Iraq’s first oil auction in decades was a stunning failure, exposing the depth of the country’s political morass. Looking ahead, Iraq’s Kurdish faction could take advantage of the situation to attract more foreign investment in the north, which will only end up exacerbating sectarian tensions in the country. Meanwhile, for those foreign energy firms that are losing patience with Iraq, potentially lucrative investment opportunities are lurking westward in North Africa.

Analysis

On July 2, after reviewing fresh bids from the world’s energy majors, Iraq slammed the door shut to any further offers from foreign energy firms to develop its existing oil fields. Iraqi government spokesman Ali al-Dabbagh said the government rejected the foreign companies because they could not match the prices offered by the Oil Ministry. Instead, the unclaimed fields will go to Iraq’s state-owned firms for additional development.

Iraq held its first energy auction June 30 for foreign investors after nearly four decades in an attempt to raise the country’s oil output from a stagnant 2.4 million barrels per day (bpd) by an additional 1.5 million bpd within four to five years. This would have been Iraq’s first big step toward realizing its enormous oil potential — the country has 115 billion barrels in proven oil reserves and an estimated 45 billion to 100 billion additional barrels of recoverable oil in unexplored territory, making it a potential rival to world energy giant Saudi Arabia.

Iraqi Oil Minister Hussein Shahristani was already up against a wall trying to convince his political rivals in Parliament and the Shiite southern oil unions that his plan to bring in foreign investment to develop existing fields was the best way to get Iraq back on its feet. His biggest selling point to the Iraqi naysayers was that he would only offer 20-year fixed-service-fee contracts that would deny any foreign firms ownership in the fields and require them to partner up with state-owned firms to manage the fields. That way, Shahristani could argue that he is upholding the political integrity of the state and insulating Iraq from foreign exploitation.

But Shahristani’s hopes were also quickly dashed when all but a couple of the 32 registered energy firms refused to accept the Oil Ministry’s per-barrel pricing terms for the six existing oil fields and two untapped natural gas fields up for grabs. Only one deal was struck — a BP-China National Petroleum Corporation consortium that agreed to the Oil Ministry’s $2-per-barrel rate to work in the massive Rumaila oil field in the south. The rest, according to the Iraqi government, will be handled by state-owned firms.

Shahristani’s timetable to increase Iraq’s oil production levels to nearly 4 million barrels per day within four to five years is now sure to be thrown off. Iraq’s state oil companies are by no means incompetent. Under Saddam Hussein they developed Iraq’s oil fields under far worse conditions (war and sanctions). But putting most of Iraq’s existing oil production into Iraqi hands will take a great deal more time and result in a lower recovery rate since they lack the technology, training and tools of the foreign firms.

This outlook is unlikely to change as long as Iraq remains snarled in factional politics. Until Iraq’s Shia, Sunnis and Kurds work out a functional power-sharing agreement that resolves such politically contentious items as Kirkuk and the reintegration of Sunnis into the Shiite-dominated government, the country’s constitution will not be respected. If and when that happens, Iraq will have a decent shot at coming up with an actual hydrocarbons law. And only then will the country be able to attract meaningful foreign investment to boost its energy sector.

In the shorter term, Shahristani may have a brief reprieve from the oil unions and his political rivals because he can argue that he stood for Iraq’s national rights in sticking to his pricing schemes and not bending to the $4-per-barrel rates of the foreign firms. But the energy battle in Iraq runs much deeper than a few business contracts. The intricate web of Kurd-Arab, intra-Shiite, intra-Sunni and Sunni-Shiite struggles are bound to intensify in the run-up to January 2010 parliamentary elections. And with U.S. troops reducing their presence in the country so they can focus more on Afghanistan, Iraq’s warring factions will no longer have a strong American buffer between them to keep the ethno-sectarian pot from boiling over. Iraq is thus hamstrung in trying to realize its enormous economic potential. The country can certainly survive on current or slightly higher oil output, but it will not thrive as a major player in the energy market for the foreseeable future.

Disillusioned by Iraq’s latest licensing round, foreign energy firms — from ConocoPhillips to ExxonMobil to Chevron — are now going to have to reconsider where to invest their money. There is still the potential for future bidding rounds in Iraq, in which the Oil Ministry could temper its pricing demands, but the political complications are only likely to increase in the lead-up to parliamentary elections in early 2010. Though major energy firms have been extremely wary about investing in smaller oil fields in Iraq’s northern Kurdish region for fear of being blacklisted by the central government in Baghdad, the investment climate could tilt more toward the Kurds in the months ahead.

The Chinese oil firm Sinopec has already announced its intent to acquire Swiss-based Addax Petroleum, which, along with Turkey’s Genel Energy (recently bought out by Heritage Oil), has recently begun producing oil for export at the Taq Taq field in Iraqi Kurdistan. Unlike the Oil Ministry’s unfavorable pricing terms for foreign companies, the Kurds prefer to offer energy firms more lucrative production-sharing agreements that allow them partial ownership of the fields. After all, the more foreign buy-in in Kurdish oil, the more insurance the Kurds have against their array of rivals, particularly those in the central government who consider deals between the Kurdistan Regional Government (KRG) and foreign firms illegal and part of an underhanded scheme to expand Kurdish autonomy at the expense of Iraq’s central authority. The KRG sees an opportunity ahead to attract more foreign interest to its oil-rich region, where some 40,000 bpd are already being exported from “illegal” projects through Turkey, the product of the only new fields tapped in Iraq in decades. But the more foreign investment the Kurds manage to attract to Iraqi Kurdistan while the Shiite south remains politically gridlocked, the more tensions will escalate between Iraq’s Kurds and Arabs and the less able Iraq will be to produce a hydrocarbons law.

Foreign firms may then have to look further west to North Africa. On the same day that Iraq held its televised oil auction, Algeria announced a new licensing round for 25 blocks of “high-potential petroleum resources” for companies with oil sands technology. Unlike Iraq, Algeria already has much of the infrastructure in place and the political cohesion to develop its oil and natural gas fields. Algeria’s last bidding round in mid-December 2008 was a bit of a dud — foreign firms didn’t show much interest for the limited amount of acreage that was offered for the fields. Moreover, the financial crisis was hitting hard at the time and many firms were feeling cash-strapped. Now, Algeria is looking for fresh bids from interested companies that have already chosen these blocks for potential bidding come December 2009.

A more direct competitor to Iraq is Libya. Now free from the weight of sanctions, Libya poses a tantalizing investment opportunity for energy firms looking for wide-acreage greenfield projects to explore and develop and to develop infrastructure from scratch. Libya has 41.5 billion barrels of proven oil reserves — the largest proven reserves in Africa — with only 25 percent of the country under exploration agreements with oil firms. With unpredictable Libyan leader Moammar Gadhafi at the helm, foreign investors have reason to be anxious from time to time. In January, Gadhafi alarmed investors when he hinted at nationalizing the holdings of foreign energy firms to shield his country from the financial crisis. The statement appears to have been a bluff, but uncertainty remains over how Libya intends to formalize a constitution that aims to downsize the country’s lagging public sector and redistribute oil revenues to the public.

The Gadhafi wild card is part of any energy deal made in Libya, but the country at least has the internal cohesion to give Iraq a serious run for its money in the months and years ahead.

This article is published at Lebanonwire by agreement with www.stratfor.com, the world's leading private intelligence provider.

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