BP Agrees To Develop A Disputed Field In Iraq

BP Plc. (NYSE:BP) has recently signed a letter of intent with the Iraqi central government to help revive its giant Kirkuk oil field in Northern Iraq. This could potentially result in a long-term contract for the company similar to the technical service agreement it already has for the largest oil field in Iraq, Rumaila. However, there are geopolitical risks associated with the project, as it is located at the heart of a larger dispute between the Iraqi central government and the Kurdistan region government (KRG). Moreover, infrastructural bottlenecks and the nature of technical service agreements awarded by the Baghdad government also make the project less attractive. ^[1]

Headquartered in London, BP is one of the world’s leading oil & gas multinationals with operations in more than 80 countries. As an integrated oil and gas major, it has both upstream as well as downstream operations. The upstream division primarily includes exploration and production activities for oil and gas while the downstream division focuses on producing refined petroleum products such as gasoline.

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Little Value Addition

The revamp of more than 80 years old oil field is a part of Iraq’s larger plan to boost its oil production over 9 million barrels per day (bpd) by 2017. ^[2] The country is currently producing around 3.25 million bpd. Production from the Kirkuk oil field has dropped significantly from around 900,000 bpd in early 2000s to just over 250,000 bpd today. However, it is still expected to contain around 10 billion barrels of oil. ^[1]

Potential value addition to BP in case it is able to clinch a long-term technical service contract with the central government will depend upon the terms of the agreement, such as base and plateau production rates, and the compensation per barrel of oil produced above the base production rate. In order to get a ballpark idea, we can assume that BP can achieve a plateau production rate of 900,000 bpd with a base of 300,000 bpd. In this scenario, the contract can add almost $4 billion to BP’s total value, assuming a compensation rate of $2 per barrel.

Although the project holds prospects of a relatively stable cash flow stream for BP, it falls in a swathe of land over which the Iraqi central government and the KRG are locked in a dispute. The KRG has opposed Baghdad’s deal with BP and maintained that any such deal would be unconstitutional as long as the dispute over sovereignty of the province continues.

Moreover, upside to the project’s value is capped by the nature of the service agreements signed by the Iraqi government. These contracts do not allow the companies to gain from higher oil prices, which makes the return on these projects look less lucrative compared to the ones governed by production sharing contracts. Infrastructure bottlenecks, red tape and payment delays further reduce the rate of return on such tightly priced agreements. Companies operating in the region have experienced problems in getting visas for contractors and security staff, delays in payments and bringing in armored vehicles and holdups in securing operating licenses. As a result, despite significant production ramp-up potential, there is little incentive for oil companies to develop oil fields in the region. In a nutshell, even if BP is able to secure a long-term deal for developing the Kirkuk oil field, there would be very little for its investors to cheer about.

We currently have $46 price estimate for BP, which is ~10% above the current market price.

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1. Iraq signs deal with BP to revive northern Kirkuk oilfield, reuters.com [↩] [↩]
2. BP weighs 1 million bpd output target cut at Iraq’s biggest oilfield, reuters.com [↩]