The oil industry is Iraq’s most efficient wealth-creating instrument. Recent and near-term future oil prices, which have reached $50-60/bbl and above from $22-28 last year, are providing high income for the country, particularly in view of Iraq’s low discovery cost of about 50¢/bbl and its development cost of 50¢-$1/bbl.
The country has vast reserves potential (OGJ, Sept. 5, 2005, p. 20). An effective oil policy, however, is key to unlocking that potential.
With the country’s nearly total dependence on oil income, logic dictates the requirement for a pivotal state-owned oil industry as is generally practiced in most major oil-producing countries. Iraq National Oil Co. (INOC), in view of its successful past, should be Iraq’s commercial and technical operating arm.
It is logical as well for Iraq to permit a degree of international oil company (IOC) involvement on a partnership basis, which would be beneficial to both parties. This would make eminent sense because of competition and the push towards Iraq’s chosen market economy. IOC participation also could most effectively address Iraq’s need for fast-track oil development, advanced technology, management transfer, personnel training, and large capital investment.
IOCs could be invited to work independently from INOC on risky exploration, however, if that proved to be in the best interests of the state and always with requirements for “local content.”
Privatization is no longer an option. It offers no particular advantage that cannot be gained by partnerships with IOCs. And Iraqis in general disapprove of privatization, a fact to be acknowledged in a future democratic country.
Legacy
Since the 1970s, national oil industries in the Middle East have been managed under an organizational pattern in which an oil ministry makes policy and carries out administrative and supervisory responsibilities, while a national oil company undertakes exploration and production. Most of these countries have a state monopoly over the oil industry, while only a few have permitted partnerships with IOCs on a tax and royalty basis.
The return of IOCs in Saudi Arabia is limited to exploration and development of gas only and in Iran to service contracts with buy-back terms and conditions. In Iraq, invitation to the IOCs has fluctuated between production-sharing agreements (PSAs) and buy-back agreements since the mid-1990s.
Iraq’s methodology-having a national oil company-was similar to that of the majority of Middle East countries until INOC was closed down in the late 1980s and the company’s functions taken over by the Iraqi ministry of oil.
The IOCs, including many from among the majors, flocked to Baghdad negotiating over the years until the end of the Saddam Hussein regime in spring 2003.
Only the Chinese and the Soviets had signed agreements. The remainder had drafts or had only initialed agreements, but none had carried out operations on the ground due to United Nations-enforced sanctions. A further legacy of Saddam Hussein’s regime left Iraq in potential disputes with other countries.
No sooner had Saddam Hussein’s government collapsed than the country’s oil industry and its dilapidated wells, infrastructure, and vital equipment-particularly the communications and control systems-suffered from serious looting and damage. Gradually the frequent sabotage turned the country literally into a battle zone. Disorder, chaos, and insecurity became commonplace, and there was a serious lack of effective management, transparency, and accountability. The serious shortage of oil products, for example, is partly due to corruption.
These turbulent circumstances, along with Iraq’s current gridlock and legality issues with the IOCs, have seriously limited the ministry of oil’s ability to perform (OGJ, Sept. 12, 2005, p. 18).
Ministry limitations
The oil ministry and its operating companies, known for their competence, could not be insulated from this chaotic environment. Concentration on efforts to formulate oil plans and policy became, of necessity, secondary to more urgent matters. Rehabilitation of oil infrastructure and restoration of capacity to a prewar level were sidelined.
Engineering, procurement, and construction management tenders for development of a number of oil and gas fields were met with little success, as first-class engineering contractors did not participate. Even drilling tenders have been unsuccessful in attracting sufficiently qualified companies.
Perhaps as a last resort, the ministry issued memorandums of understanding (MOUs) to companies for the training of ministry personnel and for the study of future oil field development and gas projects without obligations.
A serious drawback lies in the ongoing discussions on the potential allocation of certain oil fields to MOU holders on a negotiated basis. Such MOUs could have the latent effect of discriminating in favor of these companies unless remedies are ensured in the future through well-designed tenders giving all bidders equal access to pertinent data and discussion opportunities under strict transparency and accountability conditions.
Iraqi experts demonstrated a high level of capability and competence under the severe working conditions caused by authoritarian rule, UN sanctions, and three devastating wars.
Since the end of the Saddam Hussein era these experts have been working under further severe operating conditions under three management changes-from the Coalition Provisional Authority to Bahr al-Ulum, then Thamir al-Ghadban, and back to Ulum-and in the vacuum created by the absence of studied and approved oil plans and policy.
Furthermore, with the country struggling under continued serious unrest, some ministry personnel have been kidnapped and others assassinated. Some 246 oil installations, including five oil wells and 51 export pipelines, were blown up in 2004, compared with 77 sabotage operations in 2003.
Despite these obstacles, the ministry of oil has managed to maintain oil production at 2 million b/d, of which it exports about 1.5 million b/d. The ministry’s many accomplishments under exceedingly trying circumstances leave many optimistic about the ultimate success of Iraq’s oil industry.
And, although the ministry was denied an allocation for investment in its 2004 budget, it is now awaiting delivery of $3 billion that has been promised for 2005 industry investment.
Recent oil policy
Ayad Alawi, Iraq’s last prime minister, formulated an oil policy that removes exploration, development, and related operations from the ministry and allocates them to a newly established INOC. However, INOC’s operations would be limited to existing, producing oil fields, and there would be the prospect of its being partially privatized, with shares sold.
Alawi placed emphasis on expediting the entry of IOCs into Iraq to start developing the country’s undeveloped fields. Under his plan they would participate under a modified type of PSA that bars any government entity-even a future INOC-from becoming a party in the PSA. This essentially would transfer into IOC hands the decision-making on Iraq’s oil field development and oil exports and consequently its future income.
The policy also calls for cutting out the negotiating time that goes into optimizing contract terms and conditions, assuming that what may not be gained but given to other countries can be extracted later on the basis of the most-favored nation clause.
But this clause existed during the concessionary contracts era when the majors dominated the concession agreements in an oligarchic market that had common terms and conditions so that improvement in any one country was passed on to the others.
Today’s agreements in different countries, however, are not necessarily similar, and the players and host countries have multiplied in number. The terms and conditions of each contract are unique to the host country and to particular exploration and development, and rewards reflect the associated E&D risks and costs.
Saddam Hussein era negotiations, which were politicized, used to take years. Tendering was never adopted. No doubt future negotiation should be limited to strict tenders with a predefined timetable and under true transparent and accountable processes.
Alawi also was Iraq’s first oil minister to appreciate and promote in his oil policy the requirement for “national local content” to encourage and professionally develop Iraqi private enterprise. The policy even suggested that preferential treatment be given to Iraqi service companies. This policy aspect is important in order to develop a sorely needed Iraq oil industry in a future market-oriented economy.
However, his vital policy lines would have run counter to terms of the Transitional Administrative Law (TAL) annex that governs transitional governments. With the exception of debt reduction negotiations, TAL prohibits contracts that impact the long-term development of the country.
Policy guidelines
The oil policy should be prepared with the utmost care and diligence over a sufficient period of time in order to allow for constructive debate.
The following oil policy guidelines, which remain a focal point of agreement among most Iraqi oil technocrats, are intended to provide a basis for deliberation and discussion. At this stage they are still aspirations, with the hope that they may likely turn into reality.
Consultation. It is in the national interest that, in making oil policy, the ministry of oil consults with an Iraqi think tank comprised of competent national oil technocrats in an atmosphere of constructive debate. Rules and procedures should be developed for incorporating advice and consultation from the think tank. The group’s selection should be based solely on merit and the absence of any conflicts of interest.
Free expression. It is important in such an exercise that constructive dialogue is encouraged and that opinions are expressed without recrimination in order to arrive at an optimal oil policy.
“National content.” Major national oil companies such as those of Norway, Iran, and Russia have adopted policy elements requiring as much as 51% of oil industry work in their countries be performed by local service companies and personnel.
Iraq’s oil policy and planning must also ensure optimum benefits to the nation, which is the rightful proprietor of this depleting asset. As the INOC charter states: “The hydrocarbon resources are the inalienable and imperceptible property of the state.”
Petroleum is a nonrenewable, depleting asset. It merits conservation, optimum fiscal reward, the participation of the national oil company, and inclusion of “national content,” which should be built into every contract with the IOCs, but not to the extent that this impacts on Iraq’s need for oil exploration and development to remain competitive.
Such a “national content” policy should promote or build participation by national private oil companies, services, and manufacturing capabilities; the transfer of knowledge, management, and technology; and inclusion of local research and technical institutions.
Income diversity. For these reasons and to compensate for depleting petroleum as a source of national income, investment in other economic endeavors should be made to ensure continuity of income. Once this is achieved there is room for lesser dependence on a state oil monopoly.
Reinstating INOC. As long as Iraq’s economy remains dependent on oil income, it is absolutely necessary for it to establish a national state-owned oil industry and give it a pivotal role in exploration and development operations. This will ensure that decision- making for orderly E&D operations and the continued safeguarding of income for the treasury remain under national control.
IOC partnerships. Developing partnerships among the national oil industry and IOCs is the best option for expediting the building of the Iraq oil industry to dimensions commensurate with its huge resource base. These partnerships would enable Iraqis to incorporate state-of-the-art technology and management techniques, acquire necessary investment capital, and accelerate the realization of benefits through efficiency and healthy cooperation.
IOC security and fair return on investment. To conduct business in Iraq, IOCs and foreign contractors will require stability and security, law and order, and assurance of the safety of their personnel and capital investments. Iraq must provide these along with other legitimate requirements, including a fair return on investments.
Decentralizing power. The law governing administration during the transition period requires:
• “Managing the hydrocarbon resource of Iraq, which belongs to all the people of all the regions and governorates of Iraq, in consultation with the governments of the regions and administrations of the governorates;
• “Distributing the revenues resulting from their sale through the national budget in an equitable manner proportional to population throughout the country and with due regard for areas that were unjustly deprived of these revenues by the previous regime;
• “Dealing with their situation in a positive way, for their needs, and for the degree of development of the different areas of the country.”
However, a reasonable degree of devolution of power may prove necessary short of oil contract negotiation or decision thereon.
Facilities rehabilitation. Oil and gas laws and regulations and a hydrocarbon law should derive their legitimacy from a constitution enacted through due international, democratic, and legal process.
However, in the interim period, there is a consensus of opinion that the ministry of oil and its contractors are allowed to proceed with rehabilitation of the petroleum production system and its restoration to past levels and with ongoing production and development operations of short-term consequence.
Contract variables. Contracts can take any of a number of forms. These may include buy-back contracts, other service contracts, or PSAs, which preserve the state’s ownership of the petroleum resource.
PSAs appear to have wider and more favorable acceptance by the IOCs and host countries, while the ministry of oil appears to favor either contract form or a combination of the two. The most important criteria, however, in all forms remain the investment return to both parties, the share to each party, the extent of “national content” and the degree of other economic and fringe benefits to the nation, and the degree of the government’s control in exercising and maintaining administration and supervision without infringing on the company’s rights to carry out operations effectively and efficiently.
Transparent tendering. Tendering should be the only process for selecting companies interested in working on exploration and development operations. Tender data should be comprehensive and announced according to well-defined time schedules. This should involve general information meetings set for interested parties. Interested bidders should submit prequalifications, as only prequalified parties would be invited to bid. They should be given equal opportunity to access a comprehensive database. Bids should be evaluated, and short-listed bidders given a fair chance to participate in discussions leading to selection of the winner. The procedure, evaluation, discussions, and decision should be fair and transparent. Assigning a fee to the bids and access to the database is advisable to eliminate the less-serious parties and improve bid quality.
Agreements. Agreements between the state and IOCs must be written and applied in good faith. They must be balanced and fair in order to avoid disputes and to endure. They may, however, permit reviews in the light of changed circumstances such as those governing taxation, profitability, or market conditions.
Conflicts of interest. No member of a consortium should have interests incompatible with those of the other members or with Iraq’s vital oil industry objectives. Such conflicts could curtail a company’s investment and retard the consortium E&D obligations.
Avoiding politics. Oil policy and its organizations should not be politicized, and appointments should be based solely on merit.
Outlook
Although the ministry of oil, under difficult circumstances, has accomplished much, it is unlikely to be able to build capacity beyond 2.5 million b/d by yearend. Capacity is likely to reach 3-3.5 million b/d some 2 years later.
One may anticipate that plans and policies of the kind stipulated herein will be accepted and applied, a hydrocarbon law enacted, and INOC reestablished by mid-2006.
The IOCs’ current cooperation in conducting training, studies, and evaluations under the MOUs gives Iraq every reason to anticipate having serious oil field development operations under way by yearend 2007-assuming that a reasonable state of order and stability prevails.
A number of elements are working to accelerate improvement to the state of law and order and conditions for construction: the use of advanced methods of electronic surveillance in combating acts of sabotage; the readying of a trained Iraqi police force and army; the anticipated withdrawal of coalition forces; and the oversight of a constitutional, democratically elected government in place in 2006.
In addition, politicians and the government are gradually realizing that the use of debate and reconciliation promises to pay dividends and could prove more effective than the exchange of accusations or use of military force.
On the distant oil scene, Iraq could face intensified competition from other major Middle East producers. And Iraq’s production growth to 5-6 million b/d by the year 2010-as anticipated by the ministry of oil and most observers in the recent past-appears very unlikely; 2013-15 is more likely.
It also would appear that Iraq and its oil industry have reached the bottom, so the most likely direction for it now is up. ✦
