Comments on Iraq's Petroleum Laws …

                       Comments on Iraq's Petroleum Laws
                                 by Dr Fadhil J. Chalabi

The primary objective of a Petroleum Law for Iraq is to create favourable conditions
for speeding up investments in the development of the country's rich oil reserves,
and for increasing as rapidly as possible the oil revenues necessary to salvage the
country from its present economic ruin and poverty.

Oil policy should not be considered separately from economic issues but rather in
relation to the country's economic and social needs. It should also take into account
the long-term trends in world energy and the future of oil in the world energy mix.
Oil is Iraq's only hope and it is crucial, therefore, that this asset be used rationally
without the preconceived ideological and non-economic notions of the past, and be
replaced by a pragmatic approach that focuses on a cost-benefit approach and
emphasises a strict time-frame. In this respect, certain basic facts should steer
policymakers towards achieving these objectives.

1) The former regime with its irrational, bellicose policies, and its furtive and self-
   defeating tactics vis-à-vis the UN inspectors, which unnecessarily prolonged
   sanctions for over 12 years, caused Iraq to lose a huge amount of oil exports.
   These losses can be measured by comparing Iraq's actual production between
   1980 and 2003 with its previous production of 14.5% of OPEC's total production,
   had that production continued without the intervention of wars and UN sanctions.
   The difference between the two magnitudes represents losses of oil exports
   amounting to 18.6 billion barrels of oil (or 1.9mbpd), a colossal amount of almost
   twice the reserves of an OPEC member such as Algeria. Based on the average
   monthly price, the value of those oil export losses amount to a financial loss of
   $435 billion since 1980, or $44 million a day. These production losses have been
   to the advantage of OPEC countries, especially Saudi Arabia which in the
   absence of Iraqi oil has benefitted in being able to increase its quota system from
   5.4mbpd to 8.4mbpd.
     Given the dependence of Iraq's economy on oil, such ruinous losses have broken
     the economic backbone of the country. In 1980 Iraq's per capita income was
     almost equal to that of Greece, but since Iraq's impoverishment this income is
     equivalent to a poor central African country, such as Burundi. This means that an
     oil policy for Iraq should aim to compensate for the enormous losses that have
     reduced Iraq to this level of poverty, i.e. a policy that would secure as well as
     speed up oil production and exports. Furthermore, Iraq needs a huge inflow of
     capital to rebuild the infrastructure with which to embark on projects and create
     jobs in a country where the number of unemployed now reaches as much as 50%
     of the labour force, and 70% of the country's youth.

     Iraq's resource-base is so vast that, according to a CGES/Petrolog study, Iraq
     could produce at a high rate of 6-8mbpd until the end of the century before
     production shows signs of depletion. This means that speeding up production to
     that magnitude would have no effect on the life-span of oil reserves in Iraq.

2)   The rate of growth of world demand for oil is on the decline, except in China and
     India which both constitute the only engines of oil-demand growth left. Demand
     has weakened with the huge improvements in the conservation of energy and
     increasing energy efficiency. This has been particularly obvious in the case of
     Western Europe and Japan, where the share of oil in total primary energy has
     been in sharp decline. In the US and even in China it has become of paramount
     importance to rationalize energy consumption in order to reducing the amount of
     oil necessary for achieving economic growth. This trend first began as a result of
     the 1970s price shocks. In the case of Western Europe the combined share of
     natural gas and nuclear power in total primary energy increased from 11% to
     37.6%, obviously at the expense of oil's share of total primary energy ­ with the
     Gulf's oil exports suffering much more than Africa's.



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   With the price hikes of 2006 there have been increasing calls in the US, as well as
   the world over, for reducing dependence on imported oil. Nuclear energy phobia
   provoked by Chernobyl and, earlier, the Three Mile Island accident, has largely
   been mitigated with the urgency of government focus on reinvesting in nuclear
   power, especially now in the US, China, and in Europe. The pressure on oil has
   gained momentum from the time of Kyoto and the increasing environmental
   concerns expressed about global warming and CO² emissions.

   In the area of power generation the share of oil has been in sharp decline globally
   because of alternative energy sources, nuclear energy, natural gas; and even
   clean-coal technology is underway.

   In the area of transportation, where the alternatives to gasoline prove more
   difficult, it is only a question of time before the present trend of using more and
   more biofuels (ethanol), together with increasing projects for hybrid engines, and
   ultimately the hydrogen fuel cell, will become economically feasible. All this
   conversion to alternative energy sources should alert Iraq's oil policy formulators
   and finally inform all legislation so as to create the best environment for
   investment, above all by opening the industry to foreign investors to speed up the
   production of Iraq's only great asset.

3) Apart from alternatives energy sources, there is now, thanks to technology, a
   greater availability than had been envisaged of non-OPEC oil, which hitherto had
   been thought to have reached a plateau. North Sea oil, for example, which before
   was predicted to be depleted by the 1990s, still continues its production (in
   Norway especially) because of enhanced recovery technology. Furthermore, the
   rate of decline in that area will not be as steep as was previously forecast. In
   addition, there is now more oil from the Former Soviet Union, the Gulf of Mexico
   and West Africa.


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4) The implications of all these demand/ supply trends are that the need for OPEC
   oil is bound to decline over time. In fact, the world is on the threshold of a major
   transformation in terms of global energy in the coming two or three decades.
   This means that growth rates in Iraq's oil production and exports will be faced
   with increasing difficulties in the future.

   In other words, the sooner Iraqi production is underway, the better; otherwise the
   same fate of the millions of tons of coal that were left buried underground, will
   befall the vast amounts of Iraqi oil which risks being left buried underground with
   no market outlet in the distant future.

   These conclusions about world supply/demand trends differ from the optimistic
   forecasts of the International Energy Agency (IEA) which predict a continuously
   robust growth in the world demand for oil, faced with declining non-OPEC
   supplies; and thus, accordingly, the need for OPEC oil will continue to increase
   leaving good room for the expansion of Iraq's oil industry. These IEA forecasts
   do not take into consideration the impact of high oil prices and technological
   progress affecting both supply and demand. It is always the case with IEA
   forecasts that they begin with high rates of demand growth which later need to be
   revised downwards. It is not inconceivable that the IEA adopts a position that is
   politically motivated.

5) During the 1990s, the former regime negotiated with various international oil
   companies from Russia, China, France, Italy, with the aim of developing some of
   Iraq's giant oil-fields. The Iraqi government signed agreements with Russia's
   Lukoil and CNOC of China, while other agreements were left unsigned ­ and all
   were based on the `Production Sharing Agreement' formula. Nothing ever came
   of them because of the UN sanctions. Nevertheless, the Production Sharing
   Agreement (PSA) is a valid model with which to consider for future policies
   concerning Iraq's oil, although this does not exclude other arrangements
   (including joint ventures) that could hasten the production of Iraq's oil.
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6) Examining the draft agreement for the PSA, the latter model seems a logical
       method for speeding up investments in Iraq's oil. Strangely, however, there has
       been a campaign against the PSA showing this as a means of Western pillage,
       which it is not.

       The source of this opposition is quite evident. A major obstacle to the growth of
       Iraq's oil industry is the opposition from within the world oil industry itself. The
       last thing that OPEC and non-OPEC producers want to see is a speedy recovery
       of Iraq's oil. With weakening demand growth, the emergence of a substantial
       amount of Iraqi oil on the market would result in either a price fall or in OPEC's
       other members (especially Saudi Arabia) being compelled to reduce their
       production to allow Iraq to increase its production without a negative effect on the
       oil price. Therefore, many OPEC members will do everything possible to thwart
       the comeback of a large amount of Iraqi oil. In fact, the whole world oil industry
       regards Iraqi oil production as a potential menace, threatening world oil prices.

7) This underlies much of the fuss that we have witnessed in some of the Western
       press, warning Iraq not to get involved in Production Sharing Agreements with
       the international oil companies. By giving a misconceived, incorrect description
       of the PSA as a `rip-off' of Iraq's wealth, The Independent of London published
       (7 January 2007) a long article on the subject, deducing that according to the PSA
       model the oil companies could gain as much as 70-75% of the profit! This is
       totally false, baseless, ludicrous and fabricated.

       Equally erroneous, a certain Gregory Muttit1 produces articles that continually
       harp on about the PSA as a means of pillage of Iraq's oil, while at the same time
       he professes to be concerned about Iraq's national interests! Such a "campaign"
       can only be motivated by those doing their utmost to prevent the rapid recovery
       and growth of Iraq's oil industry.
1
    a co-director of Platform, who describes himself as a `specialist in Iraqi oil policy'.
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8) In the previous draft Petroleum Law for the Iraqi oil industry, the PSA formula
   was mentioned among other forms of co-operation with the international oil
   companies, such as service contracts for developing Iraq's oil resources.
   However, the latest draft amendment has replaced the PSA model with a
   "Development and Production Contract" (DPC), purely, it seems, as a reaction to
   this media hype. Details concerning this change were reported by Dow Jones on
   16 January 2007, quoting a senior Iraqi official, who states that the motive for this
   amendment was "to avoid media fuss" yet omits any mention of the need to serve
   first and foremost Iraq's oil industry, and according to whom the DPC will state
   the following terms:

      "Companies cannot book crude oil reserves of any given oil field in their
      own market capitalizations, as is the case with ordinary PSAs. Iraq will
      pay the costs of the contract in cash, rather than paying back the money
      through produced crude oil or products...

      All equipment brought by the company to carry out the contract is the
      property of Iraq. The company, however, has the right to use this
      equipment to carry out work in Iraq... Profit received by the company is
      to be agreed on by both sides, for example, one dollar on each barrel
      produced for a certain period of time..."

   This amendment amounts to the elimination of investment incentives for major
   oil companies to come and invest in Iraq.

   The most important thing for the companies is to be able to upgrade their access
   to reserves, but with this amendment there will be no incentive at all for the
   companies to invest. Without this access, oil companies can just as well buy crude
   from the market without risking any investments.

   Deprived of such secure access, the new formula amounts to something similar to
   the "buy-back" agreement, which in the case of Iran offers very little attraction
   for foreign investors. The Iranian constitution forbids foreign investors to have
   any access to Iranian reserves. In this way, despite its substantial reserves, Iran's

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    oil industry continues to decline, and in Iraq's case the same will happen. Iran
    cannot even produce its own OPEC quota.

    Another strange amendment to the Draft Petroleum Law is that Iraq will sign
    DPC agreements to develop only undiscovered oil fields, and not the discovered
    oilfields. This means that all the discoveries of the 1970s, which have added huge
    reserves and giant oilfields, such as the Majnoon, West Qurna etc., will have only
    the investment of the INOC, which has neither the financial nor technical means
    to develop them.

 9) All these proposed amendments represent a regression of the initial recognition
    for the rapid development of Iraq's oil. Increasing oil production from the current
    rate of 2mbpd to 6mbpd, which is already technically feasible, cannot be achieved
    by the INOC without the co-operation of the international oil companies, which
    own the financial resources, advanced technology and extensive world markets
    needed. Without their input, the vast sums needed for rebuilding the country
    would not leave the amount of capital needed to reinvest in the oil industry and
    bring on production speedily enough.

10) Enough of the dogmas and slogans in the name of nationalism. Instead, it is far
    better to look at oil as a means of restoring part of the lost welfare of Iraqi
    society. Gone are those days when, as in the 1970s, Iraq was rich with a $35-40
    billion surplus in its current account, able to afford the service contract, and with
    plenty of Iraqi oil-expertise, which has now fled the country or else is cut off
    from the reality of what is going on in world oil.

    This paper has not touched on the thorny problem of Iraq's Constitution, on the
    basis of which the Kurdistan authorities have entered into PSA contracts on
    unfavourable terms for the producer. I shall touch upon this issue in a separate
    paper.

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