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Simon Watkins

Simon Watkins

Simon Watkins is a former senior FX trader and salesman, financial journalist, and best-selling author. He was Head of Forex Institutional Sales and Trading for…

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Big Oil’s Exodus From Iraq Is Great News For Russia

  • An exodus of Western oil companies from Iraq has left Russia in a very advantageous position when it comes to negotiating its production deals there
  • Russia and Iraq have been tussling over production and profits at the West Qurna 2 oil field for years, and now Russia feels it has the opportunity to improve its position there
  • Russia has always put geopolitical influence ahead of economic returns in Iraq, but now the opportunity has arisen for it to secure both

Given the mass exodus of major Western oil companies from Iraq in recent months, and no sign of this reversing any time soon, Russia and China are in an even better position to advance their own interests in the oil- and gas-rich country. The opportunity has in no way been diminished by Iraq’s elections in the last couple of weeks that left anti-U.S. firebrand cleric, Moqtada al-Sadr, in place as de facto leader, alongside his ‘Sairoon’ (‘Marching Forward’) coalition. This has not been lost on Lukoil in its approach to the supergiant West Qurna 2 oil field, located around 65 kilometers northwest of the southern port of Basra and with roughly 14 billion barrels of reserves in place. Like the first sparrow of spring, threats from Lukoil to Iraq’s Oil Ministry over West Qurna 2 – and then the other way around – are a regular and much-anticipated feature of the oil year for seasoned market watchers and this year has been no different. First was Lukoil’s threat to sell part or all of its stake in the field unless its terms are improved, whereupon the Oil Ministry did nothing for a while. Then came the Oil Ministry calling Lukoil’s bluff and saying that it would leave if it wanted, provided that a suitable buyer was found, whereupon Lukoil was silent for a while. And now the familiar fork in the road has been reached in which the Russian firm has said that if it is to stay then it wants an improvement in the deal it has at West Qurna 2.

Both sides have their reasons for wanting a change in how the field operates and the key event that shaped all of the subsequent tactical posturing on both sides occurred in the lead up to August 2017 when Lukoil announced that it was to dramatically increase output at West Qurna 2. At that time, the West Qurna 2 field had been steadily producing around 400,000 barrels per day (bpd) - about nine percent of Iraq’s total oil production - for some considerable time under the operation of Lukoil, which held a 75 percent stake in the field (the remainder being held by Iraq’s state-run North Oil Company). The development plan was to increase crude oil production to 480,000 bpd in Phase 2 and then to add another 650,000 bpd to the total in Phase 3, which would focus on the deeper Yamama formation. The ultimate 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).

The problem, even back then, though, from Lukoil’s perspective was that it believed the level of remuneration it was receiving per barrel drilled was too low. By that point, the Russian company had already spent at least US$8 billion on developing the field, according to its spokesmen, but was only being compensated US$1.15 per barrel of oil recovered. This was the lowest rate being paid to any IOC in Iraq at that time and was dwarfed by the US$5.50 per barrel being paid to GazpromNeft in its development of the Badra oil field. 

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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, it was also aware that even with Iraq’s world-low lifting cost per barrel of oil (along with Iran and Saudi Arabia) of US$1-2 per barrel without capital expenditure included (and US$4-6 per barrel including capital expenditure) its profit per barrel based on recovery compensation alone 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. 

This said, back in August 2017, Lukoil was assured that the Oil Ministry would pay the US$6 billion that it owed the company expeditiously and that a higher compensation rate per barrel would be looked into as soon as was feasible. In addition, the Oil Ministry would 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 cost per year to Lukoil anyhow. The Russian company, for its part, would invest at least US$1.5 billion in the oil field in the following 12 months with a view to raising production from the 400,000 bpd level to 1.13 million bpd, it was agreed.

More problems from the Russians’ perspective began almost as soon as the new agreement had been made, with delays in the re-payment of the US$6 billion owed to it by the Oil Ministry and in the less rigorous application of the development investment program as well. 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 full volume that it knew it could at that point, as it believed – with some justification – that it was not going to be paid for any extra efforts that it made. 

From the Oil Ministry’s perspective, though, its own view of Lukoil’s activities markedly changed in November 2017 – just three months after the agreement of August – when it found out that not only had Lukoil hit 650,000 bpd production over various extended periods in the previous two months but that it could sustain production of at least 635,000 bpd for the foreseeable future but was choosing not to do so for the economic reasons outlined above. “At that point, the Oil Ministry agreed to extend the timeframe of the contract to 25-30 years, effectively reducing the daily cost of capital per barrel of oil recovered and to allow Lukoil the option of increasing its stake from the present 75 percent to 80 percent,” a source who works closely with Iraq’s Oil Ministry exclusively told OilPrice.com. “In return, Lukoil agreed to invest an extra US$1.4 billion 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.

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Once again, though, another year or so went by with Iraq’s Oil Ministry unwilling and/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 Putin’s 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 real leader of Iraq – 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,” the Iraq source told OilPrice.com. 

What has changed from the basic stand-off position was the recent withdrawal of several IOCs from Iraq, as highlighted by OilPrice.com, and the lack of change in real leadership in Iraq as a result of the recent elections. “Some of Lukoil’s senior management think that the time is right once again to try to force the Oil Ministry into making good on its previous promises to increase its per barrel compensation on the [West Qurna 2] field,” said the Iraq source. Even more specifically, according to a senior oil and gas industry source in Moscow spoken to by OilPrice.com: “Lukoil has made it clear that it is not making the 18.5 percent revenue per year from West Qurna [2] that it had expected and is only making around 10 percent per year and that this is not enough and the Iraqis have to make it better or it [Lukoil] will reduce its presence in the field.” 


By Simon Watkins for Oilprice.com

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