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Middle East governments offer sweet deals to private oil companies New development contract formulas shift price risk to governments; impact will be global, van Meurs tells IAEE Kristen Nelson PNA News Editor
Middle East governments are changing the kind of oil and gas development agreements they make with oil companies, and the impact could reach as far as Alaska, Pedro van Meurs told the International Association of Energy Economists in Anchorage May 31.
Past agreements between resource-owning governments and resource-developing companies, van Meurs said, defined what the government got. The investor got what was left. In Alaska, which has a fiscal system similar to what has been common in the Middle East, government’s take is defined by royalties, severance tax, corporate income tax and property tax. What is left goes to the investor.
But in Iran, Iraq, Kuwait and Saudi Arabia, which have been closed to private investment in oil and gas development, governments are opening their countries to private investment — and the structure of the deals those governments have negotiated or are discussing is radically different, van Meurs said. The new deals define what goes to the investor — the government gets the rest.
The price risk What is changing, van Meurs said, is who takes the price risk.
In the kind of oil and gas fiscal system typical in the Middle East — and in Alaska — the investor takes the price risk. Van Meurs, a Calgary, Alberta-based economist specializing in fiscal systems, illustrated with oil at $12 a barrel and oil at $24 a barrel.
Say the cost to develop that barrel is $6. That $6 cost is fixed. The divisible income — what remains after the cost is deducted — is what the government and the investor can split: At $12 oil, this divisible income is $6; at $24 a barrel, divisible income is $18.
Van Meurs used the example of a 10 percent royalty: $1.20 a barrel royalty for $12 oil leaves $12 less $6 in cost less $1.20, or $4.80 a barrel in corporate income; at $2.40 a barrel royalty for $24 oil, however, $24 less $6 in cost is $18 less $2.40 a barrel, which leaves $15.60 a barrel in corporate income.
By percentage, van Meurs said, at $12 oil, the corporate take is 80 percent of the divisible income. At $24 a barrel, the corporate take is 87 percent.
“The government take is progressively less — it declines from 20 to 13 percent,” he said. “The corporate take and the government take shift quite dramatically with price movements in some countries or jurisdictions of the world, Alaska being one of them.”
The corporate take of divisible income at different oil prices varies around the world, and is different in the Middle East and North Africa than in the rest of the world. Corporate take worldwide averages 27 percent at $12 a barrel oil, 33 percent at $18 a barrel oil and 34 percent at $24 a barrel oil, van Meurs said.
But corporate take varies much more by price in the Middle East and North Africa: At $12 a barrel, corporate take averages 11 percent; at $18 a barrel, 22 percent; and at $24 a barrel, 24 percent.
Cash flow affected Under systems like those in the Middle East and Alaska, van Meurs said, “cash flow of the private oil companies disproportionately increases with price, if the price goes up, and disproportionately decreases with the price, if the price goes down.” That makes the Middle East, he said, “a more volatile area from a cash-flow point of view than the rest of the world.”
In the Middle East, “until recently, the corporate take is generally lower… The corporate take typically goes up strongly if the oil price increases. This means that the Middle East become disproportionately more attractive if the oil price goes up, and disproportionately less attractive if the oil price goes down.
“Interestingly,” he said, “the fiscal system of Alaska is very similar to the Middle East. So actually, what is concluded here for the Middle East is very much the same for Alaska.”
The fiscal system in Alaska, van Meurs said, is “highly unstable” for corporate cash flow “unless the oil price is exactly $17 a barrel and stays that way.”
New terms in Middle East “The big change that’s taking place in the world is that now Iran, Iraq, Kuwait and Saudi Arabia are all opening up to private investment,” van Meurs said. This change has taken place over the past two years — formerly those countries were closed to private investment and consequently off limits for private investment by international oil companies.
“Now it seems as if the four countries all at the same time, all for very different reasons, are opening up their borders,” van Meurs said. And, he noted, they are collectively sitting on some 600 billion barrels of oil, some 60 percent of the world’s oil reserves.
And these countries are cutting very different deals than those done elsewhere in the world, deals called service agreements.
“In a service agreement,” he said, “you define what the company gets and whatever is left is for the government. In the rest of the world you typically define what the government gets and the rest is for the investor.”
Iran, Kuwait, Saudi Arabia, Iraq and even Venezuela, he said, are now doing it the other way around: “Governments are going to define what the investors get and the rest is for the government.”
Iran was first Iran started with a buy-back model, van Meurs said. The buy-back model is Islamic in concept, based on the fact that you’re not allowed to earn interest but you can buy and sell, he said.
“So what Iran did is they made a compact that is called a buy-back model, and what they did is essentially define the project that the oil company will do. They negotiate that, then they define what the company will get for it, which means how much capital they can recover and how much operating cost they can recover.” The first project, a small oil field, the profit was defined as $75 million, van Meurs said.
“And so they will define the profit, they will define your cost and that’s it. That’s what you get. If the oil price goes to $30 a barrel, that’s for the government. If the oil price goes to $10 a barrel the government will absorb that percent of the difference.”
With 100 percent of the price risk on the shoulders of the government, 100 percent of the capital and cost risk is on the shoulders of the investor, van Meurs said, “because the profit is already defined. What they’re going to get is already defined.”
In Kuwait, where he is currently a consultant for the government, van Meurs said they are considering the same concept. “The only thing is that the fee structure is a little bit more evolved and deals with a different style of fees to give specific incentives.” Kuwait is looking at fees for on-going oil production, fees for oil production enhancements and fees to encourage conservation of gas.
Iraq, which has concluded production sharing compacts in the past, is now switching to Iranian style service compacts, van Meurs said.
“Saudi Arabia,” he said, “is still considering what to do and what kind of contractual policies to instate.” Initially, he said, Saudi Arabia is looking primarily at gas production, and it is likely they will do something like Kuwait.
New agreements progressive Unlike regressive fiscal regimes (Alaska and old-style Middle East agreements) where the corporate take goes up as the oil price goes up — these are strongly progressive systems where the government take goes up if the price goes up.
From an oil company perspective, van Meurs said, “price is no longer an issue…”
So the Middle East will be split between countries with progressive and those with regressive fiscal systems.
But, he said, “Iran, Iraq, Kuwait and Saudi Arabia are sitting on most of the oil and consequently if those deals start to crystallize in large numbers, then this is going to have a very interesting impact on the oil business.”
The Middle East is largely major oil company territory, he said, and these agreements will allow the major oil companies to essentially “create a strong portfolio in the upstream where the oil price no longer matters.”
Because these deals are being done for existing fields, the risk of finding oil is removed. Van Meurs said the deal he is working on in Kuwait is for four existing oil fields with 7 billion barrels of oil. “So the oil is already there. There is no exploration risk in these fields.”
Iran is already looking at agreements for 40 fields with major oil companies including Total and Shell. Iraq is still embargoed, but has pre-negotiated a whole series of these compacts, some of them very large — 5 billion barrel fields.
“So consequently, what you see, is a whole new style of deals evolving between the international oil industry and governments. No price risk, no exploration risk.”
Governments control production levels In addition to getting private investment, the Middle East countries making these deals are retaining production control, because the deals are structured, van Meurs said, to control production.
The governments allow production to increase in steps to match OPEC production level objectives. It increases the value of the deals to the governments, he said, because if “these compacts work properly on that basis, then of course OPEC has a very strong instrument to pursue their OPEC policies because now they actually have foreign investors developing their crude oil resources and they get the same benefits that they otherwise would have had, which is a very narrow production-level management…”
The governments have the benefits of the price increases and whereas in the past they had to use their budgets to develop the next set of fields, that’s no longer necessary — private investors are doing that.
“So consequently,” van Meurs said, “for the next few years what you’re going to get is the combination of production-level management and private investment.”
Special class of deals These deals are for large fields and so they are going to be available only to larger oil companies, van Meurs said. And they are going to change the way those companies look at investment opportunities worldwide.
“If you can make good rate of return without price risk and without exploration risk, why should you go out and take all of these risks on something … and maybe the fiscal system is regressive and if the oil price goes down you’re out of luck anyway, even if you discover it?”
Van Meurs said these new agreements create “an entirely different set of circumstances” which he believes will have an important impact over the next five years on how major oil companies are going to look at the world.
What it will give major companies, he said, is the ability to take a portfolio management approach to their investments — to have projects with no price risk to balance projects which do have price risk.
“The more certainty you have in certain parts of the world, the more aggressive you can be in risk taking in other parts of the world,” van Meurs said.
The other thing to bear in mind, he said, is that while there will be significant investments made in terms of barrels being developed, the Middle East has known fields and is a low-cost area to develop, “so $1 billion in the Middle East goes about as far as $5 billion here.
“So although from a technical point of view more oil will be developed, the actual cost of development is not as much as you would think and consequently although it will have an important impact” on production levels and the role of the oil industry, the impact on capital expenditure will be “relatively modest.”
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