Thirty contestants, only one winner in the Iraqi oil licence gameshow

There's a lot of oil to be pumped and the government is desperate for the cash, so why did the major players walk away? David Strahan reports

The auction of Iraqi oil production licences last week was truly historic – not least because it was the first such exercise ever to be broadcast live on TV.

More than 30 companies were expected to compete for eight contracts, all in front of the cameras. In effect, the Iraqis had set up a high-stakes reality TV show, with Hussain al-Shahristani, Iraq's minister of oil, in the role of Sir Alan Sugar, and company executives as the desperate wannabes. Some bidders feared it would degenerate into an unseemly scramble, and with good reason.

The prize was far more valuable than an apprenticeship. Iraq not only has the world's third-biggest official reserves at 115 billion barrels, but its giant fields are uniquely underexploited, following three decades of war, sanctions and insurgency. "Iraq is the last big, low-cost play in conventional oil anywhere in the world," says Bill Farren-Price, a Middle East expert and energy director at Medley Global Advisors. The licence round was meant to raise Iraqi oil production from 2.4 million barrels a day to 4 million, and with so much to fight over, the Iraqis seem to have assumed the working title for their gameshow was "I'm an Oil Company, Get Me into Here!" But that's not quite how it turned out.

One by one, the companies dropped sealed bids for each of the fields into a box, and then the government announced what it was prepared to pay. At that moment, "there was a collective dropping of jaws around the table". Just one contract was awarded and seven failed, as the bidding exposed a massive gulf between the expectations of the companies and the government.

The contracts were designed to increase the output of some of Iraq's biggest fields by rewarding the successful bidder for every barrel produced above a set target. But the companies wanted between two and 10 times more than the government was prepared to pay. To work on the Bai Hassan oil field, for instance, ConocoPhillips demanded $26.7 a barrel, whereas the government offered $4 – compared to a global market price of around $70. After failing to reach agreement, almost 30 oil companies, including Exxon, Shell, Total, and China's CNOOC and Sinopec, simply walked away. The industry was left to work out why Iraq played such hardball.

One reason may be that Iraq was as desperate as it assumed the companies were. The government needs tens of billions of dollars for reconstruction, yet its income, which is 95 per cent dependent on oil revenues, has shrunk in line with the plunging oil price – down from $147 a barrel last July. This put enormous pressure on Mr Shahristani to squeeze the oil companies as hard as possible. If so, the tactic backfired spectacularly.

The solitary contract was won by BP and China's CNPC to produce oil at the giant Rumaila field near the Kuwaiti border which provides almost half Iraq's current output, although some argue they may come to regret it. The consortium initially tendered $3.99 a barrel, but then halved its bid to meet Iraq's maximum offer. "I am surprised they were beaten down," says Farren-Price. "It looks pretty marginal at $2."

BP has promised to almost triple production at Rumaila from 1 million barrels a day to 2.85 million, but the consortium may struggle to deliver, not least because of violence. While security has improved, the auction was on the same day US troops pulled back from Iraqi cities and a car bomb killed 27 people. Staff and infrastructure managed by foreign oil companies will almost certainly be targets for remaining insurgents and al-Qa'ida.

More fundamentally, the oil reservoirs of Rumaila may have been damaged by the effect of international sanctions imposed after the Iraqi invasion of Kuwait in 1990 until 2003. One report concluded: "Poor oilfield husbandry has already resulted in an irreversible reduction in the ultimate recovery of oil from individual reservoirs. Crisis management will continue to exacerbate the permanent loss of huge reserves of oil."

But BP is unlikely to have bought a pup, since the company was part of the group that discovered Rumaila in 1953, and has been analysing its geology under an agreement with Iraq since 2005. Chris Skrebowski, consulting editor of Petroleum Review, takes a more positive view: "Even if the reservoirs have been damaged, this is a 15 billion-barrel field. And BP has earned good will with the government for future licence rounds, and stolen a march on the competition."

None of the companies that walked away admitted regret at not folding to Iraqi pressure. The rejected bids have been referred to the cabinet for reconsideration, there is another licence round to come, and Iraq desperately needs to attract outside capital and expertise to upgrade its crumbling oil infrastructure. In the circumstances, the industry clearly feels it can play hardball, too. "The message from the industry is they weren't prepared to treat these early fields as loss leaders for potential access down the line," says one source.

David Strahan is the author of The Last Oil Shock: A Survival Guide to the Imminent Extinction of Petroleum Man, published by John Murray Ltd

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