BP Steals a March on Competitors in Iraq

RelevanceBP’s bid for the Rumaila oil field has been approved by Iraq’s cabinet. Bids were rejected on 6 other fields, and the 8th contract (Mansuriyah gas field) saw no bids. Iraq presents the classic oil industry case of IOC knowledge and money combining with an NOC’s access to reserves to secure production. The fee based contract for the Rumaila oil field is reported at $2/bbl and will probably require capital investment by the BP group. Details of the contract are scarce, but there is probably no provision for BP to book reserves. Other western IOCs (Exxon, ConocoPhillips, ENI) walked away from the auction empty handed – siting low fees as the problem. Many NOCs (ONGC, CNOOC, Sinopec, Kogas, Lukoil, Gazprom) were involved in failed bids. Why did BP take this low offer while the rest of the industry rejected it?

Analysis: BP was one of the original members of the consortium that owned Iraq Petroleum Company (along with Shell, Total and Standard Oil), that was expelled from Iraq over 40 years ago. This week it has won a contract to return to the country on terms vastly inferior to those of IPC. And yet this latest move by the IOC is shrewd and places it (and its partners) in pole position to play a leading role in the regeneration of Iraq’s oil and gas industry.

BP is gaining something of a reputation for moving quickly and decisively to capture exciting new petroleum opportunities. This was seen in Russia in 2001 where overnight the firm became that country’s biggest international investor (in any industry). Despite the media coverage in the West, BP has achieved outstanding operational and financial performance in TNK-BP, its main Russian investment. BP’s problems in Russia related to its co investors and not government action (such as that suffered by both ExxonMobil and Shell in their Sakhalin projects).

And now again BP has gained significant competitive advantage over its peer group through winning the Rumaila contract in Iraq. This competitive advantage manifests itself in:

First Mover Advantage: BP will develop local knowledge of Iraqi operations ahead of its competitors. BP will climb the learning curve quicker than others. Benefits will include better cost management (which also helps the firm to bid on future projects); geological understanding; and improved relationships with the government. The BP group has an insider’s opportunity to influence how business is done in Iraq, including day to day working arrangements with the local NOC and strategic issues such as the future fiscal terms, local content and the nature and pace of industry development. As such, its investment in Rumaila could prove to be an extremely cheap “loss leader”. Having decided to bite the bullet, BP and its partners must be quietly pleased that its advantage is magnified by the complete absence of competitors at this time.

Competition: The cold reality for many IOCs is that they are being hit by falling production and annual reserves replacement ratios of less than 100%. The world is simply not awash with large scale opportunities that would be sufficiently material to the large IOCs. While its competitors complain of unattractive contract terms in Iraq, BP has now stepped ahead in the race to grow production and replace reserves. The firm and its partners have catapulted themselves to the front of the queue for more lucrative terms in Iraq in the future. If such terms do not materialize, then the whole industry will suffer, not just the BP group. Indeed, one future scenario for the oil industry sees service contracts as dominant.

Portfolio: BP has a lower presence in the Middle East than many of its competitors, a region in which, along with Russia, all serious large IOCs with growth aspirations should be present. BP is also light on the ultra high risk plays such as Venezuela and Nigeria and therefore probably feels that there is room in its portfolio for a high risk – high reward opportunity such as Iraq.

Potential Opportunity: exploration and undeveloped discoveries (2/3 discoveries in Iraq are still undeveloped) are where the real potential lies. BP and its partners will see the Rumaila contract as the first step in realizing significant value through access to future reserves. Iraqi reserves promise to be relatively easy and cheap to exploit and will use existing technology.

Politics: The BP group’s high profile winning bid for Rumaila could quickly assume the mantle of a test case for foreign investment in the oil industry in Iraq. This should help to generate government support and political good will. Failure of the BP group will deter future investment; success will help to promote the benefits of foreign investment to the nation as a whole.

Geopolitics: in a rare occurrence for the oil industry, the interests of Iraq and the main consuming nations are aligned. Both seek increased production, the former to generate revenues for the reconstruction of the country and the latter to ease pressure on oil prices.

China: To date, media commentary has not picked up on the significance of CNPC in this bid. CNPC has already invested $3B in a deal to develop a field in southern Iraq, so has existing government relationships and knowledge of the business environment there that the BP group can exploit. China also presents a significant part of the BP growth strategy – the CNPC partnership should help facilitate good relationships in that country.

Of course, BP and its partners face significant risks and costs in Iraq that will have to be addressed. Risks include some Iraqi lawmakers that say they have legal authority to vet the contracts that the government has agreed; Iraq’s petroleum law that has not yet been passed by parliament; the lack of clarity around the division of roles and responsibilities between IOC and the Iraqi NOC; and the dilapidated state of the industry in Iraq with its problems with security, under investment, corruption, and lack of local skills (output is still lower than the pre 2003 war level). Furthermore, Iraq’s aspiration to double production to 6mbd by 2015 could cause problems with OPEC.

However, any such risks are more than compensated for by the huge opportunity that Iraq offers. BP and its partners have a lead in the race to realize that opportunity.

Speak Your Mind

Do NOT follow this link or you will be banned from the site!