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Exxon’s Move Out of Iraq Is Puzzling

Company's production is falling and Iraq has huge potential


Exxon Mobile (NYSE:XOM) — like many of its major sisters — has been trying to turn the tide of general declining production.

How? Well, by unveiling a super-sized capital expenditure budget and undertaking a healthy dose of M&A, of course. Most recently, the company made a $2 billion drilling rights purchase from Denbury Resources (NYSE:DNR) and a $2.91 billion bid for Canada’s Celtic Exploration.

While Exxon’s general focus has been on acquiring companies with vast tracts of unexplored acreage, rivals like Russian giant Rosneft (PINK:RNFTF) have been quickly adding proven reserves and fields that pump out big amounts of hydrocarbons.

In the long run, Exxon’s forward-thinking purchases and acreage will bear fruit. But in the short term, it still needs to fix the current problem of falling production — an issue it’s had for the five straight quarters.

Which is why the company’s latest move is a bit puzzling. Exxon has decided to leave one of the biggest proven fields in Iraq — just when the nation is poised to become a huge exporter of energy.

West Qurna-1

After winning the drilling concession in 2009, Exxon Mobil now decided that it no longer has an interest in drilling in Iraq’s West Qurna-1 oilfield. This past Wednesday, senior oil ministry officials in Iraq received a letter announcing Exxon’s plan to start discussions with some international oil companies — including BP (NYSE:BP), ENI (NYSE:E) and Russia’s Lukoil (PINK:LUKOY) — to sell its stake in the massive field.

Exxon was the main developer of the $50 billion project in southern Iraq, owning 60% of the field.  Royal Dutch Shell (NYSE:RDS.A, RDS.B) and the Iraqi government own 15% and 25%, respectively.

Under the terms of the operating deal, the Iraqi government pays Exxon Mobil and its partners $1.90 for each additional barrel of oil they pumped after refurbishing the already producing field. Other deals in southern Iraq between Baghdad and foreign oil companies had similar terms.

Meanwhile, Exxon is planning to start exploratory drilling in Kurdistan as soon as early 2013. This fact has irked Iraq’s central government. The Kurdish region (KRG) is self-ruled and has been locked in a feud with the Arab-dominated central government over land and oil rights.

In November of 2011, Exxon Mobil provoked protest from Baghdad when it became the first major international oil company to sign petroleum contracts with the KRG. Out of the six blocks Exxon signed to develop with the KRG, three are in dispute between the KRG and Baghdad.

The fact that Exxon is willing to risk an international incident just makes the move even more surprising — especially since Iraq’s oil potential is just getting started.

The Lost Potential

First, West Qurna-1 is a steadily producing field. Under Exxon’s watch and by using the latest hydraulic fracking and enhanced oil recovery techniques, the field has a daily output of nearly 400,000 barrels a day. The contract targets eventual output of 2.825 million barrels a day and analysts agree it should reach that amount. With oil continuing to rise, the field is still a big money maker for Exxon, Shell and the Iraqi government.

Secondly, Iraq is on the verge of becoming one of the world’s biggest exporters of energy resources. Since the end of the Gulf War, Iraq has gone through an energy renaissance and continued to build out production capacity.

In its new “Iraq Energy Outlook” report, the International Energy Agency estimates that Iraq’s contribution to the world’s oil supply will significantly increase to more than 8 million barrels a day by 2035, far outstripping its current output. The IEA expects that Iraq will dominate oil supply over the coming decades and will become the world’s largest oil exporter after Russia by the 2030s.

While getting there will be expensive — an estimated $530 billion in costs over the next twenty years — the pay-off will be greater. Iraq and the firms developing its fields stand to gain roughly $5 trillion in revenues from oil export in the same period — an average of $200 billion a year. Those are certainly some game changing revenues — the kind that can transform a nation’s future prospects.

A Pile of Problems

Given Iraq’s potential, Exxon’s move to abandon the field warrants some head-scratching. Qurna-1 is steadily pumping and adds directly to its production numbers — something the company desperately needs, as we said earlier.

Additionally, the long term outlook for Iraq as an exporter is quite rosy (although there will be some challenges and bumps ahead). In the end, $5 trillion in revenues is nothing to sneeze at. Plus, demand from Asia and prices will continue to rise, so that $5 trillion could be worth a lot more in the long run.

Finally, there’s the other side of the coin: Leaving Iraq-proper and drilling in Kurdistan could potentially spark an international incident and get Exxon banned from the nation altogether.  That’s a pretty big risk.

Baghdad has already expressed its concerns with the Obama administration. And at the same time Exxon announced it was selling its stake, Baghdad decided to exclude Turkish company TPAO from a consortium to hunt for oil in Iraq’s south after TPAO had won a contract to drill with the KRG.

That’s not to say Exxon and CEO Rex Tillerson don’t have something up their sleeves; the company is too good not too.

But for those investors who still believe in Iraq’s prospects, Shell makes a strong portfolio candidate. It has partnered with Iraqi government on several other fields besides Qurna-1 and analysts expect it to be the number one bidder for Exxon’s stake in the field should it come up for sale.

As of this writing, Aaron Levitt was long RDS.A and RDS.B.

Article printed from InvestorPlace Media,

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