August 12, 2002
Major trading firms that lift Iraqi crude are accusing the UN sanctions committee and the overseers of purposely adopting practices that minimize Iraqi oil sales, according to MEES soundings. Traders allege that the UN is not only delaying the approval of price formulas beyond reasonable periods but is also being inflexible to a degree that has made Iraqi oil prices uncompetitive with similar grade crudes.
The purpose of this exercise, according to traders, is political, aiming "to hit customers with large losses to try and prevent the Iraqi program from being maintained." One trading firm told MEES, "the way the overseers have refused to adapt their methodology in the face of evidence that it clearly limits liftings in Europe and the Far East, and now refuse to adapt to the changed circumstances in the west, leads one inevitably to the conclusion that the minimization of liftings is not the side effect but is the goal of their actions." (For full text of the statement see below).
However, a UN diplomat told MEES that the overseers' job is to set prices at fair market value, and they have no agenda with respect of how the export of Iraqi oil goes. The diplomat added; "As you know there has been a surcharge for some time. Iraq chooses to administer that and the overseers set the price at a fair market value. This does affect the exports, but they cannot take that into account. They have to set a fair market value regardless of who likes them for doing so and who does not like them for doing so."
Regarding the terms of the price set for July, which has caused the latest controversy, the diplomat argued that the overseers had "adopted a consistent methodology for setting prices over time. In fact, the July price was more than generous. This is because what the overseers do is assess what people can get for their oil during the month of loading, or around the loading days in case the loadings are uneven. On that basis, if you take an alternative grade like Mars, you will see that its average price for July was 40 cents higher than in June. However, the other thing that happened was that on 18 July the price of Mars plummeted by 50 cents and that was what traders were left with if they hung on to their cargoes in August. So some traders lost money. But the overseers use the same methodology and they have to keep consistent regardless of what the outcome is."
On 6 August, SOMO's Acting Director, 'Ali Rajab, sent a letter to the head of the sanctions committee stating that Baghdad has submitted high prices that "do not represent a fair market value and are inequitable" because "we had no choice," as these prices "were suggested by the UN oil overseers after long discussions."
An example of the problem is the way Kirkuk prices were determined last month. There was only one lifting of Kirkuk in July for re-sale in the US. The oil was loaded by the tanker Kristhild, which had a bill-of-lading dated 12 July. The only sale from that vessel was done on a fixed differential to Valero, who reported the trade (as did the seller) at WTI minus $2.20/B. This would require a fob price of WTI minus $3.45/B just to break even. According to one trader: "The original Iraqi proposal at WTI minus $3.05/B was already too expensive. Hence, the UN insistence on raising this even further to WTI minus $2.90/B has no merit or justification and appears to be designed solely to penalize lifters for lifting and stop them from doing it again. It is likely to have that effect." MEES learns that Kirkuk sales have been so depressed that there have been no liftings since 2 August, and none are scheduled in the foreseeable future.
The following analysis of the Iraqi price situation was supplied to MEES by an oil trading firm which handles significant volumes of Iraqi oil:
"The UN Oil Overseers office is charged by the sanctions committee with agreeing with SOMO the official sales price of Iraqi crude oils. This has to be at a ‘market' level, such that the Iraqis are not left with the opportunity to demand payments over and above those made into the UN escrow account for the crude oil, but not either at a level that discourages liftings and leaves the humanitarian aims of the account under-funded.
"This balancing act has never been an easy one for the overseers. The volatility of the price differentials and the worldwide spread of the markets into which these barrels have been sold have often given the contract holders and lifters together the opportunity to make (or lose) more money than the few cents the UN had intended to leave them. In the event that there has obviously not been money in a lifting it has sometimes been possible for lifters to fail to lift barrels. Eventually the UN felt pushed to a position where the only way that they could see to meet their mandate was to price retrospectively.
"Unfortunately, retrospective pricing has not been very successful, either in terms of reducing the opportunity for the lifters to make enough money to be able to make a payment to the Iraqis or in maintaining the escrow account funds. For buyers both in the Med (where voyages are typically short and the oil is often exported as products before it is priced in as crude oil) and in the Far East (where the very early buying window means that there can be as many as three monthly price changes between buying the crude and it being priced), the uncertainties introduced by this pricing method have effectively removed Iraqi crudes from the market. This may not have been the intent, but it has certainly been the effect, of the change to retrospective pricing.
"Before retrospective pricing, the main market for Iraqi crude oil was the USA. The long voyage times here have meant that the end-user buyers can wait for the barrels (especially Basrah Light) to be lifted, and then be (retrospectively) priced to be sure that they are not paying a large premium over the OSP. The buying window has thus moved later since the introduction of retrospective pricing. This of course has not helped the UN to fix prices, which depended on barrels lifted being sold to provide the pricing evidence. The evidence is really still there as the prices for the previous month's cargoes are still being sold at a differential to other grades.
Extraordinarily the overseers have chosen to adopt an inflexible methodology based on theoretical (and dubious) values relative to Mars on a day well before the barrels can be sold to end-users. At the same time they completely ignore the reported values of actual sales of actual Iraqi barrels in the market. In the current market this has the effect of assuming that sales could have been made at much higher prices in the first-half of July rather than at the much lower (50 cents/B) prices now prevailing into which the barrels actually have to be sold. The way in which the overseers have refused to adapt their methodology in the face of evidence that it clearly limits liftings in Europe and the Far East, and now refuse to adapt to the changed circumstances in the west, leads one inevitably to the conclusion that the minimization of liftings is not the side effect but is the goal of their actions."
Iraqi Exports in July Iraqi crude oil exports under the UN oil-for-food program have declined steadily since the beginning of the year. Exports in July averaged 1.07mn b/d, compared to the first-half average of 1.24mn b/d, the 2001 average of 1.71mn b/d and the 2000 average of 1.92mn b/d. SOMO's target is to export 2.2mn b/d under the oil-for-food scheme, but this target has not been reached because of frequent disruptions during the year.
Iraqi Oil Exports Under the Oil-For-Food Program (Mn B/D)
On 1 August, the Executive Director of the UN Office of the Iraq Program, Benon Sevan, sent a letter to the head of the sanctions committee warning of the shortfall in Iraqi oil revenue as a result of the decreasing oil sales. He stated that whereas the sanctions committee has so far approved the sale of 316mn barrels during phase XII (which runs from 30 May to 25 November), only 67.3mn barrels have been actually exported. Mr Sevan appealed to the sanctions committee and the Iraqi Government to "take all necessary measures to resolve the difficulties encountered in improving the critical funding situation, including, in particular, the long outstanding question of the pricing mechanism for Iraqi crude oil exports."
The following is the text of the letter sent by the Executive Director of the Office of the Iraq program, Benon Sevan, to the Chairman of the sanctions committee on 1 August:
"It is with grave concern that I have to draw your attention, and through you the attention of the members of the Security Council committee established by resolution 661 (1990), that two months into phase XII of the humanitarian program pursuant to Security Council resolution 986 (1995), as at 31 July 2002, Iraq had exported only 63.2mn barrels of oil under the program. That amount is lower than previous recorded levels of monthly exports under the program, particularly during phase VIII, averaging more than 2mn b/d. Of the total volume of oil exports, 36.1mn barrels (57.1%) were exported through Mina al-Bakr, and 27.1mn barrels (42.9%) were exported through Ceyhan, Turkey.
"The estimated revenue generated from the oil exports thus far in phase XII is just under $1.5bn, at current prices and rate of exchange. Even by the most conservative estimates, some $1.5bn in revenue has been lost, owing to a reduction in the level of Iraqi oil exports. In May, the average rate of exports was 1.012mn b/d, and dropped to 835,000 b/d in June. In July it stood at 962,000 b/d.
"Should the current reduced levels of Iraqi oil exports persist, based on current prices and exchange rates, it is estimated that during phase XII the total revenue from oil exports under the program would be some $4.5bn. After the deductions pursuant to relevant Council resolutions, a total of only $3.22bn will be available for the implementation of the humanitarian program during phase XII. Accordingly, we would be facing a shortfall of $1.86bn in the implementation of the humanitarian program during the current phase, the distribution plan for which has been budgeted by the Government of Iraq at $5.08bn.
"The above situation is further exacerbated by the cumulative revenue shortfall from earlier phases, which has left the program without resources for funding 1,040 approved applications, with a total value of more than $2.2bn as at 31 July 2002. Accordingly, a mere $1bn would be left for financing any additional applications.
"It may be recalled that there are currently some $5bn worth of applications that had been placed on hold by the Committee. As earlier announced by the Office, the implementation of paragraph 18 of the new procedures under resolution 1409 (2002) will be completed by 15 September 2002. While welcoming the recent approval – under the new procedures – of some $25mn worth of applications previously placed on hold, including priority applications in the health sector, the regrettable fact remains that there are no funds available for the issuance of letters of approval for such applications.
"I should also like to add that, owing to the shortfall of funds, the UN could not pay the minimum fee for the use of the Kirkuk-Yumurtalik pipeline for the export of Iraqi oil through the Turkish port of Ceyhan, pursuant to paragraph 2 of resolution 986 (1995). We could only afford paying up to 50% of the required amount.
"The increasing shortfall in funds will have very serious consequences on the humanitarian situation in Iraq. I do not wish to be redundant by spelling out the reasons for the substantial shortfall in the revenues available for the implementation of the program, as all concerned are fully aware of them. I should like to make a most heartfelt appeal to all members of the Committee and the Government of Iraq to take all necessary measures to resolve the difficulties encountered in improving the critical funding situation, including in particular the long outstanding question of the pricing mechanism for Iraqi crude oil exports. The cooperation of all concerned is essential.
"Finally, I should like to reiterate that, irrespective of improvements in procedures, including those recently adopted by the Council in resolution 1409 (2002), without the necessary funds available in the escrow account, it will be impossible to implement the humanitarian program effectively."
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