Oil in post-Saddam Iraq

The following is a paper delivered by Issam al-Chalabi at the 6th annual “A Tale of Three Seas” conference in Istanbul on 10-12 June, organized by Cambridge Energy Research Associates (CERA).
Mr Chalabi held the portfolio of Iraqi Oil Minister from March 1987 to October 1990 when his tenure was terminated and he retired from government service. Since 1991 he has been working as a consultant in 'Amman, Jordan.

The war is over in Iraq and the post-war situation is unfolding in ways that might not have been expected. Oil installations sustained little war damage and yet the resumption of production and export is proving harder owing to lack of security and disorganization. But we need to be realistic in viewing Iraq’s oil prospects and preparing the right approach to encourage international investment to develop its production to a level more compatible with its huge reserves.
But let me first go quickly over the developments that have taken place during the last three months. During the CERA February conference in Houston, many believed that the war on Iraq was inevitable, regardless of the UN position. The question then was about the timing. On 20 March the war started. The US and the UK led the invasion without the consent of the UN.

The war lasted less than three weeks. Saddam’s statue was brought down on 9 April with hardly any resistance from the Republican Guards and other Iraqi forces. The coalition forces were victorious. Saddam’s 35 years of power came to an end. The despot had disappeared and the question, yet to be answered is: where is Saddam? Is he dead or alive? And where are the weapons of mass destruction? On 22 May, Security Council Resolution 1483 was adopted unanimously. Those who opposed the war kept quiet. They changed their positions and accorded legitimacy to the presence of the coalition forces. The victorious always dictate their terms.
Resolution 1483 defined the coalition forces as an occupation force and bestowed upon it the title of the Authority. The world body legitimised the occupation. It transferred legal control to the Authority, which is now referred to as the Coalition Provisional Authority (CPA). Accordingly, a new Iraq is in the making. However, many questions remain unanswered as to its shape and destiny.

The CPA has already taken steps to dismantle the army, the security forces, the Ba'th party, the police, the information ministry, the military industrialization establishment and many other organs of the Saddam regime. These steps have created a big vacuum in the country since there is no Iraqi entity yet established to replace what was dismantled.
The CPA announced at the beginning of June its intention to abandon plans for the convening of a national conference and opted instead for a 25-30 member Political Council, which would later be transformed into an Iraqi Interim Administration. This is not expected before end of next month and the CPA is likely to be in control of Iraq for no less than two-to-three years. The UN role remains marginal.

Economically, the UN sanctions were lifted, other than those covering the arms trade, and the CPA was granted full control over the newly established Iraq Development Fund. All future oil revenue of Iraq, as well as Iraqi money abroad that was previously frozen in various world capitals, along with any assistance or aid granted to Iraq -- all these resources would be deposited in the Development Fund to be disbursed at the direction of the CPA in consultation with the Iraqi Interim Administration.
Security Council resolution 1483 also states that oil sales shall be made in accordance with prevailing international market best practices subject to auditing by an international committee. Accordingly there will be no more discounted oil to Iraqi neighbours, no more smuggling and no more sales to nameplate companies. Moreover, there will be no more barter deals other than possibly the exchange of fuel oil, which is available in large volume in Iraq, with petroleum products in neighbouring countries.

One can safely assume that the gradual return to normalcy of the Iraqi oil industry will be monitored rather closely by the world oil industry for the transparency of its operations. Exactly how strong Iraq will return to the world markets remains to be seen. Whereas the country’s pre-1990 production capacity stood at 3.5-3.8 mm bpd, output prior to last March was 2.7 mm bpd with some Iraqi officials insisting on a higher figure of 3 mm bpd. In fact, Iraqi oil exports reached a level of approximately 2.2 mm bpd through certain periods of the oil-for-food program.
There was very little damage to Iraqi oil facilities during the war itself, with the major damage being a direct hit on the K-3 pump station on the strategic pipeline. However, the oil industry was a victim, and continues to be, of the looting, ransacking and burning after the war. It has taken several weeks for the oil establishment to restore production to meet local consumption needs.

As a result, after an initial modest levelof around 200,000 bpd, production was increased to approximately 700,000 bpd by early June. It is expected to reach 1.3 mm bpd by July and increase gradually to around possibly 2.7 mm bpd by year-end. Accordingly, exports will fluctuate and could start at around 0.5 mm bpd, increasing gradually to less that 2 mm bpd by year-end.
It is my understanding that if serious efforts are not taken to deal with aging reservoirs and the badly maintained surface facilities, then even this production capacity might not be reached within the timeframe being talked about these days. The downstream industry is in a much worse condition. It remains gasoline oriented with the fuel oil cuts exceeding 55 %. It goes without saying that serious and immediate steps must be taken to rehabilitate and upgrade the refineries while attempting to meet local demand. This explains the reasons behind the resumption of fuel oil exports to Jordan and Turkey in return for exchange of LPG and gasoline.

There is no better way of explaining the oil industry situation in Iraq today than to quote the following from an article published by Dan Yergin last month: "The industry is in a state of dilapidation. The underground reservoirs have been damaged by years of mismanagement. The entire infrastructure -- whether wells, pipelines, pump stations, or ports -- is in poor shape. Equipment is rusting and malfunctioning. Environmental pollution is widespread. That the whole apparatus is able to operate even at current levels is a testament to the skill of Iraqi engineers. They have been geniuses at improvisation."

Now that the Security Council has given its approval, and provided immunity, for the resumption of Iraqi oil exports, it is expected that oil exports will start during the second half of the month, basically from Ceyhan. The program calls for the sale on a tender basis of the 8 mm barrels stored in Ceyhan before the war, as well as approximately 2 mm barrels of crude in the southern storage facilities.
Regular exports, however, are not scheduled to start before end-June or early July, depending on the security situation and the upgrading of logistical facilities in the fields, depots, and headquarters. It is not clear yet at what exact level exports will be sustained at the initial level. This will have to await a more detailed assessment of the overall situation in the fields.

The Iraqi oil industry, like all other sectors, is being overseen by the Americans through Phillip Carroll as head of an Advisory Board. The full names of the Board have not been announced yet. An Iraqi interim administration, made up of current oil officials, was installed last month. So far there has been no policy announcement, either by the Americans or the Iraqi side, of medium or long-term oil policies.
The focus, in the short term is to direct efforts during the next two-to-three years on the rehabilitation and upgrading of the country’s oil production capacity to the pre-1990 level. It is hoped that this will take place along with serious measures to stop deterioration of sub-surface conditions, even if it means a decline in overall capacity for some time. There will be much assistance needed from foreign companies including service, drilling, construction and engineering firms.

The estimated cost of these programs during this period is around $ 5 bn. There are some who say that it would be better not to spend money rehabilitating fields, with the concentration instead being on new development. They are certainly wrong. Kirkuk oilfield might be over 70 years old but it still possesses huge reserves which, if properly managed, could continue to produce 500,000-700,000 bpd for many years to come.
With regards to future prospects, it is a fact that even without any additions to the current proven oil reserves of around 112 bn barrels, Iraq’s production capacity can be increased to 6 mm or even 8 mm bpd. Here again, logic dictates that this may not happen before 2010. To achieve this, there will definitely be a need for the major involvement of foreign investment, technology, and expertise. There are several models to choose from, basically production-sharing contracts (PSCs), development and production contracts (DPCs), or modified buy-backs or risk contracts.

However, to undertake such a task, a number of conditions need to be met. These include security, stability, a freely elected Iraqi parliament and government, legislation of fiscal and tax laws to safeguard the interests of all parties concerned, and guarantees on return on investment, as well as a new hydrocarbon law and a well-defined oil policy adopted by a freely elected legislative body. To be realistic, such measures cannot be expected to be adopted and be the law of the land before a period of around three years.
Major international oil firms have expressed their readiness to be involved in the development of the Iraqi upstream once there is a recognized government approved by the Iraqi people. This involvement, if materialized in full, will open the door for investments in the range of around $ 30 bn-$ 40 bn. However, there are many who continue to express fears about the openness of the Iraqi upstream to international firms. These sources have called, accordingly, for a level-playing field and transparency.

The issue of existing contracts and agreements remains unclear. While Russia and some other countries have called for their deals to be honoured, no decision has been made by Iraq, though various statements by Iraqi officials have indicated that these deals are null and void. There are three contracts with Russia, China and Vietnam, as well as nine other agreements with other countries. The most important of all is without doubt the contract concerning the second phase of West Qurna oilfield with a production capacity of approximately 600,000 bpd. LUKoil has threatened to go to arbitration if it does not have its way and reactivates the contract.
It is my opinion that this matter of previously signed deals might well be handled in one of the following ways:
-- To regard all these deals as null and void.
-- To consider each case on its own merits, taking into consideration the economic and political interests of Iraq.
-- To form consortiums, including existing contractors, so that other companies with better capabilities, financial re-sources, technology and experience can participate in the development of these fields.

What about privatisation?
There are some circles that assert that in order to attract international oil companies, Iraq would need to take measures leading to the partial privatisation of its oil industry -- something similar to what was adopted in Norway when 20 % of Statoil’s shares were sold in the international stock markets. But for that to be considered we need to remember that, at the time, Norway was enjoying political stability, had already established capital markets and had spent over 10 years preparing for corporatisation before moving to privatisation.
None of the above applies in Iraq; therefore the argument does not hold water. In the case of Iraq, oil is not only abundant in large volumes but development and operation costs are also among the lowest in the world. The fact of the matter is that proven reserves are plentiful and potential investors will not be hard to find. This was pretty clear even during the Saddam era and the UN sanctions regime. It is an open fact that scores of companies of different nationalities went to Iraq during the past decade, held extensive talks with Iraqi oil officials, and either concluded or signed upstream contracts as we discussed earlier.

A basic tenet about Iraq and oil is the deep-rooted feeling among the people that the oil wealth of the country belongs to the state and is a sovereign issue. Any move or steps to bend these principles in Iraq would lead to a lose-lose situation for Iraq as well as the international oil firms. Moreover, it is essential that whatever the legal and political framework that will emerge at the end of the day in Iraq, and whether there is a unitary or a federal state, the oil industry should remain central both in the sense that it is part of the central government and run in a unified way for the country as a whole.
There are those who assert that Iraq’s national oil industry has failed in its responsibilities. The fact of the matter is that the national oil company has performed as best as it could, considering that the country has been into three major wars and was subjected to 12 years of sanctions during the past two decades. It was the political leadership that failed the country.

The Iraq National Oil Company (INOC) did its best under the most difficult circumstances to preserve the nation’s wealth and deliver under severe dangerous circumstances. As a matter of fact, INOC had no more than a few years during the 1970s to exert real efforts to develop the industry and its potentials. For example, the plans being proposed to develop the country’s production capacity to around 6 mm bpd were in fact drawn up as far back as 1979-80 when tender documents were issued for the development of the well-known five super-giant fields. This program did not materialize because of the Iraq-Iran war. Another attempt was made in 1990, but that same year Iraq invaded Kuwait.
Hence, if privatisation is to be ever considered, then there will be a need to lay the groundwork for the future and understand nationalism -- looking far beyond the record of the last regime. And if decisions are not taken carefully, there will be a big risk of backlash. Having said this, partial privatisation of some of the downstream activities can and should be pursued, possibly through local and/or foreign investments as was proposed and partially implemented during the period 1987-90.

Finally, there are those who are proposing that Iraq should withdraw from OPEC. This goes against the country’s interest and will serve no purpose. In fact the record shows that since the introduction of the OPEC quota system in 1983, the capacity of Iraq’s export facilities wasalways less than the allocated quota because of wars and sanctions. The only exception was the very short period in the early 1990s after the completion of the second phase of Iraq's pipeline to the Red Sea and prior to Iraq's invasion of Kuwait.
Basically, and without getting into the details, Iraq’s OPEC quota, recognized at parity with Iran, is currently around 3.5 mm bpd. A practical review of the situation shows that it would take Iraq three years to reach that level of production and many more years to exceed it. Moreover, Iraq has no government today and cannot even be represented in OPEC or any other international organization, until a recognized government is installed. Accordingly, it is premature and irrelevant to raise the issue today.

Before I conclude, and since this conference has discussed gas potentials, let me add a few words about Iraq’s gas prospects. Official estimates put reserves at 108 tcf, three-quarters of which is associated gas -- with more than half of that found in alreadydeveloped and producing fields. Further reserves are expected with further exploration activities.
The development of the gas industry was never a priority in Iraq, though plans for transporting gas to Turkey go back to the 1960s. I myself worked on that project in 1967. Over the past few years, a project was considered by Turkey and Iraq involving the transportation of supplies from five gas fields in north-eastern Iraq, supplemented by associated gas. A project to export gas to neighbouring countries, and possibly to Europe, should be among Iraq’s future projects.

Iraq and its people have been the victims in the past. Let us hope that there will be a bright future ahead. They deserve it.
People question whether the existence of oil wealth has been a curse or a blessing. Let us hope that this will not be questioned any more and that the Iraqi people will start to benefit from this wealth.