IRAQI OIL PRODUCTION: WILL THE SOUTH RISE AGAIN?

S E C R E T SECTION 01 OF 04 BAGHDAD 003497 SIPDIS E.O. 12958: DECL: 11/04/2018 TAGS: EPET ENRG EINV EFIN PGOV PREL SENV EWWT IZ SUBJECT: IRAQI OIL PRODUCTION: WILL THE SOUTH RISE AGAIN? REF: A. BAGHDAD 3397 ¶B. BAGHDAD 1061 ¶C. BAGHDAD 2354 ¶D. BAGHDAD 3101 Classified By: Economic Counselor Michael Dodman, reasons 1.4(b,d) ¶1. (S) Summary: Oil Ministry officials estimate production in Iraq's southern oil fields has declined by approximately 100,000 barrels per day (bpd) so far this year, bringing the target production rate to 1.8 million bpd. The main culprits are the reliance on mismanaged enhanced recovery techniques to increase output and the dilapidated infrastructure in the fields. The Ministry of Oil (MoO) requires outside assistance to arrest declines in production. The October 13 London meeting launching Iraq's first petroleum licensing round (Ref A) is a step in the right direction to arrest the declines, but actual work on the fields will not start until 2010 at the earliest. The South Oil Company (SOC) is interested in engaging with oil service companies to provide a solution, but they have, as yet, not been willing to actively work in Iraq. Falling oil prices exacerbate the problem of declining exports -- a serious development given the GOI's dependence on oil for budget revenues. End summary. History of Neglect and Destruction -------------- ¶2. (U) The Iran-Iraq war started a period of isolation for the Iraqi oil industry after a time of great expansion. During the war both sides targeted oil facilities. The main battlefields of the war straddled the reservoirs in southern Iraq. The southern oil fields suffered a severe lack of investment during the nine year conflict and many high potential fields remained undeveloped and still contain landmines from that war. The short pause between the end of the Iran-Iraq war and the invasion of Kuwait allowed little time to rebuild the neglected infrastructure. Fighting in the 1991 war further damaged the southern infrastructure and the following ten years of sanctions precluded major international or domestic investment. Potentially Destructive Field Management -------------- ¶3. (C) Without access to modern field management techniques the Iraqis began injecting water into the reservoirs to maintain field pressure, an accepted enhanced oil recovery technique that also includes gas injection and steam flooding. Proper water injection maintains reservoir pressure and moves oil toward production well heads, increasing both the production of a well and potentially the ultimately recoverable reserves in the reservoir. Normally 3-D and recently 4-D seismic, well-pressure and production monitoring and well-logging are required to define and monitor water injection. The Iraqis had access to none of these. The improper use of water injection into the reservoir potentially displaces oil in the reservoir and leads to an increase in water production of wells. Without an effective means to correct these problems, the Iraqis close wells down when the "water cut", the proportion of water to oil produced, increases to a level they cannot handle. Improper water injection can cause permanent damage to an oil reservoir, but various steps can usually reverse the damage with time and much higher costs to the field developer. Known Problems in the Iraqi Fields -------------- ¶4. (S) SOC leadership recently told the Minister of Oil that the southern fields require extensive work including reworking of existing wells, drilling new wells, monitoring well production, and extensive rehabilitation of the surface infrastructure. Due to water injection and water drive within the reservoirs, the southern fields are producing increasing amounts of water and the SOC cannot effectively dispose of the water produced. The SOC dumps this water into rivers and on land, but the high salinity of the water produces environmental damage. The MoO informed Econoff that they have seen a production decline trend in the south of 100,000 bpd over 2008. They further explained that the problems with many southern fields remain, but hope to maintain the current production levels throughout 2009. (Comment: We believe this estimate is overly optimistic and previous SOC estimates of a 200,000 to 300,000 bpd decline in 2008 could be more in line with actual declines coming over the 2009 to 2010 time period.) Recently, for similar reasons, the North Oil Company (NOC) announced they would level off production at approximately 600,000 bpd. The NOC stated that limiting production would help preserve reservoir integrity and increase the quality of BAGHDAD 00003497 002 OF 004 oil produced. (Comment: This statement could relate to attempts at decreasing or maintaining water cut in current production.) Unknown Factors and their Effects -------------- ¶5. (C) In addition to problems with water cut in the fields, Embassy energy experts believe that some wells have reached the "bubble point." At the bubble point, pressure lowers to the point where associated gas at the well bore separates from the liquid, forming a barrier that prevents crude oil from entering the well. Such a condition requires re-working the well in order to once again produce oil. The MoO does not have the capability to re-work wells on a large scale or the capability to process increases in gas produced. (Note: We know that the MoO is currently dealing with issues related to water injection and increased water cut. We have no direct knowledge that gas coning is occurring, but strongly suspect it plays a role in shutting down wells and reducing production. End note.) Declines in the Future -------------- ¶6. (C) Comment: Without a means to correct reservoir degradation, Iraq will continue to see a steady decline in production over the foreseeable future. The MoO currently predicts a production rate of 1.8 million bpd in the south and a steady production rate of approximately 600,000 bpd in the north. These estimates may be overly optimistic. The production issues facing Iraq tend to increase with further production without remedial action being taken. Reservoir pressure that had been partially maintained by water injection will drop as the MoO reduces the practice. The NOC policy to plateau production is a step in the right direction, but without re-working wells and further drilling, there is no guarantee that production will remain stable. The situation in the south appears worse. A September 28, 2008 emergency meeting in Baghdad to address southern production concerns demonstrates that the Iraqis recognize the problem and that the MoO is trying to mitigate its effects. A return to the summer 2008 production highs of 2.5 million bpd will not be possible without significant investment and outside assistance and time. Should current trends continue, Iraqi output may fall another 100,000 bpd in 2009 to 2.3 million bpd or lower. End comment. Falling Exports -------------- ¶7. (C) In October, MoO officials told Econoff that they have targeted 1.4 million bpd for southern exports and for northern exports to stay steady at approximately 350,000 bpd. (Comment: The 1.4 million bpd could potentially be the 1.4 million bpd mentioned previously by DPM Barham Saleh (Ref B). End comment.) This approximately 1.75 million bpd target export total is approximately 10 percent less than 1.93 million bpd exported sustained between December 2007 and March 2008. It is also below the 2.0 million bpd and 1.9 million bpd export averages currently being used in GOI 2009 budget estimates. Should production fall further the 1.75 million bpd target could fall as well. As discussed above, declines in production should be expected but are not guaranteed. ¶8. (C) Additionally, the MoO plans to bring more refining capacity online. This expansion could potentially decrease crude oil available for export approximately 210,000 to 220,000 bpd by 2010. The increased availability of refined petroleum products in Iraq would benefit the entire country, but would still remain well below the estimated demand. Therefore, the loss in potential crude exports would not reduce the need for imported refined products to meet GOI target levels. Looking for Ways to Correct the Problem -------------- ¶9. (S) In 2004 and 2005, BP and Chevron conducted studies on the water injection efforts in the southern fields for the Iraqis. Recommendations from these studies were very similar to the measures the SOC reported to the Minister of Oil recently. Unfortunately, the Iraqis did not follow BP and Chevron's recommendations when first given the opportunity. As a result, production trends continue to decline while SOC and MoO leadership have often stated that corrective measures would require outside assistance to implement. (Comment: The recently failed short-term TSA contract talks (Ref C) and the initial two to three year phase to arrest production declines, built into the new contracts described in the October 13 London meeting, are implicit recognition that BAGHDAD 00003497 003 OF 004 outside assistance is needed to correct the problem. End comment.) ¶10. (S) The Minister of Oil recently gave permission to the SOC and NOC to contact oil service companies. In a September 25, 2008 letter addressing declines in southern production, the SOC recommended contracting with "internationally respected service companies" to conduct the work required to rejuvenate the fields. This work would be done between 2008 and 2010. (Comment: This could bridge the gap before the large international oil companies start contracts to be awarded in June 2009 as described in the October 13 meeting. This work should begin in 2010. Two groups within MoO could be sparring to promote somewhat different approaches. One group believes the Ministry should draw on international oil company, IOC, capabilities. The second group believes Iraq has the capability to run developed fields itself and that IOCs should not be invited in. Both groups agree that oil service companies will need to work in Iraq. The "go it alone" group prefers to hire oil service companies directly while the "internationalist" group sees the IOCs bringing them in. End comment.) Ministry of Oil looking to do business -------------- ¶11. (C) Ministry of Oil officials at the DG and Deputy Minister levels related their desire to engage with U.S. and other western oil service companies. On several occasions, ministry officials told Econoff that they would be happy to accept USG assistance to bring oil service companies into Iraq. Deputy Minister Shamma pointed out that prior to 2003 many oil service companies conducted business in Iraq. He added that Schlumberger operated extensive facilities in southern Iraq. MoO officials complain that currently oil service companies sell products to Iraq but do not engage on the ground. They have identified Weatherford International as the only oil service company with an active presence in Iraq. (Comment: Weatherford currently operates a small number of drilling rigs in southern Iraq. End Comment.) All of the officials identified security as the reason oil service companies had left Iraq. They complain that even though the security situation has improved, the companies have not returned. (Comment: The MoO has not released any major bid offers for oil service companies to engage on the ground in Iraq. End Comment) ¶12. (C) MoO officials have expressed a desire to meet with oil service companies willing to do business in Iraq. These statements seem to be at odds with previous reactions by Minister Shahristani. Despite the stated need and desire to meet with oil service companies, Oil Minister Shahristani has forbidden MoO officials from traveling out of the country to attend oil conferences until after the upcoming December conference in Baghdad. (In the past, Shahristani has also cut off parts of the ministry to USG officials due to "U.S. meddling.") MoO officials express dismay at this policy. Potential Fixes with Problems -------------- ¶13. (S) The service contracts unveiled at the October 13 London meeting could present a potential long-term solution to the problem. Work on these contracts will begin in 2010, if the MoO is able to maintain the current time schedule. The MoO included a two year rehabilitation phase in these contracts. They do not expect production declines to stop and increases in production to occur until after that period. Additionally, the MoO promised all rights in southern Iraq to capture and process associated natural gas and export any excess not consumed domestically to Shell in a head of agreement deal signed in September 2008 (Ref D). This agreement would seemingly preclude the use of gas injection as an enhanced recovery technique for the rehabilitation phase work by the companies that bid on operating the fields. Major oil companies expressed this as a point of concern after the London meeting. The MoO does not have the capability or infrastructure to practice gas injection at this time. ¶14. (S) KRG production could add up to 50,000 bpd to the exports in the near term. Greater amounts of KRG crude are probably a year or more away once the GOI and KRG reach a political compromise. KRG producing fields will require extensive investment in supporting infrastructure, including pipelines to connect them to the current export system. Even in the near term, KRG crude oil production will not offset declines in production for at least a year, by which time the MoO hopes to have the parts in place for the twenty year technical service contracts described in London. BAGHDAD 00003497 004 OF 004 Not all Fields are Created Equal -------------- ¶15. (C) These conditions occur to varying degrees in most of Iraq's producing fields, in both the north and south. Evidence suggests the southern fields have recently experienced greater problems than the northern fields. Some fields' surface infrastructure have degraded further than others. Surface infrastructure affects field production as well as reservoir conditions. We have indications that some fields' production trends remain on the increasing slope. Unfortunately, for most fields the production trend appears on the downward slope. Without steps to mitigate these problems, which cannot be done using solely Iraqi capabilities, crude oil production in Iraq will trend lower for the foreseeable future. Comment -------------- ¶16. (C) The MoO cannot address the current trends without outside assistance. The Minister of Oil's decision to allow regional operating companies to contact international oil service companies is a good step. However, it is not certain that this permission will translate into actual contracts: Baker Hughes representatives spoke with Embassy Officials in August 2008 and expressed on-going concerns about the security environment, but also saw opportunities to do business in Iraq. ¶17. (C) Declines of 200,000 bpd in production would translate into a decline of more than ten percent in export potential. The MoO could choose to deprive refining and electricity generation instead of exports. This would cost the GOI more than gained due to increased requirements for imports, and also runs counter to the priority accorded to increasing electricity output. Many MoO officials understand the most viable alternative is to contract with oil service companies for the interim and contract with large international oil companies for the long term. However, as seen in many other ministries, there remains a reluctance by some at the MoO (perhaps coming down from Minister Shahristani) to actively seek foreign expertise. ¶18. (C) Decreasing production and export potential in the Iraqi oil sector will lead to greater constraints on the GOI budget, which are already taking hold. Oil exports account for more than ninety percent of government revenues. Reduced exports combined with falling oil prices could create a situation where Iraq loses the cash flow to finance the capital infrastructure projects desperately needed by the country. Iraq needs international investment and active participation by oil service companies now to arrest the current decline trends and to address the country's future infrastructure needs. CROCKER