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Exxon's Kurdistan

Why did Exxon strike a deal with Kurdistan at the cost of upsetting Baghdad? Because Kurdistan offered up one of the greatest oil basins in the world, roughly half the size of Abu Dhabi.
It was one of the oil industry's worst kept secret - that Exxon Mobil has quietly signed a deal with Kurdistan Regional Government (KRG) for six exploration blocks.

The central government in Baghdad fumed and fretted but Exxon remained mum for months, even as KRG announced the deal with great fanfare.

Iraq's central government has long held the view that all foreign oil contracts with the KRG are illegal, and it has been working on an oil law for some time, which aims to reconcile these differences with the KRG and other provinces.

At first Baghdad threatened to cancel Exxon's existing service contract for the massive West Qurna-1 oilfield in southern Iraq, but then told Exxon it could keep working if it froze its Kurdistan project.

Exxon finally ended its months of silence in its annual report.

"Exploration and production activities in the Kurdistan region of Iraq are governed by production-sharing contracts negotiated with the regional government of Kurdistan in 2011," said Exxon in its report.

"The exploration term is for five years with the possibility of two-year extensions. The production period is 20 years with the right to extend for five years."

Why did Exxon strike a deal with Kurdistan even though it threatened its huge West Qurna-1 deal?

Oil and gas research consultants IHS Energy says much of the acreage in the highly prospective Zagros Fold Belt region in Kurdistan ranks among the best basins in the world for large oil prospects and is now entering a period of consolidation as major players enter the market.

Despite the discovery of seven billion barrels of oil during the past five years, the majority of the known geological structures remains to be drilled, reports IHS in its IHS Herold Kurdistan Regional Play Assessment.

"The Zagros Foothills exploratory play in Kurdistan is the highest potential onshore area in the world, especially to be looking for oil. The drilling results there from the last several years easily justify the high ranking given to the area by my colleagues at IHS Global Insight," said Robert Gillon, director of energy company research at IHS, and co-author of the assessment along with Katherine Flynn, energy company equity analyst.

"The key here is that with the exception of some distant blocks on the Iranian border, nearly all the exploration licenses have been issued since 2007 -- there is no more land available. Despite the uncertain geopolitical situation, the play is ripe for consolidation, particularly for larger companies who wish to take advantage of the potential of this huge play and who have the financial resources and intestinal fortitude to stomach the significant risks."

HALF THE SIZE OF ABU DHABI
The area in the northeastern part of Iraq that's in play is spread over 35,000 square kilometres and is half the size of Abu Dhabi.

And ExxonMobil is not the first company to strike a deal in the Zagros Fold Belt, as the area has seen numerous discoveries and developments.

"While some of the large structures within the core of the fold belt were drilled and proven to be productive, the IHS report noted, none were commercially developed prior to 2006 due to internal political considerations," notes IHS.

The initial production sharing contract (PSC) was issued by the Kurdistan regional government to Genel Energy in July 2002 covering lands that included the Taq Taq structure. During June 2004, DNO International was awarded a production sharing agreement that included the Tawke structure. Since that time, 47 additional PSCs have been granted, for a total of 49 licenses awarded to date in the region.

According to Gillon, these licenses all have a five-year exploration period with a two-year extension possible. "The play is at the stage now where the operators must make declarations of commerciality or relinquish the acreage without going to production. Secondly, many of these licenses are held by smaller companies with limited financial resources. Their need for capital should make this region of interest to E&P; clients, to their capital providers, and to equity investors."

RISKS GALORE
The area is not without its risk but it makes up for it with low transaction values of its reserves and a lower net present value of existing fields compared to other parts of the country.

According to IHS Herold company valuation analysis, several of the companies currently operating in the play are significantly undervalued in the market--by as much as one-fourth to one-half, which is likely due to several risk factors, although the entrance into the play by ExxonMobil and the interest shown by French oil giant Total has clearly been a benefit to the equity pricing of these smaller producers.

Total chief executive Christophe de Margerie recently said that his company was interested in Kurdistan.

"From what we are hearing the conditions of the fourth bidding round in Iraq do not appear very attractive," Christophe de Margerie said at an event. "The interest in Kurdistan is that there are plenty of gas and oil reserves there and contractual conditions are better."

This last point is attracting many of the major players and may serve as a great exit point for many of the independent players operating there.

"Taking into account the size and geographic spread of their acreage positions, as well as drilling results to date, there are several companies that stand to benefit most as the play evolves," said Giddon. "They pose very attractive acquisition targets."

But the oil companies also face technical challenges, such as lack of capacity in the pipeline system and the service industry which is not equipped to manage increased production.

"The value in the play is there, that is clear. What is not clear is whether that value will be realized in a timeframe that is acceptable to investors. The key to success for E&P; companies operating in Kurdistan is that they must have a very high tolerance for risk, and they must be patient in waiting for a payday. The rewards may be great, but they may not be realized for some time," wrote Gillon.

M&A; ACTIVITY
The area has seen a number of acquisitions in the region over the past six months. Recent deals include the USD4 billion Vallares and Genel Energy merger and a USD600 million Afren farm-in, which highlight the size of the resource and potential upside.

Vallares has indicated its intention to spend a part of its US$2.1bn cash balance on further acquisitions in Kurdistan over the medium-term and expressed interest in DNO's Kurdistan assets, but the presence of Exxon has now raised all valuations.

Citibank expects the licensing activity to slow down in the short term, as very few areas remain unlicensed.

"However, the industry's interest in the region continues to grow, and positive progress on the political issues could see M&A; accelerate for the following reasons:

• The exploration story for Kurdistan is now largely understood. The play has been de-risked by recent drilling. The availability of oilfield services and drilling equipment has improved in the last few years.
  

• Despite recent activity, acquisition costs remain low on per barrel basis. Vallares' acquisition has valued Genel's 2P resource base at $6/bbl, and significantly lower if recent resource revisions are taken in account. Afren's recent acquisition was completed at US$2/ barrel.
  

• A large number of licences are still held by small (often private) companies that have limited access to capital sufficient to fulfill exploration commitments.
  
  "We believe some smaller players could be willing to reduce their stakes in exchange for financial and technical capacity to appropriately assess acreage prospectivity," notes Citibank.

• A bilateral agreement between the KRG and the central government will likely serve a catalyst for majors to enter the region. The large-caps have so far been precluded from entering Kurdistan, and focused on developing supergiant fields in Southern Iraq.
  
  Citibank see a final wave of consolidation, when these restrictions are lifted. "We believe large resource holders will be the focus of M&A; activity by the majors (vs exploration acreage), unlocking value for small- and mid-cap players."

CONCLUSION
The arrival of Exxon Mobil and possibly Total has raised the stakes in Kurdistan and opened it up to fresh investment opportunities and also forced Baghdad's hand in finalising the oil law that has been pending for years.

In many ways it is a good development and the central government should seize it. The government could choose this moment to move forward with the oil and gas law and even make its own contracts more attractive to Big Oil.

That would usher in development not only in Kurdistan but wider Iraq as well.

Also Read: Kurdistan's riches

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