CHINA-IRAQ OIL CONTRACT HIGHLIGHTS PRESSURES ON

C O N F I D E N T I A L SECTION 01 OF 02 BEIJING 003575 SENSITIVE SIPDIS STATE FOR EAP/CN JHABJAN STATE FOR EEB/ESC/IEC/ENR STATE FOR INR/EC STATE FOR INR/EAP STATE FOR INR/NESA STATE FOR NEA/I E.O. 12958: DECL: 09/10/2023 TAGS: ECON EFIN ENIV ENRG IZ CN SUBJECT: CHINA-IRAQ OIL CONTRACT HIGHLIGHTS PRESSURES ON CNPC REF: A. BAGHDAD 02951 ¶B. BEIJING 03366 ¶C. BEIJING 01374 BEIJING 00003575 001.2 OF 002 Classified By: Minister-Counselor Robert Luke for Reasons 1.4 (b) and ( d) ¶1. (C) Summary. Iraq drove the terms of the oil service contract with China signed in August 2008, and China will probably move slowly in implementing the terms of the agreement, according to Chinese energy experts. CNPC signed a USD 3 billion oil service contract to develop the Al Ahdab oil field southeast of Baghdad (see reftel 03366). The experts said that CNPC was under tremendous pressure from the central government to ensure a stable supply of oil and signed the contract because of growing international energy competition, rising domestic demand for oil, and its interest in getting into the Iraqi oil market. The deal is probably linked to China's decision to forgive USD 8 billion in Iraqi debt in 2007 and while the terms of the contract are not particularly favorable, China may see the contract as a way to win future preferential treatment from Iraq. End Summary. Deal Less than Favorable -------------- ¶2. (C) The decision to structure a deal as a service contract instead of a production-sharing contract was driven by Iraq (see reftel 02951),according to Peking University Professor Zha Daojiong. He speculated that Iraq pushed the deal with China to signal to other countries, such as the United States and Great Britain, that Baghdad would take a tough negotiating position in signing future oil contracts. Given the less than favorable terms of the deal for China, Zha expected China National Petroleum Company (CNPC) to move slowly in implementing the agreement, saying China would probably not send oil workers anytime soon and it was unlikely that we would see oil from the field for at least two years. (Note: According to press reports, Iraq announced that if work did not start on the Al Ahdab field within two months, China would risk losing the contract. End note.) ¶3. (C) Zha said CNPC agreed to the contract because it was managing three "squeezes". CNPC was being squeezed by global energy competition, which increased the negotiating leverage of oil exporting nations, growing domestic demand for oil, and what Zha described as the tenuous nature of energy contracts, which are often renegotiated. Zha emphasized that as a major oil importer, China benefited from bringing additional oil supplies onto the market, even if CNPC would not enjoy a share of the profits. Energy Foundation Chairman Yang Fuqiang added that CNPC aimed to get its foot in the door in the Iraqi oil market and further diversify its energy sources. Business and Political Considerations -------------- ¶4. (C) Zha and Yang said the deal was driven by both business and political considerations. CNPC has a history of engagement in Iraq going back to the oil for food program and is actively seeking replacement reserves abroad to supplement stagnant domestic production. Additionally, the cost of domestic oil exploration for CNPC is high. At the same time, CNPC is under tremendous pressure from the government to ensure China has a sufficient supply of oil and the deal would not have gone through without the central government's approval. Indirect Link to Debt -------------- ¶5. (C) The oil service contract is probably indirectly linked to debt forgiveness (Note: According to reftel 01374, an official at the Iraqi embassy in Beijing said a deal to forgive Iraqi debt owed to Chinese state-owned entreprises was contingent on an Iraqi decision to uphold Saddam-era BEIJING 00003575 002.2 OF 002 contracts for oil exploration by Chinese firms. End note.) Zha said that Iraq repeatedly pressured China to forgive its debt and hinted that it would link energy deals to China's willingness to comply, but added that the USD 3 billion service contract was not a sufficient return for the debt forgiveness. Yang added that China was adopting a long-term perspective on the issue and probably viewed debt forgiveness as a way to win preferential treatment from Iraq as the Bush administration neared the end of its second term. RANDT