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Iraq Legal Hurdles Delay Norwegian DNO's Oil Project

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ZAKHO, Iraq Apr 30, 2007 (Dow Jones Newswires)

After building a 26-mile pipeline and sending out a flurry of optimistic press releases over the last three years, Det Norske Oljeselskap AS (DNO.OS), a small Norwegian oil company, is still waiting for permission to open the taps on what could be post-Saddam Iraq's first foreign-developed oil field.

The hold-up: Iraqi politicians back in Baghdad, a nine-hour drive south of here, have yet to approve a hydrocarbons law laying down the legal framework for foreign investment in the country's sensitive oil industry. Lawmakers could vote on a version of the law in May but the legislation has already missed a series of deadlines since the U.S.-led invasion four years ago.

DNO's plight in this remote Kurdish town in northern Iraq underscores one of the thorniest obstacles to jump-starting Iraq's creaky petroleum industry; most of the oil-rich country is wracked with ethnic and religious violence, making it almost impossible for big international oil companies to work here.

In this peaceful, semi-autonomous Kurdish enclave in the North, a number of small foreign companies like DNO are still waiting for their operations to be officially sanctioned by Iraq's central government. DNO was among the first to sign a deal with the Kurdish government in 2004 and has spent millions drilling wells and building infrastructure.

But the delay in the oil law has put back DNO's production start-up, originally expected early this year.

"We have heard so much about DNO's oil coming on stream, and yet the production start date remains uncertain," says Alex Munton, an Edinburgh, Scotland-based oil analyst at consultants Wood Mackenzie. "It says a lot about the political and legal challenges of working in Iraq."

DNO signed its contract just four months after the two sides' first meeting.

"DNO took a lot of risk when they signed," says Kurdish oil minister Ashti Hawrami. "It was before Iraq's constitution was approved so the legal status of the deal was very unclear."

The potential rewards make the legal and security risks worth taking. The area DNO has been exploring may have approximately 100 million barrels of oil. The Denmark-sized Kurdish region has potential oil reserves of 12 billion to 45 billion barrels, according to the Kurdish oil ministry. The high end of that is equal to about a third of Iraq's total proven oil reserves, the world's fourth biggest, according to the International Energy Agency.

Yet legal issues prevent DNO from exploiting even a small part of the area's oil riches. DNO can only start shipping oil legally when it has an export license, which the Kurdish government must get on DNO's behalf from the Baghdad federal government, says Hamer al-Ghadhban, oil and gas adviser to Iraqi Prime Minister Nouri al-Maliki.

That will happen after the oil law, which will provide the framework needed to attract foreign investment, is approved by the Iraqi parliament, Ghadhban says.

"We could have been in the position to deliver small volumes of oil by tanker trucks already today," says DNO Chief Executive Helge Eide.

"We've commenced start-up and extended well testing of individual wells. However, we're currently awaiting the outcome of the ongoing process," he says, referring to the oil law.

While DNO grapples with legal and technical issues, security remains a key challenge. The Kurdish military has secured much of the three-province Kurdish region, which has not seen an insurgent attack in almost two years. DNO hasn't had a single security incident threaten its 120 or so employees in northern Iraq.

Still, since the Iraqi oil sector resumed operations in June 2003, insurgents have killed or kidnapped more than 400 oil officials and workers, according to Iraq's oil ministry. Nearly all of these have occurred outside the Kurdish region, but one DNO official advises caution. "We've been fortunate, but that could change once the oil starts flowing."

The drafting of Iraq's oil law highlights the ethnic and religious tensions that beset the country. Iraq's Shia and Sunni groups want the same right as the KRG to sign oil deals with foreign companies and have vowed to fight the KRG's legal right to do so if they don't get parity.

Iraq's various religious and ethnic groups are under pressure to agree to compromises on a number of issues, including how the country's oil revenues will be shared, for a May parliamentary vote.

Eide says DNO won't move even small volumes of crude until the oil law is in place, with many Baghdad lawmakers already unhappy about the five contracts signed by DNO and other small Western oil firms with the Kurdish government.

An independent panel must vet DNO's deal, and the four others, once the law becomes final. DNO and the Kurds amended their contract in December to ensure it meets all requirements of Iraqi law, and Eide and Kurdish oil minister Hawrami say they are confident no more changes are needed.

Concern about the legality of the deal has periodically undermined DNO's stock, though it hit a record high a year ago when DNO said it had discovered a sizable find at the Tawke oil field here. In Oslo, DNO shares are trading around 12 Norwegian kroner, down 29% from a stock-split adjusted record high of NOK16.94 hit a year ago. But that level is still about eight times higher than before the Kurdish deal.

For its part, DNO has some practical issues on the ground, including the construction of a final section of pipeline that will snake over the region's rolling hillsides and connect with an Iraqi state-run pipe that delivers oil to the Turkish Mediterranean port city of Ceyhan, then on to international markets. It also has to deal with tricky logistics; the region lacks a local supply base and most equipment must be imported at extra cost, in both time and money.

Eide remains sanguine on the impact of near-term delays on cash-flow.

"Our cash balance at the end of 2006 was about $70 million, and we expect that our cash flow from operations will increase in 2007 on the back of increased production," he says.

DNO is hoping production from its operations will start at around 5,000 barrels a day and ramp up to 25,000 barrels a day, or double its total current output, by end-2007.

Such levels are a drop in the ocean of the 85 million barrels-per-day global oil market, but significant to DNO, whose output has struggled to break above 13,000-15,000 barrels a day the past three years. DNO also operates in its native Norway, Equatorial Guinea, Mozambique and Yemen.

Analysts say for DNO to reach its end-2007 output target would bode well for further exploration in the area, but say achieving much more success, like topping output of 100,000 barrels a day over the next five years, could also make DNO a takeover target.

"Reaching that level indicates to the big players that there are sizable quantities of oil in place in this region. I believe a big company would move in," says John Olaisen, an Oslo-based analyst at Carnegie investment bank of Sweden. Olaisen has rated DNO's stock "neutral" for about a year and does not own DNO shares.

DNO has explored less than 15% of the acreage under its contract, according to Eide, and already there is talk of a potential suitor. Sources told Dow Jones Newswires recently Norway's biggest oil company by production, Statoil ASA (STO), has hired a bank to advise on the possible acquisition of DNO, but said any move by Statoil would come after Iraq's draft oil law is finalized.

Sources say the Statoil discussions with DNO appear, in part, to be driven by the potential the area in which DNO is operating is more promising than originally thought, but also by concerns that DNO's contract may be made less lucrative to comply with Iraq's oil law, potentially making DNO more open to a possible bid.

Eide declined to comment on whether Statoil had made an approach. Statoil has declined to comment on the matter.

Copyright (c) 2007 Dow Jones & Company, Inc.

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