OIL MINISTRY RENEGOTIATING CHINESE CONTRACT

C O N F I D E N T I A L SECTION 01 OF 02 BAGHDAD 002638 SIPDIS E.O. 12958: DECL: 08/17/2018 TAGS: EPET ENRG EINV PREL IZ SUBJECT: OIL MINISTRY RENEGOTIATING CHINESE CONTRACT REF: A. BAGHDAD 2354 ¶B. 07 BAGHDAD 4046 Classified By: CETI Ambassador Charles Ries, reasons 1.4(b,d) ¶1. (C) SUMMARY: On August 11, the Ministry of Oil announced that it would renegotiate terms of a 1997 contract with the China National Petroleum Company to develop the Ahdab oil field in Wasit province. On August 17, Oil Minister Shahristani left on an overseas trip that reportedly would include a Beijing stop to carry out an additional round of negotiations. While the specific form of the new contract is murky, pricing issues and financial terms are sure to be a focus of discussions. An Oil Ministry contact said Shahristani is hoping that development of an oil field with the Chinese would be less controversial than an earlier package of Technical Service Agreements under discussion with oil majors. The latest initiative, however, could founder without a Hydrocarbons Framework Law and other legislation in place to define Ministry of Oil authorities and prerogatives. END SUMMARY The Original Deal -------------- ¶2. (C) On June 4, 1997, the Saddam regime signed a 26-year Production Sharing Agreement (PSA) with a subsidiary of the China National Petroleum Company (CNPC) to develop the Ahdab oil field in Wasit province. The contract provided for a $13 million signing bonus to the Ministry of Oil (MoO) and required CNPC to invest $600 million in the first seven years. The professionally prepared contract stipulated that CNPC would have to partner with an "Iraqi entity" that would have a 25% participating interest in CNPC's share of the contract. CNPC had a target to produced 90,000 barrels per day within six years. The contract also had a provision that CNPC would compensate MoO for windfall profits on a sliding scale if the price of the oil exceeded $17.50 per barrel. ¶3. (U) The MoO released a statement August 11 that Oil Minister Hussein al-Shahristani had met with Chinese Ambassador Chang Yi to revive the contract. MoO spokesman Assim Jihad also told the media that an Iraqi delegation would be traveling to China to work on the terms. Jihad also told the media that Shahristani also discussed construction of a power station in Al-Najibia, Basrah province, with the Chinese ambassador. (Note: We understand that Shahristani left August 17 on an overseas trip with an itinerary including Beijing.) "Oil Daily" reported August 11 that the PSA would be converted into a TSA. Oil Daily's sources specified that CNPC would provide, or arrange to provide, all capital, machinery, equipment, technology, personnel and services necessary for the agreed work plan and would be responsible for all costs and expenses. Tactics -------------- ¶4. (C) On August 14, a Director General (DG) at the Ministry of Oil briefed us on the reasons behind the decision to renegotiate the CNPC contract. Emphasizing that the deal would lead to a negligible increase in Iraq's production, he said Shahristani thought the contract would set a useful precedent while avoiding some of the pitfalls that had dogged plans to award Technical Service Agreements (TSAs) with the oil majors (ref A). First, the DG noted, the Iraqi public and politicians had a more favorable view of China and so would not be as wary of Chinese deal, like they had been regarding TSAs for oil majors like Exxon and BP. Second, since the contract was based on an already awarded PSA, there would be fewer arguments that the contract should have been awarded on the basis of an open bid. He indicated that, for this reason, the negotiations would have the existing PSA language as a starting point, with the specific terms modified to develop a kind of hybrid arrangement. Third, the TSAs were ambiguous with regard to the entity that would be the "state partner" in the contract, since the yet-to-be-formed Iraq National Oil Company should have this function, but the CNPC contract had the MoO State Oil Marketing Organization (SOMO) as the partner. Finally, in agreeing to renegotiate the contract, our source said, the GOI was responding to persistent Chinese pressure and the two sides had quietly been reviewing the contract for over a year. (Shahristani had first mentioned it to us December 3, 2007, ref B.) Issues -------------- ¶5. (U) The August 18 Middle East Economic Survey (MEES) reported that the Chinese had significantly increased their BAGHDAD 00002638 002 OF 002 cost estimate for the field's development, but that the Iraqis would only accept a moderate cost increase due to inflation and expected CNPC to lower its estimate. The Chinese have also asked for security assurances, since the field is located in Wasit province, which borders Iran and has recently been the target of a security crackdown. MEES also notes that the withdrawal of 2,000 Georgian troops, most of them based in Wasit, had unexpectedly complicated the security outlook. ¶6. (C) The MoO DG agreed that the contract's economic terms, e.g., whether CNPC would pay a lump sum or be charged fees and the price per barrel, would be the focus of the next rounds of negotiations. In addition to pricing issues, a Deputy Oil Minister told us at a separate August 14 meeting that Iraq would expect the Chinese investment to be at a higher technical level than that required in the original arrangements. He noted that the original development foresaw the drilling of vertical wells, but that MoO now wants CNPC to drill a number of wells from a single well pad, so that the new wells would not interfere with agricultural activity in the area. Contradicting his colleague, the MoO Deputy Minister also affirmed that the new deal would not be in the form of a PSA, but that MoO had drafted the new contract so that it would be consistent with provisions of the draft Hydrocarbons Framework Law. COMMENT -------------- ¶7. (C) While the MoO's reported reasons for renegotiating a contract with the Chinese seem sound from an Iraqi point of view, we have seen, in the case of the TSAs, how logical and prudent steps to increase petroleum production have foundered in the absence of a certain legal framework. Shahristani, by all accounts, is eager to be able to point to concrete achievements as Oil Minister, which, thus far, are few, but he is also focused on implementing a first licensing round to develop existing fields. The China deal could be a distraction and draw political flak and, if it does, Shahristani could easily back-pedal as he has before. So whether the contract is eventually signed may depend on how eager the Chinese government is to conclude it, how flexible they are, and how hard they push. CROCKER