* BP agrees with Iraq to cut development budget on field by$1 bln
* Drop in crude prices has hit country's oil revenue hard
* Baghdad delays oil contract negotiations as prices rally
* Oil majors believe production-sharing contracts unlikely (Adds quotes, details on contracts negotiations, background)
By Rania El Gamal
DUBAI, May 18 (Reuters) - BP has cut its developmentbudget for Iraq's giant Rumaila oilfield by $1 billion this yearafter the government warned a slump in crude prices and itsbattle against Islamic State was making it difficult to pay oilcompanies.
The British oil major has agreed with Baghdad to reduce its2015 spending on the country's largest oilfield to $2.5 billion,from the initially planned $3.5 billion, an industry sourcefamiliar with the matter said on Monday.
International firms operate in Iraq's southern oilfieldsunder service contracts, whereby they are paid a fixed dollarfee for volumes produced.
But the arrangement has put Baghdad's coffers under immensestrain, as a dramatic drop in crude prices since last summer hashammered the revenue it receives from selling oil.
Oil companies have proposed millions of dollars of budgetcuts, a senior Iraqi oil ministry official told Reuters inMarch.
It came after the government - wary of a boost in productioncosts that would further stretch state finances - asked them torevise development plans by considering postponing new projectsand delaying already committed undertakings.
The oil ministry could not be immediately reached forcomment on Monday.
Production from Rumaila is expected to remain steady ataround current levels of about 1.4 million barrels per day in2015.
Foreign oil companies, already complaining of infrastructureconstraints, say they see little chance of a rise in Iraqiproduction this year or even next.
Iraq's inability to increase output as fast as it haspreviously announced could help ease the global oil glut morequickly than anticipated and thus support prices.
The OPEC producer sought to renegotiate the terms of itscontracts with international oil companies.
In a series of letters sent to companies such as BP, RoyalDutch Shell, ExxonMobil, Eni andLukoil since January, the oil ministry set out theneed for change in response to "the rapid drastic decrease incrude oil prices".
RALLY
But global oil prices - which more than halved lastyear from a peak of around $115 a barrel in June - have sincerebounded. They were trading at above $66 a barrel on Monday, upfrom $45 in January.
The rally is making the need to renegotiate contracts lessurgent for Baghdad, oil executives say. The government is hopingthat prices will rise above the $60-70 a barrel range by the endof the year end to potentially avoid the need to revisecontracts at all, industry sources say.
However in the meanwhile, the executives say, there is arisk of long delays in the government paying foreign companiesand approving field development plans.
"The problem is that the ministry of oil firmly believesthat prices will pick up and this is the real problem, this iswhy things are delaying," one executive told Reuters.
A second executive said: "They are hoping that all theirproblems will go away with the price of oil going up. But theprice of oil won't go up."
Industry sources said approvals by Baghdad for tenders tobuild new crude-processing facilities had already been delayedby up to six months in some of the main southern fields.
That was due to both the government's lack of cash to repaycompanies for the cost of building projects and a cumbersomeapproval process for field development, the sources added.
The drop in oil prices means Baghdad is paying companiesmuch more than it would under the production-sharing modelfollowed elsewhere.
However, while Baghdad has sought to renegotiate terms, oilexecutives say it unlikely to switch to a completely differentmodel - such as production sharing - any time soon.
Oil companies have presented various models for Iraq toconsider but no response has been received so far, sources say.
"They are not going to change the contract, they can tweakit but not change it. They may try and bring the cost recoveryto be somehow connected to the price of oil, they may change theremuneration fee to be somehow connected to the price of oil,"said the second oil executive.
"But they are not going to change the structure of thecontract, I don't believe that." (Editing by Dmitry Zhdannikov and Pravin Char)