Iraqi oil-2: Future grounded in old INOC

Sept. 12, 2005
Iraq’s oil future rests in the reestablishment of Iraq National Oil Co. (INOC), which was taken over by the country’s ministry of oil in the late 1980s.

Iraq’s oil future rests in the reestablishment of Iraq National Oil Co. (INOC), which was taken over by the country’s ministry of oil in the late 1980s. The country would be better served by separating the national operating companies from the ministry of oil, which would enable the ministry to focus on such issues as developing policy, supervising resource conservation and management, and negotiating and issuing licenses.

INOC was established as Iraq’s national oil company in 1964 by Law No.11, which had dual objectives:

• “Establishing a national oil industry that would serve as the basis for future oil exploitation activities in the areas of which the rights of exploitation have been restored to the state by Law No. 80 of 1961.”

• “Laying down of the groundwork necessary for the growth and development of the industry so as to create an advanced oil economy not limited in scope to exploration of crude oil but extending to effective engagement in the various phases of the oil industry.”

Prior to the establishment of INOC, international oil companies (IOCs) were the major players in Iraq’s oil development efforts.

IOCs, nationalization

Historically, the major IOCs in the Middle East established the largest industry, and at times the only industry, in various oil-producing countries. IOCs demonstrated a high degree of efficiency and became the largest provider of revenue to the state, gaining great economic and political power. They formed distinctive foreign and privileged enclaves, and the terms ‘concession’ and ‘concessionaire’ thus developed derogatory implications. As a result IOCs became further associated with the colonial era, as Middle Eastern major oil-producing countries were under direct or indirect foreign influence.

The history of Iraq Petroleum Co.’s (IPC) formation and the way that shares were distributed among British, French, Dutch, and American companies is evidence of the role politics played in the Middle East in acquiring oil concession rights during World War I and in its aftermath.

The major oil concessions had common ownership, which permitted effective control, and common features, such as extended periods of exploration and exploitation. IPC in Iraq, for example, had 75 years, Kuwait Oil Co. in Kuwait, 92 years; and Saudi Aramco in Saudi Arabia, 66 years.

Other advantages existed, such as frozen terms over the long life of the concession and rights to large concessionary areas without relinquishment in most of Iran, almost all of Iraq and Saudi Arabia, and all of Kuwait, Bahrain, and Qatar.

In addition, the concessionaire held exclusive rights to carry out operations without sufficient obligations governing the exercise of those rights. Absent, too, were some basic government rights in vital matters such as tax and royalty, company plans, and application of conservation and best oil industry practices.

Most of these advantages, however, dissolved during the 1950s-70s, under changing circumstances and collective pressure from host countries through the Organization of Petroleum Exporting Countries.

Nationalization through gradual share acquisition by OPEC members was achieved by the late 1960s and early 1970s as a result of collective bargaining under OPEC’s umbrella.

Iraq, however, negotiated outside of OPEC and failed to reach a negotiated agreement after adopting confrontational demands. These led to unilateral legislative action to enforce relinquishment of 99.5% of the concession areas through Law No. 80 in 1961.

Law No. 20, which followed in 1970, made it illegal to give up the additional 0.5% of producing acreage to the companies (originally permitted in Law No. 80), and it closed the door against any possible negotiated settlement, which left Iraq’s oil industry frozen.

The life terms of Middle East concessionary agreements could not then be met because they were not balanced, and some clauses, such as Iraq’s 20% participation, were written to make application impossible. The agreements were passed under duress after World War I, when the national governments of the day were being established or were in the process of gaining their full sovereignty. The IOCs often took corrective measures too late when damage had already been done.

It is for these reasons, among others, that there is consensus among Iraqis, the government, and many IOCs not to enter into long-term oil exploration or production agreements until such a time when a legal, democratically elected government is in place and recognized by the international community, with a constitution and a petroleum law in place.

Most IOCs prefer to deal with socially and politically stable regimes because they recognize the added risks resulting from instability. Attempts to short-circuit or bypass this would meet with failure in the medium or long term. The long-term success of IOCs would depend to a large extent on their success in entering fair and balanced agreements far from the short-lived, short-term political gains made in the aftermath of the March 2003 political turbulence.

INOC’s role

INOC’s charter gave it wide-ranging powers and scope (see p. 19). However, for more than 4 years it was not given the 25 million Iraqi dinars in capital specified by the charter. Nor was it allocated an area to explore or given an oil field to develop.

North Rumaila oil field, which remained the focus of many politicians as the first oil field for INOC to develop, was allocated to it in the early 1970s when Iraq nationalized its oil industry.

INOC also became a third party negotiating with IPC’s parent companies on Iraq participation and the amount and location of the exploration and development area. INOC kept itself engaged as well in negotiations among the government and IPC parent companies, providing briefs on the numerous issues under dispute where relinquishment and government participation were pivotal.

Because INOC inherited IPC and its associated companies, its full-time occupation became evaluating exploration and production records, sorting out data, building a databank system, assessing Iraq production and exploration capacity, and formulating oil policy and field development plans singly or in joint ventures. The exercise provided excellent training for INOC staff.

However, the country’s economy remained almost totally dependent on oil income from IPC, and INOC remained barred from any field exploration and development for a few years because of political instability, the lack of government policy planning, absence of investment capital, and fear of retaliation by the companies or their governments-the 1953 overthrow of Iranian Premier Mohammed Mousadeq in a coup d’état was still in mind.

Draft settlement agreements, concluded in 1965 after a year of exhaustive negotiation, were not implemented.

The proposed settlement would have formed a new joint stock company of IPC parent companies BP PLC, Royal Dutch/Shell, Cie. Francaise des Petroles (now Total SA), and Mobil Corp. Esso, which saw the agreement as an unacceptable compromise, refused to participate. The agreement would have given each of the four companies 16.67% of the shares, with 33.67% left to INOC, and a ‘sole risk’ clause to resolve possible differences over operating and investment plans.

The joint venture area of operation was limited to 8% of the country, which left 91% relinquished to government control and only an additional 0.5% allocated to IPC. With the recognition of Law 80, the companies would retain only 1% of the areas containing producing fields that they had already developed and were operating.

This would have set a precedent in 1965 for majors entering into participation with host countries for the first time and accepting relinquishment principles. The offer would have to be made to other Middle East host countries in accordance with the “nations most favored” clause.

The politicians chose otherwise, and the authoritative Revolutionary Council rejected the proposed agreement at a time when socialism was the fashion and the government had lost its zeal. Socialist-oriented politics took precedence over commercial and economic wisdom.

Iraq nationalized its oil industry during 1972-74 amid a wave of collective negotiations through OPEC on behalf of its members, apart from Iraq (OGJ, Dec. 15, 2003, p. 34). The other countries arrived at the same goal through negotiating gradual equity participation, which led to total acquisition in some cases, while others preferred the JV solution under a tax and royalty fiscal system. INOC was operational from the early 1970s until the ministry of oil assumed control of it in the late 1980s.

However, the cost to Iraq in monetary terms and loss of markets was high.

INOC performance

INOC had demonstrated a high degree of success and established an historical record of achievements.

As it became operational, it entered into service agreements with France’s Enterprise de Recherches et d’Activités Pétrolières (now Total AS) and others in the early 1970s, then began oil exploration and development on its own and with the aid of oil service companies. It maintained the high exploration successes of its predecessor IPC and achieved speedy development work, multiplying the country’s reserves, accelerating building production capacity, and expanding oil markets.

IPC and its associated companies had developed the oil industry in Iraq over some 5 decades on a sound technical basis and produced generations of Iraqi oil experts and technocrats. However, their exploration and development progress was very slow because most of the IPC consortium members had greater interests elsewhere in the Middle East. In addition, Iraq’s confrontational policy, which took the route of legislation rather than negotiation, required compromise.

INOC proved itself highly successful in the operation of the fields it inherited. It took over seven producing fields having a total production capacity of 1.5 million b/d and a host of undeveloped or delineated discoveries. It tested prospective and proven formations above and below the main producing formations and discovered fields and delineated new structures.

INOC logged some 40 prospective formations. IPC and its associated companies had logged most of them but had left them insufficiently tested or neglected as long as they tested only a few thousand barrels per day of oil.

The exploration drilling intensity doubled to three wells/year from the concession-era rate, while the overall success rate was maintained at three out of four wells. IPC’s total drilling intensity amounted to 10 wells/year in the 1960s, compared with INOC’s 36 wells/year in the 1970s and 92 wells/year in the 1980s during the years of the nationalized era. In 1989, the nationalized oil industry drilled 178 wells and more than 1 million ft.

Iraq achieved a discovery rate exceeding 6 billion bbl/year during 1972-77, which matches best records for total discovery in the rest of the world, and production capacity reached historic peaks of 3.5 million b/d by 1979.

INOC rebirth

INOC’s successes are evident. Its engineers demonstrated ingenuity and resourcefulness in trying to make good what their politicians had allowed to be destroyed during three wars and United Nations sanctions. Its plans and performance not only achieved its target income but also developed production capacity assets and explored and tested every potential oil formation vertically and horizontally, thereby multiplying the country’s reserves.

However, corrupt and confrontational government policy and the severe working environment of wars and sanctions led to losses of opportunities for technical and managerial training.

For a reestablished INOC to achieve success, several issues would need to be addressed:

• The national oil company should become the state’s pivotal enterprise, whose function is to implement government policy for upstream oil industry operations in order to accomplish the government’s objectives.

• It should be established as an independent, commercial company in accordance with prevailing laws and regulations that give it sufficient powers and obligations to function with effectiveness, efficiency, transparency, and accountability.

• It should have sufficient capital and the right to borrow and enter into JVs or associations with others in accordance with approved contractual regimes.

• Its board should be appointed by the government and be formed from among leading petroleum experts.

• Production capacity expansion should be based on a composite master plan, which takes into consideration the country’s developmental and economic needs. It also should be based on optimal use of the proven reserves housed in numerous reservoirs and oil fields in different locations, which are capable of producing 10 million b/d. Alternative options should be designed to plow in potential reserves to a capacity of 12 million b/d. (OGJ, Sept. 5, 2005, p.20).

• Corrective measures must be taken to repair the formation damage to currently producing fields wherever possible and to enhance oil recovery.

• Market capacity, investment, and operating capital and the role of each in the operating national oil companies should be simultaneously assessed and integrated into the plan.

• The complementary role of the IOCs also should be assessed along with administrative, legislative, and regulatory needs. Production rate, however, should be governed by economic and social capital needs and the state supervisory and regulatory capability.

• Because most of INOC’s 1964 charter terms remain valid, a reestablished INOC charter may use much of it, with some modification to reflect Iraq’s planned change to a market economy and the oil industry changes since 1964.

Successful implementation of these changes will depend on future Iraqi oil policy and actions taken by the government and the ministry of oil.

Next: Iraq’s oil policy will be the key to unlocking its oil potential.