Benchmarking the Remuneration Fees for the Iraqi Oilfields

By- Ahmed Mousa Jiyad

Mr Jiyad is an independent development consultant and scholar. He was formerly a senior economist with the Iraq National Oil Company and Iraq’s Ministry of Oil, Chief Expert for the Council of Ministers, Director at the Ministry of Trade, and International Specialist with UN organizations in Uganda, Sudan and Jordan. He is now based in Norway (Email:
mou-jiya@online.no).

Introduction
The mystifying avalanche of remuneration fees long held by IOCs began when one of the consortiums participated in the first bid round, Lukoil/Conocophillips, expressed readiness to make remarkable move by agreeing to slash its remuneration fess to an astonishing one-third of its original offer. Soon after the announcement, it appears that other IOCs have in fact made or are making similar cuts in their respective remuneration fees particularly for the two prized oilfields: West Qurna 1 and Zubair.
News coming from Baghdad indicates that consortium ENI/Occidental (Oxy)/Korea Gas Corporation (Kogas) have wan the Zubair oilfield, and announcement on West Qurna1 is eminent.

The purpose of this intervention is to shed lights on these remarkable and fast developments, and attempt to understand and explore their causes, consequences and implications for all involved in and concerned with Iraq’s petroleum upstream sub-sector. Since the bid for the Zubair oilfield seems to have been closed for the ENI lead consortium, I will examine the impact of this development and explore the options for West Qurna1.

First bid refreshment on the Zubair and West Qurna1 oilfields
The conclusion of the Zubair deal would mean that the ENI led consortium had reduced its Remuneration Fee-per additional produced barrel-RF/b from $4.80 to $2.0 (representing a reduction of 58.3%, though in June bid event they reduced their RF from $4.80 to $4.40), and with its Plateau Production Target-PPT of 1,125,000 bd, it would have 930,000 bd of additional capacity over the Initial Production Rate-IPR of 195,000bd stated by the Ministry of Oil-MoO.

The other significant development is the exclusion of the Chinese SINOPEC from this consortium. This indicates that Baghdad means business and its deed matches words regarding IOCs involvement with KRG contracts. This could have further implications consolidating Baghdad position and stand on these contracts.
The expulsion of SINOPEC has also implications on the participation interests within the consortium. For June bid the participation interests were: ENI 35%, SINOPEC 20%, Oxy 25% and Kogas 20%. It remains to be seen how the 20% share of SINOPEC is distributed among the remaining three partners or a fourth partner had come instead? This could have consequences on the cost-structure of the consortium and thus might have contributed to the reduced RF! However, Iraq could claim the share of SINOPEC and with this it increases the State-partner’s participation interest from 25% to 45% and could request it to be carried-over as well.

Incidentally, nothing surfaced regarding CNPC/BP (66.67: 33.33), which had the most favourable candidacy on the Zubair oilfield considering its initial RF $4.09 and its, though slightly low, PPT of 1,075,000. Does the absence, so far, of CNPC/BP from the race for this oilfield indicates an Iraqi-risk exposure limitation or capacity-constraint of both IOCs- BP and CNPC?

While the Zubair oilfield appears to have been done the situation with West Qurna 1 seems not yet.
During the first bid round held on the 30th June 2009, West Qurna 1 oilfield received 5 competitive bids from IOCs based on the two bidding parameters, Remuneration Fee per additional produced barrel-RF/b and Plateau Production Target-PPT, as summarised below:
 

Bidders	PPT (bd)	RF ($/B)
Exxon/Shell	2,325,000	$4.00
CNPC/Petronas/Japex	1,900,000	$2.60
Lukoil/ConocoPhilips	1,500,000	$6.49
Total	900,000	$7.50
Repsol/StatoilHydro/Maersk	650,000	$19.30

Information from the Ministry of Oil-MoO on West Qurna 1 oilfield shows Initial Production Rate-IPR of 258,500 barrels daily (bd); minimum Plateau Production Target-PPT envisaged by MoO is 600,000 bd and the MoO is willing to offer a Remuneration Fee-RF of $1.90/b for additional production over and above the IPR.

Since none of the above five competing IOCs/consortiums had came with a RF bid equals to what the ministry had offered, the ministry asked the IOCs to reconsider their position and submit new RFs. At that time only two of them did so: Exxon/Shell reduced its RF by 30 cents to $ 3.70 and CNCP/Petronas/Japex reduced its RF by only 2 cents to $2.58.i

After almost 100 days and in a surprise move Lukoil boss Vagit Alekperov was reportedly said “the consortium of Lukoil and ConocoPhillips is ready to enter into direct talks concerning the West Qurna-1 project on the terms that were announced earlier by Iraq's Oil Ministry”.ii No confirmation or denial from ConocoPhillips had surfaced so far. It is assumed, therefore, that Alekperov speaks on behalf of the two partners in the consortium. However, the domino effects of this announcement is still in motion.

Options before MoO revisited.
In an earlier contribution published on MEES, I suggested three options for the Ministry of Oil to deal with the oilfields offered under the first bid round. Under option two I suggested “The ministry could request the same competing consortiums for West Qurna and Zubair to reconsider their bidding parameters by accepting the ministry’s RF and competing on the PPT (and the duration of the plateau period as a new bidding parameter).” iii
By accepting the “terms that were announced earlier by Iraq’s Oil Ministry” Lukoil/ ConocoPhilips had done what was suggested above and thus reduced its RF from $6.49/b to $1.9/b, a significant reduction of $4.59/b.

It appears also that the MoO had entertained the said option two mentioned above and asked the remaining IOCs and their consortiums to revise their positions, keeping in mind the Lukoil/ ConocoPhilips offer as the new baseline.
The baseline automatically disqualifies both Total and Repsol/ StatoilHydro/ Maersk from the race on grounds of their respective comparable low PPTs, in addition to their high RFs, and the remaining two consortiums Exxon/Shell (All-Western) and CNCP/Petronas/Japex (All-Asians) would compete with each other and with baseline holder Lukoil/ConocoPhilips.

There are four possible outcomes if the MoO decides to go this extra mile:
1-The remaining two consortiums agree to reduce their RF to $1.90/b and retain their respective PPT. In this case Exxon/Shell becomes the favourite since this consortium offers the highest PPT. The question remains is how is it possible that the consortium would be able to make the required reduction from $3.70 to $1.90. One possibility could be the utilisation of Shell presence in southern Iraq if and when the deal regarding gas joint venture comes into fruition. This joint venture could provide invaluable “cost-related-externalities” that could contribute to reduce the cost of West Qurna 1 oil field.
This eventuality could face three daunting hurdles: first the gas join venture with Shell is far from final. It has encountered serious hurdles and the year deadline (22nd September 2009) was extended for another six months accordingly. The opposition to this deal from parliamentarians and oil professional remains high.iv The second is that “Exxon/Shell” consortium is politically sensitive since both are remnants of old seven sisters with tarnished image and reputation, and thus would be projected by Iraqis as agents of imperial powers who are coming back to control the national wealth. Finally, if West Qurna 1 was awarded to Exxon/Shell and the gas joint venture with Shell was finalised, then these two IOCs could acquire powerful position in the country’s petroleum sector, which could have serious national security implications. These considerations could work against offering this filed to Exxon/Shell;
2-The remaining two consortiums decline to reduce their RF to $1.90/b and retain their respective PPT. In this case Lukoil/ConocoPhilips becomes the favourite. However, since the Minister of Oil has confirmed in his press conference on 13th October 2009 (as reported on the Iraqia TV) that at least Exxon/Shell has accepted to reduce their RF, then this option is not valid anymore;
3-The remaining two consortiums agree to reduce their RF to $1.90/b but reduce their respective PPT to a level higher than that of Lukoil/ConocoPhilips. Actually this possibility was suggested by the Minister of Oil as an explanation that the IOCs went for very high PPT and thus came–up with high RF. Reducing their PPT could, by implication, lead to reduced RF (The companies went wrong, in his view, by setting overly ambitious output targets that inflated payment expectations for the producing fields in the first round.)v In this case the consortium with the highest PPT becomes the favourite provided that the new PPT is “reasonably higher” than that proposed by Lukoil/ConocoPhilips. According to the Minister’s press conference, Exxon/Shell will reduce its PPT from 2,325,000 to 2,100,00 b/d.vi Hence, Exxon/Shell could become favourites, and thus we are back to outcome one above;
4-The remaining two consortiums agree to reduce their RF to $1.90/b but reduce their respective PPT to that of Lukoil/ConocoPhilips, 1,500,000 bd. The same argument made regarding to point 3 above applies. Theoretically, though, if this scenario materialises then MoO could use additional bidding parameters before the three consortiums to compete for and crowd–out each other.

We have to take note again of the absence, so far, of the All-Asians consortium, and wonder if they would come with a last minute surprise?
Moreover, the above analysis would give more chance and probability to Exxon/Shell over Lukoil/ ConocoPhilips. The question then is why the latter made this move in this particular time? Has this any thing to do with West Qurna2 oilfield, which is destined for bid round two? Few paragraphs on this matter are worthy the effort.

Lukoil is the largest Russian private oil company. In terms of total production the company was ranked number 11 in 2005 on world scale.vii Just like all other Russian fully or partially state-owned and private sector oil companies, Lukoil enjoys financial and political support from the State. Russia like other BRICs (Brazil, Russia, India and China) countries, assigns strategic importance to having access to petroleum resources worldwide, and thus grant their companies additional support and priority to attain such objectives of high national interests and security.
Furthermore, Iraq occupies special importance in the geo-political screen of the Russian strategic thinking. “Russian oil companies were encouraged and directed by their government, as a matter of state policy, to invest in Iraq”viii.
In terms of ownership, 20 % of Lukoil is owned by ConocoPhillips and the remaining 80% is Russian ownership. This means that Lukoil/Conocophillips business relationship is much more than bid-oriented consortium, for West Qurna 1 oilfields. Moreover, this has significant meaning for ConocoPhillips if and when Lukoil succeeds in acquiring lucrative business opportunity in Iraq’s petroleum upstream.
Lukoil has or could have a wealth of important information and data on Iraqi petroleum upstream sector from the era of the former Soviet Union, when both countries enjoyed decade of close economic and technical cooperation in the aftermath of oil nationalisation in Iraq early 70s. During the eighties, Lukoil signed a series of construction, engineering and drilling contracts for West Qurna-I, each on a turnkey lump-sum basis.
In 1996/7, Lukoil won the rights to develop West Qurna2 field and signed a 23-year contract giving it a 68.5% equity interest, with two Russian oil companies, Zarubezhneft and Mashinoimport, acquiring 3.25% each.
That agreement was repealed by Iraq in December 2003, but the top political level meetings that took place in Moscow (Al-Maliki-Putin) and Baghdad in 2009 had revived Lukoil’s hope for West Qurna 2 oilfields and thus had expressed its readiness “to adopt a contract to Iraq’s new legislation”ix
The question now, was this move by Lukoil/ConocoPhillips has any thing to do with a deal regarding West Qurna 2, bearing in mind again that this oilfield is listed among the field for second bid round?

Considering the above four outcomes, the possible effects in terms of additional plateau capacity over the Initial Production Rate, which is the prevailing production rate at the time of the bid round, could range from a minimum of 1,242,500 bd in case Lukoil/ConocoPhillips wins the bid to a maximum of 1,841,500 bd in case Exxon/Shell wins it.
When we add the additional capacity envisaged for the Rumaila oilfield under BP/CNPC deal (PPT: 2,850,000 bd, and IPR: 956,000 bd, which was the prevailing production rate at the time of the bid round and not necessarily the baseline production adopted at the signing of the contract) and Zubair oilfield under ENI lead consortium (PPT: 1,125,000 and IPR: 195,000) to Wes Qurna 1 as discussed above then the additional plateau capacity from these three oilfields alone could range from a minimum of 4,065,500 and a maximum of 4,705,5000 bd. The corresponding total plateau production capacity from these three oilfields could range from a minimum of 5,475,000 bd to a maximum 6075000 bd. Unless Lukoil/ConocoPhillips upgrade its PPT to alevel comparable with that of Exxon/Shell, the pendulum tilts towards Exxon/Shell more than Lukoil/ConocoPhillips, then the additional plateau capacity, in turn, tilts towards the maximum as well.

The IOCs: Adjustment of the Mindset.
IOCs attitude and response has been moving in rather distinct though not clearly demarcated phases from scepticism to consent, in apparent crack of the dominant mindset that affects their attitude and behaviour.
Pre and on the eve of the first bid event on 30th June, IOCs expressed scepticism and questioned the feasibility and wisdom of such action for petroleum upstream sector. "There's always been a risk this won't lead to anything -- but we're still going to go ahead," said an oil company executive.x
Nevertheless, all qualified IOCs participated in the biding process by attending various meetings and workshops, and thus managed to extract important concessions from MoO, that renders the related contracts in contravention with the Iraq’s best interest as previously analysed by this author when assessing the related Model Contracts pertinent to the bid round.
Having secured critical concessions from MoO, the 22 IOCs who took part in bidding event made their offers with apparent one common feature: all their PPTs and RFs were higher, with a varying degrees, than those offered by MoO. While the offered higher PPTs were, though puzzling, welcomed as good news for MoO, the higher RFs were rejected. MoO requested that IOCs reconsider and resubmit their offers and accept the ministry’s RFs. Except BP/CNPC offer for Rumaila oilfield, the remaining IOCs declined to make any meaningful reduction in their RF in order to stroke a deal. They moved, therefore, from scepticism to rejection. In the immediate aftermath of the bid ceremony IOCs, their lobbyist, and media including the petroleum-related among them began concerted campaign of cretinism on MoO accusing the latter for been unreasonable by dictating tough conditions, and complaining about (and also criticizing) the Chinese oil companies for only being state-supported, were able to cut the deal with BP. Most petroleum commentators considered the event as failure, fiasco, dud, etc and thus put the blame squarely on the ministry’s RF. “Oil industry executives and analysts described this [$2/b] as a shockingly low price, given the political and legal uncertainties of doing business in Iraq.”xi Acordingly Iraq was asked to “be prepared to soften some of its terms.”xii
This phase of blaming game lasted for a while, then signals of serious reflection began to emerge saying that IOCs should not leave Iraqi oil to be dominated by China, and thus began revising their economics and assumption, probably arriving at an apparent conclusion: if BP/CNPC can do it so could we. "That fear of competition [from the Chinese or the other national oil corporations] has led to the conclusion that the risks of staying out of Iraq are greater than the risks of going into Iraq."xiii This was coupled with renewed recognition of the strategic importance of Iraq’s upstream petroleum and what this represents in terms of lucrative business opportunities. “Very few such places are open to foreign participation, regardless of the terms that oil companies are willing to accept”xiv
Such reflection and revision have led them to come along the original position of the MoO and finally conceded to its proposal. Hence four IOCs- BP, CNPC, Lukoil and ConocoPhillips, have moved from scepticism to acquiescence, nnd this sets the motion of the domino effects on other IOCs.

MoO: No more concessions.
On its part the Ministry of Oil had made enough and serious concessions to the IOCs that, in the humble opinion of this author, had led into having Models contracts with so many flaws and inadequacies, that in their totality could not be to the best interest of the Iraqi people.xv Any further concessions, especially after the widely known RFs, could be seen by many as tantamount to political suicide and lack of patriotism.
Nevertheless, the MoO seems to have adopted somewhat “positional” negotiation strategy by sticking to its own terms hoping to “getting IOCs to say yes without it giving-in”. Such strategy is akin to the analysis I suggested when addressing “options before MoO”, referred to above.
The MoO’s learning curve and its gradualist approach to minimise the RF seems to be working well so far. From Al-Ahdab through Rumaila to Zubair and, probably to, West Qurna 1, the RF per barrel of additional production has declined from $3 to $2 to $1.90 respectively.
This could also indicates to an emerging “benchmarking” for Iraqi upstream petroleum opportunities, which IOCs have to observe, digest and learn to live with it by modifying their economic assumptions, calculations and business strategy thinking, though some had expressed fear that such benchmark as becoming reality eventually.xvi

Reduced RF: Complacency but with needed Clarification
As mentioned above BP/CNPC had reduced their RF from $3.99/b to $2.00/b to secure the Rumaila oilfield deal. For West Qurna1, Lukoil/ConocoPhillips consortium expressed readiness to reduce its RF from $6.49/b to $1.9/b, Exxon/Shell was reported to have accepted also to follow suit and reduce its RF further from $3.70 to $1.9, and ENI lead consortium reduced their RF from $4.8, to $4.4 and finally to $2.0 for the Zubair oilfield. Other IOCs could reduce their RF but so far no confirmation was made.
These announced reductions are very substantive in both absolute and proportional terms, compared with their original offers. This is a matter that deserves very serious examination and careful analysis.
However, what is really important is for the MoO not only to show satisfaction and feel comfortable but has the responsibility, and as part of the learning process, to be sure for three important matters:
First, Request from all consortiums to deliver 3Cs: Clear, Comprehensive and Convincing explaining on how could they managed to reduce their RF by such significant margins, the cost structure, the economics and the premises upon which the original and the revised RF were based upon etc. The prolonged development partnership that could last more than 20 years for each oilfield entails full transparency from the contracted IOCs to enhance confidence and reduce potential conflicts. The IOCs must, therefore, provide correct, accurate, complete and convincing explanation on how is it possible for them to make such unprecedented reduction in their remuneration fees;
Second, the MoO has to begin from now to enhance the professional capacities pertinent to accounting, auditing and verification of accounts related to these contracts. It could be even more advisable that such a body be an independent and administratively belong to an entity outside MoO to ensure complete insulation from IOCs influence. The main purpose for such precautionary measures and capacity development is to insure that the reduction in the RF will not be re-captured through other means during the contract period. It should be mentioned in this juncture that the Model contract for these oilfields suffer from serious loopholes and flaws in the accounting, invoicing and verifications procedures that could provide opportunities for costly financial irregularities (MEES 52:30, 27 July 2009); and
Third, MoO has to provide full, complete and accurate answer and explanation to the claim made by the ENI's Chief Executive Paulo Scaroni who was reported saying "We cut our fee (but) the whole structure of the contract has been changed,", "There has been a sweetening of other elements to the point that this contract is meeting our requirements in terms of return on investment."xvii What are these changes in the contract, what are these sweetening, and were they offered also to others or only to ENI lead consortium?

Strategic Significance vs. Circumstantial Challenges
Iraq’s petroleum upstream sector has important strategic worth and significance but also faces sever and daunting challenges, which are mostly of temporary and or circumstantial weaknesses.
Briefly stated, strategic significance include the number of geological structures, proven reserves, probable reserves/ oil in place, geographical proximity, multiplicity of export outlets, oil and gas (free and associated), historical aspects of the industry, size of the fields (implication on economies of scale, access to petroleum and business opportunity), infrastructure availability (with need for modernisation), partnership potential in downstream petroleum inside and outside Iraq, cost (capital and operating)

Iraq has additional “tactical” advantage, which could be used to further and consolidate its strategic strength, and improve the contractual condition for the best interest of Iraq. The former regime had concluded six contracts in attempt to break the sanction. These were unilaterally suspended but legally may be still enforceable since related laws enacted them are still valid.
The contract related to Al-Ahdab with the Chinese CNPC was renegotiated and thus was converted from PSA to service contract. Iraq could renegotiate the remaining contracts on much improved terms than those for Al-Ahdab taking into considerations the qualitative aspects of the related fields. In other words Iraq should develop differentiated strategy commensurate with the significance of the related oilfield. Once this is done then they could constitute the baseline for any future contracts involving IOCs, and thus consolidates Iraq’s negotiation position and enhances its strategic strength.

Circumstantial challenges include security, political uncertainty, legal frameworks predictability, manpower and human resources, brain drain (this can turn to be strategic asset-for private sector contribution or returning back or even working with the IOCs), corruption, management problems, the relation between the “executive” and the “legislative” branches and the stalemate within the Council of Representatives- CoRs, are among the recognised and very daunting challenges.

Most of the debate, especially within the pro-IOCs media and few Iraqi oil professionals, show the tendency to inflate the magnitude of the circumstantial challenges and assumes their continued existence for longer term. In the mean time very little attention and weight was given to the strategic considerations of Iraq’s vast petroleum resources. In consequence to such treatment the strategic strength are unfairly undermined by exaggerated challenges that are of a short to medium term characteristics, especially when discussing the outcome of the first bidding round and the call for softer terms in the second bid round.xviii

By Lukoil/ConocoPhillips latest move the recognition of Iraq’s petroleum upstream sector’s strategic important is partially restored, and this had induce other IOCs to acknowledge the same, and refrained from unduly inflating current challenges on the expense of its long term strategic worth.

What are the implications on the domestic politics?
This latest development and consent by IOCs after 100 days of procrastination has implications on the domestic political scene as well.
The move could be seen or presented as triumph for the ministry of oil and its chief Dr. Hussain Shahristani, and indicates to its correct (tough) approach and strategy to deal with the IOCs. In a sense it could be considered as delayed success for both the ministry and the minister. And this has further implication for the political future of the minister himself, since the latest developments could convert what had been seen as “political liability” into clear “political asset”.
Recent news indicate that he seems to have been put on the sidelines as possible candidate for the same ministerial portfolio if Al-Maliki wins the January 2010 election, or even as the one who draws the parameters’ bottom lines for the 2nd bid round.xix Specifically, it was reported that Al-Shahristani have said to be dissatisfied with the Iraqi government’s decision to appoint former oil minister Thamer Al-Ghadhban as Head of a committee to supervise the second round of the oil service contracts.xx
News also indicates possible shifting alliance of Dr. Hussain Shahristani’ towards Al-Jaffari block, the Iraqi National Alliance, in return for secure the same ministry for him again if the latter block wins.xxi
However, the presence of the Government Spokesman, Ali Aldabagh, beside Al Shahristani in the press conference could indicates continued confidence of PM Al Maliki in his oil minister, and a renewal of his leadership in the meeting of 18th October, with the IOCs regarding the second bid round.
Obviously this latest development and the renewed confidence in him by the PM would strengthen his position with the IOCs and enhance his political scores domestically with any winning blocks in January election. On the other hand, he was asked so appear before the House of Representative on October 27th, and possibly this time he might face tougher stands and vote-of-no-confidence.xxii

Regardless of the fate of Dr. Hussain Shahristani or where will he end up next January, the position of the ministry has undoubtedly be enhanced especially against those, both Iraqis and others, who called upon the ministry to “soften” its terms and be ready “to pay more”, particularly for the forthcoming bid round. Obviously, the latest actions by IOCs after Lukoil/ConocoPhilllips move suggest otherwise. The writing on the wall is almost done and the benchmarks for oilfields remuneration fees are emerging. Moreover, the ministry could take this opportunity and suggests necessary steps to improve the contractual terms that are not to the best interest of the Iraqi people, as was previously assessed and still by this author (MEES 27 July 2009)
____________________________