Global Oil Companies Undercut US Policies Toward Iraq

February 23, 1998

Global Oil Companies Undercut U.S. Policies Toward Iraq, Iran

By BHUSHAN BAHREE Staff Reporter of THE WALL STREET JOURNAL

GENEVA -- Far from the war rooms where politicians and generals study maps with little silhouettes of aircraft carriers and fighter jets, other people are poring over another map, with silhouettes that represent stunningly large pools of oil. On that map, the U.S. is already losing the battle for Iraq.

Whatever the outcome of the latest standoff with Saddam Hussein, Washington's efforts to contain Iraq -- and, less belligerently, Iran -- must eventually yield to the global economics of oil supply and demand, industry experts say. They sketch a simple picture: World demand for oil is rising, existing supply is running near capacity and new supplies are considerably skimpier than Iraq and Iran's vast potential, much more expensive to develop and will be slow to come on line.

The upshot, say international oil companies and industry experts, is that world demand will inevitably undermine the longstanding U.S. policy of dual containment in the Persian Gulf. Both Iraq and Iran have been welcoming foreign investment in recent years, and non-American companies have shown little reluctance, despite the threat of U.S. reprisals, to plunge in or at least establish ties so they can do business as soon as the green light goes on.

"We will definitely need their oil" in a few years, says Franco Bernabe, chief executive of Italy's giant energy company ENI SpA. With the lead times to bring oil fields into production measured in years, that means starting now. "We will have to come to terms with these countries very soon," adds Mr. Bernabe in an interview.

Major oil deals in Iraq, done and pending

Field Company Status* Reserves (billions of barrels) Majnoon Elf Aquitaine (France) Done 9.0 West Qurna Lukoil, Zarubezneft and Mashinoimport (all Russian) Done 7.5 Nahr Umr Total SA (France) Done 3.5 Ahdab China National Petroleum Corp. Done 0.4 Subba China National, Machinoexport (Russia) and Lamaj (Netherlands) Pending 2.2 Ratawi Royal Dutch/Shell (Netherlands/U.K.) Pending 1.4 Halfayah China National, Agip (Italy), BHP Oil & Natural Gas Co. (India) and others Pending 0.7 Nasiryah Agip (Italy), Repsol (Spain) Pending 0.5

*Done deals are production-sharing contracts subject to ratification once U.N. sanctions on Iraq are lifted. Source: Petroconsultants SA, Geneva

Drilling on Dangerous Ground

That's not how Washington sees it. U.S. officials insist they aren't planning any changes in the dual containment policy -- which seeks to limit the trouble-making potential of Iraq and Iran's governments until they are less inclined to make trouble -- despite the lack of enthusiasm and support from Washington's Western allies. "Clearly, there is an interest in Iranian and Iraqi oil," a U.S. State Department official says, "but some of those nations who are less vigilant than we are on containment are motivated by commercial interests."

That motivation is certainly driving major oil companies toward Iraq and Iran, which have some of the cheapest oil in giant deposits. "The world won't come to an end if we don't have their oil," says Cyrus Tahmassebi, president of Bethesda-based Energy Trends Inc. and former chief economist of Ashland Oil. But it would be a great misallocation of capital to walk away from oil that costs $2 a barrel to produce, and go to the North Sea and other places where production costs are $5 to $10 a barrel, Mr. Tahmassebi says. The U.S. Energy Department puts the cost to produce a barrel of oil in the Persian Gulf at between 99 cents and $1.49 a barrel, depending on the size of the field.

Forecasters assume that, one way or another, the oil capacities of the Organization of Petroleum Exporting Countries, of which Iraq and Iran are members, will be expanded to meet rising demand. Otherwise, says the U.S. Energy Department's oil-market review, prices could escalate.

Who Will Supply Extra Oil?

Who will supply all the extra oil? ENI's Mr. Bernabe says Iraq's reserves, the second-largest in the world after Saudi Arabia's, and those of Iran, which are somewhat smaller, will have to come into play. And neither Iran nor Iraq has the finances to substantially expand production capacity without foreign capital.

"It's not an easy situation," says Tatsuo Masuda, head of emergency preparedness at the Paris-based International Energy Agency. "From the point of view of global security, it is desirable to have more oil capacity in reserve."

The safety buffer of unused capacity is estimated variously at around two million barrels a day above the 75 million barrels a day of oil the world is expected to consume this year. Saudi Arabia, mindful of its key role in world oil markets, already is considering expanding its output capacity by some 2 to 12 million barrels a day.

But Saudi Arabia, like Kuwait, isn't open to foreign oil companies seeking production assets. For that, companies have to look elsewhere.

Eyeing Caspian Sea Region

The U.S. has promoted the Caspian Sea region as an alternative for oil companies hungry to buy oil reserves that they can't find themselves. Companies from the U.S., Europe and elsewhere are now active in such oil-rich countries as Azerbaijan and Kazakstan. But the Caspian is no Middle East when it comes to oil reserves, and finding export routes through the territory of contentious neighbors continues to be a problem despite several recently announced pipeline agreements.

The U.S. Energy Department predicts that the entire Caspian region may be able to export some three million barrels a day of oil by 2010, when world demand by some estimates is expected to be about 96 million barrels a day. Many other estimates of Caspian Sea exports during this period are lower, suggesting that oil from this region will be too little and too late in the medium term, when rising demand is expected to coincide with a peak and a subsequent decline in North Sea output from around 2003.

Only the Persian Gulf countries have the reserves and easy accessibility to markets, and could account for half of world production 15 years from now.

Iraq's proven reserves alone, at some 112 billion barrels, compared to Saudi Arabia's 250 billion barrels of proven reserves, are more than a tenth of the world total. The U.S. Energy Department estimates Iraq's probable and possible resources, an uncertain reckoning, at an additional 215 billion barrels. And they are concentrated in very large, easy to exploit pools of oil -- an attractive prospect for oil companies that can use economies of scale.

Explosion of Activity Predicted

Once sanctions are lifted, "there will be an explosion of activity in Iraq," says Alexandre Muller, a geologist specializing in the Middle East at Petroconsultants SA in Geneva.

In fact, the head of Iran's parliamentary oil commission recently said the country needed to invest $90 billion over the next 10 years just to avoid a drop in oil production.

Oil industry experts think that in Iraq, some $30 billion to $60 billion may be needed to raise oil production to about six million barrels a day. A former Iraqi oil minister, Fadhil al-Chalabi, says the country will need about $5 billion to bring its production capacity to pre-Gulf War levels of slightly more than three million barrels a day in the first two or three years after sanctions are lifted.

With such investment needs at stake, Iraq and Iran are welcoming foreign oil companies. It's an offer that oil companies find increasingly hard to decline despite the threat of U.S. reprisals. More than 40 companies continue to negotiate for contracts, including for exploration rights in Iraq's western desert, which is thought to contain large undiscovered reserves. Indeed, Iraq has exploited only a few of the fields it has already discovered.

So far, the losers in Iraq are oil companies from the U.S. and Britain -- which shares Washington's hard line toward Iraq -- the very countries that may end up leading the bombing of the country.

"The size of Elf [France's Elf Aquitaine SA] as a company would double overnight" with the stake it's negotiating with Iraq for the Majnoon field, says Roger Diwan, an analyst at the Boston offices of consultancy Petroleum Finance Co. And Majnoon is just one of Iraq's supergiants.

But some analysts, looking at their supply-and-demand projections and factoring in the recent Asian economic crisis, don't think such huge resources need to be developed in Iraq so soon. "We can get away with output restraints on Iraq" for some time, especially because Saudi Arabia still has the capacity to produce more oil, says Fareed Mohamedi, a managing director of Washington-based Petroleum Finance Co.

In the end it comes down to a matter of timing, with oil companies that aren't restricted by being British or Americans eager to secure cheap oil assets that they know will be needed in a few years, if not sooner. And the low-cost giants of the Middle East can still do wonders for a company's profit. Says Mr. Tahmassebi of Energy Trends: Iran and Iraq will be "a bonanza for oil companies."