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A Sticky Proposition
New York: January 18, 2010
By John Stephenson

You would think that international energy companies would be tripping all over themselves to get into Iraq—a potential energy superpower that sits atop vast oil reserves. But they aren't. Iraq is currently pumping around 2.4 million barrels per day of crude oil, but by 2017, the known oilfields could be spewing out 7 million barrels per day. Some analysts believe that within the decade, Iraq could be producing up to 10 million barrels per day and challenging Saudi Arabia as the world's dominant energy producer.

But in spite of the potential, many western companies have refused to bid to develop Iraq 's biggest oil fields. That's surprising given just how desperate Western oil companies are to find crude oil that is cheap to produce and easy to refine. Big Oil, or the so-called super majors, has another problem that access to Iraq 's giant oil fields could solve—declining reserve lives. The reserve life (reserves divided by current annual production) of a company is a measure of how long they can continue to produce at their current rate before they deplete their booked reserves. For Big Oil, the average reserve life is a sobering 12.2 years.

On December 12, 2009, Iraq concluded another round of auctions to develop its oil fields with far better results than the June auction, six months earlier. The June 2009 auction was a disaster—a televised extravaganza that resulted in just one contract out of eight being awarded.

Unlike the December auction, the June auction was doomed from the start. Most of the fields that were up for auction were existing fields that required refitting of old Iraqi equipment and the downsizing of ineffective management.

The December auction succeeded because the auction consisted of oilfields that were untapped. Royal Dutch Shell and its partner, Petronas of Malaysia, won the right to develop the Majnoon field, one of the world's biggest untapped oilfields. The biggest prize on offer, the West Qurna-2 field went to Norway 's Statoil and Russia 's Lukoil.

While the Majnoon field holds promise, its current production is only 46,000 barrels per day, but Shell believes that it can eventually boost production from the field to 1.8 million barrels per day. Majnoon could become one of the world's great oilfields, yet for all of Shell's troubles, it is only guaranteed a fee of $1.39 per barrel—a pitiful amount.

Mindful of the nationalists in parliament, Iraq 's leaders have toughened up the terms of the bidding, to all but remove any economic incentive to Big Oil, lest they be accused of selling prized oil assets on the cheap.

And while the latest round of Iraqi oil auctions is hardly going to light a fire under any company's stock price, many Western investors are hoping that their participation in the auction process will help them get a foot in the door for future energy auctions. That hope, may be woefully misguided.

Iraq has no law protecting foreign oil investments within the country and there won't be a law until after the upcoming elections this March. The new oil fields will require massive infrastructure investments to bring the oil from the ground and ship it to a refinery in a country that is still ravaged by ongoing violence. To recoup their investment, foreign oil companies will need some assurance that the Iraqi government can guarantee security for their oil facilities, a tall order in a country where the political opposition to foreign development of Iraqi oilfields runs deep.

Strong production growth from OPEC countries will be necessary to balance surging demand for oil from Asia . Iraq holds great promise as a leading energy producer, however, much will need to be done to quell the violence and to bring order, stability and necessary investment to the country so it can attain its potential.

The situation in Iraq underscores a broader theme for Big Oil—an increasing hostile global investment climate for increasingly scarce resources. With a declining set of opportunities for Big Oil, an investment in these super majors is fraught with risk. Savvy investors should orient their portfolios towards oil and gas companies active in Canada 's oil sands region of Alberta . While the oil is expensive to produce, it's plentiful, with reserve lives of close to fifty years for many investments.

StephensonFiles is a division of Stephenson & Company Inc. an investment research and asset management firm which publishes research reports and commentary from time to time on securities and trends in the marketplace. The opinions and information contained herein are based upon sources which we believe to be reliable, but Stephenson & Company makes no representation as to their timeliness, accuracy or completeness. Mr. Stephenson writes a regular commentary on the markets and individual securities and the opinions expressed in this commentary are his own. This report is not an offer to sell or a solicitation of an offer to buy any security. Nothing in this article constitutes individual investment, legal or tax advice. Investments involve risk and an investor may incur profits and losses. We, our affiliates, and any officer, director or stockholder or any member of their families may have a position in and may from time to time purchase or sell any securities discussed in our articles. At the time of writing this article, Mr. Stephenson may or may not have had an investment position in the securities mentioned in this article
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