Oil companies offer to cut 2015 spending in Iraq

The slump in crude prices to below $60 a barrel from $115 in June has slashed government revenues in Iraq

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Oil companies have proposed millions of dollars of cuts in development spending in Iraq, a senior oil ministry official said, after Baghdad told them low oil prices and its fight against the Islamic State of Iraq and Syria (ISIS) had made payments difficult.

In a series of letters sent to companies such as Royal Dutch Shell, BP and Exxon Mobil since January, seen by Reuters, the oil ministry set out the need for change in response to “the rapid drastic decrease in crude oil prices.”

The slump in crude prices to below $60 a barrel from $115 in June has slashed government revenues in Iraq, OPEC’s second biggest exporter, just as it faces economic crisis triggered by ISIS seizure of north and western provinces and surging expenditure to fund a military counter-offensive.

In view of the fact that a significant proportion of development costs are passed on to Iraq, the oil ministry called on firms to revise their oilfield development plans by considering postponing new projects and delaying already committed projects as long as no additional costs were incurred.

They should cut development budgets “by a certain percentage” and request subcontractors to reduce costs in order to match “the new oil prices world,” the ministry said.

Those cuts should be made against a backdrop of maintaining or even increasing current oil production levels, the February letter added, requesting a response by the end of that month.

Most companies have replied, a senior oil ministry official said, with the largest offered cut in spending coming from Shell, which proposed slashing investment spending this year by more than a third to $1.5 billion from $2.4 billion.

BP proposed a cut to $3.25 billion from $3.50 billion, Lukoil to $2.1 billion from $2.3 billion, while Exxon Mobil said it planned to maintain development spending at $1.8 billion and Eni had yet to reply, he said.

“No direct meetings have been held with any of the foreign companies. We are now only testing waters with them via correspondence,” said the official, who declined to be named because of the confidential nature of the correspondence.

A BP spokesman said the company held regular, confidential discussions with Baghdad about the development of the Rumaila field, which was operating normally.

A spokesman for Lukoil said the firm had received a letter from Iraq asking to postpone all new developments or reduce works in 2015, adding: “We are studying it.” The West Qurna project was developing on schedule and unchanged so far.

Exxon, the lead contractor to rehabilitate West Qurna, declined to comment. Chief Executive Officer Rex Tillerson said last week it was talking with Baghdad on restructuring oil agreements to help the government meet its near term cash needs.

Eni and Shell were not immediately available for comment.

Sharing risks

International firms operate in Iraq’s southern oilfields under service contracts, currently based on a fixed dollar fee for additional volumes produced - a formula which has seen Baghdad’s bills ballooning just as its oil revenues collapse.

“The oil ministry has irreversibly taken the decision to amend its service contracts with foreign firms, due to the cash crisis brought by oil prices drop,” the ministry official said.

“We have to acknowledge that current contracts were hastily drafted and short-sighted in failing to take into consideration the impact of a potential oil price crash.”

A letter sent to oil firms last month asked them to propose amendments to their contracts “based on the linkage between oil prices and cost recovery and due remuneration as a sliding scale,” so that both sides “take the risk and enjoy the reward.”

The proposed amendment did not mean Baghdad was planning a formal move to production sharing contracts, but finding a middle ground between that and the current arrangements.

“We should fix these flaws to save our economy from collapsing,” the official said.

A source at one of the oil majors said such discussions were not unusual: “For the past five years we had cost inflation in the industry as oil prices rose. Now we have cost deflation as prices fall. We renegotiate contracts with service and engineering companies all over the world to achieve lower costs without impacting production."

Oil Minister Adel Abdel Mehdi said 10 days ago that Iraq was renegotiating the contracts with a view to restoring Iraq’s state share to around 20 to 25 percent, after it was reduced in recent amendments to around 5 percent.

He said that under current contract terms, Iraq’s payments due to international companies in 2015 would reach $18 billion.

It has already accumulated debts from last year and 2013. The government says it has started work on issuing a Treasury bond, and may resort to seeking forward payment for exports to address its growing debts to the firms, Finance Minister Hoshiyar Zebari said.

For now, sources say, Iraq is not providing the service companies with the repayment volumes they are due and is instead sometimes assigning more cargoes to companies who purchase its crude for cash under term contracts in monthly export schedules.

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