for large firms with a strong workforce on the ground.

"Another solution, " Ciszuk explains, "which is advocated by the current Iraqi government, is that Kurdistan contracts are brought in line with the contracts Iraq has signed. This would mean that a lot of the companies that actually entered Iraqi Kurdistan might not be as happy to have their PSAs converted into technical service agreements with so small profit margins as those given in Iraq proper. And because there is a difference in geology and depending whether these are exploration tracks or mature discoveries, the altered contracts might not necessarily make sense from the company's point of view. So that would risk scaring away investment from Iraqi Kurdistan, and that is what the Kurds have been saying."

Still, the relative assurance of the southern Iraq's oil reserves is counterbalanced by the costs involved of setting up projects in the region. "We are talking about some of the world's            largest fields," says Ciszuk. "That is of course very interesting, but only for the largest companies who can mobilise huge projects and can afford to invest billions. That makes the threshold very high for entry into Iraq proper."

Indeed, still exhausting the supply of the mega fields discovered in middle of last century, Iraq has little in the way of exploration projects in the pipeline, and with no small to mid sized fields, junior companies are unable to tap into this huge market. In Iraqi Kurdistan on the other hand, exploration projects are not only popular, but seem to be paying off. Heritage Oil, which has had exploration operations in Kurdistan since 2007, announced in January a giant discovery of a significant gas field, holiding a reported 12.3 trillion cubic feet. "The discovery of a major gas field... in-place with exceptional flow rates makes this one of the largest gas fields to be discovered in Iraq," said Heritage CEO Tony Buckingham in a statement. "This well has substantially de-risked the field so we have the confidence to accelerate the work programme. We are considering various development options including a tie-in to planned infrastructure that will achieve first production for both oil and gas in 2015. This discovery has the potential to generate substantial further value for our shareholders and benefit the people of Kurdistan and Iraq."

And since speaking to Ciszuk, the Iraqi central government has reached an agreement with the KRG to resolve the impasse on exports from Kurdistan, with activity expected to resume from February 1^st. According to Kurdish Natural Resources Minister Ashti Hawrami, the potential oil export flow could be a round 100,000 bpd, with the capacity to reach 250,000 bpd by the end of the year. However the issue about who will pay IOCs that produce the region's oil has yet to reach a final resolution. Baghdad had seen the power sharing agreements in place in Kurdistan illegal, and had therefore not allowed government funding to reach firms operating in Kurdistan. It was announced this month however that Iraq's oil ministry had agreed to pay the exploration costs and expenses to the IOCs operating in the Kurdistan region. However it was not immediately clear how companies will be paid for their profits after the recent deal.

Nonetheless, the interest in the region is not waning, and Ciszuk suggests that there it is only a matter of time till a resolution is established, bringing many more companies into the region. "I think it's all about finding a solution to the disputes of th3 contracts. How will they look in the future, and will there be any ability to produce and export the crude and gas being found? If that is solved, that will open up a very interesting playing field for a lot of interesting players. Many midsize companies would like to go in."

And the political uncertainty facing operations in the region is not the only challenge for firms. The geology of the region is presenting its own fair share of problems. "It isn't as straightforward as other places in Iraq," says Ciszuk. Indeed, UK firm Sterling Energy has encountered some problems drilling at it Sangaw North well in Kurdistan. Though it has managed to recover the drill pipe to almost 2000 metres, the firm is now looking to side-track the well, and re-drill to around the depth at which the initial gas influx was recorded. 

"Companies are having to go through rather high pressure and unstable geological reserves where there's been problems with well collapses and a risk of sour gas leaks which can be very corrosive. That has been a challenge, especially when you talk about projects being run right now by rather small companies that are having to look after their costs. Some have tried to use the minimum equipment necessary, and might be a bit unprepared to deal with some of the tougher well conditions, just because they don't have that much money. They have raised a certain amount of money and put all of it on line to build a more or less straightforward well. And when complications arise they find it problematic."

But as Ciszuk has pointed out, the future of the Kurdish oil industry hangs in the balance of Iraq's political landscape. And until this issue reaches a resolution, the energy sector will remain uncertain. "The worst thing that could happen would be a status quo," says Ciszuk, "because the companies that entered will continue to drill; they will fulfil their minimum acreage, but apart from that they will be very hesitant to start pouring more money into the region if it doesn't look like they will be able to monetise their oil and gas. So it's coming up to showtime, I suppose for Iraqi Kurdistan. Either they can actually deliver politically and move forward and control the oil and gas industry, or it might start to see investments really tally off."