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Russian oil giant, Lukoil, has filed a preliminary development proposal with Iraq’s Oil Ministry for the Eridu oil field, according to a statement from the Ministry last week. Located in Block 10, around 120 kilometers west of Basra in southern Iraq, the preliminary consensus opinion was that the field contains between 7 and 10 billion barrels of crude oil reserves. This alone would have made it the biggest oil discovery in Iraq in at least 20 years, but subsequent Russian oil industry estimates point to reserves of up to 12 billion barrels of oil. Its remuneration fee of US$5.99 per barrel is among the highest of all Iraq’s awards under its technical service contract model, and likely peak production is estimated at between 250,000 and 300,000 barrels per day (bpd). Lukoil was awarded a 60 percent share in the Block in the fourth round of licensing in 2012, along with a 40 percent stake being given to Japan’s Inpex. Given these apparently enticing figures, why has Lukoil waited so long to move ahead with a serious development program, and why is it doing so now?
The key reason why Lukoil has been slow to move on developing Eridu is that the giant field has been caught up in the Russian oil company’s maneuverings to get a better deal for the nearby field of West Qurna 2, senior oil industry sources close to Iraq’s Oil Ministry exclusively told OilPrice.com. “Towards the middle of 2017, Lukoil felt that it had done a good job on developing West Qurna 2 in that [the field] had been steadily producing around 400,000 barrels per day [about nine percent of Iraq’s total oil production] - for some time,” said one of the sources. “But Lukoil, which had [and still has] a 75 percent stake in the field and had already spent at least US$8 billion on developing it, was only being compensated US$1.15 per barrel recovered,” he added. 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.
“So, when at the end of July 2017, the [Iraqi] Oil Ministry told Lukoil that it needed to step up production to the high levels targeted in the later phases, Russia made it clear that in order to be able to do this there would need to be an adjustment of the per-barrel remuneration terms,” the source added. Specifically, the development plan had been 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 had been slightly adjusted down from the initial 1.2 million bpd, to 1.13 million bpd. “Russia itself knew perfectly well that Lukoil could drill to the Phase 3 level of 650,000 bpd already, as it had been running test excavations at that level on and off for weeks,” the source told OilPrice.com. “The Iraq Oil Ministry then found this out in August-September 2017, and warned Lukoil that it needed to start drilling to capacity but Russia again made clear that it wanted better overall compensation for Lukoil and the Ministry broadly agreed,” one of the sources said.
Indeed, according to multiple sources in Iraq’s oil sector, Lukoil was assured that the Oil Ministry would expeditiously pay the US$6 billion that it owed the company in unpaid remuneration for oil recovery and for part of the capital outlay to that point, and that a higher compensation rate per barrel would be looked into as soon as was feasible. In addition, the Oil Ministry said that it would allow Lukoil 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 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. However, more problems began for Russia in general in its dealings with Iraq, with the first one being that the US$6 billion that Lukoil was owed by the Ministry was subject to ongoing delays. That was the genesis of the on-again, off-again participation of Lukoil in West Qurna 2 that has been evidenced again throughout this year.
So, why has Lukoil now decided to move forward on its development of Eridu? A significant part of this is that after the latest round of threats from Lukoil about withdrawing from West Qurna 2 and counter-threats from the Oil Ministry that it was free to do so but before it did it would have to pay the Ministry billions of dollars in compensation for breaking the contract, an understanding between the two sides appears to have been reached. The other part of this turnaround is that the U.S. has been staging a comeback in Iraq in recent weeks in particular, evidenced in a series of deals for major U.S. firms in Iraq’s gas and oil sectors that previously would have gone to Russian or Chinese companies. One of these that has particularly caught the attention of Moscow is the news that newly resuscitated Iraq National Oil Company (INOC) has been authorized by the government in Baghdad to directly negotiate with U.S. oil giant, Chevron, for it to develop the long-delayed Nasiriyah oil field, as fully analyzed by OilPrice.com just over a week ago.
“This is not the same as the engineering or services deals that have been announced for American companies in the past few weeks, although they are significant – this is a major exploration and development deal for a major oil field in the heart of Iraq, and if Chevron gets it, then that might be a turning point for the U.S.’s efforts to get Iraq really back on side,” underlined one of the Iraq oil sources last week. Indeed, it is extremely apposite to note in this context that not only does Nassiriya have 4.36 billion barrels of crude oil reserves in place but also it is also located in the southern DhiQar province of Iraq. Both Russia and China have significant interests in building out their influence in this oil hub area of Iraq and pushing the U.S. further out, as analyzed in-depth in my new book on the global oil markets. Perhaps the most notable recent example of this for China was the announcement that Iraq awarded a Chinese company a contract to build a civilian airport to replace the military base in the capital of the DhiQar governorate. This project, which China is due to complete the airport by 2024, will include the construction of multiple cargo buildings and roads linking the airport to the city’s town center and separately to other key oil areas in southern Iraq. Block 10, in which the Eridu oil field is located, lies in Muthanna and DhiQar, approximately 10 km southwest of Nassiriya city.
By Simon Watkins for Oilprice.com
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