ExxonMobil's deal with Kurdish region has raised a few eyebrows

Dec 01, 2011 12:00 AM

by Shwan Zulal

The latest ExxonMobil deal with Kurdistan region has raised a few eyebrows and it has brought into focus the bitter dispute between the central Iraqi government in Baghdad and the Kurdish regional government.
Current and previous Iraqi governments both lead by AL Maliki have refused to recognise the Kurdish production sharing contracts awarded by the KRG. Baghdad has also threatened to blacklist companies from the rest of Iraq if they enter into any oil and gas contracts with the semi-autonomous Kurdish region. They followed on the threat by action in August this year by excluding Hess when it became clear that it has acquired a block in the Kurdistan region.

The policy of banishing IOCs operating in the Kurdistan region from Iraq is only based on a decree form the Iraqi Oil Ministry but the attempt was never made by Maliki to enshrine the policy into the law, mainly because it will be unconstitutional to do so and partly because his shaky coalition will struggle to pass any such legislation through parliament.
Exxon is the first super-major to ignore the Iraqi government and go ahead with acquiring lucrative Kurdish PSCs. The US giant is currently operating in partnership with Shell in the West Qurna-1 field which produces nearly 400 boepd and production is on the increase. Moreover, the company will be in charge of a water desalination project, the largest of its kind in Iraq. Meanwhile Exxon is lined up to take part in the upstream auction due to be held in March next year.

Why now
Many analyst have said that Exxon has made a mistake by entering the Kurdistan region and the decision was based on political miscalculation. But looking at Exxon’s record, the company has never shied away from taking on governments in the past. The simple analysis could be that Exxon wants to sell its stake in West Qurna-1 and head for the Kurdistan region.
Apart from the fact that the Kurdish deal could be very rewarding and commercially viable, given disputes with Baghdad are resolved, there are other reasons Exxon might have considered:

Exxon is considered as an arm of the US state department and by entering Kurdistan, it is making a big political statement, while the US troops are withdrawing. Although the State Department is mute about the deal and only repeats its official line, there is a likelihood that they instigated the deal thinking it will finally bring the disputes into the forefront of the political agenda in Iraq and a solution will be found for the oil policy and revenue-sharing impasse.
Exxon’s contract in West Qurna-1 with the Iraqi government is a service contract with very tight margins. During the first round of auctions none of the oil companies were happy with the deal on offer. Only BP was successful which later became apparent that they have renegotiated the original terms of the contract. Exxon and Shell also managed to put in a later offer which was accepted for West Qurna-1.

BP has renegotiated the Rumaila contract and shifted much of the risks associated with their operation to the Iraqi government which made the small margins more attractive. However, other companies operating in the south like Shell, Exxon and other IOCs were not given the same favourable terms. After leaked BP renegotiation documents were released, it is certain that other companies like Exxon were not happy that a competitor has been given much better terms.
There is no evidence of any talks between Exxon and Baghdad discussing the contract terms after the BP deal, but if Baghdad has refused to enter talks on renegotiation of the contacts, Exxon's move to theKurdistan Region could have been designed to pressurize Baghdad to treat it equally like the BP-CNPC partnership in Rumaila.

Exxon has so far kept quiet about the Kurdistan deal and the KRG Ministry of Natural Resources has been the one who first broke the news. Therefore it is likely that Exxon wanted to possibly use the KRG as a bargaining chip, but the KRG acted by publicizing the deal.
It may be pure speculation but it is needless to say that Shell was involved in similar talks with the KRG and as soon as it became clear that the gas deal with Baghdad was about to be signed -- a deal which has been in the making for three years -- it pulled out of talks with the KRG and signed a $ 17.2 bn deal.

What next
Maliki and his deputy for energy affairs, Hussian Shahristani, have been in a dilemma on how to respond to the latest Kurdish deal. On one hand they are using very strong language and threatening to expel Exxon from the south and on the other they realize the risk of confronting the largest company in the world which has annual profits that are larger than the entire Iraqi budget.
Under the current Iraqi law, there are no legislations which can be invoked to void the Exxon contract in the West Quran-1, because of their involvement in the Kurdistan Region. The contract signed in 2009 does not contain a clause expressly giving rise to the annulment of the contract and does not expressly compel Exxon not to enter contracts with the KRG. Baghdad can only rely on the Oil Ministry directive, but according to the contract this could only mount into a breach and could not possibly allow the contract to be rescinded.

Baghdad has little option when it comes to handing out punishment to Exxon. It has already announced that it will exclude the company from the fourth bidding round and possibly take further actions. It will be foolish for the Iraqi government to breach its contract with Exxon because the reputation of the government and the issue of contract sanctity would be on the line.
Investors and companies are already weary to enter Iraq, due to security and political instability and if the government is seen to be disregarding contract obligation, it can only add to the uncertainty and political risk associated with doing business in Iraq. Such a move will be more damaging for the oil sector in particular which needs hundreds of billion dollars of investments in the next decade.

Unless Exxon wants to get out of West Qurna and sell its stake, the most obvious solution which keeps everyone happy to a degree would be to exclude Exxon from the next auction round -- already announced -- because Exxon managed to get their hands on six blocks in the Kurdistan region.
Baghdad has already ratcheted up their rhetoric for local consumption and give the impression that they are in control. Furthermore, if Baghdad feels that it has to take more actions, the option of demoting Exxon from leading the water injection project could save the face of the Iraqi government and satisfy the ultra-nationalists.

However, if Exxon keeps to the Kurdish blocks and accepts the sanctions dished out from Baghdad, the six Kurdish PSC deals will have far reaching political significance for the KRG and the acrimonious dispute over oil policy.
This simply means Baghdad is recognising the Kurdish deals by the back door.

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