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In This Report:

Companies Mentioned:
  • Exxon, Total
Action Calls
  • Sadr threatens no-confidence within 15 days 
    Not likely to result in no confidence, but may result in movement on some issues.
  • Exxon signs contract to drill 20 wells with IDC 
    Signals Exxon's commitment to West Qurna 1, and tacit support at Ministry of OIl.
  • Our take on 4th Round contracts
    Auction will only be first test for viability of exploration under fixed payments.
Headlines
  • Qubad Talabani to return to Erbil
    Most likely succession planning and sign of unity, but also signal to Baghdad?
  • Tensions with Sadr in Baghdad, Basra
    Look to Maliki's relations with Sadrists as signal of how far he's willing to push.

Calendar
  • May 23 - P5+1 Nuclear Talks in Baghdad
    Watch to see how Maliki comes out of the talks - as a regional statesman or not, as he may try to use them to try to elevate himself above the current messy domestic politics somewhat.
  • May 30-31 - 4th Round Oil and Gas Auction
    Besides watching for the success or failure of the auction to attract enough bidders, watch to see the price of the RFBs, given the higher risks involved in exploration versus the mostly operational TSCs. Prices should be a good bit higher than the TSC bids. Further, watch to see the prevailing tone for bidders and the Iraqi government, to see how the bidding is coming out relative to the expectations of both sides.
     
Action Calls

>> Sadr threatens no-confidence within 15 days. Four of the most senior political leaders in Iraq's fragile coalition have threatened to bring a vote of no confidence in the government unless "autocratic decision-making" stops, a letter published in a state newspaper on Saturday said. The four senior lawmakers - Osama al-Nujaifi, Masoud Barzani, Iyad Allawi and Moqtada al-Sadr - sent the letter to Prime Minister Nuri al-Maliki's bloc on Thursday, political sources told Reuters. The letter outlines eight demands to be met by May 13 to ensure the four leaders' support for Maliki's administration. "In case of a refusal to comply with the principles and frameworks of this agreement, practical steps will be taken, within a period of time not exceeding 15 days, to act upon a vote of no confidence against the government," the letter says. Maliki's bloc met on Thursday and pledged to hold a meeting of all of the coalition's political blocs within a week to hammer out a solution to the crisis, Ibrahim al-Jaafari, chairman of the coalition, said in a statement on his website. [Source: Reuters]
 
DUNIA'S TAKE: Sadr continues to play the long game. We continue to see Sadr as playing the long game. We don't believe Sadr needs to try to ascend to power now; and not at the head of a coalition with the Kurds and the more secular Shiites and Sunni of Iraqiya. Sadr is not likely to ally with the Kurds, Sunni, and secularists to join them in taking down another Shiite - namely Maliki - at this point. Further, Maliki knows this as well. However, the numbers are there; if these groups wanted to, together they could move for no confidence, and with Sadr, you never know. Nonetheless for Sadr, a no confidence vote would throw the doors open to compromises he would not likely want to consider, and further, there's the uncertainty unleashed by the fact that Iraqi President Jalal Talabani, a Kurd, gets to choose the Prime Minister under such a vote (although obviously with much negotiating with coalition partners). So the push for a no confidence vote is not assured at this point. However, to Sadr, what the current row is definitely useful for is positioning for the 2014 parliamentary elections and perhaps gaining some near term concessions.

Wish lists. So what does Sadr want? The first is obvious, listed in his demands - new appointees at the Security Ministries. Maliki has thus far kept the Security Ministries reporting to himself as an "interim" leader with an indefinite term. Putting somewhat independent players into those seats, approved by Sadr and others in the "anti-Maliki" coalition, would significantly curtail Maliki's ability to intimidate his foes. Second, Sadr really wants to continue to build the political capital that accrues to him as resistor to "the dictator" and protecting the "interests of the people." The Iraqiya folks, Nujaifi and Allawi, would also like the implementation of the security ministries, as well as the Erbil agreement, which at least on paper assures Iraqiya's power-sharing with Maliki. Presumably, the Kurds will want movement on Exxon and/or the PSCs. So each group has their own wish list, but likely with the Kurds and Sadr in the drivers seat, with the much-diminished Iraqiya along for the ride.

So what is next? What will be interesting will be to see if this unity survives the pressure of negotiations with Maliki, which are going on now. Since his opponents are only a threat when they are united, it makes sense for Maliki to try to split his opposition. Thus, Maliki's strongest opponents will likely get more, while he concedes less to those with less power. However, don't expect huge concessions, as Maliki knows he only needs to give just enough to avoid the as-yet highly unlikely no confidence vote. With Sadr in the most powerful position, look for the some movement on the security ministries plus potentially some symbolic populist concessions, with the Kurds possibly seeing movement on the oil and gas front. Most likely, though, Iraqiya will have to content itself with gaining on those items where their concerns happen to coincide with the other two parties'. The next two weeks will be interesting.
 
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>> Exxon signs contract to drill 20 wells with IDC. Exxon Mobil on Tuesday signed a contract with Iraqi Drilling Company in Basra to drill 20 oil wells in one of world's largest fields with recoverable oil reserves. Vice-President of Exxon Mobil, Jon M. Penn signed the contract with the IDC head. Penn said the contract represented an important step for Exxon. "The contract that we are executing with IDC (Iraqi Drilling Company) is for 20 drill wells in West Qurna 1 for a value of 124 million U.S. dollars. It is an important step that we take with IDC today and it is an historic moment for our continuing partnership with SOC (South Oil Company), as well as our partners," Penn told reporters. [Source: International Business Times]
 
DUNIA'S TAKE: Confirms stalemate. In the past few weeks, the escalation between Baghdad and Erbil over Exxon has receded, as a new stalemate over oil has emerged. Both Baghdad and Erbil seemed to back away from the precipice, having come as close as they could to the other side's respective "red lines" without crossing them, thereby avoiding a potential violent outcome. What has resulted is that Baghdad, through Shahristani, has essentially called off its ultimatum to Exxon to choose between the KRG and West Qurna 1, while all parties find it convenient to ignore (for the time being) any progress Exxon may be making in Kurdistan, as long as it is not too obvious. So in essence, this has allowed Exxon to continue down its stated path of fulfilling its contractual commitments to both Erbil and Baghdad.

West Qurna 1 commitment. Well, if there was any question of Exxon's intent in West Qurna 1, this should put that to rest. Essentially, by signing up for a $124 million promise to continue drilling in WQ1, Exxon is signaling its confidence for the foreseeable future in that operation and intent to fulfil its contractual obligations. And of course since the contract is going to an Iraqi entity, it may be interesting to see who in Iraq is benefitting from this contract directly or indirectly; certainly at the very least it means incremental Iraqi employment in Basra. Lastly, since the Ministry of Oil must approve the contract, it at least means tacit approval on the GoI side. (Although we have seen before that the GoI does not speak with one voice, so stay tuned.) So chalk this up as a signal for continuity for Exxon in WQ1. And as to the KRG? Perhaps we will see some modest breakthroughs there too, based on the noise around Sadr's ultimatum. Lastly, the other company to watch is Total - as the lack of immediate consequences for Exxon may embolden them to make some moves, especially if they believe their legal footing in their Halfiya field is solid and they are willing to go through the browbeating that Exxon has endured. On the other hand, calmer heads may prevail, and Total may instead wait until production there has or is about to start before they decide to make a move in Kurdistan. Or they may not move at all, of course. Much to watch in the coming weeks.


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>> Our take on 4th Round contracts. Dunia has obtained a copy of one of the earlier versions of the fourth round model contract for the fourth round auction in Baghdad. While there may be additional edits before the final auction, below, we have our initial reactions, highlighting the major points and differences to previous contracts.

DUNIA'S TAKE: Main provisions. The 4th round model contract will be familiar to anyone who has seen typical exploration contracts in the extractive resource industries. This contract is based on a 30 year basic license, with multiple opportunities for extensions. Like the Kurdish PSCs, there is a basic exploration period, followed by a development period, with the former transitioning to the latter when the company files a declaration of commercial discovery. Also like the Kurdish PSCs, there are opportunities for multiple discoveries and thus multiple development areas can be declared within one license area, with each development area subject to its own costs and cost recovery individually. (Thus a company can make money in one and lose on another - cost recovery is separate.) Also, as in the case of the Kurdish PSCs, the sovereign entity, in this case the Government of Iraq (GoI), retains many privileges, while the contractor, by signing up, undertakes minimum milestones that it must meet in specific time frames. Further, as is common with such contracts, there are local preferences in terms of hiring and subcontacting, "Iraqization"/knowledge transfer, and of course, education and infrastructure funds to support development of the local economy. Lastly, the contractor has a right to be reimbursed for its costs in exploring for hydrocarbons once a discovery is made, as well as a certain amount of profit once all initial costs are recovered. So far, so typical.

Differences. However, there are a few major differences that together will determine the success or failure of the bidding in the 4th round on the 30th and 31st of May, and perhaps the long term viability of any deals that come out of the bidding round
. Among those key differences, the following jump out as the largest:
  • Flat remuneration fee. This is the greatest difference, as this flat fee (the Remuneration Fee Bid, or RFB) ensures that while the contractor takes on all the risks typical of an oil company exploring in Iraq, its benefit per barrel of oil equivalent (boe) is capped by whatever RFB it enters in the auction. Now, while the bidder will still have some upside based on how many boe are actually discovered and commercially extractable, it will not benefit from upside in the oil price - all of that upside is reserved for the GoI.
  • Declining remuneration. We note this because, while declining compensation is not unusual in and of itself, when paired with the flat fee, it is particular damaging to the ROI of any business case. In the 4th round model contract, the remuneration fee decreases by 20% at certain break points beyond the initial cost recovery period. Once initial exploration costs are recovered, the company receives only 80% of the initial RFB per barrel, going down to 20% per barrel once a 150% profit above the initial costs is recovered. It should also be noted that there are certain expenses that are not included in cost recovery, including the initial bonus paid to the ROC at contract signature and the technical training fund set up for knowledge transfer and training for Iraqis in-country.
  • Rejection options. The GoI has the option to reject the contractor's declaration of commerciality if less than 200 million barrels of oil equivalent is found, if the Regional Oil Company (ROC) determines that 200 million boe production or more is not satisfactorily demonstrated, if the discovery is integrated into an existing development area, or if the declaration of commerciallity contemplates crude oil production in a gas block. This last term is particularly painful, given that an oil discovery tends to be worth much more than a gas deposit. In essence, this puts a number of further constraints on the ability to make the money on the contract, above and beyond the flat RFB. While governments routinely have veto powers over production on their lands, these additional constraints make a potentially difficult ROI moreso.
  • 7 year holding period. The GoI has reserved the right to approve the declaration of commerciality, but require an holding period of up to seven years prior to development. Now, the government must then pay for the company's costs plus interest, but this potentially postpones any ROI for a very long time.
Overall conclusions. So the 4th round contracts retains all the usual constraints of a typical resource contract, including tight oversight by the government entities, where the ROC can overrule the contractor under certain conditions. Further, also typically, the ROC has the option to create a Joint Operating Company (JOC), which is funded by the contractor, but where ownership is shared with the ROC. So, as in most resources contracts, the host country does not take on the direct risks of the exploration, but is able to share in the spoils. The main difference in this case is that these onerous contraints are not countered by the possibility of outsize rewards, but instead, the profit per barrel is capped at a defined number. As a result, while both these contracts and the Kurdish PSCs share the chance that all exploration costs will be lost, break-even on the 4th round contracts is likely to stretch farther out into the future, with a potential hiatus of up to seven years,  and the eventual ROI is likely smaller and less certain. Further, there is less room for a "home-run" type payback which might justify the risk.

What to watch for. This does not necessarily mean the auction itself will fail, but the contracts could be fundamentally flawed from the outset. So besides looking to see if the GoI is able to secure any bidders at acceptable prices, we would look for two other signals. First, the RFBs that are entered in the auction to should be monitored. We would expect they will be substantially higher than those that occurred in previous bidding rounds, as the risks in exploration are significantly greater and the dollars risked can be much larger than in the more operationally oriented TSCs to date. Thus, with more at stake and riskier, look for companies to require higher bids. Further, given the significant minimum exploration obligations in the contracts, contractors may find that as they explore and learn more, their flat RFBs give them little hope in an ROI, but they are still locked into millions in commitments. So just as Statoil recently exited WQ2, there is possibly an even higher chance for early exits with 4th round contracts, given the higher uncertainties in oil exploration versus the operational improvements required by the TSCs. So the viability of the fourth round won't be decided by the end of the bidding; at that point, the test will have just begun. Far more indicative will be the number of companies that end up looking for the exits partway through their contracts.

 


Headlines

>> Qubad Talabani to return to Erbil. Qubad Talabani, the longtime Iraqi Kurdish Regional Government (KRG) envoy to Washington, will move to Kurdistan this summer after a twelve-year run representing Iraqi Kurdistan here that has seen the US invasion and withdrawal from Iraq. Talabani, 34, the son of Iraq’s president Jalal Talabani, will head up a new strategic policy coordinating body reporting to the Kurdistan region’s prime minister, Talabani said in an interview last Tuesday. He will be based in the provincial capital of Erbil, and accompanied by his family. “Clearly, professionally, this is a step in the right direction for me,” Talabani said. “After twelve years of being here, I am sad to leave this great city but excited to start a new challenge.” [Source: al-monitor.com] Our take: Most likely, this is succession planning on the part of the Kurds. Qubad's father, Jalal Talabani, is president of Iraq, but has had difficulties with his health recently, sparking some speculation about how long he will remain active in politics. Further, the elder Talabani recently moved to Erbil, the capital of Kurdistan from his party's traditional home city, Sulaymaniyah, sparking speculation about the standing of the PUK in Kurdish politics. With Qubad returning to Erbil, it may just be that the intent is to ensure continuity at the PUK and to support Kurdish unity as Massoud Barzani, Kurdish President and head of the other major party, the KDP, has Erbil as his headquarters. And more importantly, given that one of Maliki's strongest weapons against the Kurds is to exploit division between the two major parties, perhaps the concentration of the leadership of both in Erbil is a signal to Baghdad about Kurdish determination.
 
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>> Tensions between Maliki and Sadr in Baghdad, BasraSWAT teams reporting directly to Prime Minister Nouri al-Maliki's office started a search and arrest campaign late Monday night in the Tunis quarter of northeast Baghdad looking for “terror suspects”, according to a press source. Some local residents claimed that even Sadrist followers and “Mahdi Army members” were among those arrested. Meantime, Maliki's Islamic Dawa Party has denied reports that it has “seized a government building” in Nasiriyah to use as its headquarters, despite insistence that it had on the part of cleric Muqtada al-Sadr. Dawa’s spokesperson in Dhi Qar, Abu Huda al-Shatri said that the Dawa party has a legitimate sublease with the building’s owner to rent the gymnasium for 800,000 dinars per month. Earlier in the week, responding to one of his followers, Sadr accused Dawa of “seizing” the property, which he claims belongs to the Directorate of Eduction in Dhi Qar. “My advice to them is to vacate the premises immediately,” Sadr wrote. [Source: burathanews.com]  Our take: The actions of Maliki's personal SWAT teams in Baghdad, and his Dawa party in Basra could be unsettling if they signal Maliki or his affiliates are willing to challenge Sadr's followers head-on. Maliki has used intimidation tactics like this effectively before, particularly against Iraqiya, so expect him to test the waters, especially with negotiations continuing on Sadr's no confidence threat. However, as we have noted before, Sadr's followers tend to be a more volatile breed, so Maliki's intimidation tactics could spark a violent reaction. Maliki knows this of course, so hopefully these are not an emerging pattern. But watch what happens between Maliki's and Sadr's followers to be sure negotiations, and not violence, decide the outcome of Sadr's ultimatum.

 


About Us

With offices in Washington DC, Dubai and Kampala, Dunia Frontier Consultants (DFC) provides consulting services to investors and corporations operating at the frontiers of 21st century business. Dunia works closely with a small number of clients internationally to provide an unparalleled level of service. With a world-class staff and highly efficient global network of consultants and partners, we support your endeavors in several key areas:
  • Emerging Markets Investment. The heart of our business, we offer a full suite of financial services, including deal sourcing, due diligence, valuation, and market survey support;
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Dunia in Iraq
Dunia has performed dozens of due diligence and market surveys in the agriculture, oil and gas, manufacturing, logistics, and real estate sectors of Iraq. Dunia recently completed an in-depth survey of the upstream oil and gas sector, a number of surveys of the housing and real estate markets of non-Baghdad locals, and continues providing actionable insights on developments in the Ministry of Oil, its operating entities, and with comprehensive analyses of the on-the-ground situation surrounding the major oil fields under development. 
 
Contact: 
Kyle Stelma
Managing Director
Fairmont Hotel Suite 712
Sheikh Zayed Road
Dubai, UAE  65736
kyle.stelma@dfcinternational.com 
971.55.925.9869

The views expressed in this report in connection with securities or issuers accurately reflect the views of Dunia Frontier Consultants and no part of Dunia’s compensation was, is, or will be directly or indirectly, related to the specific recommendations or views expressed in this report. Dunia Frontier Consultants is an independent business and financial consulting firm with a specific focus on emerging markets and has not received compensation from any of the companies mentioned in this report. All pricing of securities in reports is based on the closing price of the securities’ principal marketplace on the night before the publication date, unless otherwise explicitly stated. This report is provided for informational purposes only. This report is not, and is not to be construed as, an offer to sell or solicitation of an offer to buy any securities and/or commodity futures contracts. The securities mentioned in this report may not be suitable for all investors and may not be eligible for sale in some jurisdictions where the report is distributed. The information and opinions contained herein have been compiled or arrived at from sources believed reliable, however, Dunia Frontier Consultants makes no representation or warranty, express or implied, as to their accuracy or completeness. Dunia Frontier Consultants has policies designed to make best efforts to ensure that the information contained in this report is current as of the date of this report, unless otherwise specified. Any prices that are stated in this report are for informational purposes only. Dunia Frontier Consultants makes no representation that any transaction may be or could have been effected at those prices. Any opinions expressed herein are Dunia Frontier Consultants’ and are subject to change without notice. Neither Dunia Frontier Consultants nor its affiliates accepts any liability whatsoever for any direct or consequential loss arising from any use of this report or its contents.
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