Shell's Basra Gas Company (BGC) joint venture is to sell dry gas from Iraq's southern oilfields to state-run South Gas Company (SGC) at a fuel oil-linked price comparable to current US prices.

SGC will sell it locally at a fraction of the cost, an official agreement summary obtained by Reuters shows.

After lengthy pricing discussions, the final draft deal signed in July by Baghdad, Royal Dutch Shell and Mitsubishi offers the multi-billion dollar project's developers more attractive sale prices than are available in most other countries in the region.

At the same time, it will ensure fuel-starved Iraqi power plants get cheap fuel. The crude and fuel-oil linked pricing formula in the final deal summary implies that, at a Brent price of around $102 a barrel early on Tuesday, the BGC joint venture would get around $4.38 per million British thermal units (mmbtu) of dry gas sold to SGC.

That means the BGC joint venture would sell gas in Iraq at less than a third of the $15/mmbtu enjoyed by sellers in parts of Asia.

Yet the price is broadly in line with those in the US
market, the world's largest and most competitive, and higher than what producers can usually sell for in the Middle East where low price policies support energy-intensive industry. Shell declined to comment.

It is unclear from the summary at what price SGC, which holds 51 percent of the JV, would sell raw gas to the Shell-led joint venture for processing.

But if the final draft is approved by the cabinet, Baghdad has decided SGC will then sell the processed gas it buys back from the JV at just $1.04/mmbtu to Iraqi industry to ensure they get enough cheap feedstock to be competitive in a region where Saudi gas guzzlers pay as little as $0.75/mmbtu.      

Through SGC, the Iraqi government will effectively be giving local industry tens of billions of dollars in fuel subsidies by selling the processed gas it buys from BGC at a huge loss.

Iraq estimates it should still make tens of billions of dollars from taxes, fees and nearly $18 billion in SGC raw gas sales to the joint venture, according to the summary submitted by the Oil Ministry to parliament.

How much Baghdad makes or spends will depend on Brent crude prices. Higher oil prices would widen the gap between the dry gas price and the fixed end-user gas price, swelling the subsidy cost. But it should also be offset by higher oil revenues in a country which hopes to rival leading exporter Saudi Arabia by the end of the decade.     
The BGC joint venture is a vital part of Iraq's master plan to boost electricity production to meet an expected demand surge and cope with a rapid rise in associated gas output as Iraq embarks on one of the biggest oil programmes in history.

Because Iraq burns a lot of fuel oil in its power plants, the parties have agreed that SGC should pay the joint venture 33.6 percent of the "international price" of fuel oil to ensure gas is always the cheaper option.

In the absence of a reliable international benchmark for fuel oil, the contract will apply a formula in which fuel oil is deemed to be valued at 74 percent of the Brent crude (the rate of relation between the two fuels over the last two years), then divided by an energy content conversion factor of 5.79 and the result divided again by about three.

"I can understand why they have done this because it's so difficult to come up with a transparent floating international fuel oil price," said Jonathan Stern, director of gas research at the Oxford Institute for Energy Studies. The pricing mechanism may need to be tweaked if oil prices rise or fall dramatically, he added. - Reuters