On Monday 25th January, news of coordinated bomb attacks in Baghdad made headlines around the world, highlighting the ongoing violence that continues to grip Iraq. Also on the same day, the government reported that the man known as “Chemical Ali,” one of the most ruthless allies of Saddam Hussein, was executed for crimes against humanity. Receiving far less attention was a development in the country that could have a major impact on the Iraqi economy and the global crude oil market.
A consortium comprised of Exxon Mobil (NYSE:XOM) and Royal Dutch PLC has (LSE:RDSB) reportedly finalized a deal with the Iraqi government to develop the massive West Qurna phase 1 oil field in southern Iraq, a welcome sign of progress in the efforts to introduce advanced western technologies to one of the most oil-rich regions in the world. The agreement represents the first time a U.S.-led group has been allowed into the country’s lucrative oil industry since the invasion of Iraq in 2003. Exxon Mobil has an 80% stake in the venture while Shell holds the remaining 20%.
Last year, the Iraqi government held an auction for the rights to develop certain oil fields in an effort to rebuild the country’s war-torn economy. Exxon and Shell originally proposed an arrangement whereby the venture would be paid $4 for each barrel of oil extracted above the current level of production. The government rejected the proposal, and the two sides ultimately agreed on a fee of $1.90 per barrel. The Exxon/Shell team could reportedly increase production to more than 2.3 million barrels per day, a significant increase from the 279,000 barrels currently produced.
Oil ETFs in Focus
In terms of incremental oil production revenue, the deal is a relatively small one for both Exxon and Shell. If the venture is able to increase production as planned, daily revenue from the field could total nearly $4 million. Assuming year-round production, the West Qurna field could generate $1.4 billion annually, or less than 0.5% of Exxon’s current annual revenue. In addition to labor costs, the venture will be required to insure all employees and equipment in an extremely risky operating environment.
While this particular deal may not be materially accretive to either company’s financial statements, the real value may lie in the foothold established in the Iraqi market. It is estimated that Iraq has well more than 100 billion barrels of proven oil reserves, one of the largest supplies in the world. But western companies have long been prohibited from doing business in the country, forcing Big Oil to search for crude in more remote and generally more expensive locations.
The potential for lucrative partnerships is enormous. Following years of violence, sabotage, and political corruption, Iraq’s oil industry is in shambles, producing far less crude oil than before the U.S.-led invasion. If the plan to partner with Exxon and Shell proves effective–it seems as if the economics should certainly work for the Iraqi government–this deal could be the first of many to get up and running.
ETFs to Watch
Stability in Iraq hinges on stability in the national economy, which remains largely tied to the oil industry. While the partnership with western companies is likely to bring controversy to the Middle East state, it may also supply badly-needed cash reserves to a government facing numerous expensive challenges. Investors will be curious to see how this situation plays out, as the outcome could impact a number of markets around the world.
Three ETFs in focus as Iraq takes its next major step include:
- iShares S&P Global Energy Index Fund (IXC): The list of holdings for this ETF reads like a Who’s Who of Big Oil: Exxon, BP, Chevron, Total, Shell, and ConocoPhillips make up almost half the total assets. If the initial venture proves successful, Western oil companies (along with their valuable extraction technologies) could be welcome in Iraq.
- United States Oil Fund (USO): The additional two million barrels of oil per day is a drop in the global bucket, so supplies won’t surge and prices won’t plummet on this deal. But if Iraq is able to ramp up to near full capacity in coming years, prices could come under some pressure. USCF also offers a short oil fund (DNO) designed to inversely reflect movements in the price of light, sweet crude oil.
- Dow Jones U.S. Oil & Gas Exploration & Production Index Fund (IEO): In recent years, large oil companies have turned their attention to offshore oil fields, investing heavily in discovering new reserves in previously untouched locations. If Iraq opens its doors, it may spur a shift in strategy that ultimately impacts those companies engaged in exploration and production.
This article was first published by ETF Database
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