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Iraq warns oil companies of spending cuts

Iraq's oil ministry has issued a stark warning to the international oil companies running its energy sector that it will slash spending in 2016 as the country feels the full effect of low crude prices and the fight against Islamic State.

A Sept. 6 letter from an oil ministry official is fresh evidence that Iraq is struggling to maintain a swift expansion of its energy sector that has made it the Organization of the Petroleum Exporting Countries's second-largest producer with 4 million a barrels a day or more this summer.

The letter--addressed to "all contractors" and reviewed by The Wall Street Journal--warned big oil companies in Iraq such as Eni SpA of Italy, Russia's Lukoil Holdings, Anglo-Dutch firm Royal Dutch Shell PLC and U.K. giant BP PLC to submit conservative funding requests in 2016. Independent energy companies maintain and expand Iraq's fields with government money and are reimbursed for production with oil.

"Because of the drop in our oil-sales revenues, the Iraqi government has sharply reduced the funds available to the Ministry of Oil," the official, Abdul Mahdy al-Ameedi, wrote. "This will...reduce the funds available for the reimbursement of petroleum costs to our contractors."

Mr. Ameedi also wrote that the oil ministry didn't expect lower funding to "reduce production from the levels that were [already] stipulated."

Mr. Ameedi and the oil ministry didn't respond to requests for further comment.

Iraq has been reeling from crude prices that have fallen to less than $50 a barrel, down from highs of $114 a barrel last year, with no near-term recovery expected until 2016. A dispute with the Kurdistan regional government has resulted in much of the country's oil being exported without any benefit to the central government as it fights a costly war with Islamic State.

In August, Iraq's oil export revenues were about $1 billion lower than in the previous month, at around $3.8 billion, down from $4.9 billion in July and $5.3 billion in June, according to the Iraqi State Organization for the Marketing of Oil.

Analysts have warned that budget problems could affect Iraq's ability to pay oil companies, potentially resulting in no new development of any of the country's oil fields in 2016 beyond essential maintenance.

For example, BP is the lead operator of southern Iraq's large Rumaila field, where production was 1.3 million barrels a day at the end of 2014. There are plans in place for a further multibillion-dollar field development that would add 800,000 barres a day by 2020, but that timing is now under threat.

Asked about the 2016 budget for the Rumaila field, a BP spokesman said the company's short-term focus is on maintaining current production levels. He said longer term, the company is working with Iraq to fully develop the field to 2.1 million barrels a day.

Any query about the size of the company's budget to do so, he said, "is really a question for the [Iraq] government."

An official at a different European company in Iraq said he is worried that production levels could drop off if reduced spending means investment in new production isn't made. He said the worst-case scenario would be a lack of investment, prompting his company to declare force majeure--allowing it to pull back or stop production without legal liability because of forces beyond its control.

Other contractors, including oil-field services companies and engineering contractors, are also bracing for their respective 2016 budgets to fall off a cliff. High costs for security, labor and insurance make maintaining an operational presence in Iraq expensive. Any large cuts to budgets could result in companies deciding to pull out or operating with fewer employees.

"Ofcourse we are worried about this," said an executive from a large multinational oil contractor working in Iraq. "We are trying to clarify whether they are going to just shred the 2016 budget or are also going to defer payments for monies already owed."

There are already signs that Iraqi production levels could suffer soon. The number of operating oil rigs slumped to 44 in July, compared with 96 in June 2014. In a market report released Friday, the International Energy Agency said Iraq was producing more than its sustainable capacity of 4.1 million barrels a day.

marketwatch