The US-led attack on Iraq will have far-reaching repercussions for the global oil and gas industry for years to come, well beyond the near-term ramifications of the conflict.
Scenarios abound, most of them predicated on the assumption that the regime of Iraqi President Saddam Hussein will be toppled in the conflict. Because the timing of that presumed eventuality—and any collateral consequences—was still uncertain at presstime, most of these scenarios will be adjusted in the weeks to come. But they all hinge on the same basic outlook: There will be a myriad of opportunities for investment in a post-Saddam Iraqi oil and gas sector.
These investment opportunities break out as near-term and long-term scenarios. The former envisions a speedy resumption of oil exports to garner revenue for humanitarian relief and other pressing needs in the war-torn country. The latter considers the prospects for future opportunities to reconstruct, rehabilitate, and expand a war-damaged and otherwise dilapidated petroleum sector. Most tantalizing for prospective investors is the opportunity to exploit all underdeveloped and underexplored oil resource that some speculate may rival Saudi Arabia's (OGJ, Mar. 24, 2003, p. 42).
The oil market's focus on these prospects—namely Iraq's future ability to ramp up oil production—has contributed to what could be an unwarranted complacency about near-term oil supplies. Indeed, so strong is this presumption that oil futures prices began to plummet immediately after US President George W. Bush issued his 48 hr ultimatum to Saddam Hussein to disarm immediately or face the consequences. While some members of the Organization of Petroleum Exporting Countries, especially Saudi Arabia, have worked strenuously to boost oil output to build a big enough supply cushion to offset an Iraqi outage, others are grappling with fresh outages or continuing uncertainty over their oil exports (see Market Movement, p. 5). The Saudis' efforts in particular have led both the US and the International Energy Agency to relent on plans to release strategic stocks. Those efforts may have been too successful: Already, OPEC is considering calling an emergency meeting to decide on output cuts if oil prices fall too far (see Market Hotline, p. 68).
All of this could prove to be a rush to judgment. While the opening days of the war seemed to go well for the US, UK, and other coalition forces, later setbacks and mounting casualties hinted darkly of the possibility for a protracted conflict and what that might entail. In addition, angry protests against the US-led attack on Iraq proliferated worldwide, posing particular concern in heavily Islamic countries that are also key oil exporters.
And most troubling is the continuing prospect of sabotage targeting oil facilities and shipping (see related story, p. 22). The widely feared torching of Iraqi oil wells—as Saddam Hussein had ordered throughout Kuwait's oil fields during Operation Desert Storm in 1991—at first was limited to a handful in southern Iraq. But the situation was far from completely secure last week, with the northern oil fields still threatened and the possibility of sabotage to Persian Gulf export facilities still lingering at presstime.
If the US-led campaign against the regime of Saddam Hussein—and especially the currently murky plans for postwar Iraq—prove successful, it will redraw the map of the Middle East. Ultimately, the region—the volatile center of gravity for the world's oil markets for a generation—could undergo a transformation that ushers in less strife and more reforms that could lead to even greater investment opportunities. That is bound to have a moderating effect on future oil price hikes and volatility in general.
But if things go badly with the coalition's military campaign or with the repercussions that ensue, that could mean higher oil prices and volatility persisting, perhaps for some years. The last time that happened, the result was global economic recession, squashed demand, and a scramble to develop alternative oil supplies, alternate energy sources, and stringent conservation measures. Only a consequent squeeze on OPEC market share that eventually resulted in collapsed oil prices deflated the move to alternatives.
This time around, the oil industry might not be so "lucky," especially with sustained high oil prices coinciding with mounting calls for the "decarbonization" of energy over climate-change fears. This time, the switch to costly alternatives might be permanent.
Post-conflict Iraq
Analysts say politics and spending will control how fast the oil sector recovers in a post-conflict Iraq.
A White House proposal to Congress calls for $74.7 billion, mainly to fund the initial cost of the war but also including some humanitarian aid for Iraqi civilians and foreign aid to Israel and Turkey.
Congressional sources said the funding assumes the conflict will last about 30 days, although the White House refuses to speculate on how long the war will last.
In the longer term, much of the country's reconstruction is expected to come from oil revenue, although the mechanism for that remains uncertain.
Transition government
The White House also expects the US would run a new transition government through an interim civilian authority made up mainly of retired US diplomats under the direct control of the military. Under the current blueprint, indigenous Iraqis have a limited role in running the country during the first few months of occupation; the United Nations' role remains unclear.
US officials won't commit to how long they want a US-run government to remain in place; Washington has indicated it may consider a larger UN role within 6 months.
How the White House ultimately decides to run the country has obvious implications for future industry investment.
Deutsche Bank AG analysts Mar. 25 predicted two separate phases: reinvesting for reliability, followed by "greenfield" development.
"We expect an interim, partly Iraqi, administration to use the basic INOC (Iraq National Oil Co.) structure to reinvest in existing fields, with advice from the international oil (companies) and oil services contracts to stabilize output," Deutsche Bank analysts said. "This may well result in a decline in output near term, as uneconomic and unsafe wells are redrilled. Most likely, Iraq stays in OPEC, and a quota of around 3 million b/d leaves room for some 0.5 million b/d of new growth, more likely in 2004 than 2003."
Martin Purvis, senior consultant with Wood Mackenzie, told investors at a Mar. 18 Deutsche Bank teleconference that the geological promise the country holds is formidable; he predicted potential Iraqi capacity of 6 million b/d by 2012.
But legal wrangling may prevent multinationals from seeing meaningful investment there for several years.
"While the coalition would no doubt like to tear up the Saddam-era deals, this could create legal challenges in the international courts," Deutsche Bank said.
This, plus the time needed to rebuild Iraq's government, including INOC, points to several years' delay, analysts say. To speed the process along, multinationals may join what could prove to be very interesting marriages of convenience.
"The outcome might be partnerships between the 'incumbents' and 'coalition' companies," Deutsche Bank said. "TotalFinaElf (SA) and BP PLC? ChevronTexaco Corp. and OAO Lukoil? Interestingly, BHP (Billiton Petroleum Pty. Ltd.) seems to be in both camps. Could Woodside Petroleum Ltd. be another way in for Royal Dutch/Shell Group?"
Purvis notes that some of the existing contracts may in fact be honored, which would be good news for some majors.
Production-sharing contracts to develop Iraqi oil reserves signed by French and Russian oil producers under Saddam Hussein's regime will probably be honored, predicted Purvis. Future contracts may be less generous, resembling development and production deals that allow companies to develop, but not own, reserves and other assets. Nevertheless, the terms may be attractive enough to pressure Iran and other Persian Gulf countries to lower their own contract expectations.
More-immediate issues
PFC Energy (formerly Petroleum Finance Co.) warned in a recent advisory to clients that Washington may be "seriously" underestimating the amount of money that will be required to rebuild the country, particularly in the postwar phase.
"While the Pentagon has recently announced that the US will fund the running costs of the occupation, US officials are also looking to tap into Iraqi oil revenues to fund postwar current and capital spending in a country where pent-up demand is huge following 12 years of sanctions and where economic expectations will be very high," the report said. "However, these oil export funds will be much lower than the Bush administration seems to anticipate. Even at an oil price of $25/bbl (for West Texas Intermediate crude), Iraqi exports are unlikely to yield more than $14 billion in revenue during the first 2 years after a war, leaving a huge budget deficit (as much as $10 billion) that neither the White House nor Congress will be willing to fund."
PFC said that the war itself could cost as much as $90 billion once deployment is taken into account, and reconstruction costs alone are likely to total around $250 billion over 10 years.
Immediately after the war, the interim US-led government will likely seek UN authority to run a modified oil-for-aid program for a few months at least, PFC predicts. On the Iraqi purchasing and distribution side, authority will be transferred from Baghdad to the UN, the group said. But the oil sales side is less clear. PFC said it is likely the US will turn to its own civilian authority to sign oil sales contracts and invoices.
Oil sector post-Saddam
The US also must be careful in what role if any it should play in deciding whether the state-run oil sector should be privatized, analysts say.
"How do we protect the oil facilities and bring in companies and materiel to sustain and improve those facilities without being criticized for 'taking over' oil or giving the appearance of somehow taking the oil?" asked Amy Myers Jaffe, energy adviser at the Houston-based Baker Institute for Public Policy at Rice University.
The US already faces a public relations problem over Iraq's reconstruction. The French government, for example, said on Mar. 25 it wants assurances from the US and the UN that US companies will not be given an unfair advantage for contracts to rebuild the oil sector and critical infrastructure.
A senior Department of Defense official tried to calm these concerns during a Mar. 24 Pentagon briefing: "This is not about the US trying to gain advantage by taking these oil fields or to preserve its own oil industry. It is solely and most importantly to preserve the capability of the Iraqi people to stand up very quickly after a Saddam regime and become a functioning, capable member of the economic community."
PFC warns, however, that the US's current plans for the oil sector remain "particularly opaque."
The White House is said to be considering putting immediate responsibility for the sector in the hands of US Department of Energy officials, PFC said, but details remain unclear.
There also is a continuing debate in the administration on what future direction the country's oil sector should take. PFC said that, in the longer term, there have been suggestions that the US may take over the running of the sector directly in association with selected Iraqi technocrats, either existing or retired, with the upstream being placed under the authority of a former US oil company executive. However, many neoconservative hawks argue that the sector should be fully privatized and open to foreign investment.
Iraq's oil infrastructure
For the time being, though, a more-immediate concern remains the status of Iraq's oil fields and near-term export capability. British military sources earlier reported almost all Iraqi oil facilities were mined or booby-trapped. At presstime, it was still unclear as to how great a threat remained to Iraq's oil infrastructure.
EIA said all Iraqi oil exports have halted, "with the last ship having loaded oil from storage tanks at Turkey's port of Ceyhan Mar. 20. With the departure of (UN) staff from Iraq, the UN oil-for-(aid) program is effectively on hold. Also, no oil is leaving Iraq's Persian Gulf port of Mina al-Bakr. Most of the oil production and pipeline infrastructure in the south is now under coalition control."
Southern Iraqi oil fields are secure, and coalition forces are making good progress in taking control of the rest of the country, US President George W. Bush told reporters Mar. 23. But he cautioned that coalition efforts are just beginning what could be a "tough fight" to oust Iraqi leader Saddam Hussein.
"(US coalition forces commander Gen.) Tommy Franks put a plan in place that moved on those oil fields quickly, and at least in the south, they are secure," Bush said. "And that is positive news for all of us. Most of the south is now in coalition hands. Obviously, there are pockets of resistance in a place like Basra."
Coalition special operations forces also captured three key oil terminals in southern Iraq and on the Persian Gulf used to export oil via tankers, Brooks said. Soldiers found weapons, ammunition, and explosives. Meanwhile, Kuwaiti officials reported Mar. 23 that coalition forces secured a 140,000 b/d refinery in Basra.
Tyler Dann, an analyst in Banc of America Securities' Houston office, said: "Coalition troops are experiencing more success in securing the fields in the southern no-fly zone, representing around 60% of Iraqi production." Securing fields in the north "will likely take more time," Dann said, due to Turkey's refusal to allow the US to station attack troops there.
The Iraqis damaged only 9 of the 500 wells in the Rumaila oil fields, setting some afire, before coalition forces took control, US military officials said Mar. 22 in Doha, Qatar. Seven remained ablaze at presstime last week.
However, firefighting had to be suspended because a group of Iraqi military disguised as civilians later tried to recapture some of the wells. A press conference planned Mar. 24 in one captured Iraqi oil field was canceled by the US military because of danger from Iraqi forces. Reuters news service reported that fighting had driven out civilian well control specialists who had been brought in to extinguish well fires in Iraq's Rumaila fields. The US military stepped up security near Rumaila after reports of armed Iraqis in the vicinity, but a US military spokesman stressed that "they won't be able to destroy the (Rumaila) wells."
Reuters quoted Brian Krause, vice-president and senior well control specialist for Houston-based Boots & Coots International Well Control Inc., as saying: "It's not nearly as safe as they said it was. We're kind of sitting ducks out there."
Shortly after the well fires had been confirmed, the US Army Corps of Engineers awarded Halliburton Co. subsidiary Kellogg Brown & Root (KBR) a contract to assess and extinguish oil well fires in Iraq.
The initial task involves hazard and operational assessment, extinguishing oil well fires, capping oil well blowouts, and responding to any oil spills. The firefighting portion of the work was subcontracted to Boots & Coots and Wild Well Control Inc., with some assistance from the government of Kuwait.
Following this task, KBR will perform emergency repair, as directed, to provide for the continuity of operations of the Iraqi oil. Previously, KBR developed a contingency plan at the US Department of Defense's request. This contract will be used for an interim period until the Army Corps of Engineers procures additional contracts to provide a broad range of services required to support full execution of the contingency plan.
In 1991, Halliburton and Boots & Coots were instrumental in extinguishing and bringing under control many of the 749 wells Iraqis torched in Kuwait.
Lingering threat
Damage to Iraq's oil fields is still a danger, said Michael C. Lynch, head of Strategic Energy & Economic Research Inc., Winchester, Mass. "If up to 1 million b/d of (production) capacity is destroyed, the effect will not be severe, as Saudi Arabia can offset it. More than that, and the market will need a release from strategic reserves," he said. Any release of emergency oil supplies would have an immediate effect on markets, pushing oil prices lower, said Lynch.
Meanwhile, Dann said, "We understand that the pipeline from northern Iraq to the export terminal at Ceyhan in Turkey is now pumping at a minimum rate of 500,000 b/d, with no tankers scheduled to load the approximate 4 million bbl of Iraqi oil now waiting in storage at the other end." Other sources report oil tanker traffic in the Persian Gulf has slowed since US-led forces launched the attack on Iraq (OGJ Online, Mar. 21, 2003).
"Because global stocks are tight, significant reduction in tanker loading for a week or more (at gulf terminals in Kuwait, Saudi Arabia, and Iran) could tighten markets over the next 2 months," Lynch warned. "Low inventories and the tight OPEC capacity situation means that companies might hoard, i.e., become reluctant to release supplies into the market. This could create a vicious circle, particularly without a release from strategic reserves."
Furthermore, he said, "US gasoline supplies are now quite tight, and if US consumers panic and rush to fill their tanks, it could trigger spot shortages (principally at wholesalers), news of which would encourage further hoarding."
Other curtailments
While market analysts for months have speculated about the prospect of lost Iraqi volumes owing to a military conflict, scant attention was paid to the possibility of precautionary curtailments in neighboring countries.
Kuwaiti officials reported they are maintaining oil production at 2.4 million b/d and will close their Raudhatain and Sabriya fields, which border Iraq, only if necessary. Shortly after the first attack on Baghdad was launched, air raid warnings were sounded in Kuwait City as Scud missiles from Iraq struck that area. The head of Kuwait Oil Co. previously said all of Kuwait's northern oil fields would be shut down to protect workers in case of war in Iraq. In February, affiliate Kuwait Petroleum Co. shut in Al Abdali and Al Ratqa oil fields near the Iraqi border that together produced 35,000 b/d but said it would make up the production with increased output at Ahmadi, Burgan, and Magwa fields.
Meanwhile, various companies operating in the Persian Gulf area have shut down operations and removed personnel from the war theater:
- Shell Iran Nowrooz-Soroosh Development, a Royal Dutch/Shell Group unit, suspended operations at its 60,000 b/d Soroosh oil field in the northern Persian Gulf 90 km west of Kharg Island, Iran, citing concern for the safety of its employees. Soroosh, which has been in production since December 2001, and nearby Nowrooz oil field, which is scheduled to start producing by the third quarter, lie close to Iraqi waters. A Shell spokesman in Tehran said 260 foreign and Iranian staff had been pulled out of the area, but activities at the offshore fields would resume "as soon as possible." National Iranian Oil Co. will provide security for the sites during the shutdown. Shell said that when hostilities cease, it would try to compensate for the lost production. Iran's oil ministry earlier this year had said that Soroosh oil production would reach peak capacity of 190,000 b/d by September. A Shell spokesperson in London said these fields were the only closures Shell plans due to war fears, although some staff members have been evacuated from Syria as well.
- GlobalSantaFe Corp. reported earlier this month that it would suspend drilling operations at all six of its land rigs drilling in Kuwait by Mar. 17 (OGJ Online, Mar. 14, 2003). The company evacuated 386 nonresident employees.
OPEC responds
Because of the Iraqi supply outage, OPEC announced Mar. 20 that it was temporarily suspending members' production quotas to maintain world oil supplies and prices in the wake of shortfalls due to the hostilities in Iraq.
OPEC ministers earlier said they would keep at least 2 million b/d of extra production capacity ready for use in case of a world supply shortage. However, the International Energy Agency claimed that OPEC has spare capacity of less than 1 million b/d (OGJ Online, Mar. 12, 2003).
OPEC Pres. Abdullah al-Attiyah said the group's members were "to take full advantage of crude-extracting capacities beyond each nation's established quotas."
Saudi Arabia's Minister of Petroleum and Mineral Resources Ali Al-Naimi said Saudi Arabia is committed to keeping oil prices and the market as stable as possible despite the current disruptions in the area.
"All precautions have been taken to ensure the flow of oil supplies," Al-Naimi emphasized. Saudi Arabia "will continue to implement the resolutions of the 124th conferenceU" that stressed OPEC's readiness to make supplies available "under any circumstances," the ministry said.
US Energy Information Administration data showed OPEC production as of Mar. 20 was 26.5 million b/d, only slightly lower than the November 2002 figure of 26.9 million b/d.
PetroLogistics—the European think tank that monitors oil tanker traffic—estimated Mar. 25 that production among the 10 OPEC members excluding Iraq increased by 780,000 b/d to 26.08 million b/d in March from its revised February estimate. However, it said that increase was more than offset by the decline in Iraq's estimated production to 1.45 million b/d in March from 2.6 million b/d earlier.
The UN is expected to soon consider a measure that would effectively restart the oil-for-aid program without the participation of Baghdad. UN and US officials both have said they want money from Iraqi oil sales to be used for humanitarian assistance to the Iraqi people and war refugees.
Supplies adequate?
Even with the halt of UN-sanctioned oil exports from Iraq, senior Bush administration officials said world energy supplies are now "more than adequate." But the White House did not rule out a future release from the 599 million bbl Strategic Petroleum Reserve if market conditions change.
"I am confident that increased supplies already on the water, the response by OPEC and major producers like Saudi Arabia and, if needed, our large strategic stockpiles will ensure that our economy will have the ample supply of energy it needs," Sec. of Energy Spencer Abraham said Mar. 23.
The White House has run into criticism by some in Congress who say the administration should have used the SPR already as a way to calm markets and to soften the impact higher energy prices have had on a faltering US economy. DOE has declined to detail the specific conditions that need to be met for it to consider an SPR release.
Despite "some logistical constraints and relatively minor disruptions to Iraqi oil infrastructure," previous market speculation that the war might trigger major displacement of Middle East oil supplies "has waned considerably," Dann said.
"Assuming no significant long-term oil field damage, it won't be long until OPEC must deal with seasonal demand retrenchment and its own oversupply," he said. "While (it is) politically difficult to discuss at this point, we expect that OPEC could easily be talking about production quota reductions, once military activity subsides."
Market 'too complacent'
The lessening of fears over major supply outages may be premature, according to some analysts.
In a strongly worded report Mar. 24, Paul Horsnell, head energy analyst for J.P. Morgan Securities Inc. in London, charged, "The oil market has become too complacent about the war, its risks, and the risks of the postwar situation."
He said, "Oil markets fell (Mar. 21) on unconfirmed (and since then unrepeated) reports that US Special Forces have secured Kirkuk oil field (in northern Iraq). Given the sheer size of Kirkuk field, we do not find it credible that all the Kirkuk wells could possibly be secure."
More important, Horsnell said, "The world oil industry is currently running very short in terms of discretionary inventory cover. In the US in particular, crude oil inventories (are) running close to minimum operating levels." At the same time, he said, "The US is now entering a period in which crude oil runs rise seasonally."
Horsnell said, "In all, the system needs an oil surplus to, first, stop the current inventory falls; more surplus to meet the increase in refinery runs; and then even more surplus to provide some cushion away from the rocks of low inventory cover."
World markets are depending on the other 10 members of OPEC—particularly Saudi Arabia—to make up any shortfalls in oil supplies resulting from the war in Iraq.
However, Horsnell noted, the recent drop in oil prices "has already taken prices to precisely where Saudi Arabia wants them, i.e., within the OPEC target band. Further, some traders seem to be seriously thinking that they could attempt to push prices below the bottom of the target band, i.e., precisely where Saudi Arabia does not want them."
Under those circumstances, Horsnell said, "We would not expect very many of the Saudi barrels in inventory to actually make it to market, and in addition we would expect the level of Saudi production to be scaled back significantly."
Contributing to this special OGJ News Analysis were Washington Editor Maureen Lorenzetti, Senior Writer Sam Fletcher, Associate Editor Judy Clark, Senior Staff Writers Steven Poruban and Paula Dittrick, Executive Editor Bob Williams, and OGJ correspondents.