ExxonMobil Caught in Iraq Political Standoff

One of the world’s largest oil producers, ExxonMobil (NYSE:XOM), has found itself in the middle of a political minefield as it attempts to take advantage of one of the largest oil plays in the Middle Eastern crude powerhouse of Iraq.

In October 2011, ExxonMobil signed production sharing contracts for six blocks covering 848,000 acres in the Kurdistan Region of Iraq. The deal was labelled a success by analysts in that the blocks fall within the Zagros fold belt region – considered by experts to be the highest potential onshore crude location in the world.

A lot has happened in a short amount of time. Last month it was confirmed that ExxonMobil had not made the final list of 47 pre-qualified bidders for the fourth round of Iraq energy exploration rights on the basis that it had signed a deal with the semi-autonomous Kurdistan Regional Government (KRG).

Out of the race

The aim of the fourth round is primarily to expand Iraq’s natural gas production capacity to satisfy the power generation sector and create gas-based industries, as well as increase the country’s crude reserves. The auction covers twelve new exploration blocks, which could add a potential 29 trillion cubic feet of gas and 10 billion barrels of crude to Iraqi reserves.

The KRG and Baghdad have had long-running disputes over political autonomy, oil rights, and contested territories, while hostilities rose recently after a clash over oil exports. Tensions reached new heights when in April the KRG suspended its supply of oil for export through the national Iraqi pipeline, claiming that Baghdad had not fully repaid operating costs to producing companies. The Iraqi government responded by threatening to deduct what the oil would have generated in sales from the KRG’s annual budget allocation – potentially halving it.

Regulatory uncertainty

According to the Iraqi Oil Ministry website, Exxon has been removed from the list, while Syrian General Oil has been added as a pre-qualified bidder, highlighting the fact that as major oil companies enter geologically-promising but politically-challenging jurisdictions they face increasing regulatory uncertainty.

“Exxon Mobil was disqualified from the fourth bidding round because of its contract with the Kurdistan Regional Government,” Sabah Abdul-Kadhim, head of the legal section of Iraq’s Petroleum Contracts and Licensing Directorate, told Reuters. “We made it clear to Exxon Mobil from the beginning that they should cancel contracts they signed with Kurdistan, otherwise they would face tough measures from the oil ministry.”

According to reports, the Iraqi government and ministry were infuriated when news of Exxon’s deal with the KRG was announced. Kadhim went on to add that any company that signs any deal with the KRG will not be allowed to participate in any bidding rounds organized by Iraq’s oil ministry.

Poor timing

The timing of the cut is poor. Crude is trading near the $100 per barrel range, and the International Energy Agency has confirmed that Iraq’s crude production rose by 195,000 barrels per day (bpd) in April to 3.03 million barrels. The country’s oil exports also rose to 2.51 million bpd – the highest level since 1979.

While many have been surprised by the decision to cut such an influential player from the bidding process, it highlights the long-standing tension between Iraq and the KRG, which strongly believes that it has the right to undertake deals independently. Many believe the KRG has woken a sleeping giant that will use its clout with international oil companies to contain Kurdistan’s ambitions.

While the action of omitting Exxon was a shock, many had felt that by striking a deal to explore reservoirs with the KRG, ExxonMobil could also be in danger of losing its West Qurna field deal with the central government. The field contains 43 billion barrels and is considered the second-largest oil field in the world; the country’s ministry has since confirmed that the West Qurna deal is not under threat.

“Untrustworthy partners”

According to International Crisis Group (ICG), a non-governmental organization committed to preventing and resolving conflict, the disagreement between Iraq and the KRG lies in that of the six explorations blocks making up the Exxon deal, two, along with a corner of a third, lie across the Green Line, which divides the KRG from the rest of Iraq.

“While ExxonMobil may have calculated that by doing so it could help bring Baghdad and Erbil to the table and effect progress on a federal hydrocarbons law, the likelier outcome is that both sides will further entrench their positions, thus increasing the chances of violent conflict,” the ICG noted. “From Baghdad’s perspective, the Kurds are making mincemeat of any attempt to have a unified federal oil strategy; increasingly, it views them as untrustworthy partners in government who are seeking to break up the country.”

The ministry is sending out a very clear message to those in the production business with its iron-fist approach seeming to have had the intended effect. French company Total (NYSE:TOT), along with Chevron (NYSE:CVX) and ConocoPhillips (NYSE:COP) were reportedly contemplating deals with the KRG, but have since pulled out on fears of being excluded from the greater Iraqi oil play.

This latest move will send shudders throughout the market. While many might consider the region to be the “wild west” in relation to supply, decision makers within the upper levels of oil majors will have to realize that this region is unique and that respect and personal interrelations are still very much the foundations of an industry too often swayed by financial gain.

Securities Disclosure: I, Adam Currie, hold no direct investment interest in any company mentioned in this article.