Friday, January 8, 2010

Jay Park on al-Shahristani Plan


If you are interested in this whole question of the ramp-up of Iraq's production, don't miss Jay Park's comment on my cross-post at The Oil Drum. According to his LinkedIn profile, Jay Park is Partner, and Chair, Global Resources Practice Group at Macleod Dixon LLP in Calgary.  He has been practicing law in the oil and gas area for three decades.

Here's a couple of excerpts of what he had to say (but read the whole thing and the follow-up discussion at the link above).

I have been involved for a number of years with the Iraqi oil industry, and I am familiar with the Technical Service Contracts (TSCs) which were awarded in the First and Second Petroleum Licensing Rounds by the Petroleum Contracts and Licensing Division (PCLD) of the Iraq Ministry of Oil (MoO). I have met Dr. Al-Shahristani and many of the other MoO executives. Consequently, some of what I know can shed light on the opinions and comments above.

It seems to me that the possibility that Iraq may actually succeed in doing this should be taken seriously.

Let me explain why I agree with this sentiment. In 2004 and the years that followed, MoO entered into a number of "Memoranda of Understanding" with various major international oil companies (IOCs) to study the discovered Iraqi fields, both producing and non-producing, and share this information with MoO. Extensive analysis work was done by the IOCs, in the hopes that the work would lead to an award of a contract for the fields, or at least, the knowledge gained would give an upper hand in a bid process. Neither proved to be the case; all contracts have been awarded by bidding, and all information was shared with prospective bidders. The consequence is that all IOCs went into the bid process with good knowledge of the fields.

The Technical Service Contracts impose an obligation on the IOC (who becomes a a "Contractor" for the relevant Iraqi regional oil company, such as the South Oil Company, or the North Oil Company) to increase production to the Plateau Production Target. This must be done within 6 years (for First Round fields) or 7 years (for Second Round fields). The PPT must be maintained for 7 years.

The Plateau Production Target was one of two factors which the IOCs bid during the rounds. The second bid factor was the Remuneration Fee, expressed in dollars per barrel. The winning bid was determined using a formula involving (in the First Round) the product of the production target and the remuneration fee, or (in the Second Round) a point system that put 80% of the weight on the Remuneration Fee.

In either case, there was a tremendous incentive on the bidding IOCs to propose a VERY high Plateau Production Target. It has been said that MoO was amazed at the PPTs that were bid. MoO had hoped to get commitments for 6 million bbl/day of production; instead, they got 12 million bbl/day, even though less than all of the fields were awarded.

Can these production rates actually be achieved in Iraq? On the 'yes' side of this case are the following arguments:

The IOCs had good information about these fields
The Contractor's remuneration fee is based on a per-barrel fee which creates an economic incentive to achieve the PPT
The Contractors have a contractual obligation under the TSCs to reach the PPT. If they fail to do so, there are non-performance penalties under the TSC that grind down the already-modest remuneration fees, and other possible consequences
I don't make it my business to bet against some of the world's most capable companies achieving objectives that they are contractually bound to perform, and with economic incentives that encourage such performance, when they voluntarily set those objectives with all the relevant information they needed.

and

Here are some more responses to miscellaneous comments, where my knowledge of Iraq and the TSCs may improve understanding.

I don't think the amounts the foreign companies have agreed to for these contracts are adequate to secure the experienced staff they need to accomplish the task in the immediate future.

The remuneration fees are certainly very modest. However, there is 100% recovery of the Contractor's costs, so I disagree with the comment above. Indeed, there is even an "R" factor component in the remuneration fee calculation that creates an incentive for the Contractor to incur higher costs than it otherwise might pay (a feature that the economists call "goldplating").

The remuneration fee is the 'profit' to the Contractor. And it is less than many people understand. The table in Stuart's post that lists the fields and the remuneration fee shows the gross fee. There is an Iraqi state partner in the Contractor consortium who gets 25% of that remuneration fee, and then there is income tax of 35% on the remainder. So the $2.00 per barrel fee that BP and CNPC agreed to receive for Rumailah becomes only $0.97 after those deductions. At $80 oil, that is 98.7% government take-- a new world high.

I am a little hard pressed to come up with a list of mature producing regions that have shown a five fold increase in production in 10 years, but I suppose that many things are possible.

Please remember that Iraq's situation is unique. In 2003, they had six discovered fields with reserves of over 5 billion barrels of proven reserves-- and only three of them were producing. They had 21 discovered fields with between 500 million barrels and 5 billion barrels of proven reserves, and only nine of them were producing. And they have 35 fields with less than 500 million barrels of proven reserves, and none of them were producing. It is this significant discovered but non-producing capacity that is the source of the potentially large increase in production. This is not comparable to the development profile of other basins, because no other country has ever kept so many fields offline for so long.

Does anyone on this site have on the ground experience of being a westerner in Iraq in the last six months?

Yes. Westerners need to take precautions in Baghdad, and in Mosel, and certain other places. But I have clients actively drilling in various parts of Iraq with no security problems when ordinary precautions are taken. Security issues vary by locality, in Iraq, and elsewhere. I have visited Iraq three times-and there are certain parts of New York City where I am not prepared to go.

I think this answers a number of questions I had (especially why Dr al-Shahristani's ambitions went from 6mbd to 12mbd so quickly).

6 comments:

Per said...

Shahristani's plan:

Shahristani said the 12 million bpd target will merely be Iraq’s capacity, and that actual output will be based on market demands and aligned with OPEC. There is language in the contracts that compensates foreign companies if production is reduced, he said.

From
http://www.ordons.com/200912302081/iraq-oil-output-to-rival-saudi-arabia-if.html

Datamunger said...

Stuart,

From Jay Park's comment:

However, there is 100% recovery of the Contractor's costs....


From what you've seen, is there any significant risk of absolute loss to the IOCs?

Normally with oil production, there is risk of loss since even apart from cost overruns, the price of oil may fall below the budget assumption. That doesn't seem to exist here with the per-barrel fee settup.

Jay wrote:

there was a tremendous incentive on the bidding IOCs to propose a VERY high Plateau Production Target.

Sounds familiar. We both know that in the tech biz, there are lots of contracts that look much bigger than they are. People promise the world. There is some chance of a big gain without that much money at risk. Often comes to nada. No huge deal since all that was really at stake was a chance to make money.

Stuart Staniford said...

Datamunger - I really don't know whether the IOC's face a risk of outright loss. It sounds from Jay's comments that it's a cost-plus contract, in which the company wouldn't usually face such a risk. But there could be all kinds of little provisions about this or that scenario and I wouldn't know. There is a signature bonus (of $500m in the Rumaila case IIRC) so if the companies did nothing at all, they could lose that. But it's not a huge number on the overall scale of these contracts.

In the current environment in high tech during the recession and slow recovery, startups have to hit their targets or face a very serious funding risk. So most of those companies that still exist are projecting fairly conservatively and then doing what it takes to hit the target. But in the past, I would agree I have seen behavior such as you describe.

I guess the jury will be out for now on whether these plateau's will get hit or not. I plan to see what I can dig up on one or two of the biggest fields and see if we can form any clearer opinion about their prospects (we are never going to know the level of detail the IOCs know, but at least our incentive structure is comparatively disinterested).

Datamunger said...

Well then, on the face of it, these look like piece-work contracts. Which can be very robust and flexible and given all the uncertainties might be rather smart. [I have seen nominally large contracts between sizable tech firms boil down to piece-work in the end. Delivered goods much smaller than stipulated without anything blowing up]

Seems like IOCs aren't going to get kicked out for under-performance. Everybody's got incentive to stay in the game and produce (maybe even at huge cost: if I interpret Jay correctly). If true, a feeding frenzy isn't impossible.

JJ said...

Datamunger:

There is some measure of cost risk to the Contractor, but nowhere near as much as in an exploration contract.

The Contractor receives cost recovery out of 50% of the revenues from incremental oil production. Cost recovery begins once incremental oil production attains an 'initial production increment target' which is a fraction of the Plateau Production Target. So, if the Contractor does not attain the IPT, then it will never recover costs. However, the IPT should be easily obtainable.

There is a risk that total costs will not be recovered by the end of the contract term, but with 50% of incremental revenue going to cost recovery, that seems unlikely unless Iraq elects to take only a fraction of the PPT.

The signature bonus payment that Stuart refers to was in fact a recoverable loan for the First Round fields, and a non-recoverable bonus for the Second Round fields. For the recoverable loan, the risk is the same as any other cost. For the non-recoverable bonus, the Contractor has to hope that the Remuneration Fees are substantial enough to result in a reasonable return on that investment.

Jay

Venezuelan said...

I got a question for you Jay:

Does the 2nd Bid Round "Remuneration Fees" calculated based on incremental or total production?

Thanks,

CB