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Cablegate: Basra: A Glum Shell Wonders About Next Steps On (Delayed?)

DE RUEHBC #0054/01 2701225
R 271225Z SEP 09



E.O. 12958: N/A


BASRAH 00000054 001.2 OF 003

1. (SBU) Summary. During a recent visit to Basra, Royal Dutch
Shell representatives told PRT EconOff that local stakeholders
expressed continued strong support for its flared-gas project.
However, they also expressed frustration about Shell's apparent
inability to finalize the deal with the GOI anytime soon,
evidently due to GOI's political hesitation ahead of upcoming
national elections. Media reports have also hinted at a
possible delay, also citing the January 2010 elections. Local
Basra businesses and government leaders have also widely noted a
"wait and see" attitude among businessmen, who now prefer to
wait until the formation of the next GOI before committing to
any new projects. For Shell, any such a delay past elections
could translate into several more months of uncertainty.
Nonetheless, despite their frustrations, Shell reps told EconOff
that given the project's vast potential, they are "in it for the
long haul," and reminded us that they work in "tougher climates"
in many parts of the world. And if indeed the project is
delayed (and this is still uncertain), maybe it is best in the
long run for Shell to deal with a new GOI in power in 2010,
rather than negotiating with what is now essentially a lame duck
GOI. And for a project that could be a multi-decade,
multi-billion dollar deal to the benefit of many Iraqis, it
could be worth the wait. End summary.

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Project offers financial, environmental benefits
============================================= ====

2. (SBU) As reported in refs C and D, the South Gas Utilization
Project is a 51-44-5 percent, South Gas Company
(SGC)-Shell-Mitsubishi joint venture (JV) to gather, process and
market the natural gas currently flared (openly burned) from
Basra Province-based oil fields. (Note: As forecast in ref B,
Mitsubishi recently bought a five percent stake in the JV. End
note.) The project commits Shell to install processing
facilities and other infrastructure required to end the flaring
of about 700 million cubic feet per day of associated gas. A
preliminary "Heads of Agreement" deal signed in September 2008
called for a final agreement within 12 months. Among the
pending agreements are a Shareholder Agreement, South Gas
Development Agreement, and a pricing mechanism. A final
approval by the Council of Ministers (COM) is also required.

3. (SBU) The benefits to Basra and the Iraqi treasury are clear.
According to Shell, the flared gas is equivalent to 130,000
barrels/day of oil, and the energy equivalent of 3,500 megawatts
of electricity, the latter almost half of Iraq's current
production. According to Shell, the lost commercial value from
this flared gas is USD 6 million per day, or about USD 70 per
second. The dry gas and natural gas liquids, including
liquefied petroleum gas (LPG) produced by the JV could allow
Iraq to reduce its weekly current LPG imports of 4,000 tons.
The GOI would also benefit from Shell's 15% corporate tax
payments and SGC's 51% share of any JV net revenues. Last but
not least, and according to Shell's calculations, the
elimination of this gas would save 20 million tons per year in
CO2 equivalent emissions, which equates to the emissions from
three million cars.

Shell's latest Basra visit, and continuing "quick wins"
============================================= ==========

4. (SBU) Shell's latest visit to Basra, led by security and
infrastructure executives Ms. Elsine Van Os and John Davies,
included meetings with its local staff, subcontractors, members
of the Provincial Council, the Basra Investment Commission, and
the U.S. 34th Infantry Division Commander. According to Shell,
local stakeholders expressed their continued support for the
project. Shell representatives also reviewed for Basra PRT
EconOff its several months-long "quick win" projects, which they
admitted are designed in part to win public approval for the
project. Projects include the rehabilitation of an 18 MW
generator at the Rumaila oilfield, which will help SGC achieve
electricity self-sufficiency (allowing more electricity to a
power-starved public); the rehabilitation of a dry gas
compressor to facilitate gas export; and the refurbishment of
two vocational technical schools (which will also supply
graduates for Shell to hire).

South Gas DG also expresses general optimism

5. (SBU) Separately, in two recent meetings with PRT EconOff,
South Gas Director General Mr. Ali Hussein Khadayer expressed
enthusiasm about the Shell project, that it will help raise gas
production, and that it had the support of workers and
management ("there is no controversy" about it). (Note: While

BASRAH 00000054 002.2 OF 003

Ali said that the project is still on track for a late 2009
final agreement, SGC plays no role in negotiations, as all
decisions are made within the MOO. End note.)

Still, project could face delays

6. (SBU) However, Shell acknowledged that signed contracts and
final COM approval that had been previously expected by the July
to September timeframe remain elusive, for several reasons.
They indicated that the main problem, and the one widely heard
in Basra business circles, is the upcoming January elections,
which they contend are complicating GOI efforts to finalize the
Shell deal. They also indicated that disagreements have emerged
between Shell and MOO on the asset valuation study that
accounting firm Ernst and Young did (ref C), and which will
establish the current replacement value for SGC's facilities.
According to Shell, the study will establish a value on the GOI
contribution to the JV, and the less value that a dilapidated
SGC infrastructure is considered to be worth, the more MOO would
theoretically have to pay. Shell also cited bureaucratic
problems delaying the deal, with the recently-concluded 27-day
Ramadan season which slowed down negotiations, and more
generally, the MOO bureaucracy which they contend lacks the
capacity to negotiate and execute these Shell contracts.

Shell's frustration

7. (SBU) Davies and Van Os expressed frustration, impatience and
even some surprise at the GOI's "irrational" and
"self-defeating" behavior for such a "clearly beneficial" deal.
Despite one year of time-consuming and expensive work executing
quick wins and lobbying the GOI and interest groups, the GOI
"can't see how important this project is and that it is in
everyone's interest." Although Shell has not made figures
available, so far, project's costs so far could be in the range
of tens of millions of dollars. They acknowledged that a delay
until after elections could translate into months more of delay,
as it could take an additional several weeks or months for a new
government to form. They said that despite all their lobbying
and outreach, there is still a lot of "resistance" to and
"ignorance" about Shell's intentions, and that there is still a
very strong belief in Basra (and Iraq) that foreign companies
will do nothing but "exploit," "hurt workers," and in this case
raise gas prices.

Media reports also hint at delay

8. (SBU) Recent media reports have also indicated a possible
delay. Deputy Oil Minister Ahmed al-Shamaa was quoted last week
that the political atmosphere was "not right" for the Shell deal
because of the focus on the election, and that the deal is
likely to be delayed until after the election. Oil Ministry
spokesman Assem Jihad said that while an agreement was "not far
off," he acknowledged that negotiations "are still ongoing, and
the one-year deadline can be extended." Other media reports
have cited objections from "nationalist" legislators and worker
groups, who argue that the deal would allow Shell to monopolize
the area's gas market, and unduly influence prices.

Local businesses also in a "wait and see" mode
============================================= =

9. (SBU) Local contacts also note a widespread local perception
that due to elections and attendant uncertainties about the
composition of the next national government (and its views about
foreign investment), many businesspeople are now in a "wait and
see" mode. They contend that it is unknown "who will be on top
and who will be out of a job," and that it would be pointless to
negotiate contracts with people who may be out of a job soon,
and for projects that could soon be out of favor. Prospective
investors -- Iraqi and foreign -- think it best to let the dust
settle after post-election horse-trading, which could take weeks
or months after the January election. Even Basra-based UK
diplomats, keen to see the deal move forward, acknowledge that
signing the deal at this late stage of the GOI's term could be

But Shell still in for the long haul

10. (SBU) Shell reps said that while "there is a limit to our
patience," and despite the delays and "pressures from Shell
headquarters," for now it has no plans to give up on the
project, as potential returns are still too great to walk away
from. They also pointed out that Shell's activities seek to
create whole new areas of wealth with this new source of gas and
revenue, so it is not threatening any existing or vested

BASRAH 00000054 003.2 OF 003

interests. They said that this fact could stand in contrast to
many international oil companies (IOCs) seeking business in Iraq
which could sometimes open up a "hornet's nest" with the
prospect of new and transparent business practices that might
threaten local interests (such as IOCs' intentions to meter
production and/or exports, any lack of which is alleged to
facilitate theft). While Shell certainly plans to observe
strictly transparent business practices, by creating entirely
new sources of wealth, it could face less local resistance to
its activities.

And is experienced in tough climates

11. (SBU) Van Os and Davies reminded PRTOffs that while for some
IOCs, working in Iraq might seem risky, Shell actually faces
equally tough or tougher environments in places such as Nigeria,
Russia, and Venezuela. Nevertheless, they admitted that Iraq
presents "its own set" of unique and complex security,
bureaucratic and political challenges, many of which they've not
encountered before. On this latest trip, Shell sought the PRT's
own security assessment of Basra. They noted that Shell's
corporate headquarters is "extremely risk averse" to the
potential loss of life -- and Mitsubishi is "even more so."
Senior Shell representatives (and PRTOffs) were present during a
March 2009 rocket attack on the Basra COB, and the event
evidently sent them back to their Kuwait base to re-assess.
Nevertheless, they came back.


12. (SBU) While a possible delay is frustrating to Shell, such
holdups during election seasons are not uncommon in democracies
in the run-up to a big election, as people in power (who seek
re-election) can be reluctant to make decisions that can be used
against them for political gain. GOI politicians are very
sensitive to the perception of any "giveaway" to Shell, or
otherwise having their nationalist credentials questioned. And
the fact that Shell's was a "no-bid" contract could make some
politicians even more wary (even though there are strong legal
arguments against the need to tender this "mid-stream" activity
- ref C).

13. (SBU) And as hard as a delay might be for Shell, if there is
a delay, maybe it is best in the long run. A deal signed with
the next government, rather with a government in its final days
of power, could have more staying power. Signing a deal now
could be a waste of time and money if a radically different GOI
comes into power. And if the Shell flared-gas deal truly is one
than can be a multi-decade, multi-billion dollar project
benefiting a wide sector of the population, which we believe it
can be, it could be worth the extra months wait.

© Scoop Media

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