The fact that Chevron is heading back to Iraq may lead to a win-win attitude that benefits both sides.
Last week’s headline about Chevron potentially taking on new upstream exploration and development work in Iraq was an eye-opener. It has been a long time — a decade — since we have seen the major Western international oil companies (IOCs) actually increasing their commitments in Iraq. Since then, the standard assumption has been that Chinese and Russian firms would take on much of the development work and that Iraq, while still in the top five oil producers globally, would fail to achieve the potential market share it could achieve, given its reserve base.
When the US invaded Iraq in 2003, the case for Western companies to invest there was strong. The prevailing zeitgeist in the world oil market was increasing scarcity and generally rising prices. The Western IOCs were incentivized to scour the ends of the earth for resources and to do business in countries in which security and political risks were substantial.
It ended up taking six years after the invasion for the new Iraqi state to enact a legal framework for these projects, which differed greatly from the production sharing contracts (PSCs) the industry would have preferred. The “technical services contracts” offered were less lucrative, but still allowed the foreign companies to achieve substantially enhanced returns if they succeeded in surpassing their agreed production targets. A slew of contracts were awarded, the largest being for enhancement and production capacity additions at existing fields. There was also some hope in the industry that the more lucrative PSCs could eventually be used for greenfield exploration in Iraq.
By the mid-2010s, however, the tide of Western IOCs began to roll out. While there were notable exceptions, the bulk of the Western companies ended up selling off their operations in Iraq or at least substantially reducing their capital expenditures. With the shale revolution playing out in the United States and concerns about potentially slowing demand growth beginning to drive sentiment in the financial markets, the risk versus reward tradeoff in Iraq no longer looked so compelling to CEOs and their boards. The largest American IOCs — in particular, ExxonMobil and Chevron — started redirecting the bulk of their capital expenditure into US domestic development projects, and the industry as a whole became much more risk averse.
That zeitgeist now seems to be reversing a bit. The extremely low production costs available in Iraq give it one inherent advantage if investors are confident that long-term demand will hold up, even if it may not be growing much. The Iraqi government also now has more of a track record and has proven its durability. It may not be the government American officials had hoped for in 2003, and it may be heavily Iranian-influenced and rife with corruption, but it has now been through several election cycles and has been able to produce governing coalitions that are reasonably stable without US hand-holding.
The document signed between Iraqi officials and Chevron is a non-binding ”heads of” agreement covering exploratory drilling in the four blocks comprising the Nasiriyah field, where seismic survey work has yielded very promising results, and additional development of the existing Balad field in Iraq’s southern Dhi Qar Governorate.
A binding contract will come at a later stage, but it will be interesting to see what, if any, terms Iraq is willing to modify to attract upstream investment. For Chevron to have made it to this stage, it is likely that there has been some flexibility shown in closed-door discussions. Prime Minister Mohammed Shia al Sudani hinted at this in a statement saying that his government had “adopted a different approach in dealing with major oil companies and their investments in Iraq, particularly American ones.”
The Dhi Qar projects are targeting a notional 600,000 bpd in additional production volume after seven years, and if Iraq is truly committed to a new approach, there could be a very substantial rise in its production capacity. This comes at a time when global demand is seeing a deceleration of growth, even if it is likely to flatten out and not fall much from the mid-2030s.
Much of the incremental demand has been coming from US shale, Brazil, and ExxonMobil’s development project in Guyana in recent years, though US production cannot grow indefinitely, and production costs have been rising. Saudi Arabia and the UAE are currently trying to take back their market share, even if it means weaker prices in the near term. If Iraq starts to resume its growth with contracts that make that worthwhile for American and other Western IOCs, that would probably have to displace other, higher-cost investments in capacity elsewhere.
An enhanced American presence in Iraqi upstream development in the future also would probably benefit American influence in Iraq and the region more broadly. Prime Minister Sudani seems to see the greater financial upside for Iraq, which could be unlocked by a broader return of Western and American IOCs.
The pressure to avoid being seen as giving away the farm to American companies while the US was still an occupying power in Iraq perhaps led to a suboptimal contract structure, and now with the benefit of hindsight and the receding of the resource nationalism that prevailed in the 2000s, we may see more of a win-win attitude that benefits both sides.
About the Author: Greg Priddy
Greg Priddy is a Senior Fellow for the Middle East at the Center for the National Interest. He also consults for corporate and financial clients on political risk in the region and global energy markets. From 2006 to 2018, Mr. Priddy was Director, Global Oil, at Eurasia Group. His work there focused on forward-looking analysis of how political risk, sanctions, and public policy variables impact energy markets and the global industry, with a heavy emphasis on the Persian Gulf region. Prior to that, from 1999 to 2006, Mr. Priddy worked as a contractor for the US Energy Information Administration (EIA) at the U.S. Department of Energy. Mr. Priddy’s writing has been published in The New York Times, The National Interest, Barron’s, and the Nikkei Asian Review, among others.
Image: Shutterstock/ssi77
