Preliminary assessment of the GSDPC

Ahmed M. Jiyad

Norway

Email: mou-jiya@online.no 

 

This assessment is primarily of and based on the text of “Model Gas Service Development and Production Contract “GSDPC” dated May13, 2009”, presumably finalised by the Iraqi Ministry of Oil-MoO, and was communicated to me on 19th June 2009 by colleagues within the internet circle.

I should emphasise at this stage the following:

1-     The GSDPC is supposed to be about gas fields, but most provisions therein are more related to Oil fields than to Gas fields. This render the text of GSDPC weak in substance and structure to be a base for “contractual obligations”;

2-     The format of the document is in MS Word, and not in Pdf. I assume, therefore, the text as real, original and authentic unless MoO confirm otherwise;

3-     My opinions expressed hereunder, can be interpreted to be applied to both type of fields- oil and gas- unless specified differently;

4-     The date the GSDPC was finalised was May13, 2009. Had MoO made it available for evaluation then, many concerned Iraqi oil specialist we could have studied it carefully and provide constructive opinions on it;

5-     The prime purpose and intention of this assessment is to provide professional, comprehensive and impartial assessment of the contract but I will be guided by the Constitutional core principles of “ownership” and “best interests of the Iraqi people”

 

In this assessment I will focus on the main issues following the structure of the contract.

 

Matters of Legality

I have argued during the last two years that the “executive branch”, i.e., the Council of Ministers and MoO are not constitutionally empowered to “inter into force” such contracts, and only the Parliament/ Council of Representatives-CoRs has such authority. Legal opinion submitted recently, 4th June 2009, to CoRs on this matter by three Iraqi Lawyers is in line with such understanding.

Therefore, the coming into force of this contract, and any other contracts, by an approval from CoM pursuant to Article (§) 39 of the contract can be contested on grounds of illegality and unconstitutionality.

Furthermore, the fact that the English version of the contract prevails over the Arabic version in case of dispute, pursuant to § 2.1 and § 35.1, would make any approval by CoM, based on the Arabic text of the contract and/or Arabic correspondent, by MoO to CoM, related to seeking such approval, was NOT constructed on the effectively governing text, and thus could be ill-informed, by will or negligence or incompetence.

 

Conclusion: CoM should read and read carefully the English text of the contract before authorising any body to “sign” it. Similarly, CoR should read and read carefully the English text of the contract before “approving” it, and “enacting” it by Law.

 

 

Duration of the Contract

The duration of the contract could be open-ended but not less than 20 years, pursuant to § 3.2, expandable by 5 years, pursuant to § 3.3, and extendable in consequence of different circumstances mentioned in § 12.2 (f); § 12.6; § 31.4 and § 41.17.

The word “basic”, in § 3.2, could imply minimum, and thus the period could be 20+. Also “basic” cannot be interpreted as “up to” which has been reported in the media.

While recognizing the usefulness and needs to have a reasonable duration to attain the stated production capacity objectives the duration of 20+years is indeed unjustifiable, and should not be acceptable especially for the discovered oil fields included in the 1st bidding round, especially when compared to the range of less than 9 years for such service contracts.

 

Conclusion: the period of 20+years envisaged in the contract are too long for Service Contract, and with the possibility of unfavourable conditions as spelled out hereunder of this contract    such along period could work against the best interest of the Iraqi people.

 

Exclusive Rights

In addition to the unusually and unnecessarily long duration, the contract offers, in § 2.3, the contractor the “exclusive right to negotiate a separate agreement to explore for and develop the undiscovered potential reservoirs”.

Apart from the likelihood that such exclusive rights could prolong the presence of the “contractor” for similar duration as discussed above, such formulation of “exclusive right” could generates three detrimental consequences. First it weakens the negotiation position of the Iraqi side to deal with these “undiscovered potential reservoirs” during the 6 year period mentioned therein; second, it will “tied-up” more of the petroleum resources, and third, the “rights exclusivity”, in addition to long duration looks like “book reserves” of the Production Sharing Contracts/Agreements PSCs/As type.

There is no strong and convincing justification to offer the contractors with such “exclusive right” to future discoveries. If need be and in order to provide incentives for the contractors, then the said article be redrafted to eliminate such exclusive right.

 

Conclusion: the contract should not offer explicitly and implicitly any “exclusive right” to any IOCs to future discoveries.

 

Signature Bonus

According to § 4.2 the signature bonus paid shall be considered Supplementary Costs and shall be recovered by 20 Quarterly payments beginning with the ninth Quarter following the Quarter of the Effective date (§ 19.2 (a)) and shall bear interest at LIBOR plus one percent (1%) (§19.2 (e))

 

The wisdom of the decision to convert signature bonuses into interest-bearing loan is questionable since it causes serious financial losses and tantamount to giving away what should have been financial revenue and, moreover, create financial burden with its own complications and sever detrimental ramifications on the economy at large.

As it is well known the bidding fees, signature bonuses, and various rental fees are among the “pre-production” fiscal terms in petroleum upstream contracts between the host government and the IOCs. The purpose is to allow a host government to earn revenues even before discovery/production occurs. Furthermore, and to maximise such revenues also, it can be used as a bidding parameter when there are many competitors.

It is worth mentioning in this juncture that record high signature bonus of $2.2 billion was paid by the Chinese company “Sinopec” in 2006, to outbid its competitors to get the rights for oil and gas exploration in two blocks in Angola. 

Two exploration blocks, with all risks involved, in Angola generate $2.2 billion in signature bonus revenues, while 6 producing oil fields (currently producing over 2 million b/d, according to MoO “Information on Contract Areas”) and 2 known gas fields in Iraq generate nothing in signature bonuses! But this is not the end of the story.

 

It is therefore, very regrettable that instead of including signature bonus among the bidding parameters that could have generated financial gains to Iraq at this financially critical time, MoO not only gave them away but converts them into debt.

And this takes me to the second issue, the interest rate on the recoverable signature bonus.

 

The rate of interest at LIBOR plus one percent (1%) should not have been accepted even considered let alone accepted for the following reasons:

First, we are dealing with IOCs not bankers or short terms trade suppliers. IOCs, should be more than happy to have an access to lucrative business opportunities with significant strategic worth and implications;

Second, the margin of (1%) over LIBOR is very high, and thus unacceptable indeed. During the worst time of the 80s we accepted to pay such a margin for tow occasions only, but not related to “project financing”, and we suffered a lot from that until Iraqi negotiators managed to reduce it much lower than that.

Third, the LIBOR itself is not suitable as interest rate threshold and it generates uncertainty. Today it might be low but 7 years ahead it could go up and thus could to heavy financial burden;

Fourth, considering the recent decision by CoM to seek “deferred payment” possibilities to finance projects, offering LIBOR plus one percent (1%) in oil and gas contracts sets dangerous presidence and could either de-rail these “deferred payment” orientations or make them very costly.

 

Conclusion: The rate of interest at LIBOR plus one percent (1%) on signature bonus is totally and emphatically unjustifiable, and if need be these signature bonus should be interest-free.

 

 

National Petroleum Policy and Management

Many provisions in the contract would vest major decision making powers in the hands of the Operator, the Contractor, the Joint Operating Company-JOC, Join Management Committee-JMC and Board of Directors-BOD, with regards to matters related to Work programmes, Budgets, all types of Development Plans (§ 9; 11; 12 and 13), without specific reference to MoO.

 

In all these matter the MoO has absolutely no role to play. This could very well lead to weakened national control regarding approvals of Work programme, Budget, Development Plans, and thus weakening any potential for national petroleum policy and management of the petroleum sector.

Furthermore, this contravenes most related provisions of the draft Federal Oil and Gas Law-FOGL. If and when this FOGL is enacted there will be very serious conflicts between the provisions of the contract and FOGL. (See also, The financial interests of the IOCs hereunder)

 

National sovereignty regarding, for example, any production management and for whatever reasons will be restricted by the provisions of (§12.5 (d); §12.6 and §19.7). This should be rejected since government curtailment of production for whatever reason is an act in and for the national interest.

 

The Contractor, under §9.11, have the right to review previous commitments made by National Oil Company-NOC (and for that mater SOC, NOC and MOC in other contracts) and may terminate them.

 

On financial maters the possibility of breaking-down or splitting major contract into many sub-contracts would be suffice to avoid any approval from higher level in the hierarchy. The Operator, for example, can avoid the approval by JOC according to (§9.19 c(i)); JOC can avoid the approval by JMC or BOD according to (§9.19 c(ii)); and JMC or BOD can avoid the approval by NOC according to (§9.19 c(iii)). The amounts involved in these three levels are $20, $30 and$50 millions.

 

Furthermore, the legal nature and character of JOC is not well explained in the main body of the contract. Will it be established and function pursuant to the Iraqi Private Company Law? 

These financial matters related to contracts wards suffer from serious oversight gap that could results in significant financial implications, which eventually could shoulder the Iraqi side with heavy burdens. Yet, MoO has no say in such contracts at these three levels of decision making.

 

Conclusion: the contract comprises many provisions capable of restricting, eradicating and weakening the role of any federal or national entity or authority in its pursuit to develop national petroleum policy, exercise sovereignty or financial oversight.   

 

Interference in the work of SOMO

Maters related to “Valuation of Petroleum” (§18) could leads in the Contractor’s interference in SOMOs pricing mechanism and procedure (§ 18.3), or requires SOMOs involvement in the   substantive and verification purposes for deemed value of gas (§ 18.4). Worst still the contract even make it mandatory on SOMO, to accept the cooperation of the Contractor in matters of particular domain of SOMO, pursuant to § 18.5, and the cost of such participation are to be considered “Petroleum Cost”.

 

The issue of payment in cash or in kind is relevant matter here as well. The options of payment in cash or kind, in oil, should remain always as an option for the Iraqi side to decide at any time it sees fit, and thus (§19.3) is not acceptable and thus should be amended accordingly. The same applies to (§19.8) 

 

If all contractors given such privilege and opportunity to involve them with SOMOs work then SOMO will not continue to exists, and this is further testimony that these contracts would dismantle national sovereignty slowly but surely.

 

Conclusion: the role and function of SOMO could be seriously hampered and malfunctioned by the privileges given to the contractors under these contracts. All provisions of particular reference to SOMO should be redrafted in such a way that SOMO, not the contractor, should have the prerogative to decide matters relating to SOMO. Furthermore, all payments, as a basic rule, should be an option and at the discretion and election of the Iraqi concerned side.

 

Remuneration Fees

Remuneration fee is a major cost item, which has direct implications of field development capital requirements and production cost of petroleum. The Remuneration Fee per Barrel of Fuel Oil Equivalent shall be determined on the basis of the R-Factor according to (§19.5(d)).

However, while we could accept the “Remuneration Fee Bid-RFB” as the base when R-factor is less than (1.0) we could pose the following questions: what are the justification of these  high percentages, 80 % (as cap) down to 30% (floor), which they could result in higher remuneration fee? Why not having, for example, 50% (as cap) and 15% (as floor)? The second question is why these percentages were not used as “bidding parameter”? Had MoO used them used as bidding parameters then IOCs would compete on Remuneration Fee Bid (RFB) and the reductions on it as function of the R-Factor.  Substantial savings could be made had we adopted this alterative method. Finally, the 8 oil and gas fields offered in this bidding round have different potentials. The Minimum Plateau Production Target (MPPT/bd) varies between 220,000 b/d for Bai Hassan oilfield to 1,750,000 b/d for Rumaila oilfield. It could have been much better and more rewarding for Iraq had MoO adopted differentiated approach depending on the potential of each field.

 

Conclusion: method used for remuneration fee is not adequate and could leads to Iraq losing significant financial sums, in comparison with alternative methodology of differentiation based on the field potential on one hand and use two, instead of one, bidding parameters.

 

 

Service Fees and Invoicing

Service fee is another major cost item in these types of contract. Provisions in this contract relating to invoicing these fees and other fees cause serious concern.

The date of submission of an invoice should not be consider as the date of entitlement, rather the date of final approval after due verification, in accordance with sound and acceptable accounting procedure, should be taken as the date of entitlement. Accordingly §19.8 is not correct and has to be drafted accordingly. The same applies to similar matters throughout the contract.

 

Another provision obligates NOC to pay any costs, expenses or fees as reported and invoiced by the Contractor even when NOC dispute all or any of these costs, expenses or fees. NOC can use dispute settlement mechanisms, mentioned in the contract to settle the matter (§20.8)

This is rather unreasonable since the Contractor can invoice any amounts and NOC has to pay it regardless of its objection. What if the arbitration or expert opinion came in favour of NOC years later? Matters related to when and how the contractor reimburses NOC and whether the contractor pays interest on the amount involved etc is not addressed. This requires serious revision and redrafting of (§20.8). The same applies to similar matters throughout the contract.

 

Conclusion: Book keeping, accounting procedure, auditing requirements, financial reporting and all related maters in the contract has to be reviewed professionally and carefully.   

 

The financial interests of the IOCs

The contract in its §29.4 provide protection for any “change to the Law, , or by revocation, modification, or non renewal of any approvals, consents or exemptions granted to Contractor, , in order to maintain Contractor's financial interests under this Contract reasonably unchanged.”

 

This is stabilization or pre-emptive regulatory capture clause and could have devastating recourse effects with substantial financial on the Iraqi interests. With contract duration of 20+ years any government decision or legal instrument over this long period could affect the financial interest of the contractor one way or the other. Therefore, the final cost of the contract will depend entirely on the number and magnitude of claims that could be made by the contractor and the outcome of the arbitration process.

 

Conclusion: this is very serious clause with highly detrimental consequences on Iraq. Deleting this clause is priority, or redrafting it to reduce its impacts to the absolute minimal.

 

 

The Impact on Iraqi companies and entities.

The contract mandates the contractor and the operator to use the principle of “competitive basis” with those available in the international market regards local goods and services (§ 30)

Emphasising competitiveness would undoubtedly end the prospects of any development in local industries and service providers and could de-link the upstream oil sector from the rest of the economy. This could have, also, direct detrimental consequences on oil-related companies both public and private and thus weakening them and the prospects of their development. Through income factor effects, the competitiveness practises would exacerbates the “Dutch disease” impacts on the national economy.

 

The contract, though, provide limited possibilities in supporting Iraqi entities, such as date processing or laboratory examination or analysis (§ 14.3 & § 14.5), but no specific actions were mentioned.

 

In development terminology the backward and forward linkages of the upstream oil sector will be degraded contributing to imbalanced and enclaved local economy. If all contracts in 1st and 2nd bidding rounds do the same then the negative impacts expand from local to national level.

 

Conclusion:  the contract could weaken existing oil-related Iraqi companies and hinder the development potential of new ones, thus limiting the sustainable development local communities and national economy.

 

Assignment and Pledge of Rights

The contract through a very complex article (§ 28) gives the contractor and, for that matter, all foreign partners the possibility of assigning and pledging their rights. This is subject to a written approval by NOC.

The implication of this article is similar to the justification given for “booking reserves” under PSAs, and such understanding is substantiated by the length of the contract.

 

Conclusion: Article 28 could produce a “booking reserves” effect, therefore NOC should be extremely careful and should consult legal expert before giving any written approval pursuant to this article. It is much better, though to delete this article all together.

 

Training, Technology and Scholarship Fund-TTSF

Though the contract envisages under (§ 26.2) the establishment of TTSF. The Fund shall also be used for supporting oil and gas related technology and research including the establishment or upgrading of research institutes inside the Republic of Iraq. The Fund payment shall not be recoverable as Petroleum Costs (§ 26.3).

This is true, however, this expense is included as Expenditure for purposes of determining the R-Factor (§19.6 (ii)), and the Remuneration Fee is a function of the R-factor.

 

Conclusion: the TTSF which appears to be unrecoverable could be recoverable partially. Therefore, deleting (§19.6 (ii)) would make TTSF fully unrecoverable. Specific reference to Iraqi Universities and related academic entities should be incorporated here.

 

Other Matters

Ø      Employment issues Iraqization programme should be more assertive (§9.21 and §26.2);

Ø      Matters related to JMC  (§13), needs clarification regarding the 4th member, location of meetings, time-limit for sending documents to JMC members; quarterly meetings;

Ø      Annual reports by the Contractor and Operator (§5 ) should be more comprehensive to include other important issues such as environmental incidents, progress in Iraqization programme, etc;

Ø      Site inspection (§16) this could affects the purpose, conduct and the outcome of the inspection to begin with;

Ø      §18.7 needs clarification something missing (multiplying by what?);

Ø      There are many inaccurate cross referencing to articles;

Ø      CBI should be consulted regarding (§21.3) concerning payment in foreign currency for good and services acquired inside Iraq.

Ø      24.4) is unacceptable especially in case of “Gross Negligence or Wilful Misconduct”;

Ø      Force Majeure. This implies these (security conditions in Contract Area, the political and security conditions generally prevailing in the Republic of Iraq) are Force Majeure in any other days after the date of signing (§31.5)

Ø      Contractor’s office in Baghdad is an obligation on NOC why? (§36.2);

 

 

Final conclusion: considering the above and their possible implications it seems this contract and all other contracts related to 1st bidding round do not and could not deliver the best interest for the Iraqi people.

 

 

Ahmed Mousa Jiyad,

Norway.

 

22nd June 2009.