Investing in Iraqi Oil

Matthew Carr
by Matthew Carr

Iraqi Oil

In Douglas Adams’ iconic The Hitchhiker’s Guide to the Galaxy, Deep Thought tells us the ultimate answer to the ultimate question of life, the universe and everything is “42.”

The origin and meaning of that number has always intrigued fans.

But Douglas Adams explained that there was no real rhyme or reason why he chose “42.” It just popped in his head and he went with it.

I always liked Deep Thought’s answer because 42 is a key number for people in the oil business – it’s the number of gallons in a standard barrel of oil.

Now, I don’t think there are any sectors as exciting as oil, particularly now. We had a record year in 2011 in terms of prices. This year will be another record year as companies spend $598 billion on E&P. And next year looks like it will be a record year in its own right in terms of price, and it’s not even here yet.

Why? The U.S. Energy Information Administration (EIA) revealed last week that it expects the price of West Texas Intermediate (WTI) crude to average $104 per barrel in 2013.

That’s an astonishingly high yearly average, particularly in a time where Europe and the United States are trying to pull their economies out of the toilet. So a lot of energy investors are looking for opportunities to cash in.

Oil, Oil Everywhere

Right now, the price of NYMEX benchmark crude is over $100 per barrel. And it’ll likely stay above that threshold for most of 2012. The Iran nuclear standoff is providing a psychological updraft to price. And this is on top of the number of “black swan” events that drove the commodity markets in 2011.

The Arab Spring movement that began in late 2010 led to upheavals across the Middle East, impacting oil supply from countries such as Libya. And ongoing conflicts in Nigeria, Sudan and South Sudan are also weighing in.

But we’re about to see major supply bumps in the crude market… And some of the biggest bumps will come from countries that have seemingly fallen off investors’ radars.

  • Next year, the first production from Norway’s Barents Sea will start flowing.

  • Post-Ghadaffi Libya expects to double production by 2014.

  • The Kazakhstan Kashagan field will see its first commercial output in 2013.

  • Plus, we have all those rich shale plays in North America ramping up production, as well as continuing strength from the Canadian oil sands.

But possibly the most notable is the number of major projects in Iraq coming online. Over the next few years these projects may propel its oil industry to rival that of Saudi Arabia in terms of output.

The Power Struggle Looming As An Industry is Reborn

After nine years of conflict, the United States troops finally left Iraq late last year. It marked the official end of the war.

During most of the post-war U.S. occupation of Iraq, the country’s oil production averaged about two million barrels per day (bpd) – the highest it had been in two decades. But that output is growing. It now stands at 2.9 million bpd with plans to hit 3.4 million bpd in 2012.

Projects coming online in 2013 could skyrocket Iraq’s oil output to nine million bpd.

By 2017, Baghdad has set what many see as an overly ambitious goal of having Iraq’s oil production top 12 million bpd. That would rival the Middle East’s juggernaut Saudi Arabia.

It’s a boom time for the Iraqi oil industry.

Over the weekend, Iraq cut the ribbon on the first of five new single-point mooring export terminals that will ultimately handle five million bpd of export capacity.

Like Libya, decades under the thumb of a corrupt dictator, war and international sanctions hamstrung Iraq’s oil industry potential. But it’s entered a whole new era.

Though this new era isn’t without some controversy… The international race to tap Iraq’s massive 143 billion barrels in oil reserves has sparked a power struggle between Baghdad and the semi-autonomous Kurdistan Regional Government (KRG).

And international oil companies (IOCs) now find themselves stuck between a rock and a hard place.

The Difference is R=X/Y

The central Iraq government and KRG are competing for companies to come in and develop resources. But there’s tension brewing as Baghdad doesn’t formally recognize contracts IOCs ink with the KRG Ministry of Natural Resources.

For example, on Monday, Exxon Mobil (NYSE: XOM) was barred from competing for contracts in Iraq’s fourth oil and gas licensing auction in May. This is because Exxon signed six deals with the KRG.

Hess Corp (NYSE: HES) was barred last year by the Iraqi government from working anywhere else in the country after it had done the same. And now France’s Total S.A. (NYSE: TOT) is debating whether to negotiate with the Kurds, meaning it could end up blacklisted, as well.

But over the weekend, Total’s CEO said that the company won’t likely participate in the upcoming Iraqi auction anyway, citing the opportunities with the KRG are more attractive.

The biggest hurdle for IOCs is that if they work with the central Iraq government to develop fields in the country, they actually don’t own any of the oil they produce. Instead, they’re paid a service fee on each barrel they pump out.

Under the KRG contracts the companies share profits from oil sold with the KRG.

Kurdistan claims to hold 40% of Iraq’s oil reserves. So it’s a difficult choice – take a smaller return on a larger resource base or a larger return on a smaller one.

How to Play Three Recoveries At Once

I’m always on the hunt for opportunities in beaten-down neighborhoods of the markets – Japan, Europe, sectors affected by disaster, etc.

This why I think Total provides a really intriguing opportunity. And not just because it might go forward with some Kurdistan development.

Total is Europe’s third-largest oil company. Like most European companies, it took one on the chin in 2011, off about 16% from the highs it set in the spring. And the start of the year hasn’t been spectacular yet, with the company’s stock up about 3%.

Last year, its earnings rose 17%, but that was primarily due to the high price of Brent, because its output declined 1.3%. Fortunately, management wants to rectify this. And has an aggressive strategy to take on more risks in the oil and gas sector this year to bolster production.

A deal with the KRG would exemplify this move. As well as its recent deals in Uganda, Kenya and the Ivory Coast. It’s also looking to construct a crude processing plant in Saudi Arabia to reduce its overall exposure to European refineries. The company is going to spend more than $20 billion this year to expand its resource base. So, it’s building up a head of steam.

Even more intriguing is that it just inked a $34-billion deal with Japan’s Inpex – which sells natural gas to Tokyo Electric Power – to build one of the world’s largest liquefied natural gas (LNG) facilities in Australia.

So, we have a company not only involved in the ongoing recovery in Iraq, but also looking to capitalize on Japan’s increasing reliance on energy sources other than nuclear.

Plus, from a technical standpoint, Total’s inching closer to that coveted “golden cross” where the 50-day moving average crosses above the 200-day moving average. That’s one of those ultimate bullish signals.

Good Investing,

Matthew Carr

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