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 km from Basra and with roughly 14 billion barrels of reserves in place.
Like the 1st 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.
1st 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 % 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 $8 billion on developing the field, according to its spokesmen, but was only being compensated $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 $5.50 per barrel being paid to GazpromNeft in its development of the Badra oil field.
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 $1-2 per barrel without capital expenditure included (and $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 $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 $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 $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 $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 3 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 2 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.
A source who works closely with Iraq’s Oil Ministry exclusively told OilPrice.com said:
- 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 % to 80 %
- In return, Lukoil agreed to invest an extra $1.4 billion in the short-term and a further $3.6 billion down the line, depending on variables including OPEC quotas and the continued development of export capacity in the south
This prompted a visit in February 2019 to Iraq’s then-Prime Minister, Adil Abd Al-Mahdi, of Russian President V.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.
The Iraq source told OilPrice:
- 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 said:
- 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
- Lukoil has made it clear that it is not making the 18.5 & revenue per year from West Qurna  that it had expected and is only making around 10 % 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
Author: Simon Watkins