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Emerging Iraq - Opportunities and Risks for the Oil and Gas Industry

  • Iraq
  • Energy and infrastructure

15-02-2012

A new chapter

There are fresh signs that 2012 will witness the beginning of a new chapter in Iraq’s socio-economic history, cementing its position as a key market for international investment, particularly in the energy and natural resources sector. With the fifth largest population in the Middle East and with the third or fourth largest oil and gas reserves in the world, Iraq is undeniably under the spotlight and will be watched by international investors who may be exploring opportunities in new and lucrative markets.

Following over a decade of sanctions and conflicts, Iraq is now experiencing economic growth and is in a strong position to attract international investment. On a macro level, the changing demographic and increasing population necessitates the development of hospitals, schools, social housing and infrastructure. Large-scale and long-term projects, likely to involve foreign investment, are essential for changes of this nature. As well as creating jobs, these projects are likely to stimulate the economy which will in turn provide further investment opportunities in Iraq.

There are clear signs from Iraq that it is a nation inviting economic progress. In 2006, Iraq’s parliament passed a foreign investment law designed to streamline regulations and make it easier for foreign investments and foreigners to own land. As part of that process, the National Investment Commission was formed which it is intended will offer a one stop shop for foreign investors looking to make substantial investments in Iraq.

Oil and Gas

Iraq’s peak oil production was in 1979. Since this time production has fallen, primarily due to instability in the region, rather than due to the depletion of petroleum reserves. The absence of adequate oil and gas infrastructure has been and continues to be an issue, reflected in the fact that 60% of the gas it currently produces is flared or reinjected as it cannot be currently utilised on site or exported.
Iraq is now investing heavily in an effort to build its oil and gas industry. The Ministry of Oil in Iraq launched three licensing rounds in the period 2008 to 2010 and is in the process of the Fourth Licensing Round. During the same period the Kurdistan Regional Government (KRG) has also granted oil and gas concessions, on an ad-hoc negotiated basis rather than through licensing rounds, in the semi-autonomous territory in the north of Iraq.

Investment has been particularly apparent in Kurdistan, which Tony Hayward (CEO of Vallares, and former CEO of BP) recently described as one of the last great oil and gas frontiers. Similar investment is now happening in the oil and gas fields near the southern city of Basrah. Recently the Iraq Oil Ministry, Royal Dutch Shell and Mitsubishi signed a $17 billion dollar deal to help re-build existing and develop new infrastructure in order to process natural gas. The deal involves the formation of a joint venture company, to be called the Basrah Gas Company, which will process gas for domestic consumption as well as gas export projects. Of course, this type of work is itself not without its difficulties, with contractors recently reported as being involved in a $50 million payment dispute with the Iraqi government over the upgrading and modernizing of an oil field in South Iraq for which it is reported they have not received payment over a two year period.

Difficulties and delays

There are a number of political areas of disagreement relating to the licensing of oil and gas in both Iraq and Kurdistan. These are too involved to be discussed in detail here but the following examples give an indication of the difficult and often intractable nature of present controversies:

  • The Iraq Constitution envisages that detailed enabling legislation
    will be passed in relation to the licensing of oil and gas rights – a new Petroleum Law. This Petroleum Law, a draft of which was proposed as early as 2007, has not yet been agreed as a battle continues between the Cabinet (which wants centralized control) and the Parliament, including supporters of the KRG (which prefer de-centralized control).
  • The extent to which the laws in force prior to the passing of the Iraq Constitution in 2005 remain in force is disputed. Based on pre-existing regulations the view of Parliament is that all awards of oil and gas concessions should be approved by the Parliament. To date this has not occurred in respect of agreements entered into by the Ministry of Oil nor by agreements entered into by the KRG.
  • The Iraq Federal Government and the KRG remain in
    fundamental disagreement over the scope of their respective powers and the impact on these powers of the Iraq Constitution. The Iraq Federal Government takes the view that it retains the sole right to negotiate and sign oil and licenses. In contrast, the KRG’s position is that it has the right to negotiate and sign oil and gas licences in the Kurdistan region. Two parallel systems co-exist. As a consequence the Ministry of Oil has declared the KRG’s regional Petroleum Law to be illegal and (with limited exception) refuses to deal with any companies which have dealt with the KRG, as most recently illustrated by its very public disagreement with ExxonMobil.
  • Historically some of Iraq’s oilfields lie in disputed border areas, including Majnoon, Abu Gharab, the Badra field, and Siba (along the border with Iran). Iraq also has fields that some argue lie partly under Kuwait and there is a dispute with the KRG relating to how much of the Kirkuk oilfield lies within Kurdistan.

The Fourth Licensing Round

The developments which are being offered pursuant to the Fourth Licensing Round are in large part undeveloped fields – some reports have stated that none of the blocks contain previously discovered oil and gas fields. This is in contrast to earlier licensing rounds where a number of the fields had been partly developed and required rehabilitation, so there was relatively little exploration risk. This made the earlier rounds, in the opinion of the Ministry of Oil, more suited to licensing through technical service contracts with remuneration for the oil and gas contractors being based on a dollar per barrel recovery. Given that the Fourth Licensing Round consists largely of exploration prospects, the expectation of the pre-qualified oil companies was clearly that the appropriate legal contract should follow the form of the potentially higher risk and reward sharing production sharing agreements (similar to those employed by the KRG) rather than technical service contracts. This is in itself interesting as one of the charges that has been levelled at the production sharing agreements being offered by the KRG is that the offering of a production sharing agreement went beyond the remit of the Iraq Constitution!

It may be this expectation that has resulted in the Fourth Licensing Round being delayed a number of times, most recently on 30 January 2012. Official reports have suggested that the auctions have been delayed to give the oil companies more time to consider and evaluate a revised contract model, other reports suggest the oil companies are pressing for better terms than those currently on offer.

Risks

Despite the allure of Iraq as an emerging market, there are still risks, stemming mainly from years of unrest. There are continuing political risks as evidenced by the ructions in the Iraqi government shortly after the US withdrawal, as well as the Arab Spring which has had repercussions for most countries in the region. Security remains an issue which significantly adds to the cost of doing business in Iraq. Other problematic issues include bureaucracy and an uncertain regulatory and legal framework. A particular concern for many Western businesses is the fact that Iraq is not yet a full signatory to the New York Convention, which is an international convention which provides for the enforcement of foreign arbitral awards. This means that foreign investors, who may wish to avoid the vagaries of the local Courts by providing for disputes to be referred to foreign arbitration, are likely to encounter difficulties in enforcing any subsequent arbitral awards in Iraq.

Doing business in Iraq

Whilst these issues demonstrate the risks of doing business in Iraq, the country is moving in the right direction and there are potential opportunities for international investors prepared to take the plunge.

Upcoming Events: doing business in Iraq

International investors are likely to be concerned with both the practicalities and the legalities of doing business in Iraq.

Eversheds and Sanad Law Group will be hosting a number of events on doing business in Iraq, taking place in Abu Dhabi, Dubai, Riyadh and London. If you would like to join us to discuss the opportunities, please click here to register your interest.


Sanad Law Group and Eversheds

Eversheds is currently one of only a few international law firms with an office on the ground in Baghdad, through their relationship with Sanad Law Group. We are uniquely positioned to offer local advice in the areas of foreign investment, mergers and acquisitions, commercial transactional work and general corporate matters. This service comes with all the advantages of forming part of a large international law firm complete with its multi-jurisdictional oil and gas team. We are proud to have a very successful record in completing and concluding a number of transactions on the ground in extremely difficult and challenging times.

To discuss the content of this article or learn more about Eversheds in the Middle East, please contact:

Salam Zuhair
Senior Associate
Tel: +96 47 90 18 62 263
salamzuhair@eversheds.com 

Jason Lovell
Partner
Tel: 0207 919 4554
Intl: +44 20 7919 4554
jasonlovell@eversheds.com

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