The Iraqi oil minister recently announced that Exxon Mobil (NYSE:XOM) will be selling out more than half of its stake in the West Qurna I project to China’s biggest energy firm, PetroChina and Indonesia’s Pertamina. The deal reflects Exxon’s declining interest in the project due to lower returns as well as ongoing issues with the Baghdad government, over deals signed by the oil major and the semi-autonomous Kurdistan region government (KRG). 
The West Qurna I field is one of the largest conventional oil fields in the world with estimated resources of around 8 billion barrels. Exxon entered into a technical service contract with the Iraqi government in 2010, to boost the production rate from the field to ~2.8 million barrels per day (MMBD) from ~0.25 MMBD. The company holds 60% operating stake in the $50 billion project while Royal Dutch Shell holds 15%, and the Iraqi state oil company holds the remaining 25% stake. The venture gets paid a fixed amount per barrel of oil produced over the baseline production of 0.25 MMBD along with full cost recovery. The field is currently producing over 0.5 MMBD and is expected to reach a level of 0.6 MMBD by the end of the year. 
The technical service contracts awarded by the Iraqi central government prevent oil companies from reporting their share of the production volume, which is a closely watched metric in the investor community. These contracts also 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. Moreover, 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 the oil fields in southern Iraq.
Exploration companies have been lured to sign contracts with the KRG as it has offered attractive production sharing contracts while the central government has given out service contracts that compensate players based on a production linked fee. The better security environment in Kurdistan also makes the region more lucrative to companies intending to set up local operations. However, despite these advantages, the risk of future amendments or the tightening of agreement terms is inherent to pursuing any deals with the KRG, as the central government does not recognize the validity of such regional contracts. Moreover, the risk of missing out on any lucrative deals with the central government in the future also comes along with such agreements. Differences between the KRG and the central government of Iraq over the vast oil wealth in the northern regions of the country continue to widen despite growing interest from oil majors to begin operations in the area.
After Exxon’s contract with the KRG to explore 6 blocks in the semi-autonomous region was made public towards the end of 2011, the central government banned the oil major from participating in future rounds of bidding to develop new oil fields and removed it from the lead role in developing a multi-billion dollar water injection facility in southern Iraq. Voices within the government also threatened that Exxon could lose its contract to develop the massive West Qurna I field unless it relinquished its plans to explore Kurdistan. Towards the end of last year, Exxon informed the Iraqi central government of its wish to sell all of its stake in the West Qurna I development project.
We believe that Exxon’s increasing focus towards investment in the Kurdistan region could help the company add low cost, high quality reserves to its portfolio. However, the considerable political uncertainty associated with the project could also add future complications. We currently have $91 price estimate for Exxon Mobil, which is almost in line with the current market price.Notes:
- Minister: ‘West Qurna 1 deal imminent’, upstreamonline.com [↩]
- Exxon Looks to Sell Part of Iraqi Project to PetroChina, wsj.com [↩]