August 28, 2008 / 5:32 PM / 11 years ago

China has head start over West for Iraq oil

DUBAI (Reuters) - China crossed the line first in the race for big oil contracts in post-Saddam Iraq and has gained a head start over Western oil majors in the competition for future energy deals.

A view of Baiji oil refinery in Baiji, 180 km (112 miles) north of Baghdad, June 30, 2008. REUTERS/Sabah al-Bazee

China’s biggest oil company, state-run CNPC, agreed a $3 billion service contract with Iraq on Wednesday.

The deal could set a precedent for terms that fall far short of the lucrative contracts the oil majors had hoped for as they jostled for access to the world’s third largest oil reserves.

Starved of investment since the Gulf War of 1990-1991 and the subsequent U.S.-led invasion of 2003 that removed former President Saddam Hussein, Iraq holds some of the world’s last large, cheap, untapped oil reservoirs.

“The biggest significance of this deal is that CNPC will benefit as the first international oil company to be developing one of the giant discovered oil fields in Iraq in the new era,” said Alex Munton, analyst at global consultancy Wood Mackenzie.

“They will be the first with people on the ground and the first to develop a working relationship with Iraq’s oil ministry.”

Now CNPC and China’s other state-supported oil firms are likely to face off with Western oil companies in a bid round for other long-term contracts to enhance giant fields already in production. Iraq aims to sign those deals in mid-2009.

Baghdad needs billions of dollars of investment to overhaul and expand its energy sector after years of sanctions and war.

Energy-hungry China has already provided tough competition for Western oil majors in Africa. Chinese state oil companies can take on more risk than big oil firms as securing future energy supplies is a matter of strategy rather than profit.

“Given traditional markets have been dominated by well-established international oil companies, new entrants such as CNPC have to focus on new markets,” said Gong Jinshuang, a researcher with a think tank run by CNPC.

The revised deal could prove to be on worse terms than the original signed with Saddam but that would be a pragmatic choice, he added.

TOUGH TERMS

CNPC faced no competition for Adhab, a renegotiated contract first signed under Saddam in 1997. Full details have yet to emerge, but it is know that the new service contract is for a set fee, a change from the initial production sharing agreement

(PSA).

Production sharing contracts were common in the 1980s and 1990s in the days before oil prices shot up, when the oil majors held the whip hand over producer countries who competed with each other for investor capital by offering generous terms.

“This deal is a ‘game changer’ in my view,” said Jason Kenny, oil analyst at ING in Edinburgh. “The majors are going to have to seriously rethink their returns criteria and resource ownership flexibility.”

Oil majors prefer PSAs as they get a share of output, providing an incentive to maximize production and allowing them a share of revenues from any oil price rise.

But governments of oil producers worldwide have moved to take a bigger slice of record oil income, PSAs have become rarer and set-fee contracts more prevalent.

Baghdad has yet to say publicly what contract model it will adopt for fields already discovered but not yet producing such as Adhab. But the CNPC deal may have set a tough standard.

“This could set a precedent for Iraq,” said Samuel Ciszuk, Middle East energy analyst for Global Insight. “Looking forward to future bidding rounds, Iraq could cease to be that opportunity that people had hoped for and become a different play altogether.”

ISOLATED CASE?

Others said the Adhab deal may be an exception, not a template.

The deal is to develop a billion-barrel field to feed an oil-fired power plant with capacity of 1,320 megawatts to be built by another Chinese firm, Wood Mackenzie’s Munton said.

Iraq is short of power and Oil Minister Hussain al-Shahristani has come under political pressure to do more to meet domestic electricity demand.

“It’s difficult to see this having a wider implication for the majors and other contracts,” said Munton. “This is a self-contained project, and is different in many ways to the large-scale projects to boost oil capacity elsewhere in Iraq.”

Adhab could bode well for other projects linked to power generation, such as Royal Dutch Shell’s scheme to capture associated gas that is currently flared at oilfields in southern Iraq.

Oil majors will hope that Shahristani’s signing of Iraq’s first long-term oil contract might prove good news rather than bad.

“If anything this is a sign that Iraq is serious about these long-term contracts and that Shahristani can get them signed,” said one oil company executive whose company is in the hunt for Iraq deals. “This will focus big oil companies even more on the upcoming bid round.”

Additional reporting by Jim Bai from Beijing, editing by Anthony Barker

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