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Key findings of the Iraq Energy Outlook

The International Energy Agency (IEA) released this October a special report which is considered a landmark in the institution’s Word Energy Outlook series. The purpose of this article is to present the key findings of this report, which looks at Iraq’s present situation, assesses the immediate challenges to Iraq’s full development of its oil reserves and projects three possible long-term development scenarios for the hydrocarbon sector. The future of the Iraqi hydrocarbon sector holds great promise, first of all for Iraq itself, but also for the global energy markets. The success will depend on the government response to present uncertainties and bureaucratic obstacles, an efficient long term thinking and government commitment to timely development of the energy infrastructure. With appropriate and steady levels of investments, Iraq’s golden future as a world class oil and gas supplier could be here to stay, making Iraq the biggest and most significant unfolding story for the world oil market today and a key pillar of the global oil supply system in the future.

“High reserves, easy geology and low costs” these are the words that chief IEA economist Fatih Birol used to describe Iraq’s oil industry in the press conference launching the publication, on October 9^th. Today Iraq is the fifth country in the world in terms of proven oil reserves and the 13^th in terms of proven gas reserves. Oil production has increased significantly reaching 3 Million barrels per day (Mbpd) in 2012 of which 2.4 Mbpd was exported. The country targets over 9 Mbpd production by 2020. As one of the most underexplored countries in the world, Iraq has an enormous potential to become a global and regional energy powerhouse. Already the third largest global oil exporter, after Saudi Arabia and Russia, Iraq is seen as the biggest piece of good news in the global oil supply in the last couple of years. Iraq has several undeniable advantages the most important of which is probably that of some of the lowest production costs in the world for both oil and natural gas. As Maria van der Hoeven, the IEA Executive Director stated during the press conference: “The resources are there and everybody knows it, the question is how much time will it take Iraq to develop them? (…) It is not a matter of resources, but a matter of speed and meeting the conditions.”

Over the last three decades Iraq was prevented from reaching its full potential as an oil producer by wars (Iraq-Iran war of 1980-1988, first Gulf War, second Gulf War) and the international sanctions regime that left the oil industry infrastructure severely deteriorated. “Iraq’s troubled history over the past three decades has held back its economic development” states the report.

Oil is the cornerstone of Iraq’s economy (it generated 95% of government revenues and accounted for 70% of GDP in 2011) and is seen as the main engine for economic growth and future diversification of the economy away from oil. However, the oil and gas sector combined currently account for “less than 2% of total employment”. Overreliance on oil in the energy mix (80% vs. less than 50% in the Middle East) and flaring of associated gas (over 60% in 2011) are some of the immediate challenges facing the energy sector.

Oil: geology, costs and production

Iraq’s peak production (3.5 Mbpd) was reached in 1979. A lesser known fact is that the Iraqi production was historically dominated by two super-giant fields: Kirkuk in the North and Rumaila in the South. The first went into production in the 1920s, while the second in the 1950s and both account for 80% of Iraq’s cumulative production. The importance of Rumaila field continues to this day, with 1.3 Mbpd out of the daily oil production of 3 Mbpd this June coming from this oil field alone.

Two years ago, the Iraqi Oil Ministry revised upward the country’s proven oil reserves figure from 115 Billion barrels to 143 Billion barrels, making Iraq the holder of the third largest proven conventional oil reserves after Saudi Arabia and Iran. 60% of the proven reserves come from five super-giant fields in the South: Rumaila, West Qurna, Zubair, Majnoon, and Nahr Umr. In addition, the Ministry of Oil estimated in 2010 some 215 billion barrels of undiscovered resources. To give a sense of the resource potential, the report emphasizes that Iraq has drilled only 113 of the 530 potential hydrocarbon bearing structures. In addition, prior to exploration activities currently underway in the Kurdistan Regional Government (KRG) area, most of the exploratory wells have been drilled before 1962!

The Iraqi oil reserves are mostly located in the South – where the country’s super-giant fields are and in the North – the Zagros foldbelt where the Kirkuk reservoir is and the other KRG fields. But Iraq has also significant undiscovered hydrocarbon resources, especially in the Western Desert – the “least explored of the three main basins” in Iraq, thought to be particularly rich in gas.

The Iraqi hydrocarbon geology is sizeable (thus prone to economies of scale benefits), straightforward, onshore, often located in flat terrain – all of which contribute to some of the lowest capital and operating expenditures in the world. In the last couple of years Iraq has organized four bidding rounds (two in 2009, one in 2010, one in 2012) and has awarded 20 service contracts to consortia (19 in 2009 and one in 2008) mostly in the southern part of the country. Some 50 additional contracts have been awarded by the Kurdistan Regional Government (KRG), most of which are Production Sharing contracts (PSC), in the northern part of the country which is also “one of the most active exploration regions in the world” according to the report. So, for now it seems that the federal system of hydrocarbon development (service contracts) co-exists with the different approach of the KRG (PSC) until a decision is reached on the final version of the federal hydrocarbon law, under discussion since 2006.

While the ‘below ground endowment’ is extremely compelling, some ‘above ground’ obstacles remain and are a cause of uncertainty as to the realistic pace of development of the Iraqi energy sector. Some of these future challenges include: transportation infrastructure, availability of water (for injection into wells), institutional efficiency, security concerns, politics, but also questions related to the future production profile. The good news is that overall the security situation in Iraq is improving, a consequence of the IOC market entry following the 2009 tenders.

Key Oil Fields
Field	Location	Relevant facts
Rumaila	South	the second largest producing field in the worldafter Ghawar. It has a recovery factor of more than44% and a good access to export infrastructure.
West Qurna	South	geologically an extension of Rumaila. Split byEuphrates river into 2 phases: Phase I (South) -developed by a consortium led by ExxonMobil andPhase II (North) – led by Lukoil.
Zubair	South	One of the earliest discoveries in the region,overshadowed by Rumaila. In 2009 ENI wasawarded a service contract.
Majnoon	South	Discovered in 1970s by Petrobras. Productionhindered by significant unexploded ordnance in thearea left after the war with Iran.
Halfaya	South	Operated by a consortium led by PetroChina
East Baghdad	Centre	A super-giant field beneath the capital, althoughoffered in the second round, did not receive anybids. No major progress expected.
Ahdab	Centre	Operated by PetroChina, low expected output.
Badra	Centre	Operated by GazpromNeft, first production in 2013.
Kirkuk	North	Super-giant field with three production areas: twooperated by the North Oil Company and the third(the Khurmala dome) – under a KRG contract.
Tawke	KRG area/North	The only five fields with current production underKRG awarded contracts.
Taq Taq	KRG area/North
Kurmala dome of Kirkuk field
Shaikan	KRG area/North
Condensate from Khor Morgas field	KRG area/North
		Source: compiled by author from the IEA report

Iraq has three main old refineries: in Doura (near Baghdad), Basrah and Baiji. A new refinery has been built in Erbil and bigger ones are under construction in Karbala, Nassiriyah, Kirkuk, and Missan.

One particular area for future focus is the investment required in the onshore and offshore energy infrastructure, addressing the shortage of storage and pumping capacity and water availability for reinjection, particularly in the South where fresh water resources are constrained. The report states that “Individually, none of these projects is technically complex or difficult to implement; but collectively they demand a high level of integrated planning and timely execution in order to avoid limiting the productive potential of the major southern fields”. In the later case, there is a plan to construct a Common Seawater Supply Facility (CSSF) – a complex water treatment project with a final total capacity of 10-12 Mb/d that would process Gulf seawater and pump it 100 km inland for use in the major oil producing areas. But time is of the essence and given the scale and complexity of such a project, delays are to be expected.

Another key issue raised in the report with implications for global markets will be the ability of Iraq to develop spare production capacity.

Natural Gas: “from sideshow to center stage”

Iraq’s natural gas is mostly associated gas (70%) with only a small number of non-associated gas fields. The official Iraqi proven reserves of conventional natural gas are 3.4 Trillion cubic meters (Tcm), but ultimate recoverable reserves are estimated to be higher (in the order of 7.9 Tcm). Unlike oil, the figure for natural gas reserves was not revised in 2010. With respect to gas production, the report outlines the

“predominance of the southern region”, with an “early stage” production in the north and “non-existent” altogether in the west. The greatest potential for future gas production is in Kurdistan. There is a difference in quality depending where the gas comes from. Natural gas from the South has a high content of natural gas liquids (NGLs) – on average about 30% – while natural gas from the North is drier. Natural gas was always second to oil and “has historically been a secondary consideration for the government”, but this is beginning to change.

Currently natural gas is severely underutilized in Iraq. More than 60% of the gas produced in 2011 was flared. Efforts are underway to reduce this wastefulness. For instance, Iraq joined the Global Gas Flaring reduction Partnership and plans to redirect its natural gas production into domestic electricity production. Presently, oil accounts for 80% of primary energy demand in Iraq, while in the rest of the Middle Eastern counties it is lower than 50%. A switch from oil-based power generation to gas-fired power generation could be a policy solution in order to meet the growing domestic demand for electricity and free up more oil for export. Iraq also wants to become a natural gas exporter, but this will require first putting in place the infrastructure necessary to capture and process the associated gas and develop the non-associated gas fields. The IEA projections show that natural gas production is expected to grow from less than 10 Bcm in 2010 to 90 Bcm by 2035 (in the Central Scenario) and to 115 Bcm (under the High Case scenario). The increase will come mostly as associated gas from the Southern oil fields, but also non-associated gas in the North. Thus the IEA projections suggest that in the future natural gas “ceases to be an occasionally useful by-product of oil production, as in the past, and becomes a more pivotal and autonomous part of Iraq’s energy strategy”.

A part of the solution could be provided by the Basrah Gas Company (BGC), a JV formed between state-owned South Gas Company (51%), Shell (44%) and Mitsubishi (5%). Its purpose is to come-up with concrete projects for gathering and processing associated gas from Rumaila, Zubair, and West Qurna I which include some 13 Billion USD worth of investments in rehabilitation of existing facilities and two major processing plants in the area, but also an additional 4 Billion USD for a possible LNG export terminal. Many uncertainties remain however regarding the incentives for these investments, as under the current service contracts companies are not remunerated for the associated gas production. Moreover, the domestic gas price is fixed at a little over 1$/MBtu, making the economics of domestic gas marketing insufficient to motivate such a big investment, although the long term value that Iraq could extract from channeling associated gas production in the south towards gas-fired power generation is certainly huge.

As for non-associated gas production, the biggest contribution is expected to come form the north (the KRG area). From the gas fields already discovered, production is anticipated to come mainly from: Khor Mor, Chemchemal, Miran fields (KRG area), Mansuriyah (in the north), Akkas field (in the west) and Siba field (to date the only gas field appraised in the south). Thus, Iraq is seen as a serious potential supplier of cost-competitive gas to Europe via pipelines and to Asia via LNG tankers.

Electricity – moving away form oil-fired power generation

One current challenge is the lack of reliable supply. An immediate priority is building additional generation capacity, estimated at 6 GW. The gap is currently dealt with by using private household generators or generators shared at neighborhood levels (non-grid generation). The power infrastructure is in need of rehabilitation, upgrading and investment in capacity expansion. Another main takeaway is that there are separate electricity grids for KRG and the rest of Iraq, as well as separate institutions (an Iraqi Ministry of Oil and a KRG Ministry of Natural Resources; and two separate Ministries of Electricity). The distribution and transmission losses are the highest in the Middle East. Electricity prices are “heavily subsidized”. The report singles out among challenges a weak payment discipline and the presence of many illegal network connections. The IEA estimates that the Iraqi power sector will require annual investments over 6 Billion USD by 2035 if the transition from oil-fired power generation to gas-fired power generation is to take place. If however the transition does not materialize, it will cost Iraq about 520 Billion USD worth of foregone cumulative oil export revenues, concludes the report.

Future perspectives

The IEA projects 3 scenarios for hydrocarbon development in Iraq until 2035:

• Central Scenario (plausible case) – features cautious assessments, estimating a 5.6 Mbpd oil output by 2035 that will supply mainly the Asian markets. The cumulative investment required is estimated at 400 Billion USD until 2035, an annual average of 20 Billion USD compared to the 7 Billion USD invested in 2011. Iraq could gain 5 Trillion USD from oil export revenues up till 2035, a scale of revenues deemed by the report to offer a truly “transformative opportunity’. Gas exports are projected to start in 2020 and reach 20 Bcm by 2035.
• Optimistic Scenario (high case) – oil production reaches 9 Mbpd by 2020; higher investments (600 Billion USD) bring also an additional 1.8 Trillion windfall revenues compared to the Central Scenario.
• Pessimistic Scenario (low case) or Delayed case – production growth to 4 Mbpd in 2020 to 5.3 Mbpd in 2035. If investments remain at 2011 levels, there will be significant revenue loss over the entire projected period – 1.6 trillion USD lower than in the base case scenario.

According to IEA, 90% of these investments in upstream and midstream will come from the Iraqi treasury (in various forms), as opposed to the downstream sector where Iraq seeks to attract private investment. The line of responsibility for management is divided: in upstream it lies with the IOCs while in midstream (transportation, storage and export) – it lies with the Iraqi Oil Ministry. On the downside, among the main hurdles are: the high costs of doing business (Iraq ranked 164 out of 183 in the World Bank’s Doing Business in 2012 report); unreliable provision of basic services (power); regulatory obstacles and delays; overblown public sector, poor access to finance. Security risks remain although these are “not uniform across Iraq”. IOCs have to deal with the legacy of landmines and unexploded ordnance.

In conclusion, it seems that the success and the pace of adding new production capacity in Iraq in the coming years will be determined by a few critical factors: commitment to undertake the required investments, effective government decision-making process, co-ordination, and a clear oil market strategy. The golden age in the Iraqi energy sector is very much achievable, but will require substantial investments, more clarity on the long term energy strategy (for both oil and gas) and on the legal aspects for exports (access to markets, particularly for gas). Iraq has strong fundamentals that make it incredibly well positioned for overtaking Russia as the world second largest oil supplier, after Saudi Arabia, around 2030.