In late August 2008, Iraq’s oil minister announced that China’s major oil company, CNPC, had signed a contract with the government to develop the Ahdab field, resurrecting an arrangement reached in 1997. The Ahdab field lies 160 km south-east of Baghdad and was discovered in 1979 by the Iraqi National Oil Company. The original agreement signed  by CNPC with Saddam Hussein’s government was a production sharing contract which gave CNPC rights to the oil produced from the field as well as to profits accruing from the sale of this oil. The contract was never implemented on account of UN sanctions and then war and a change of government.

The new arrangement is a Technical Service  Contract. CNPC will take a 75% share in a joint venture company, with the Iraq National Oil Company taking the other 25%. The company will be paid an agreed fee for every barrel of oil produced. CNPC will have no rights to the oil and no opportunity for additional profits beyond this fee.

Though consistent and reliable information is scarce at the time of writing this piece, the main elements of the contract appear to be as follows. It is a twenty year agreement. Output will rise to 110,000 barrels per day in three years. Payment to CNPC will be US $6 per barrel, and the level of this fee will decline to US $3 per barrel. The total value of the contract is estimated at US $ 3 billion. In return CNPC will provide technical advisers, workers and equipment, but must also hire and train Iraqi workers.

For Iraq this is an important first contract in the post-Hussein era, excluding those ongoing foreign investments in the Kurdish region of the country. But it is only a small  first step, for the government’s aim is to raise production from 2.5 million barrels per day at present to 4.5 million barrels per day in the year 2013. Thus the Ahdab field will only contribute 5% of this incremental production. But one investment is better than none, at least for government credibility and for the morale of the National Oil Company.

CNPC too will also feel they have achieved a major success in securing this contract, for two reasons. Firstly, they have gained a foothold in a country which has the second largest remaining reserves of oil in the world and which offers the opportunity for further contracts in the future. Secondly, though the contract does not offer the large profits associated with most oil-field development agreements, it does provide a good business opportunity for CNPC’s service companies.

In this respect it is important to understand that CNPC has a number of objectives when it invest overseas. The most important of these is to gain access to oil and gas reserves in order to secure the long-term future of the company. These investments are normally carried out by CNODC, a company jointly owned by CNPC and its listed subsidiary PetroChina.

CNPC itself is a wholly state-owned holding company. At the time of restructuring in 1998, all the domestic productive assets were assigned to PetroChina. CNPC was left holding the service companies and many other assets. After restructuring  CNPC still employed nearly one million people. With limited opportunities for service provision within China, the rest of the world suddenly became an attractive option for CNPC to both earn profits and retain a large proportion of its skilled workforce. Thus CNPC’s service and construction companies have not only followed CNODC as the latter has invested around the world, but have also sought and won business on their own account. To a certain extent the Chinese service companies have become competitors to the major international oil field service companies, at least in terms of price, and have a strong reputation in delivering large construction projects through hazardous terrain on schedule.

The view of the Chinese government on this Iraqi project is not known. It is interesting that an official from the Chinese Ministry of Foreign Affairs denied that agreement had been reached. This may reflect caution or may mean that the Ministry had not been closely involved in the deal. In the past China’s government would have considered that overseas investment in oil and gas fields by Chinese oil companies was important for enhancing China’s security of supply. In recent years there has been a growing realisation on the part of many government officials and their advisors that such investments do little or nothing for the nation, but only enhance the potential profits for the oil companies. So I doubt that officials charged with national energy security will take much comfort from this deal, not least because the country is still unstable. The Ahdab field itself could become a target for attack, and the oil will have to travel 300 km by pipeline to the coast and then pass through the Straits of Hormuz by ship.  This is hardly an arrangement which enhances security of supply for China.

The Chinese Ministry of Foreign Affairs will be taking note. On the one hand the significance of China as a player in the Middle East petroleum scene has taken a step up, as its companies now have contracts in Iran, Saudi Arabia and Iraq, three countries which between them hold 40% of the world’s oil reserves and 20% of the gas reserves. On the other hand, China is now exposed to new risks: security risks to individuals engaged in the project; reputational risks if the management behaviour of CNPC does not match international standards; and diplomatic risks resulting from the country’s deeper engagement in the Middle East.

What is the significance of this contract for future contracts, either with Chinese companies or with foreign companies? It could be argued that CNPC has been very clever to win this first contract. It has been the first company to gain a firm foothold in this important oil province and in doing so has set the terms which all other companies will have to follow. There may indeed be some short-term first mover advantage to CNPC. However, the experiences of Chinese oil companies in other oil-rich countries suggest that host governments are not always blinded by the apparent generosity of their Chinese visitors. In both Angola and Nigeria, for example, the governments have taken steps to curb some of the ambitions of the Chinese companies.

In the case of Iraq, the sheer scale of the investment, skills and technology required will ensure that they cannot rely solely on the Chinese national oil companies nor on national oil companies from other developing nations. Further, the nature of this service agreement is such that the flow of capital and skills is unlikely to be as large as required if Iraq’s government insists on it being a model for future contracts, as Iran has been discovering with its Buy Back Agreements. So the Ahdab agreement may indeed be a first step for Iraq’s government and for CNPC, but it may well not set a precedent. Indeed, even CNPC itself will be looking for more profitable deals in the future.

Philip Andrews-Speed is Director of the Centre for Energy, Petroleum and Mineral Law and Policy at the University of Dundee, UK