Iraq recently signed its first oil deal in 35 years with a foreign company.

And – quite surprisingly to many observers – the company wasn’t one of ours.

Not surprisingly, the U.S. news media barely acknowledged the deal – even though the agreement was major news throughout the rest of the world.

According to reports from Baghdad, the 22-year deal between the Iraqi government and the China National Petroleum Co. involves $55 billion, or 87% of Iraq’s current total revenue at a conservative long-term estimate of $100 a barrel.

The deal is actually a renegotiated version of a 1997 agreement between China and a Saddam Hussein-led Iraq. That original deal included production-sharing rights, but under the new contract China will be paid for its services, but will not share in profits,
The New York Times reported. The payments will be made in cash – and won’t be “in kind” payments of crude oil, the newspaper said.

While this deal, on its face, appears to be just another global oil-services contract, it’s actually a very significant development in the hunt for long-term energy supplies. In fact, it actually demonstrates that – when it comes to nailing down those long-term oil supplies – China is an expert, and is playing a very deep game. And the outcome of that game will certainly have substantial long-term implications for consumers and investors both here in the United States, and in markets abroad. Here’s why:

• With estimated reserves of 115 billion barrels, Iraq is tied with Iran for the world’s No. 2 position, trailing Saudi Arabia, which has estimated reserves of 264 billion barrels, according to estimates from the Energy Information Administration.
• In a country where electricity is in short supply, the oil produced from the Ahdab Oil Field will help fuel a planned power plant that would be one of the largest in Iraq. By helping Iraq with this key initiative, China can expect to gain a solid foothold in one of the most oil-rich nations in the world, analysts say.
• At the end of the day, the deal clearly highlights something that most U.S. investors haven’t focused on yet – namely that the eventual winners in this game may not be such well-known giants as Chevron Corp. (CVX), ExxonMobil Corp. (XOM), or other household names. Deals like this one and the host of others that are undoubtedly close behind suggest that tomorrow’s winners may have names most English-speaking investors can’t pronounce, since they’ll be distinctly Arabic or Chinese in nature. [Two recent installments of Money Morning’s popular new “Buy, Sell or Hold” feature have focused on Chevron. Take some time to peruse the original story, as well as the update.]

China’s Shrewd Long-Term Oil Plan

The important thing for investors to understand now is that oil ownership, as I have said for many years, is an illusion. It does not guarantee price, nor profit. What really matters in the end is having secure supply lines and sources from the Middle East (and other parts of the world).

Under this new contract, CNPC will provide technical advisors, oil workers and equipment to help develop the Ahdab oil field southeast of Baghdad, said Assim Jihad, a spokesman for Iraq’s Oil Ministry.

While China won’t participate in the profits from the oil it helps pump, it is shrewd enough to realize there will be long-term benefits. Analysts who see the bigger picture here agree with our view.

“There are some political profits for China,” Ibrahim Bahr al-Ulum, a former Iraqi oil minister, told The Times. “They need access to Iraq, and when they need oil, at least the Iraqi people will feel that China has done something for them.”

And that’s not all. Before 2003, Iraq had oil agreements with China, Russia, Indonesia, India and Vietnam – three of which included production-sharing agreements, The Times reported. But the big jump in oil prices, the new government and a myriad of other changes that have taken place since that time prompted Iraq to reconsider the terms of those deals, Iraqi officials said.

Iraq continues to negotiate other service contracts with ExxonMobil, Royal Dutch Shell PLC (ADR: RDS.A, RDS.B), Total SA (ADR: TOT), BP PLC (ADR: BP), Chevron, and some smaller oil companies. The deals have been reduced in length from two years to one after Iraq took a lot of flak for not putting the contracts out for competitive bidding.

But China’s contract was the first major one to be completed – and for one simple reason, Jihad, the Iraqi Oil Ministry spokesman, said. CNPC had “wide experience in this field,” and because many foreign oil companies were not willing to come to Iraq.

China has apparently learned how to play the global oil game with a pro’s touch. Ironically, it was the United States that crystallized this vision.

By invading Iraq, the United States dealt China’s central planning commission an embarrassing wakeup call when the second Gulf War summarily wiped out China’s oil interests in Iraq.

When that happened, China’s central planners realized two things:

• The status quo in the global oil game had changed.
• And China’s double-digit economic miracle could not be sustained with only a few oil suppliers.

What China fears most is that there will not be enough oil to go around in the very near future and that a U.S.-dominated supply chain could effectively “strangle” China’s growth.

So, it has done what the United States and other great powers have done at other times in history and gone on a buying spree from Darfur to Peru that’s turned heads and ruffled feathers all across the world.

What’s been especially frustrating for hapless Western leaders who do not understand that their actions caused this in the first place, is that China’s not afraid to do business with rogue nations like Iran, Sudan and Burma. It has even gotten chummy with Venezuela and Russia – much to the consternation of our present administration.

It’s a virtual certainty that China will maintain this policy going forward. My contacts in China and Africa have told me point blank that China’s leaders “don’t care about human rights or nukes or hostile governments. What matters is anyone who provides oil to China no matter what the rest of the world thinks.”

So, in as much as the U.S. media has dismissed this deal as only one in a long string of recent Chinese oil purchases, it’s arguably the most important deal yet. The reason: It suggests that China will go to extraordinary lengths to obtain the oil it wants and needs.

To add to its stable of captive oil suppliers, China will pay far more money, endure limitless criticism for ignoring human-rights issues and endure harsher business conditions than our companies can or will undertake. While U.S. firms must worry about sanctions, bad publicity or simply security, China worries about one thing, and one thing only – getting oil.

It’s a lesson initially learned from us. Then they refined it. Perhaps it’s time we re-learned this lesson from China.

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News and Related Story Links:

• The New York Times:
  Iraq Signs Oil Deal With China Worth Up to $3 Billion.

• CNN.com:
  Iraq signs $3 billion oil deal with China

• Money Morning Buy, Sell or Hold Feature:
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  Buy, Sell or Hold: Chevron Corp.

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• Entrepreneur.com:
  The China TSA For Ahdab Oilfield.

China and Iraq will sign a deal next week to develop the Ahdab oil field, 100 miles southeast of Baghdad, at time when political gridlock and security concerns have cast doubt over several pending short-term contracts.

The new agreement, valued at $1.2 billion, is a variation of a deal struck with the state-owned China National Petroleum Corp. in 1997, when Iraq was in the clutches of Saddam Hussein.

“The Chinese contract was signed with the former regime,” Hussein al-Shahristani, Iraq’s oil minister, said in an interview that appeared on Iraqi news Web site al-Noor. “It’s valid. It was unfair because it was a production-sharing contract. We have negotiated with them for a year. It was turned from a sharing contract into a service contract.”

Al-Shahristani, will put the finishing touches on the deal during a visit to China early next week, when he is joined by Latif Hamad, governor of the Wasit province – where the Ahdab field is located.

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“The governor will discuss the logistic cooperation with the Chinese company, especially the security side,” provincial spokesman Majid al-Atabi, told The Associated Press.

The deal with China is one of several contracts Iraq is touting in an effort to boost oil production by roughly 500,000 barrels a day, from 2.4 million barrels to 3 million barrels by the end of 2008. Iraq then hopes to increase production to 4.5 million barrels a day by 2013.  As it stands now, the country sits on estimated 115 billion barrels of reserves, but exports a meager 2 million barrels a day – 10th in the world.

Thirty-five foreign oil majors were invited to bid for contracts to provide technical support and help boost production in eight oil and natural gas fields last month. However, it was recently reported that oil majors are balking at the commitment, as the terms of the contracts have been shortened, and security concerns and political gridlock have undermined any progress.

“It appears that on present form (the Iraqi government) probably won’t proceed with most of these or all of them,” Charles Ries, coordinator for Iraq’s economic transition at the U.S. embassy told reporters earlier this week. “But I think that some of the companies are open to continued discussions even on relationship grounds, and some of the companies… don’t think it’s worth their time.”

Ries said that the contracts lost much of their appeal when Iraq reduced the length of their terms from two years to one, and when it became clear that companies who signed wouldn’t be given any preferential treatment for future long-term deals. Ries added that the deals, worth about $500 million apiece, “were never going to be hugely lucrative.”

Iraq has been negotiating with Royal Dutch Shell PLC (RDS.A, RDS.B), BHP Billiton Ltd. (ADR: BHP), BP (BP), Exxon Mobil Corp. (XOM), Chevron Corp. (CVX), Total S.A. (ADR: TOT), and a consortium of smaller firms led by Anadarko Petroleum Corp. (APC),  according to Reuters.

Anadarko has already pulled out, but officials insist negotiations are ongoing. An anonymous Iraqi official responded to reports that talks had disintegrated Wednesday, telling the AP that deals with Shell, BP, Exxon, Chevron, and Total were “still on the table,” and “none of them has pulled back.”

Development of the energy sector will be crucial to Iraq’s reconstruction and development, as oil accounts for 90% of export earnings and 70% of the country’s gross domestic product.

News and Related Story Links:

• Money Morning:
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• New York Times:
  Iraq Poised to Revive Oil Contract With China

• The Associated Press:
  Iraq, China to ink Ahdab oil deal next week

• The Associated Press:
  Iraq: Talks with oil giants continue

• Reuters:
  Iraq likely to abandon short-term oil contracts – US

Iraq has officially opened the door for foreign oil companies to invest in the country’s rich energy sector for the first time in more than 30 years.

Thirty-five foreign oil majors have been invited to bid for contracts to provide technical support and help boost production in eight oil and natural gas fields.

The contracts will be awarded in 2009, as Iraq’s oil minister, Hussein Shahristani, hopes to increase production by 2 million barrels of crude oil per day by 2013.

Iraq has the world’s third largest proven petroleum reserves, according to the Energy Information Administration (EIA). While Iraq boasts proven reserves of 112 billion barrels, the EIA estimates that up to 90% of the country remains unexplored. Only 2,000 wells have been drilled in Iraq, versus approximately 1 million in the state of Texas alone. The war-torn country could have another 100 billion barrels of oil buried in its uncharted territories.

Story continues below…

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The energy sector is crucial to Iraq’s economy and development, as crude oil export revenues represented around 60% of its gross domestic product (GDP) and 89% of government revenue, according to the March 2007 review by the International Monetary Fund (IMF).

However, wars with Iran, Kuwait and the United States have roiled the country’s infrastructure. Adding to the pain, political and economic sanctions have set Iraq’s development back decades.

Its failed invasion of Kuwait and the resultant trade embargos caused Iraq’s oil production to drop from 3.5 million barrels a day to about 300,000 barrels a day. Production in the country has regained some of its footing since then and currently stands at an approximate 2.5 million barrels per day. However, Iraq’s Shahristani has pledged to lift out put to 4.5 million barrels a day by 2013.

To accomplish this, Shahristani is offering to pay foreign oil majors such as ExxonMobil Corp. (XOM), BP PLC (ADR: BP), Total SA (ADR: TOT), and Royal Dutch Shell PLC (RDS.A, RDS.B) for their training and consultancy services. Shahristani draws the line, however, at offering foreign companies any portion of the oil to be extracted.

In fact, at a news conference in Baghdad, Shahristani was openly critical of the Kurdish regional government for signing deals that offer foreign companies shares of the oil they extract. Any firm that has already signed an agreement with Kurdistan, such as IGI Group, was left off the list of potential bidders for Iraqi service contracts.

“We do not see the necessity to have anyone sharing the Iraqi people’s oil,” the Los Angeles Times quoted Shahristani as saying. “The Iraqi oil will remain under complete Iraqi control under the auspices of the national oil company once it is established.”

The issue of sovereignty remains a sensitive subject, as many critics have theorized that the U.S. invasion of Iraq was, at its core, a plot to seize control of the country’s natural resources. Three U.S. senators have already urged the Bush administration to stop these deals for fear they would inflame sectarian tensions in the wore-torn country.

Another point of contention is that Iraq’s parliament has yet to approve a national oil law to regulate foreign contracts. Discussions remain deadlocked in discussion over how oil revenue is to be divided among the country’s diverse and volatile regions.

News and Related Story Links:

• L.A. Times:
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• About.com:
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• Energy Information Administration:
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Oil prices touched another record high Friday, hitting $84.05 per barrel on the New York Mercantile Exchange. The price was spurred on by Thursday’s lackluster inventory report, and the prospect of more violence in Northern Iraq.

The U.S. Energy Department reported Thursday that U.S. crude oil inventories declined by 1.67 million barrels to 320.1 million barrels a day the week ended October 5. It was the first decline in three weeks. The EIA also left its demand projections for 2007 and 2008 unchanged, saying worldwide demand would grow by 1.5% in 2007 and 2.4% in 2008.

The renewed threat of violence in Northern Iraq also drove oil prices higher. According to Bloomberg News, Turkish Prime Minister Tayyip Erdogan told reporters in his country that Turkey would pursue the Kurdistan Workers Party (PKK) regardless of diplomatic ramifications. Turkey’s government will present a bill to parliament next week authorizing a possible military action inside of Iraq’s borders within a year.

PKK rebels recently killed 15 soldiers in Southeastern Turkey, an extremely volatile part of country. Turkey, reportedly, has thousands of troops stationed along the northern border of Iraq, and has been resisting the temptation to cross into the tumultuous country and engage the Kurdish rebels.

"If they start shelling across the border the price is going to go up," Addison Armstrong, director of market research at TFS Energy LLC told Bloomberg. "When there is tension in the world oil gets bid up."

Iraq is currently home to the world’s third-largest oil reserves. It produced an estimated 2 million barrels of crude per day in September. Still, further political and economic disruption in the war-torn nation should have a limited effect on the world’s oil supply.

"At the end of the day, even if Turkey does cross the border, it’s not going to mean anything to the supply of oil," Armstrong said.

News and Related Story Links:

• Money Morning Investment Research:
  Oil Prices Slip, but a Rebound Could Be On the Way.

• Bloomberg:
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• CNNMoney:
  Oil hits record, pushes past $84 a barrel.