The oil sector in Iraq: Prospects and problems

Jun 11, 2009 02:00 AM

by Dr Nimrod Raphaeli

Introduction
Iraq is acknowledged to have the world's third largest proven petroleum reserves (after Saudi Arabia and Iran) and some of the lowest extraction costs. Although just a fraction of its known fields are in development, much of its oil infrastructure is in poor shape due to years of wars, sanctions, and neglect that characterized much of Saddam Hussein's rule in Iraq.
When full explorations finally get under way, Iraq may prove to have far more than the current estimate of 115-120 bn barrels. Indeed, Iraqi Deputy Prime Minister Barham Salih told that geological surveys and seismic data "by reputable, international oil companies" would suggest that Iraq has the world's largest proven reserves -- 350 bn barrels -- exceeding the proven reserves of Saudi Arabia -- 264 bn barrels. [1]

Furthermore, unlike Saudi Arabia, Iraq also has huge quantities of natural gas which have yet to be explored commercially. If its hydrocarbon resources are thoroughly explored and well managed, Iraq could easily emerge as one of the global key energy players for years to come. However, as some oil executives have said, while the opportunities are huge, the uncertainties, challenges, and risks remain daunting. [2]
Oil is the most significant element of the Iraqi economy. It contributes 60 % of the country's GDP and more than 90 % of government revenues. It is also a potential source of conflict between the central government and the provinces, particularly the three Kurdish provinces of Erbil, Suleymaniya, and Dehook, which make up the Kurdish Regional Government (KRG). According to the findings of the Iraq Study Group, the stabilization of Iraq is highly correlated with Iraq's economic success or failure, which in the medium-term is highly dependent on its hydrocarbon industry. [3]

Current production and future targets
The invasion of Iraq and the destruction of a number of oil facilities, followed by sustained sabotage activities against oil installations and infrastructure, caused a sharp decline in production between 2002 and 2003, from about 2.6 mm bpd to about 1.5 mm bpd. The crude production has since averaged 2.3 mm bpd but it is below the levels of production in both 2001 and 2002, which were about 2.7 mm.
Iraq is striving to increase production to 2.9 mm bpd by the end of 2009, but efforts so far have met with limited success. [4] Minister of Oil Hussein Al-Shahristani's frequent assertions that Iraq will raise its production to 6 mm bpd by the end of the 2008-2017 10-year plan seem less than convincing. [5]

In fact, given that facilities are aging and that new wells are not being drilled, there is substantial concern that by 2010 Iraq's oil production will decrease rather than increase. In the words of Jabbar Al-Luaibi, adviser to the oil ministry (recently promoted to deputy minister of oil), "It has reached the point where we have 300 wells not flowing in some of our biggest fields, and that means a lot of work just to get us back on track to where we were a few years ago." [6]
As a result, Al-Shahristani is facing growing criticism from members of parliament for what is perceived as the failure of the ministry of oil to increase production, which still remains below the pre-2003 level, and to attract foreign investments. In an unusual parliamentary precedent, 140 members of parliament have signed a petition calling on Al-Shahristani to appear before parliament for questioning. [7] One member of parliament went as far as to accuse Al-Shahristani of subjecting 300 oil wells to ruin. [8]

Uncertain levels of production
The level of production of Iraqi oil is uncertain because of the unaccounted-for smuggling by the Saddam regime and the subsequent theft following the invasion of Iraq in 2003. Indeed, using estimates from experts, The Iraqi Study Group pointed out that as many as 150,000 to 200,000, and perhaps as many as 500,000 bpd, were being stolen, and it recommended the installation of a metering system on bothends of the supply line. [9]
The smuggling of both crude and refined oil and the sabotage of the oil facilities and infrastructure have been so extensive that, in 2007, the Iraqi government established a special police force known as "The Oil Police" responsible for protecting pipelines, oil trucks, and the oil fields themselves. In May 2009, Lt.-Gen. Abdullah Ibrahim, the commander of the oil police, told the press that the smuggling of oil had almost entirely ceased and the acts of sabotage have declined by 90 %. As a result, the losses incurred by the Iraqi oil industry have been sharply reduced, from $ 6 bn annually in previous years to $ 250 mm at the present time. [10] There is no confirmation from the ministry of oil of this accomplishment.

The oil law
A draft hydrocarbon law was approved by the Iraqi government in February 2007 as an umbrella for four key subordinate laws: first, managing hydrocarbon investment, particularly upstream; second, revenue-sharing between the central government and the provinces; third, restructuring the ministry of oil; and fourth, establishing the Iraqi National Oil Company (INOC). The draft hydrocarbon law was taken up by the parliament, but no consensus could be reached, particularly between the central government and the Kurdistan Regional Government.
Perhaps no less thorny is the future of oil-rich Kirkuk, which the Kurds consider a part of their homeland, a view completely rejected by its Arab and Turkmen residents. With the elections for parliament set for January 2010, and given domestic political complexities and the attempts by recently elected provincial politicians to have a say in national oil policy, it is highly unlikely that in the current session of parliament there will be the resolve or the time to pass the hydrocarbon law.

In the absence of a national law regulating the issue of oil exploration, investment, and revenue-sharing, the KRG, acting on its own, has proceeded to grant oil and gas exploration rights to a number of foreign companies, including those from Norway, the United Arab Emirates, Korea, the UK, and Turkey.
The central government, and, in particular, oil minister Hussein Al-Shahristani, a Canadian-trained nuclear engineer, has strongly rejected the authority of KRG to offer oil concessions to anyone outside the jurisdiction of the central government and has taken the next step of excluding any foreign company operating under licensing arrangement with KRG from participating in any future dealings with the central government.

Rising tensions between Central Government and KRG
In the meantime, the tensions between the central government and KRG appear to be rising. Apart from the issue of oil and gas and the future of Kirkuk, the Kurds are particularly agitated by the recent statements made by Prime Minister Nouri Al-Maliki denouncing what he described as "consensus democracy" [al-dimuqratiyah al-tawafuqiyah] based on power-sharing [has-hasah] in favour of a strict majority rule which is viewed bythe Kurds and the Sunnis as an attempt by the Shi'a to monopolize political power.
In response to the prime minister, Iraq's president Jalal Talabani said that "consensus democracy is deeply rooted and it is an effective way to unite the diversified groups in Iraq. Iraq cannot be ruled by [a simple] majority. The situation continues to require a consensus." [11] The leading Shi'ite cleric in Iraq, Grand Ayatollah 'Ali al-Sistani is reported to have refuted al-Maliki's position as well. [12]

Steps to increase production: Two-tier licensing rounds
Al-Shahristani has estimated the cost for developing the oil and gas sector at $ 50 bn, a sum which Iraq cannot mobilize by itself -- hence the attempt to bring back into Iraq the international oil companies whose assets were nationalized by Saddam Hussein in 1975. These investments will be secured through a two-tier licensing procedures. [13]
The bidding will cover up to 100 bn barrels of proven oil reserves and some 80 tcf of proven gas reserves.

The First Licensing Round for the development of oil and gas fields was announced on June 30, 2008, to rehabilitate six giant producing oil fields covering 44 bn barrels and two gas fields covering 44 bn barrels of crude and 22 tcf of gas reserves. The oil fields would generate extra production of 1.5 mm bpd within three to four years, with an estimated investment of $ 15 bn.
The Second Licensing Round was announced on December 31, 2008. The round is intended to execute full development of 10 explored but not yet fully developed oil fields covering 35 bn barrels of crude and 26 tcf of gas, distributed widely throughout the country. The aim of this round is to add further production capacity of nearly 2 mm bpd, costing an estimated investment of $ 20 bn, thus approaching the aimed strategic production target of 6 mm bpd by adding the existing capacity of 2.5 mm bpd to the first round addition of 1.5 mm bpd and the 2 mm bpd of the second round. [14]

In a world in which 80 % of proven crude reserves are state-controlled, Iraq offers the international oil companies an unprecedented opportunity to tap into one of the last available huge crude and gas reserves in the world. But precisely because of this recognition, Iraq is offering potential oil and gas company bidders bidding parameters that are "eye-watering tough." [15] For example, Iraq demands an up-front "signing bonus" be paid to the host country by the selected bidders to secure exploration rights. However, it does not guarantee future revenues. [16]
As one oil executive told, "One of the big issues was that companies were to make all the investment and take all the liability and they were to have no control over the destiny of that investment and money spent." [17]

At least 35 oil companies, eventually increased to 41, including most of the majors [reference to fully-integrated international oil companies] have taken part in the bidding. These companies quickly discovered that what they were bidding for was not lucrative production-sharing agreements but rather service contracts that would offer them cash or oil as a compensation for their services.
The only company thus far to have accepted these conditions is China National Oil Company (CNOC) which signed a service agreement worth $ 1.2 bn to cover a small oil field, Al-Ahdab, in southern Iraq, scheduled to produce about 90,000 bpd. [18] The new service agreement replaces an earlier production-sharing agreement signed in 1997. Being a state company, CNOC may have non-commercial considerations for signing the agreement.

The return of the Western oil companies
The new bidding system will most likely bring back to the Iraqi oil scene a number of international oil companies, some of which had a monopoly over Iraqi oil business between 1925 and 1961. These include ExxonMobil, Shell, British Petroleum, and Total, which formed in the 1920s what was known at the time as the Iraqi Petroleum Company, or IPC. IPC was nationalized in 1972, and the assets of the foreign companies were nationalized in 1975.
While the selection of the winning bidders will be governed by a system of competitive bidding, the US companies coming back to Iraq must be doubly careful to avoid giving credence to those who have argued that the invasion of Iraq was motivated largely by the Anglo/American desire to take control again of the country's rich oil resources. [19]

Russian involvement
Potential Russian investment in Iraqi oil may have been a key item on the agenda during Al-Maliki's visit to Russia on April 10. While in Russia, Al-Maliki met with executives from the Russian major oil company LUKoil. There was speculation of a "behind-the-scenes" deal allowing a Russian company to develop a major oil field as a reward for Russian cancellation of Saddam-era debt. [20]
A Russian official publication in Arabic, Rusya al-yawm [Russia Today], said that Iraq has pre-qualified four major Russian oil companies, namely LUKoil, Gazprom, Rosneft, and Tatneft, to submit bids under the first licensing round. However, it said that these companies would have to face a serious competition from other companies. [21]

Sudden shift toward export of crude from Kurdistan
With declining oil revenues, and with Al-Shahristani coming under strong pressure to show progress in crude production, Iraq announced that it would allow the export of 100,000 bpd from Kurdish oil fields of Taq Taq and Tawki beginning June 1, with accrued revenues going to the central government. The oil fields in Kurdistan are estimated to contain 40 bn barrels of oil. [22]
On June 1, the two Kurdish leaders, Iraqi President Jalal Talabani and KRG President Mas'oud Barazani inaugurated the flow of Kurdish oil for export through the State Oil Marketing Organization. No official from the federal ministry of oil attended the ceremony, but the Kurdish minister of natural resources said the export could be increase to 250,000 bpd within a year. [23]

While the two sides have not agreed on a long-term arrangement for the distribution of export revenues, a source in Kurdistan revealed to this author that KRG considers the deal as a breakthrough, establishing the principle that oil from wells drilled in Kurdistan under agreement between foreign oil companies and KRG can be exported through the main Iraqi pipeline which connects Kirkuk with the Turkish port of Ceyhan.
At a minimum the KRG will receive 17 % of the revenues guaranteed under the federal constitution. KRG considers the event a great victory in their struggle to maintain control over the natural resources of their region.

Iraq's OPEC quota
Iraq is a founding member of the Organization of Petroleum Exporting Countries (OPEC); indeed, the cartel was launched in Baghdad in September, 1960. Like all other members of the cartel, Iraq was subject to the quota system, which establishes a ceiling on production for each member. However, after Iraq's invasion of Kuwait in 1990 and the subsequent UN Security Council sanctions which put a ceiling on Iraq's crude production limited to meeting the basic food and medicine needs of the Iraq population, Iraq was temporarily excluded from the quota system.
After the sanctions on Iraq are lifted, the issue of quota will rise again. However, since the quota reflects the size of the proven reserves, Iraq may be allotted a large quota if its proven reserves justify it. While this issue does not appear to be of present concern to Iraqi officials, it could be of concern to other members of OPEC, because the larger the Iraqi share of the OPEC's approved quota, the smaller the shares of others. Al-Shahristani stated rather candidly that some members of OPEC "hope that [Iraq's success] doesn't happen soon." [24]

Conclusion
Iraq has the potential of becoming one of the world's leading producers of oil and gas. In terms of proven reserves, Iraq is behind Saudi Arabia and Iran, but it could easily overtake Iran and could equal, if not exceed, Saudi Arabia. For Iraq to reach its full potential a number of things must happen:
a. Security must be established. Foreign oil companies are not likely to invest funds of millions of dollars required for drilling and extraction if the lives of their professional personnel is at great risk [a small risk in this business is inevitable. Witness Nigeria's Niger Delta.] Security is also essential for the transport and protection of equipment.
b. Iraq should reach a consensus on its oil law. Oil investors will be reluctant to sign service agreements with the central government while at the same time they have to deal with provincial potentates. The conflict between the central government and KRG should be resolved.
c. The licensing rounds should be simplified and made more palatable to potential investors. Fortunately for Iraq, however, the recent spike in oil prices may soften the stand of the potential bidders as the potential for profits would accelerate.

Notes
[1] The Times, London, May 20, 2008.
[2] MEES (Middle East Economic Survey), 23 February, 2009.
[3] The Iraq Study Group Report, James A. Baker III and Lee H. Hamilton, Co-Chairs. New York, Vintage Book, 2006.
[4] www.annabaa.org/nbanews/70/559.htm.
[5] Interview with al-Sharq al-Awsat, March 25, 2009.
[6] MEED, Vol. 53 No. 17, 24-30 April 2009.
[7] Al-Zaman, Iraq, May 27, 2009.
[8] Al-Manara, Iraq, May 29, 2009.
[9] The Iraqi Study Group Report, op.cit. pp. 23 and 84.
[10] Al-Sabah, May 2, 2009.
[11] Al-Sharq Al-Awsat, May 26, 2009. Al-Maliki's views against consensus democracy were first published in the Iraqi government daily Al-Sabah, May 13, 2009.
[12] Al-Mada, Iraq, May 30, 2009.
[13] Al-Mada, Iraq, May 8, 2009.
[14] From a statement by al-Shahristani at the 4th OPEC International Seminar, held in Vienna on 18-19 March 2009,
http://www.mees.com/postedarticles/oped/v52n14-5OD01.htm.
[15] MEES, 20 October, 2008.
[16] www.Iraqoilreport.com/the-biz/Iraq-hikes-signing-bonus-as-bid.
[17] MEES, 4 May, 2009.
[18] Al-Quds Al-Arabi, August 21, 2008.
[19] www.annabaa.org/nmanews/70/559.htm ; Al-Jazirah, Saudi Arabia, June 20, 2008.
[20] MEES, 20 April, 2009.
[21] www.rtarabic.com/prg_panorama/28068?print?version=1 of April 16, 2009.
[22] Al-Rafidayn, Iraq, May 13, 2009.
[23] Al-Mada, Iraq, June 2, 2009.
[24] Interview with BusinessWeek, March 19, 2009.

Dr Nimrod Raphaeli is Senior Analyst (emeritus) at MEMRI.

Alexander's Commentary

A Future?

After a long editorial silence, it is time again for a comment on world affairs.

Whilst reading through the m

read more ...
Support Our Work