VZCZCXRO1573
RR RUEHBC RUEHDA RUEHDE RUEHIHL RUEHKUK
DE RUEHGB #0955/01 0971324
ZNR UUUUU ZZH
R 071324Z APR 09
FM AMEMBASSY BAGHDAD
TO RUEHC/SECSTATE WASHDC 2582
INFO RUCNRAQ/IRAQ COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHDC
RHEBAAA/USDOE WASHDC
RUEKJCS/DIA WASHDC

UNCLAS SECTION 01 OF 03 BAGHDAD 000955 
 
SIPDIS 
 
SENSITIVE 
 
AIDAC 
 
STATE ALSO FOR EEB AND NEA/I 
 
E.O. 12958: N/A 
TAGS: EPET EAID EINV PGOV IZ
SUBJECT: Shell Moves Forward on Southern Flared Gas Project 
 
REF: A. Baghdad 90 
     ¶B. 08 Baghdad 3101 
     ¶C. 08 Basrah 84 
     ¶D. 08 Baghdad 2891 
 
Sensitive but unclassified; contains business proprietary 
information.  Please protect accordingly. 
 
¶1. (SBU) Summary:  Although the media trumpeted news of the 
September 22, 2008, signing ceremony to end flaring of associated 
natural gas from southern oil fields, Shell and the South Gas 
Company only signed a heads of agreement commitment to form a joint 
venture to execute the 25-year project.  Since then, Shell and 
Ministry of Oil, including South Gas Company, representatives have 
been negotiating earnestly on details of the joint venture contract. 
 During an April 2 meeting, Shell executives foresaw no real hurdles 
to forming the joint venture by year's end, other than the magnitude 
of the necessary preparations and shortage of time.  Ernst and Young 
will conduct an asset valuation of existing gas processing 
infrastructure by the end of May.  In the meantime, Shell has spent 
$100-150 million to upgrade existing facilities and provided a grant 
to two Basrah vocational training institutes.  End Summary. 
 
Gas Joint Venture Plans 
----------------------- 
 
¶2. (SBU) During an April 2 meeting with Oil Minister Shahristani, 
Deputy Minister Ahmad al-Shamma told EMIN Wall that Ministry of Oil 
(MoO) negotiations with Shell to form a joint venture to end flaring 
of associated natural gas from Iraq's southern oil fields were 
proceeding satisfactorily.  The two sides had drawn up a short list 
of three companies and then selected Ernst and Young to conduct an 
appraisal of current South Gas Company (SGC) gas processing 
facilities to determine the value of the infrastructure that SGC 
would be contributing for its 51% share of a joint venture (JV) with 
Shell.  Later on April 2, Energy and Infrastructure Team Leader met 
with three Shell executives to confirm the information and obtain an 
update on the progress of negotiations. 
 
¶3. (U) The Shell executives, based in Dubai, with whom we met were 
Shell Gas and Power Vice President Mounir Bouaziz (leading the 
negotiations for Shell), Shell Exploration and Production logistics 
manager Ayman al-Shukr, and security specialist James Youston.  In 
addition to Ministry of Oil (MoO) and South Gas Company (SGC), they 
met with Deputy Prime Minister Barham Salih, and the Minister of 
Transportation, the UK Ambassador, and MNF-I's Deputy Commanding 
General (DCG) during their Baghdad stay. 
 
Next Step -- Asset Evaluation 
----------------------------- 
 
¶4. (SBU) Bouaziz stressed the enormity of the task that Shell and 
South Gas Company (SGC) confront in forming the joint venture, but 
was confident that Ernst and Young could finish the asset valuation 
on time, i.e., by the end of May.  The process was familiar to the 
firm, which provides similar services regularly for other mergers 
and acquisitions.  Ernst and Young's experts would establish the 
current market price to replace SGC's facilities and then depreciate 
the replacement value based on the facility's age.  The several 
dozen gas oil separation plants (GOSP) would have a standard 
configuration, but Ernst and Young's engineers would need to make 
visits to evaluate the actual equipment and condition of the Khor 
al-Zubair natural gas liquids (NGL) and the North Rumaila NGL 
plants. 
 
¶5. (SBU) Bouaziz remarked that he wanted the evaluation process, 
which would be part of SGC's investment in the JV for its 51% share, 
to be as transparent as possible.  He was frankly concerned that the 
Qto be as transparent as possible.  He was frankly concerned that the 
valuation would be low, requiring the MoO to make a large cash 
payment, since the facilities were in poor condition.  Gas that was 
supposed to be compressed to 40 bar was only at 17 bar.  (Note:  A 
bar is a metric pressure measurement that equals approximately 14.5 
pounds per square inch, psi, which is approximately one atmosphere.) 
 The SGC's recent purchase of GE turbines for gas compression, 
however, could boost the valuation. 
 
Timeline 
-------- 
 
¶6. (SBU) Bouaziz wryly remarked that Iraqis are still novices with 
regard to international business deals, but are learning how to deal 
with international oil companies such as his own.  Shell was 
conscious, however, that any deal too lopsided in its favor would 
not survive for long.  Shell had actually provided six MoO employees 
 
BAGHDAD 00000955  002 OF 003 
 
 
drawn from various parts of the Ministry with their own laptops 
gratis, and taught them to operate analytical software to be used to 
assess the financial impact of differing terms and pricing.  The 
program had helped the MoO officials to learn such concepts as net 
present value and internal rate of return, which had been unknown to 
them, Bouaziz commented. 
 
¶7. (SBU) Bouaziz said Shell was now in the process of hiring a local 
Iraqi lawyer to register the new JV.  In addition to asset 
valuation, Shell and MoO were continuing with defining the project 
and setting a work timeline.  Shell was pushing for submission of a 
detailed JV proposal to the Cabinet (Council of Ministers) by the 
end of June, with the idea of getting final approval well before 
Iraq's national elections.  The proposal would include the 
Shareholder Agreement, the South Gas Development Agreement, and a 
pricing mechanism.  Even with the JV agreement signed, however, 
Bouaziz said there would be a transition period of six months to a 
year, with the JV taking full control no later than the end of 2010. 
 Shell, however, would make necessary investments in accordance with 
the JV plan once the JV agreement was concluded. 
 
Planned Management Structure 
---------------------------- 
 
¶8. (SBU) An Executive Committee, which Bouaziz compared to a board 
of directors, would make key operational decisions regarding the JV 
and could include other investors, such as Mitsubishi, should 
Mitsubishi become a future partner.  Shell was also proposing the 
formation of a National Gas Council, since Iraq has no gas 
regulatory authority.  The National Gas Council would count among 
its members representatives of the Ministries of Electricity, 
Interior, Planning, and Finance, and would have the final decision 
authority on matters such as gas pricing.  In addition, a Corporate 
Social Responsibility Advisory Board would be formed outside the 
formal JV structure. 
 
Shell's Lobbying Efforts 
------------------------ 
 
¶9. (SBU) Bouaziz said he and his colleagues had intensified their 
public relations efforts, with Bouaziz appearing for an interview on 
an Iraqi news program.  While Parliament would not need to approve 
the actual JV agreement, one of the three MoO members on the 
Shell-MoO joint management committee to form the JV had briefed the 
Oil and Gas Committee during a three-hour formal session.  The MoO 
official had found the Oil and Gas Committee members generally to be 
supportive of the flare gas deal.  Shell had also engaged with local 
stakeholders in the Basrah area, holding two "town hall" sessions, 
with the participation of groups such as labor, local businessmen, 
civil society, and farmers.  In a more direct effort to win public 
support, Shell had signed a contract with a U.S.-based NGO, 
International Relief and Development (IRD) (which is also a USAID 
grantee), to provide technical training through two Basrah 
vocational training centers.  The funding allows the training 
centers to teach youth to install solar-powered street lighting, 
which would also be a permanent improvement for the community, and 
to refurbish a workshop. 
 
¶10. (SBU) Bouaziz said Shell already had about 40 employees in 
Basrah and had spent $100-150 million on "quick win" projects 
described reftels, but was reaching its spending limit without 
certainty that the JV would be formed.  The projects included 
installation of equipment to improve gas processing quickly, such as 
a compressor for the North Rumaila field, a condenser, and a slug 
Qa compressor for the North Rumaila field, a condenser, and a slug 
catcher.  Of note, Shell would start construction of a 50MW power 
plant at the Khor al-Zubair NGL plant, with construction to begin 
the second half of 2009, which would start the process of taking SGC 
facilities off the national power grid. 
 
Joint Venture Operations 
------------------------ 
 
¶11. (SBU) Once the JV was formed and operational, Bouaziz noted, SGC 
would become a holding company.  The JV would purchase gas from 
upstream operators (comment: presently South Oil Company and North 
Oil Company, but potentially also the JVs formed as a result of 
first bid round contracts) and then process the gas for sale to 
domestic consumers or for export.  The new JV Basrah Gas Company 
would repair existing assets, build new ones, carry out gas 
processing operations, and be responsible for training and 
development of JV personnel.  Bouaziz said he was careful to discuss 
pricing in terms of market pricing, and not international pricing, 
since natural gas prices vary from market to market.  Shell 
recommended that natural gas be priced at the equivalent cost per 
 
BAGHDAD 00000955  003 OF 003 
 
 
BTU (caloric content) of the most readily available alternative 
fuel, which, in Iraq's case, would be heavy fuel oil.  This would be 
half the average cost of natural gas in the European Union or North 
America, which incorporates an additional transportation cost. 
 
Benefits to Iraq: JV Revenue 
---------------------------- 
 
¶12. (SBU) Bouaziz observed that Iraq, with its massive plan to 
increase electric power generation, has a pressing need for the 
additional dry gas that the JV would provide, but that the JV would 
also produce additional natural gas liquids (NGL), including 
liquefied petroleum gas (LPG) (primarily propane and butane). 
Additional LPG production would allow Iraq to reduce its LPG 
imports, now at 4,000 tons per day.  Bouaziz noted that the direct 
financial benefit to Iraq would be Shell's 15% corporate tax 
payments, SGC's 51% share of JV revenue, and feed gas payments to 
the MoO upstream operating companies, less operating expenses.  He 
also said that Iraqi gas is rich in pentane, an important feedstock 
for the production of polystyrene.  The pentane component of the NGL 
would be an important industrial resource. 
 
Comment: Meeting Energy Needs 
While Reducing Environmental Damage 
----------------------------------- 
 
¶13. (U) For all the reasons that Bouaziz noted, the formation of 
Basrah Gas Company will be an important milestone for Iraq.  Halting 
the damage to the environment alone would make this an urgent task. 
In addition, however, the 700 million standard cubic feet per day of 
gas being flared from southern oil fields contains enough energy to 
produce 3,500 megawatts of electricity, more than half of Iraq's 
current production. 
 
Butenis