Iraqi Oil: What's in It for the Majors?

If the invasion of Iraq was all about exploiting the country's oil, you'd never know it from the structure of the contracts being signed by the likes of ExxonMobil (NYSE:XOM), Total (NYSE:TOT), and BP (NYSE:BP).

In an analysis of the West Qurna 1 license awarded to ExxonMobil and Royal Dutch Shell (NYSE:RDS-A), Dr. Peter Wells (great name for an oil analyst!) puts the government take at $444 billion, or 99% of total revenue. This guy was hired by Toyota Motor (NYSE:TM) to build a world oil supply model, so I will assume he knows his way around a spreadsheet.

Wells assumes a 15% rate of return on the consortium's $50 billion investment in the field, and flat $60 oil. With higher oil prices, the contractors' returns improve, but they never get above 33%. To put that profitability in perspective, EOG Resources (NYSE:EOG) is seeing a 100% rate of return at both its core Bakken oil wells in North Dakota, and the Waskada field in Manitoba.

The economics of these Iraqi technical service contracts, in which the developers get a dollar or two for every incremental daily barrel produced, are not very compelling. Why, then, are so many majors and supermajors willing to take the plunge?

My colleague David Lee Smith put it this way last summer: "It's called getting your foot in the door of a country with an estimated 115 billion barrels of oil." The promise of getting better terms on future deals has got to be the prime motivator here.

For a while I thought that this stampede into Iraq might also be an effort to bolster sagging reserve replacement ratios. Occidental Petroleum (NYSE:OXY) books reserves on some projects where the company has no right of ownership, so I figured that the same rules might apply here. Most media reports conclude that there is no such provision in these contracts, though a Gazprom VP last month suggested the possibility of booking reserves at West Qurna 2. Even if the majors could claim reserves based on their economic interest in these giant fields, however, the revenue split we saw earlier suggests a pretty meager figure.

One last thought is that earning a 15% real rate of return is not the worst deal for these companies. ExxonMobil, for example, has billions in cash and short-term investments sitting there, earning next to nothing. Warren Buffett chose to stick his company's excess cash in a railroad. That's a heck of a lot safer than an Iraqi oil field, but on this scale, the pickings are pretty slim.