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November 22, 2005

Quick Question.

A report out from Platform. Some coverage, like in the Independent.

Iraqis face the dire prospect of losing up to $200bn (£116bn) of the wealth of their country if an American-inspired plan to hand over development of its oil reserves to US and British multinationals comes into force next year. A report produced by American and British pressure groups warns Iraq will be caught in an "old colonial trap" if it allows foreign companies to take a share of its vast energy reserves. The report is certain to reawaken fears that the real purpose of the 2003 war on Iraq was to ensure its oil came under Western control.

However, no sign of the actual report anywhere to see how they reach these numbers.

Anyone got an idea? Platform isn’t answering the phone at present.

Name of the report: "Crude Designs: The Rip-Off of Iraq's Oil Wealth"

Update. Platform have just posted it here.

Generally, oil companies make their profits from investing and risking their capital.

These oil companies, so different from every other company out there!

They argue against Production Sharing Agreements (PSAs) on the following term:

They fix terms for 25-40 years, preventing future elected governments from changing the contract. Once a deal is signed, its terms are fixed.

Well, yes actually, that’s what contracts are supposed to do.

Thirdly, they generally over-ride any future legislation that compromises company profitability, effectively limiting the government's  ability to regulate. One of the most worrying aspects of PSAs is  that they often contain so-called �stabilisation clauses�, which would           immunise the 60-80% of the oil sector covered by PSAs from all future laws, regulations and government policies. Put simply, under PSAs future Iraqi governments would be prevented from changing tax rates or introducing stricter laws or regulations relating to labour standards, workplace  safety, community relations, environment or other issues. One common  way of doing this is for contracts to include clauses that allocate the 'risks' for such tax or legislative change to the state.(64)  In other words, if the Iraqis decided to change their legislation, they  would have to pick up the bill themselves. The foreign oil company's profits are effectively guaranteed.

Well, quite, contracts are supposed to do that.

Fourthly, PSAs commonly specify that any disputes between the government and foreign companies are resolved not in national courts, but in international arbitration tribunals which will not consider the Iraqi public interest. Within these tribunals, such as those           administered by the International Center for Settlement of Investment  Disputes in Washington DC, or by the International Chamber of Commerce in Paris, disputes are generally heard by corporate lawyers and trade negotiators who will only consider the narrow commercial issues and who will disregard the wider body of Iraqi law.

Well, yes, I suppose so. We’dal love to hear Libyan oil cases decided in Libyan court rooms now, wouldn’t we, and we all think that Shell will invest billions if it were so, do we not?

Oh dear Lord:

THE NEED FOR TRANSPARENCY                                 

Ensuring that Iraq's oil wealth benefits the majority of Iraqis is not only a question of the contracts themselves.  Appropriate development also depends on good governance.                              

There are very few oil-producing countries that have managed to prevent corruption in their oil sectors, and Iraq  is no exception. Indeed, during the three decades of national control over the industry, Iraq�s oil wealth was used to sustain a brutal dictatorship and its internal security apparatus, to personally enrich Saddam Hussein and his family, and to finance                   devastating wars with Iraq�s neighbours. Meanwhile, corruption became endemic at all levels of Iraqi officialdom.

Corruption is already a problem in post-Saddam  Iraq. Investigations by US and international agencies into the financial operations of the Coalition Provisional Authority and  Iraq's interim governments have concluded that billions of dollars have been lost due to corruption, theft and inadequate accountability. The vast majority of that money, estimated to be at least $4 billion,       was derived from Iraq's oil income, which was meant to be invested in the reconstruction of the country.(85)                              

Whether Iraq�s oil is held in the public or the private sector, good governance and effective democratic institutions  will be essential. In order to prevent the emergence of another Saddam, it is particularly important to curb the discretionary power of the executive over oil income and expenditure. It is also necessary to ensure that adequate oversight powers are given  to appropriate government bodies and that transparency is enshrined in law.(i) Furthermore, all oil income and expenditure must be included in a transparent  and accountable budgetary process. Auditors should report to parliament and parliamentarians should be able to call ministers and senior officials to account. No national reserve fund should be allowed  to be used as a �slush fund�.(86)

This is the argument they use in favour of a national oil company rather than allowing foreign companies in. Yes, there are such things as market failures but simply pointing to past and current corruption in Government might not be the best way of highlighting this fact.

I mean, the national oil companies of Ecuador, Venezuela, Mexico, they are such paragons of financial virtue, are they not, never interfered with by politicians or anything?

I’d also note a small statistical sleight of hand used throughout. Yes, in the footnotes they do discuss the concept of Net Present Value. But in the Executive Summary we get these numbers:

At an oil price of $40 per barrel, Iraq stands to lose between $74 billion and $194 billion over the lifetime of the proposed contracts (2), from only the first 12 oilfields to be developed. These estimates, based on conservative assumptions, represent between two and seven times the current Iraqi government budget.

That’s a gross figure. Not NPV. In fact, as they say in the appendix:

So when we consider the profitability of a capital-intensive           project such as an oilfield development, we have to look at discounted           values.

So, all through the report we should be looking at NPV? No? So where is it in the Executive Summary? In a footnote.

The (2006) net present value of the loss to Iraq amounts to between $16 billion and $43 billion at      12% discount rate.

And do they think that 12% is the correct discount rate? Only partially, from the appendix.

The oil industry commonly uses a discount rate of12% in real terms, or 15% in nominal terms (allowing for inflation).

Folks, it’ll have to be someone better at maths than me that tells us what the NPV is at a 15% discount rate. Is there actually a loss at all?

The really strange thing about this report is that they’ve half convinced me that PSAs are not necessarily the best way to go for the Iraqis, given the low up front costs of getting to the easily drilled and already found oil fields. That assumes that their investment numbers are correct.

But all of the other stuff, as above, makes me think in the opposite direction. If they’ve got to sexup their opposition with this sort of sleight of hand then perhaps there is more to PSAs?

Update. From this blog’s contact in the Middle East oil industry.

They are extremely common.  For example, the Abu Dhabi National Oil Company (ADNOC) consists of 14 individual operating companies, almost all of which have a foreign shareholder.  For example, the following ADNOC operating companies have shareholdings as listed:

ADCO = 9.5% BP, 9.5% Shell, 9.5% Exxon Mobil, 2% Partex
ADGAS = 15% Mitsui, 10% BP, 5% Total
ADMA-OPCO = 14.67% BP, 13.33% Total, 12% JODCO
GASCO = 15% Total, 15% Shell, 2% Partex
ZADCO = 28% Exxon-Mobil, 12% JODCO

And that's just the main players in Abu Dhabi.

The Petroleum Development Company of Oman (PDO) and the Oman Refinery Company (ORC) both have large Shell shareholdings.

Qatar Petroleum is unusual in that it does not have a foreign shareholding, BUT two large companies - namely Qatargas and Rasgas - were formed by the Qatar government specifically for developing the gas fields in the north of the country.  These two companies split into different projects, Qatargas I, Qatargas II, Rasgas II, etc. and these "project companies" all have enormous foreign shareholdings, specifically Exxon-Mobil in the Qatargas II project (the 2nd largest project in the world).

Kuwait has yet to catch up and bring in foreigners, but I can assure you that within the next year or so they will have completed  a partnership agreement with BP to develop their Northern field.

So, these arrangements are extremely common.  But why?

Firstly, the foreign oil companies like Shell, BP, and Exxon-Mobil are usually far in advance of the national oil companies in terms of HSE, Asset Integrity Management, reservoir technology, etc.  It is therefore in the interests of the asset owners, i.e. the national oil companies to bring in expertise to assist them with their operations.  Given that this is more complicated than just hiring a few experts, as it involves adopting entire management systems such as HSE and maintenance procedures, the best way to do it is to partner up with a foreign major who brings in their own systems and people.  After all, why reinvent the wheel?  ZADCO recently signed a deal giving Exxon-Mobil a 28% ownership of the enormous Upper Zakum field offshore UAE, precisely because ZADCO's assets are getting towards the end of their design life and Exxon-Mobil has the expertise to extend their life and continue to operate them safely.

Secondly, and this is partly related to the first, certain technologies were developed by and are owned by foreign majors and the Middle Eastern companies have found themselves in need of this technology.  The best example of this is the Gas To Liquid (GTL) technology, which converts unassociated gas into semi-stabilised crude. Shell patented this process some time ago, and are the only company to have successfully operated a large GTL plant (in Bintulu, Malaysia). Qatar Petroleum have now instigated a $14bn project, of which Shell are stumping up $9bn to build and enormous GTL plant in Qatar.  Without the Shell involvement, the project could simply never have gone ahead.

Thirdly, there is a cash flow issue. Even though these national companies are resource rich, they have diffiiculty in turning it into ready cash as it must first pass through the layers of government.  Middle Eastern oil companies are surprisingly short of ready cash, and partnering up with a foreign major provides instant investment in the form of cash, enabling them to carry out certain projects without having to wait years for government cash.

For what it's worth, those national oil companies with a prominent western or Japanese major oil company as a partner have a far greater record in areas such as efficiency, safety, and environmental protection, and those companies who stand alone are visibly lagging behind, suffering a far greater rate of downtime and lost time incidents.  If there is one thing the Iraqi national oil company needs, it is a large western supermajor as a joint owner, something that would be enormously beneficial to all concerned parties.



November 22, 2005 in Natural Resources | Permalink


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I don't have any numbers either. But there is nothing to suggest it is of the wrong magnitude.

Iraq could produce 3m barrels per day. Profits of $30 per barrel (using a long-term oil price of $35 and costs of $5). That equates to $30bn p.a or perhaps $600 bn over 20 years.

There would be further profits from refining.

A loss to Iraq of $100-200 bn from the forced sale of their oil resources to overseas companies is entirely credible.

Posted by: james C | Nov 22, 2005 1:34:28 PM

I suppose there's your answer: insert thumb into mouth and suck. Obviously convincing enough for some.

By the way, how do "overseas oil companies" (now there's a scary phrase!) force a democratic state to do their evil bidding?

Posted by: Stephen | Nov 22, 2005 1:44:26 PM

What we have here is a classic example of two parties each with something to offer and each needing something the others don't have.

Iraq has oil reserves and resources (see previous comments for the difference). What it does not have is capital and expertise to develop these reserves quickly and efficiently (their oil industry has been deprived of capital, spare parts and new technology for the better part of 15 years remember).

The big oil companies have the expertise, the capital and the new technologies. They also have a market. They need crude oil.

Iraq will offer the development and pumping contracts in exchange for tax, royalties and employment. All those employed Iraqis will pay income tax on their earnings. There will be duty and VAt paid on imported parts and equipment.

Interestingly enough, there was a chap at Wits University a few years ago doing post-grad research into the total financial benefit to a country when a mineral resource was exploited. He didn't just look at the tax and royalty payments, but the whole financial inflow to the country. His preliminary research showed that the majority of the cash value of the reserve actually stayed in the country the foreign company took by far the smaller portion.

I would say Iraq is in the stronger position in this negotiation as they control the oil and there are several companies in Britain and the US alone who would be willing to bid for the pumping contract. Since I doubt the descendants of one of the oldest trading civilisations on earth have lost any of their business acumen a good Iraqi negotiating team will probably get a pretty tasty deal from whichever companies do win the contracts.

Perhaps if these mugus from the tofu weaving classes actually took their heads out of their bums every once in a while, they'd see that what is being proposed in Iraq is entirely normal and could even be seen as a sign of development. If the oil industry is interested in setting up long term contracts it means they have a reasonably favourable view of that country's future.


Posted by: Remittance Man | Nov 22, 2005 3:21:05 PM

For a revenue stream paying x at intervals and a discount rate r over each interval (i.e. an annuity) PV is x/r.

Proof: let the discount rate be r (e.g. 5% = 0.05), and k be 1 + r. Then the present value of x one payment interval in the future is x/k. Two periods in the future it is x/k^2. Summing the infinite series x(1/k + 1/k^2 + 1/k^3 + ...), we obtain the result x/(k-1) = x/r.

So the PV of an annuity returning $1,000 a year, discounted at 5% p.a. is $20,000. The bigger the discount rate, the lower the PV. At 15%, the ratio's about 6. NPV, of course, also takes expenditures both periodic and fixed into account. I can certainly buy the idea that development of Iraq's oil has low NPV, especially with such a steep discount rate. Of course, once the fixed costs become sunk costs, the NPV at that point suddenly jumps, and that would be a good time to get in the game.

Posted by: David Gillies | Nov 22, 2005 4:37:45 PM

They fix terms for 25-40 years, preventing future elected governments from changing the contract.

What a coincidence that this is the period over which large investments in the oil industry are thought to bear fruit! How odd that oil companies wishing to get a return on investments over 25 years are not happy with a 2 year contract.

Posted by: Tim Newman | Nov 23, 2005 5:11:21 AM

they generally over-ride any future legislation that compromises company profitability, effectively limiting the government's ability to regulate.

I have yet to see a single example of this.

One of the most worrying aspects of PSAs is that they often contain so-called �stabilisation clauses�, which would immunise the 60-80% of the oil sector covered by PSAs from all future laws, regulations and government policies.

60-80%?? As far as I know, not one national oil company has less than a 51% shareholding in any PSA arrangement. In all instances I'm aware of, the national oil company remains firmly in control and the combined operating company must fully comply with all legislation, new and future. If this were not true, I'd be out of a job.

Posted by: Tim Newman | Nov 23, 2005 5:15:45 AM

Oh, and what Remittance Man said. Bang on.

Posted by: Tim Newman | Nov 23, 2005 5:19:12 AM

The industry discount rate of 15% relates to speculative fields. It is not correct to use such a high rate to value proven fields.

My 3m bp.d figure is conservative and will be exceeded.

James C

Posted by: james C | Nov 23, 2005 1:53:12 PM

Point of law - in the UK, contracts do not 'fix' the law - either those between private parties, or those between the government and private parties. All and any contracts are subject to later changes in law. So to say that contracts are supposed to "over-ride any future legislation" is not correct.

Posted by: Katherine | Nov 23, 2005 2:50:36 PM