IRAQ: Forbidden fields: Oil groups circle the prize of Iraq's vast reserves

Publisher Name: 
The Financial Times

Royal Dutch Shell has
been quietly working with Iraq's oil ministry over the past two
years, advising it on how to increase the production of two oilfields.
Under an agreement struck after the 2003 invasion, no one from the
company, Europe's largest oil group, has set foot in the troubled
country; instead, monthly face-to-face meetings with the oil ministry
have been held in Amman, the Jordanian capital, and weekly contact has
been maintained by video-link.



The Shell-financed project - and the attention showered on Baghdad -
appears to be paying off: Shell is now negotiating a technical support
agreement in which it will be compensated for helping upgrade
production of producing fields. The oil company will again set up a
team outside Iraq, helping, among other things, to bring new equipment
into the country and training Iraqis in its use.

Shell is one of
several international oil companies - including BP and the US groups
ExxonMobil and Chevron - that have been tapping into Iraq's oil
industry by remote control.

But now, five years after the invasion, the oil groups are hoping to
take their involvement in the country to a new level. Baghdad,
desperate to increase oil production yet starved of investment, is
starting to dangle what the companies have been after all along: a
chance to develop and later explore what may be the world's most
promising untapped oil reserves. Indeed, as the companies gear up for
technical support agreements, they are also registering to pre-qualify
for the first bidding round of oil development contracts that are to
be offered by Baghdad.




"The [initial projects] were done to work with the Iraqis, get a
feeling for fields and build relationships and knowledge," says one
oil executive, speaking of the assistance projects provided so
far.




With parts of the global oil industry threatened with nationalisation
and much of the Middle East still closed to foreign ownership of
reserves, access to Iraq, with the world's third-largest oil
reserves, has long been viewed as a huge prize. Although no decision
has yet been made in Baghdad over the nature of the development or the
eventual exploration contracts that will be on offer, Iraq could prove
one of the rare countries in the region where companies will be
allowed to claim reserves as their own. "This is the big frontier,"
says Raad Alkadiri, a senior director at Washington-based PFC
Energy.

According to the oil
ministry, only 27 out of 80 discovered fields are producing in Iraq,
the result of decades of under-investment. A report by Wood Mackenzie,
the consultancy, meanwhile says the scale of Iraq's remaining oil
resources surpasses allother countries in the Middle East, including
Saudi Arabia, and its high-quality reservoirs ensure that production
costs would be very low.

But Iraq is also a
dangerous frontier. Companies invited to invest in its oil industry -
and satisfy Baghdad's plans at least to double oil production from
the current 2.5m barrels a day - will be walking into a political,
security and legislative minefield. Their involvement threatens to
exacerbate the sectarian tensions that have torn the country apart
since the US-led invasion.




International oil companies acknowledge that security, although better
over the past year, will still need to improve significantly before
workers are dispatched to Iraq. The weakness of the central government
and its patchy control over the southern part of the country, home to
80 per cent of proved oil reserves, will also be taken into account.
Perhaps most important, however, is that they could be entering a
country with deep political fissures and lingering anger at foreign
intervention, without clear legislation allowing for foreign
participation.


Despite American pressure and government desperation, a law to
regulate foreign access to the oil industry has languished in the
Iraqi parliament, a victim of sectarian disputes, particularly between
the Kurds and Arabs. Frustrated by the delays, and virtually giving up
on a successful outcome, the oil ministry has now invited oil
companies to pre-qualify for development of existing fields and says a
cabinet decision will be enough to legitimise foreign participation.
Later bidding rounds are envisaged for exploration contracts.




Officially, companies say they will insist on having new legislation
in place before investing the billions of dollars that would be needed
for development and exploration. Yet the absence of a law is not
preventing them from embarking on negotiations.




"The companies are positioning themselves; they're playing the
game and the oil ministry is trying to create a game for them to
play," says Mr Alkadiri. "Of course you can hit a whole set of
problems and the companies are aware of that and they will factor it
in. But [outside Iraq] there are no such reserves in an
unexplored territory."




Adding to the complications is uncertainty over who has the rights to
sign contracts in Iraq. The Kurdish regional government, based in
Irbil, claims that the constitution gives it power over its own
resources within the borders of Kurdistan, while the government in
Baghdad rejects this claim completely. It insists it has the sole
constitutional authority to dispose of Iraq's oil resources.




A further difficulty is that oil is unevenly distributed throughout
the ethnic regions of Iraq, with resources concentrated in the Shia
south of the country and the Kurdish north. The minority Sunni Arabs,
who formerly controlled the levers of power under Saddam Hussein, can
boast few oil reserves in their ethnic areas. Their priority in
negotiating in the new Iraq has been to ensure they receive their fair
share of oil revenues.




But the competing expectations of Iraq's communities have never been
confronted head on, and were sidestepped by the framers of the
constitution, agreed in 2005, by means of ambiguous language.




Specifically, the constitution's article 112 says the "federal
government, with the producing governorates and regional governments"
should manage oil and gas, but only from "present" fields. The
document's Article 115, meanwhile, declares that "all powers not
stipulated in the exclusive powers of the federal government" belong
to local or regional authorities.




The KRG has taken this to mean that the federal government has the
conditional right to manage fields currently producing, but that a
regional government such as itself has the power to manage exploration
and the production from newly discovered fields. To exploit this
loophole, the KRG has passed its own oil law, which allows it to sign
contracts with foreign oil companies. It has signed such agreements
with several (smaller) groups from Norway, Turkey, Austria, South
Korea and other countries in the face of Baghdad's objections.




"In the Kurdistan region, there is a constitution and there is a
law. We have two instruments that we can rely upon: the law and the
constitution are a pair, and they're consistent and in harmony with
each other in our case," says Ashti Hawrami, KRG oil minister.




Baghdad, however, has declared the KRG contracts illegal, blacklisting companies that deal with
the Kurdistan region and, more recently, cancelling export deals with South Korean and
Austrian groups that signed exploration deals with the KRG. This has
kept bigger companies away from the north.




The Kurds' assertive attitude has heightened the Sunni Arabs'
attachment to strong central control over the country's regions and
their inclination towards economic nationalism. Their political
leaders have pressed for the constitution to be rewritten to
strengthen the federal government and reduce the powers of the
KRG.




With no agreement on the constitution, the hydrocarbons legislation -
which would set terms for foreign oil companies along with an
agreement on the sharing of oil revenues locally - was controversial
from the start. After months of wrangling, the Iraqi cabinet in
February 2007 came to an agreement on a draft framework that did not
include revenue-sharing legislation. Even that has not been passed by
parliament.


Moreover, as talks over the oil law have dragged on, opposition to the
production-sharing agreements (PSAs) favoured by western oil
companies, once relatively muted, has grown among the majority Shia as
well - underlining a resurgence in nationalism as much as a reaction
to Kurdish unilateralism.




According to Hussein Shahristani, the oil minister, the cabinet's
approval of a draft hydrocarbons law last year made no reference to
PSAs, and what his ministry will offer companies are "model
contracts" that would attempt to balance investors' expectations
of financial return against domestic political concerns, not least the
determination of Iraqis to maintain ownership and control of oil
wealth. Kurdish officials, however, say the contracts envisaged by
Baghdad are PSAs in all but name.




"What's happening is that various parties are jostling for
position now rather than reaching agreement on the oil legislation,"
says Yahia Said, Iraq expert and Middle East director at Revenue
Watch, a project at the London School of Economics. "The KRG is
trying to move with as many facts on the ground as possible and the
federal government is trying to show that it's in control."




Apotential flashpoint for the oil dispute between Kurds and Arabs is
in the oil field of Kirkuk, the city that Kurds claim as part of their
region but whose status is to be settled by a long-delayed
referendum.




It is to minimise the risk of such confrontation that the US has put
enormous pressure on Iraq's politicians to agree the hydrocarbons
legislation. Judging it a crucial element for Iraqi stability, the
Bush administration listed the oil law as one of the benchmarks the
Baghdad government was expected to achieve as the US military surge
helped to reduce violence over the past year. Even with the likelihood
of an oil law approval fading, US officials continue to insist that it
is essential for signing oil contracts with foreign groups.




For international oil companies, the hope is that as the negotiations
proceed over the next year, Iraq's political and legislative
landscape will gain more clarity. Iraqi experts, however, warn that
the oil law may be dead and Baghdad's only choice, ironically, will
be to fall back on legislation from the Saddam Hussein era. Although
meant to protect the nationalised status of the industry, the
legislation did not stop the previous regime from negotiating specific
contracts with foreign companies, which were then agreed by the
rubber-stamp parliament.




"The ministry might be able to get away with [contracts] by leaning
on Saddam-era regulations. Saddam negotiated contracts that were not
PSAs [the oil companies' preferred arrangement] but with Iraq the
only remaining major resource in the world, companies will have to
have some investment there," says Tariq Shafiq, a former director of
Iraq's national oil °© company.




Shut out elsewhere, executives await the end of a long exile




Just months before US tanks rolled into Baghdad and Saddam Hussein was
toppled, US government officials met allies from Iraq's opposition
and decided it was in the country's interest for a new government to
open its oil industry to foreign participation as quickly as possible,
writes Dino Mahtani




The so called "Oil and Energy" working group of the US state
department, which met four times in 2002 and 2003 and included
influential Iraqi exiles, had put forward the idea as a crucial plank
in Iraq's postwar reconstruction plans. Increased foreign
participation in Iraq's oil industry, members argued, would help
revitalise its most important economic lifeline - ravaged by years
of neglect and underinvestment under Saddam's regime.




But it would also get US oil companies close to Iraq's reserves,
which remain significantly under-exploited compared with those of
other big producers and, according to some geologists, could hold the
world's largest deposits, surpassing even those of Saudi Arabia.




The Middle East has largely been off-limits to international oil
companies ever since a wave of oil industry nationalisation swept the
region, starting in the 1950s. In Iraq's case, the military coup
that forced out the British- and US-backed royal family in 1958 was
followed by the gradual takeover over the next 14 years of the Iraq
Petroleum Company, previously a concession that gave ownership of
Iraq's oil reserves to a consortium dominated by US, British and
French interests.


Access to Iraqi oil today would give western oil companies an
important foothold in the Middle East, home to about 60 per cent of
global oil reserves, at a time when resource nationalism is on the
rise and companies are having trouble finding new oil reserves to
replace those they exhaust. The reserves they claim are a main
determinant of their stock prices.

Western oil executives
had long been impatient with the reluctance of Middle Eastern
countries to open up to foreign participation. This was summed up in
1999 by the US vice- president Dick Cheney (below), then a director at
the oil fields services company Halliburton. "Even though companies
are anxious for greater access there, progress continues to be slow,"
he said in a speech to the oil industry.



After the US invasion, American officials collaborated closely with
their Iraqi political allies and oil industry executives. Many members
of the Oil and Energy working group had pushed for production-sharing
agreements to be introduced in Iraq after the invasion. These
arrangements would allow companies to claim a share of the reserves
produced as their own, at least for accounting purposes. In effect,
such contracts would amount to a significant step in reversing
Iraq's nationalisation process.




The oil industry was well-placed to lobby for such an arrangement.
After the invasion, former executives of big multinationals acted as
consultants to the new Iraqi oil ministry. The US then hand- picked
oil ministry officials under the coalition provisional authority,
which eventually handed over to the interim government of Iyad Allawi.
This in turn advocated partly privatising Iraq's oil industry. When
a transitional government came into place, the US backed Ahmad Chalabi
- a man who famously said in 2002 that "US oil companies will have
a big shot at Iraqi oil" - to chair Iraq's Energy Council.




Today, however, the openness of Iraq's oil industry to foreign
participation is still in doubt, not only because of the security
situation. Iraq has no national oil law in place. Its constitution is
vague about the degree of control regional governments can exert over
oil policy.




Iraqi officials know they will have the power to dictate terms to
foreign oil companies. "Iraq is definitely in the driver's seat.
They [the government] know they have one of the most prolific
resources left in the world," says Bob Fryklund, vice-president of
IHS, the international consultancy.




Energy producers such as Russia, Venezuela and Algeria have typified a
new wave of resource nationalism, in effect expropriating foreign
ownership of oil projects. In Libya, another country whose oil
industry has only just opened up to foreign participation after years
of sanctions, the government has now increased its take from all oil
projects to an average of 95 per cent, from 81 per cent in 2000. Even
in Kurdistan, where the regional authority has signed
production-sharing agreements, the government's take of future oil
produced is estimated at 87 per cent, says Mr Fryklund.




Oil industry executives say their companies will not invest if they do
not get a significant part of "the upside", industry jargon for
expected increases in production. But Tariq Shafiq, a former director
of Iraq's national oil company, says companies would be prepared to
accept variations of service contracts that pay companies fixed
returns rather than rewarding them with control over
reserves.

"Given how prolific
Iraq is, the return to international oil companies [under service
contracts] would be just as favourable as under investment
[contracts]. And I believe the companies are aware of that," he
says.
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