Big oil is turning its attention to Iraq once again. But this time, instead of fear and dread, oil companies are looking to the Gulf state with hope and optimism. In recent years, the Iraqi oil industry usually made the news for all the wrong reasons: sabotages of pipelines, bomb attacks at drilling sites, employee kidnappings, and government corruption. But U.S. and international oil firms are now focusing on the oil-rich nation as the site of expansion efforts that could prove to be very profitable.
Beginning next week, the Iraqi government will auction off oil contracts to foreign firms for the first time since Western companies were kicked out of the country in 1972 in a broad wave of Mideast oil nationalization. By welcoming in foreign contractors, Iraq hopes to boost production at six developed oil fields to levels not seen even before the country’s invasion of Kuwait in 1990. From 120 companies that expressed interest in the project, 35 — including Exxon Mobil, Royal Dutch Shell, and China Petroleum & Chemical — were invited to participate in the auction, according to a report by the Wall Street Journal’s Gina Chon.
Iraq is believed to hold one of the world’s largest proven oil reserves at approximately 115 billion barrels. But following years of war and neglect, production is running at about 2.4 million barrels per day, well below the output levels achieved prior to the first Gulf War. With the introduction of foreign technologies, Iraq hopes to boost its daily volume above four million barrels. As part of the dealings, foreign firms won’t get direct ownership stakes in the reserves, but rather will be paid if they are successful in boosting output. Although not as lucrative as a stake in the reserves, oil companies could still turn a tidy profit in this venture, given the significant size and relatively undeveloped nature of Iraq’s oil industry.
Entry into Iraq doesn’t come without significant risks for foreign contractors. Following the establishment of Iraq’s new government in 2006, the oil ministry was plagued by corruption and violence, as hundreds of employees were murdered or kidnapped. While the government has taken steps to correct these problems, significant risks remain. But apparently they’re not significant enough to scare away foreign investors.
As the bidding process unfolds and Iraq opens its doors to foreign investors, there are several ETFs worth keeping an eye on.
- iPath S&P GSCI Crude Oil ETN (OIL): Pardon me for opening with the obvious. If the expansion goes as planned, Iraq’s production capacity could increase by more than 50%. As any Econ 101 student can tell us, increases in supply generally result in reduced prices. But there are significant upside risks to oil prices as well. Retaliation against Western firms is a very real threat in this effort. If the country’s oil infrastructure were to suffer collateral damage, output could plunge, potentially setting the stage for price increases.
- SPDR S&P International Energy Sector ETF (IPW): The holdings of this ETF are dominated by the participants in next week’s auctions. If these firms do indeed benefit from Iraq’s invitation to boost its oil industry, IPW investors would see the benefit as well. But this is far from a sure thing, as the risks related to this venture are numerous and material.
- Market Vectors Gulf States ETF (MES): While the economies of many Gulf States have become increasingly developed and diversified, the dark cloud of uncertainty hanging over Iraq (and Iran) has shaded the entire region. Iraq’s stability as a nation, for better or worse, is contingent upon the health of its oil industry. If the effort to boost production is successful, government coffers could be refilled, providing the country with the resources it so desperately needs to continue on its long road to recovery. While this stability is obviously good for the people of Iraq, it would give the entire region a boost as well.
Disclosure: No positions.