Analysis: Iraq offers contract renegotiation

Iraq's government and the foreign firms developing the nine largest oil fields in the south of the country are preparing to renegotiate their technical service contracts.

Lower oil prices have severely curtailed Baghdad's ability to fully reimburse the costs of the companies and pay their fees for incremental output. The oil ministry said it has no intention of converting the agreements that it awarded to the companies in 2009-10 to production-sharing contracts (PSC). But some changes that the ministry is considering could leave the contracts looking more like PSCs than technical service agreements.

The ministry proposes linking "the companies' profits with oil prices, rather than only to a fixed fee per barrel of incremental output, so that their profits would rise when oil prices rise, and fall when prices fall". Iraq takes all of the risk under the current contract. Putting some of the price risk on the foreign partners will require the offer of an improved reward. "They are moving more towards production-style agreements without calling them that," one foreign executive said.

Foreign partners appear to welcome the proposed changes. Most accepted the technical service agreements because they wanted access to Iraq's massive reserves. An important consideration for the companies is whether any changes that are negotiated will allow them to book reserves and production. They would expect to be rewarded for exceeding production targets and saving costs. Some companies hope the cost-recovery process, under which firms invoice the ministry for development costs and wait for reimbursement, will change to one that entails getting paid directly out of the revenues from their projects.

Talks will revisit details such as development programmes, output targets and contract durations. And the ministry wants to restore the stakes of its state-run firms in the development projects to 25pc — the original share they had when the contracts were first awarded. Baghdad agreed to cut these stakes to 5pc when it lowered its long-term output targets. A larger Iraqi share would help placate any domestic opposition to changing contracts, and increase the government's take from each.

The central bank plans to issue $12bn of government bonds to help fund cost-recovery and remuneration payments due to the firms, which are owed a total of $9bn for 2014, and will be owed a further $18bn by the end of this year. The amount allocated in the 2015 budget for paying cost-recovery and remuneration fees "barely covers the amounts owed for 2014", the ministry said.

The companies are paid in crude supply equivalent to the value of the cash owed. But Iraq was unable to provide the oil companies with enough crude in February and March, because it needed to maximise its own sales to fund its budget, which is based on a $56/bl oil price and crude exports of 3.3mn b/d. February crude exports of just under 2.6mn b/d netted Iraq an average price of $47.40/bl. Contract renegotiations are expected to see foreign operators keep oil output steady this year as they focus on cutting costs. Investment in increasing capacity is not likely until a sustainable cost-recovery process is in place.

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