Given the historically elevated oil and gas prices that have resulted from Russia’s invasion of Ukraine, and the lack of a meaningful shift in OPEC+ production policy to reverse this trend, news that Iraq’s supergiant West Qurna 2 oilfield is now fully back online will be welcomed by those countries whose economies are already being damaged by high hydrocarbons’ prices. Despite Russian oil giant, Lukoil, being the prime operator of the 400,000-plus barrels per day (bpd) field, the Russian company has no reason to expect from Iraq any problems over its West Qurna 2 operations. In fact, the field may well see a quick increase in production to well over 600,000 bpd in the first instance and beyond 1 million bpd further out. Located around 65 kilometres northwest of the southern port of Basra and with roughly 14 billion barrels of reserves in place, West Qurna 2 has long been able to produce a lot more than the 400,000 bpd - about nine percent of Iraq’s total oil production - as exclusively revealed by OilPrice.com way back in May 2019. However, such increases have been stymied by tactical posturing on the one side by Lukoil - which holds a 75 percent stake in the field (with the remainder held by Iraq’s state-run North Oil Company) and on the other side by the Iraqi government in Baghdad. The key events that shaped all of the subsequent shenanigans on both sides occurred in and around August 2017.
At that time the government’s finances were still in tatters due to the endemic corruption that has plagued Iraq’s hydrocarbons sector for years. Just two years before, in 2015, then-Oil Minister, and later Prime Minister of Iraq, Adil Abdul Mahdi, stated that Iraq had ‘lost [at least] US$14,448,146,000 in cash compensation payments’ connected to its oil sector from the beginning of 2011 up to the end of 2014. Consequently, the Iraqi government needed all the oil revenues it could muster, as analysed in depth in in my new book on the global oil markets. It then asked Lukoil if it would increase production from West Qurna 2 from 400,000 bpd to, in the first instance 480,000 bpd, and then quickly to add at least another 650,000 bpd (with a focus on developing the deeper Yamama formation), in line with the original development agreement for the field. This ultimate Phase 3 target of 1.13 million bpd might appear high to some (although the original target was 1.2 million bpd) but it is entirely justified both by U.S. geologists when they were on the ground during the U.S. occupation and by various international oil companies’ (IOCs) initial surveys since then.
At that point in 2017, Lukoil was aware that on its own the West Qurna 2 development would allow it to double its overseas production once Phase 3 kicked in (Lukoil’s total hydrocarbon production globally was 2.2 million bpd in 2016). However, the Russian company was also aware that the US$1.15 per barrel recovered level of remuneration it was receiving was the lowest rate being paid to any international oil company in Iraq at that time and was exceptionally low by comparison with other development deals on similar sites. Notably for Lukoil, for example, it was dwarfed by the US$5.50 per barrel being paid to GazpromNeft on its development of the Badra oilfield. In addition, Lukoil had also spent at least US$8 billion on developing the field by August 2017, according to its spokespeople at least.
Although Lukoil could still squeeze a profit out of West Qurna 2 - given Iraq’s world-low (along with Iran and Saudi Arabia) lifting cost per barrel of oil of US$1-2 per barrel - its profit per barrel based on recovery compensation was extremely slim. Also grating on the Russian company was that because of the ongoing cash crunch in Iraq, the Oil Ministry still owed Lukoil around US$6 billion for various unpaid compensation on recovered barrels and other development payments.
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According to a senior oil and gas industry figure close to Iraq’s Oil Ministry spoken to exclusively by OilPrice.com, Lukoil made all of these concerns clear to Iraq’s Oil Ministry at the beginning of August 2017. It was assured by the Ministry that it would receive the US$6 billion that it was owed expeditiously and that a higher compensation rate per barrel would be looked into as soon as was feasible. In addition, according to the source, the Oil Ministry told Lukoil that it would also allow the Russian company more leeway in its application of the terms of the Development and Production Service Contract for the West Qurna (Phase 2) Contract Area signed by Lukoil on 31 January 2010.
This would allow for a more spread out field investment development program by Lukoil over the length of the contract, which had also been extended from 20 to 25 years, so lowering the average fixed capital and running costs per year to the Russian company. Lukoil, for its part, would invest at least US$1.4 billion in the oil field in the following 12 months with a view to raising production from the 400,000 bpd level to at least 1.13 million over the time of its contract.
However, more problems from the Russians’ perspective began almost as soon as the new agreement had been made, with delays in the repayment of the US$6 billion owed to it by the Oil Ministry. Given this slippage on the deal by the Oil Ministry as far as Lukoil was concerned the Russian company decided not to pump at the higher volumes wanted by the Oil Ministry, as it believed – with some justification – that it was not going to be paid for any extra efforts that it made. This was despite Lukoil having already done several test runs at West Qurna 2 of output at the 650,000 bpd level over various extended periods in the June and July of 2017 and believing that it could easily sustain production of at least 635,000 bpd for the foreseeable future.
“The Oil Ministry found out about these [650,000 bpd production] runs in November [2017], and challenged Lukoil about them but Lukoil reiterated that it wanted the Oil Ministry to make good on its earlier promises [made in August 2017] to start paying the US$6 billion it was owed and to finally ratify the new agreement about extending the contract from 20 to 25 years,” the source told OilPrice.com. “In addition, Lukoil also demanded the option to increase its stake from 75 percent to 80 percent,” he added. “In return, Lukoil agreed to move ahead with the extra US$1.4 billion investment in the short-term and a further US$3.6 billion down the line, depending on variables including OPEC quotas and the continued development of export capacity in the south,” he said.
Once again, though, another year or so went by with Iraq’s Oil Ministry unwilling or unable to meet its obligations under the terms of the August 2017 agreement and the November 2017 agreement. This prompted a visit in February 2019 to Iraq’s then-Prime Minister, Adil Abd Al-Mahdi, of Russian President Vladimir Putin’s Special Envoy to the Middle East and Africa, Mikhail Bogdanov. Given that on the one hand, Al-Mahdi was facing President Vladimir Putin’s main man in the Middle East and on the other he knew full well that he would have to account for whatever was said to the de facto leader of Iraq – radical cleric Moqtada al-Sadr – after the meeting had ended, it is little wonder that the meeting was “very tense,” according to the Iraq source. “However, Russia wanted to safeguard what it had in southern Iraq to add to the central role that Rosneft had in Kurdistan and to prevent the Americans from pushing it out, and West Qurna 2 allowed it to show good faith to Baghdad, so the agreements of 2017 were reiterated and that is where the matter was left at that stage,” he underlined.
Changes in the stance of both sides may now mean that the original deal to boost production to at least 1.13 million bpd will finally go ahead. On the one hand, Iraq has seen a swathe of Western IOCs exit the country’s oil sector, and needs to keep the revenues from that business rolling in from whomever wants to continue to develop its oilfields. On the Russian side, of course, Iraq is not just a longstanding strategic hub for its operations in the Middle East, as also analysed in depth in in my new book on the global oil markets, but now as well Moscow also needs all of the US$-revenue streams it can get, and banking its Iraq oil receipts through China if the need arises will not be a problem for it.
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By Simon Watkins for Oilprice.com
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