Types of International Petroleum Fiscal Regimes: Iraq
Posted by D Nathan Meehan July 16, 2011

Iraq Service Contracts

In 2008 Iraq embarked on the first of what, to date, has been three rounds of service contract awards to the international petroleum industry.

Each of the contracts has been slightly different, but all have followed the same general principle of service contract structure; namely that the IOCs (treated in consortium as a contractor) fund all activity in return for a recovery of their costs plus a fixed fee per barrel of production.  The fee per barrel was set pursuant to competitive bidding between companies.  Companies can receive their compensation either in cash or by lifting oil to the value of the fees to which they are entitled.

The first round of service contracts involved the large legacy fields of Iraq, each producing anywhere from around 200,000 BOPD to 1,000,000 BOPD.  The contract required that IOCs enter into a contract whereby, in conjunction with the incumbent Iraqi Ministry of Oil affiliate operating the field, would invest and increase oil production over the following twenty years.

The contractor fees (cost recovery and per barrel payment) comes out of a percentage of “incremental” production, defined as actual production in excess of a contractually defined baseline (defined as a percentage of annual decline over starting production).   Those costs not recoverable in one accounting period can be carried forward to the next.

No payments for cost recovery can be started until the contractors had increased production by a (usually) modest threshold amount (if accrued up to that point), and the per barrel fee only applied once this threshold had been exceeded.

Although defining contractual baselines can be a difficult and contentious aspect of such contracts, the impact of this was mitigated in Iraq as IOCs knew the baseline before the contract was awarded.

Contracts were awarded through a competitive bidding process whereby a consortia bid a combination of the production plateau they believed they could achieve, and the per barrel fee they would accept.  Points were awarded for each of the two bidding parameters based on the relative bids of others and the consortium with the most points was declared the winner of the contract.

However, a further stage in the process required that the fee per barrel not exceed a maximum previously set (but not disclosed) by the Ministry of Oil.  In the first round all per-barrel fee bids exceeded the Ministry maximum.  The winning bidder then had the opportunity to accept the Ministry maximum in lieu of that included in their bid.  Four consortia accepted the Ministry set fee as a result.  Although the maximum fee varied by contract area, it was typically in the order of $2 per barrel.

The consequences of this are that the fiscal terms for the contract are set only in part by the state.  In significant part they are also set by the industry through the competitive tender process.  The contract also contains provision that penalizes companies who do not make their plateau production bid; both an incentive to plan and maintain that level operationally, and not to bid too high in the auction.

The second and third round of service contract offerings had detailed differences, but involved the same general fee structure and bidding process.  Most of the fields on offer in these two rounds had very limited or no production, so all future production was available for paying fees.  Further, following the “signals” of the level of fees that the Ministry would accept, many of the bids were at or below the maximum set by the Ministry, although with these undeveloped fields the maximum fee was slightly higher, up to $6 per barrel in some cases.

All these contracts are (at the time of writing) in an early stage of execution and it remains to be seen what issues may emerge.  In addition to the fiscal terms as described above, contractors also had a minimum expenditure obligation over the initial three-year period of the contract.  The plateau bid has to be achieved within six years of contract award, and then maintained for a contractually defined period (ranging from six to thirteen years).  While plans for future development of the field are generated by the contractor, they must still be approved by the local Iraqi operating company, with ongoing governance being carried out through a management committee (joint contractor and Iraqi), and an annual work program and budget approval process.

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D Nathan Meehan