Laith Al-Shaher is the Director General of the legal department at the Iraqi oil ministry and one of the main negotiators of the South Gas Project with Royal/Dutch Shell and Mitsubishi. In a first for an oil ministry official, he spells out the main features of the deal in an interview with IOF editor Ruba Husari in Baghdad, as well as the nature of Basrah Gas Co, the first gas joint venture of its kind to be established in Iraq, according to the contract. (للنص العربي اضغط هنا)
Q: The South Gas deal has undergone changes since the heads of agreement (HOA) was signed in 2008. What are these changes that are reflected in the final agreement?
A: The Ministry of Oil (MoO) is committed to what has been signed in the framework agreement, but the final agreement has been finalized in a way that guarantees the rights of the MoO and of South Gas Co. The HOA did not cover the details and was more of a general framework. For example it talked about certain volumes of gas and of including all fields in Basrah province. But having signed field development agreements in the successive bid rounds, the MoO realized that the volumes of associated gas that will be produced will be considerable. So now we are talking about 2,000 MMcf/d of raw gas which should be enough to insure the success of Basrah Gas Co. Had we sticked to the framework agreement we would have had big commitments under the take or pay clauses. It’s not in the interest of the MoO to commit to bigger volumes. Those big volumes wouldn’t have served the project well.
Q: Among the criticism that was voiced – especially by the legal advisor to the council of ministers Dr Fadhel Jawad – was the issue of the legal basis for establishing Basrah Gas Co as a joint venture. What will be the legal status of Basrah Gas Co?
A: The Iraqi law does not allow for the establishment of joint venture companies, but it recognizes six types of companies, including a “mixed” pubic private type of company. So we will be establishing a mixed company and we will register it duly and it will be issued with a certificate of incorporation as an independent legal and juristic entity according to Law 21 of 1997. That law allows for the establishment of a mixed limited-liability company between a government entity and a private entity, whether Iraqi or foreign. So Basrah Gas Co will be established according to this law with a 51% share held by South Gas Co, 44 % held by Shell and 5% held by Mitsubishi. Dr Fadhel’s interesting observations were very well taken on board in the drafting of many articles of the agreement and the agreement itself has been amended with Shell’s and Mitsubishi’s consent in accordance with those observations. I expect the deal to be endorsed and we will go with whatever the council of ministers recommends. We responded directly to the legal advisor and pointed out that his points were well taken and were quite useful in our endeavor to preserve the rights of the state of Iraq. We received an answer that there is no objection to setting up a mixed company.
Q: Some Critics consider the transfer of assets from South Gas Co. to the new Basrah Gas Co. to be established, as a form of privatization of Iraq’s gas sector, which according to the critics makes it hostage in the hands of foreign companies. Is this right?
A: Whatever name you give to this process, we in the MoO take the point of view that the Iraqi Company Corporate Law allowed for the participation in mixed companies using assets. South Gas Co does not have enough liquidity and using the assets in this case to establish a mixed company will alleviate the financial burden on the MoO’s budget, within what is allowed under this law. So we are abiding by the law in this case.
Q: How much were the assets evaluated at and how has the evaluation been done?
A: The assets to be transferred, which involve just the facilities in the three fields and a few others, have been evaluated at $1.5 billion. The evaluation was done by a third party, in this case the international auditing firm Ernst & Young which has previously worked with the ministry of finance and the DFI. I personally believe the evaluation was fair. Bear in mind that the land will not be transferred with the assets but will be leased to Basrah Gas Co.
Q: What’s the total amount of the investment in this project, how much is the state’s share of that and how is Iraq going to finance it?
A: We estimate that the total investment would be about $17 billion. Each party will provide its share of the financing in respect of its share in the company. It’s worth noting here that 90% of the expenditures in the first few years will be dedicated to increasing gas supply to the local market. Our initial share in the project will be worth $1.5 billion in the form of assets and we expect our foreign partners to provide the cash flow equal to this amount until we reach the “matching date”. That is the date when total investments provided by the partners are equal to the assets provided by us. The council of ministers agreed that the ministry of finance will then finance the share of South Gas Co in the subsequent investments required by both party which for us will amount to about $4.4 billion. Further investments, if needed, will be financed from future revenues and from gas sales by South Gas Co. This means that the Iraqi side will be committed to providing financing in the first five years of the project only, first under the form of assets in the first three years and then in cash in the following two years. According to the feasibility study, the project will be generating enough cash flow to cover the investments needed in the following years.
Q: What will become of South Gas Co. when its assets are transferred to the new Basrah Gas Co? Will it continue to exist?
A: South Gas Co. will continue to be responsible for all gas operations in southern Iraq in the same way that North Gas Co. is in charge of gas operations in the north. It can carry out other gas projects in other provinces in the south such as Missan and Dhi Qar provinces. The South Gas Agreement is limited to three fields which we call “dedicated fields”. These are Rumaila, West Qurna-phase 1 and Zubair. Any gas operations in other fields in Basrah province fall under the responsibility of South Gas Co. Basrah Gas Co. has no association with any other than the dedicated fields. So South Gas Co. will continue operating as one of the MoO’s companies and will continue to exist as such in addition to having a 51% share in Basrah Gas Co. Furthermore it will be the supplier of raw gas to Basrah Gas Co. and the marketer of dry gas and other gas products produced by Basrah Gas Co. to the local market. At the end of the term of the contract, which is 25 years, the foreign partners will exit the project and all assets will revert to South Gas Co.
Q: Would South Gas Co. be able to participate in other gas projects with other foreign companies?
A: Yes, it can enter into associations with other foreign companies in other fields and other provinces, as long as this does not contradict with its commitments towards this project and does not harm the project. We have to respect our agreements and our commitments as stipulated in this contract.
Q: What will the fate of the staff of South Gas Co?
A: Basrah Gas Co. has a commitment in the contract to accept all staff of South Gas Co. and pay their salaries and benefits but the latter has the liberty to assign some of them to other projects or other locations. The decision is that of South Gas Co. and it has to be respected. It might choose to second them to Basrah Gas Co. and in that caste the right approvals will be sought in line with the Civil Service Law.
Q: How can you avoid that Basrah Gas Co. establishes a monopoly over Iraqi gas in the future?
A: The contract is very clear and defines a certain amount of gas to be allocated to Basrah Gas Co. which is 2,000 MMcf/d. This means there is no room for monopoly which would require volumes to be much bigger than that. The contract sets the limit to the dedicated three fields and to the volume of raw gas to be supplied to the new company. At one point, it might be possible to provide this volume from just two fields, which means we won’t be committed to the three fields then. Our commitment is 2,000 MMcf/d with a 15% tolerance allowed under the contract.
Q: Would Shell be adding the associated gas to be produced later from Majnoon field which it will develop separately under the service contract it was awarded in the second bid round to its operations within Basrah Gas Co?
A: No, the contract it signed for Majnoon does not allow it to do that. It will be developing the field and producing oil but the service contract it signed stipulates that it should set up gas processing facilities in Majnoon field and the produced gas will be pumped to South Gas Co, not to Basrah Gas Co.
Q: How will decisions be made in Basrah Gas Co. and how do you make sure the interests of Iraq are preserved when you have this kind of partnership between a commercial entity and a government entity?
A: According to the contract there will be a management higher committee or a higher board made up of 10 members, headed by the Iraqi side. South Gas Co. will be represented in the board in a way that preserves its rights and those of the MoO in accordance with its majority share of 51%. So Iraq’s interests will be preserved. Note that we are talking here about natural gas that is flared and we agree, based on this contract, to collect that gas, process it and use it by monetizing it and supplying products that will serve the Iraqi national economy.
Q: The main criticism to the South Gas project has always been the fact that it was not tendered but was awarded through direct negotiations. Why wasn’t it tendered for competition among several IOCs?
A: At the time, we did approach several IOCs at the same time when Shell made its first proposal but it turned out that this proposal was better than the others. Since then, this proposal went through a lot of discussion and long negotiations that lasted three years until the whole project matured. Can you imagine what would have been, had we had to conduct the same kind of negotiations in parallel with say six other IOCs? Maybe it would have taken us another ten years to conclude those negotiations while at the same time every delay of every day results in the loss of huge amounts of money to Iraq while the gas continues to be flared. We committed to what the council of ministers agreed in the HOA and all the other subsequent decisions. Our role was to bring the agreement to its best conclusion in a way that preserves the interests of the MoO and South Gas Co. We believe we have done that with two companies that are leaders in this field. No one doubts the capabilities of Shell or Mitsubishi in the domain of gas.
Q: Does this mean that similar projects in the future in other regions will not be tendered?
A: We can tender future gas projects and we can also choose to conduct them directly. It all depends on what basis and what are the justifications. If it’s going to be tendered for competition among companies, it has to be duly justified and if it’s going to be the direct negotiations way, it also has to be justified. There has to be logic to either method.
Q: But as a matter of principle, you don’t object to repeating the same exercise in other areas in Iraq?
A: I don’t object to turning the gas that is being flared into a source of revenue for Iraq in whatever way that safeguards Iraq’s interests.
Q: Is this currently on the books? Are other IOCs interested in similar gas development projects elsewhere in Iraq?
A: It is premature at this stage. We haven’t yet signed the final contract with Shell and Mitsubishi for this project and all our effort is focused on getting this done first. But it’s possible to do that in the future as long as new projects do not interfere with this one. Some IOCs have approached us and they continue to do so but we haven’t announced anything concrete yet. I personally believe it’s time we develop our gas industry and the MoO has to take this seriously. We should all work on developing more projects on the condition that they serve the interest of Iraq as a country and based on economic models that preserve the rights of Iraq and the MoO.
Q: How much are the yearly revenues that Iraq will rack up from this project and how are these calculated?
A: The revenues are calculated based on estimates according to the economic model which we had reviewed by several consultants. We believe the economic model for this project is fair. The revenues that will revert to the state will come from the sale of raw gas, taxes on profit in addition to South Gas Co’s share of profit which is 51% as well as its profit from the sales of export LNG in the future. The estimates put the revenues at some $31 billion over the life of the project after deducting state subsidies to sales gas for local consumption. On top of that the state will gain from putting an end to importing LPG and from becoming an exporter of LPG instead, and the gain from substituting fuel with dry gas in power plants and freeing that fuel for export as well. The MoO will make sure that dry gas is priced fairly to the local market in order to encourage investment in gas-based industries and support the production of electricity in addition to satisfying the local market in LPG and other products. On top of that, we will be putting an end to the flaring of gas which is costing us about $1.8 billion a year.
Q: Who will sell the gas to the local market and how will it be priced?
A: South Gas Co. will be buying the gas from Basrah Gas Co. and sell it to the local market. The priority will be to satisfy the local market fully before we turn to exporting gas. The raw gas will be sold to Basrah Gas Co. based on a formula that will insure acceptable return to Iraq and that it is resold after processing at acceptable prices too. We conducted several studies at the end of which we adopted a formula in the final contract which guarantees South Gas Co. enough cash flows in order to develop itself while at the same time provide gas supplies at decent prices to the local consumer.
Q: How do you justify that the government has to continue subsidizing the gas price to the local market?
A: Lifting subsidies to gas prices for local consumption is not possible at the moment and would result in subversive effects including increased inflation for example. This is an economic issue that is up to the Iraqi government, the ministry of finance and the central bank to decide on, it’s not a MoO decision. Furthermore, the processing of the gas to be delivered to the local market entails a certain cost and South Gas Co is a self-financed company established according to Law 22. It needs to make a profit to self-finance after deduction of costs in order to sustain itself.
Q: The contract commits the state to guarantee a certain volume of raw gas to Basrah Gas Co, which some see as a limitation on the freedom of the state to dispose of its own gas. Do you see it this way?
A: It is impossible to attract any foreign investor to commit billions of dollars in a project like this without guarantees of certain amounts of raw gas. Without those guarantees the project will not exist. Yes, we are committed to guarantee 2,000 MMcf/d of raw gas to the project including a 15% tolerance which is calculated on monthly, not daily, basis. This gives us more flexibility to preserve our rights and sustain the project at the same time. The volumes of raw gas we are talking about are not extraordinary and the three fields in question will be producing a lot more than that.
Q: How is the project treated for tax purposes? Is it considered as an industrial project since it does not conduct exploration, development and production or is it being taxed in the same way as any company involved in the upstream oil and gas sector?
A: The tax that has been applied to the project is the high end of taxes applied by the taxes authority which is 35%. That’s how it is calculated in the pricing formula in the contract. However, if the taxes authority decides to reduce it, say to 20% for example, then Basrah Gas Co. will be refunding South Gas Co. the difference by increasing the price of the raw gas, which will insure more revenue to the state. So it’s basically equivalent to 35% for the lifetime of the project. That’s quite considerable revenue to the state over the 25 years of the contract.
Q: What’s the rate of return that Shell and Mitsubishi will be making on their investment?
A:The rate of return on the investment will be achieved over the years of the contract and it will be around 15%. This is a fair return on similar investments and for a country like Iraq because it fulfills the objective of offering incentives to attract foreign investments, bearing in mind Iraq’s special circumstances. We believe this is fair for a foreign investor for such a project with huge investments like these.
Q: How do you make sure that this rate is not inflated over the years?
A: There is a mechanism that has been adopted in the contract that puts a ceiling of 17.5% so that any increase beyond that is transferred to the Iraqi side. This is done by increasing the raw gas price sold by South Gas Co.
Q: Some IOCs involved in developing oil fields on technical service contracts from the first bid round – BP is one of them – have approached the MoO with proposals to develop the associated gas in those fields themselves as an alternative to establishing the Basrah Gas Co. Would that have been feasible?
A: BP is a respectable and experienced company and we respect the proposals it has made. But we also respect our agreements and the commitments made by the government based on the HOA, which was signed with Shell before the Rumaila contract was signed with BP. We continued our negotiations with Shell and Mitsubishi without any adverse impact on other companies. Iraq will benefit from developing gas from all its fields but from an economic point of view, including all three fields from the first bid round in one project is more feasible than a separate project in each field which would have been more costly. We would like to see Iraq becoming a gas exporting country from the development of associated gas from all fields in the first two bid round and non-associated gas from the third bid round fields.
Q: BP had expressed concerns that the associated gas to be produced from Rumaila would be needed for field reinjection and might not be sufficient to supply Basrah Gas Co – which in itself contradicts with its proposal to the MoO to sign a separate gas development contract. Is there any basis to BP’s claims?
A: It is true that BP requires a certain amount of gas for field injection and other field operations. According to its Rumaila development contract it has the right to use whatever volumes needed for that purpose, but it has no right to use it for commercial purposes. Based on the production plateau target, we know how much associated gas will be produced and how much it will require for field operations. The contract bans it from flaring gas in Rumaila field and we expect it to respect its commitments under the contract to provide the gas to Basrah Gas Co. The production of 2.85 million b/d of crude from Rumaila at plateau will produce more than 1.4 MMcf/d of associated gas which is enormous.
Q: What is SOMO’s role in the export of gas?
A: The export of gas has been the subject of long discussions during the negotiations because Iraqi laws restrict the export to SOMO. Shell and Mitsubishi had asked that Basrah Gas Co be authorized to export directly but the MoO rejected that because there is no legal justification for it. So in line with the applicable laws, SOMO had to become the exporter and it will be exporting the gas and products when these are available for export, and will receive a certain fee to cover the administrative costs of exporting gas on behalf of Basrah Gas Co.
Q: The chairman of the Oil & Energy Committee in Parliament, Adnan al-Janabi, says of this deal that a bad deal is better than no deal because it is a crime to continue flaring gas. Do you agree?
A: I partially agree with Adnan al-Janabi but I believe it’s a fair deal, not a bad deal. We have put lots of efforts in it with the help of international consultants and legal offices which supported our work as well as international auditors who worked with us. And I personally believe we have reached a fair deal.