Iraq's wealth in the balance

Hussein Abdallah*
Al Ahram Weekly, 2-8 August

The present draft Iraq oil law is virtually guaranteed to betray the vital interests of Iraqis.

The US administration considers the ratification of the hydrocarbon law in Iraq as one of the major targets of the US occupation. Therefore, it has been pressing Iraq's government to pass the law, ostensibly as part of efforts to promote "reconciliation" among the country's religious and ethnic groups. Moreover, since oil provides 95 per cent of Iraq's national income, the recovery of the country's oil sector would reduce the US economic and military burden in Iraq.

Recent US government reports, however, show that much-awaited approval of this law designed to govern the granting of exploration rights to foreign companies would be just the beginning in addressing the Iraq oil problem. This law would provide only a broad framework for handling the Iraqi oil industry, leaving many devilish details to be worked out later. Another part of the law -- the distribution of revenue based on regional population -- will require a politically sensitive census to be undertaken, which is a difficult task under conditions of war.

Given that the law has been passed by the Iraqi cabinet and will be debated in parliament, it is vital to shed light on the nature of the law that already elicits fierce controversy. Overall, the law should be put on hold for several reasons, the most important of which are as follows.

First, the draft law is expected to clearly assign roles, decentralise the development of oil and gas fields, centralise control of revenues, and grant regions and regional oil companies the right to draw up contracts with foreign companies for exploration and development of new oil fields. Therefore, the law refers to several laws to be legislated later on, examples of which are the Iraq national oil company (INOC) law, the Oil Ministry law, and the appendices that design the contract models to be negotiated with foreign companies, being a service contract or a production sharing agreement (PSA). Since these laws represent integral parts of the main hydrocarbon law, it would be wiser to work out the whole integrated legal matrix and debate it in one go later on.

According to a recent report by the US Government Accountability Office, leaked in May 2007, a great deal of corruption has dogged Iraq's oil industry. Between 100,000- 300,000 barrels of oil per day are stolen and oil production has dwindled from 3.5 million barrels per day to less than two million barrels per day. The market value of such smuggling ranges between $5 and $15 million a day, with the aggregate value of corruption in the oil sector estimated by the Iraqi Auditor General at $24 billion over the past four years. Since local corruption could not flourish without a foreign partner, who must market the stolen oil or pass bribes or launder funds, it would be better not to expand foreign participation in Iraq's oil industry, and surely not under the aegis of occupying powers.

Considering the lack of measuring gauges that identify the volume and quality of crude oil and gas at production points as well as at loading facilities and shipping ports, it is all the more important to put things on hold. Even such equipment as exists is faulty. It is imperative to immediately repair or install adequate measuring equipment, whether the hydrocarbon law is passed or postponed.

Contracts that sell the national wealth of an occupied country are illegal under international law and can be cancelled once the occupied country is liberated. Therefore, the Iraqi governments should not expect to receive offers from well-established and respectable oil companies. Even if some American companies offer to develop Iraqi oil and gas, they have to keep in mind the possibility of their being disqualified once American troops leave. In such a case, any investment will aim at making as much money as possible in the shortest possible time before abandoning Iraq. In the oil industry, this is the most wasteful type of investment. The industry is, by nature, based on far-sighted projections and requisite long-term infrastructure that the speculation-driven investor would be hesitant to undertake.

Second, besides several loopholes and ambiguities, the draft law is flawed by several shortcomings and matters overlooked. Most important is the lack of parliamentary sanction over concession contracts or agreements to be concluded with international oil companies (IOCs). Parliamentary oversight is an established rule in almost all oil producing countries. The fact that such oversight is entrusted to the Federal Council for Oil and Gas (FCOG) does not furnish guarantees that the most will be made of the country's vital wealth. The FCOG is only part of the executive authority because it is formed by the cabinet; concession contracts and agreements negotiated and prepared by the executive authority should be sanctioned, or not, by parliament.

Article 5 of the draft law provides that parliament shall approve all petroleum treaties that Iraq signs with other countries. Yet this article does not apply to concession contracts and agreements, which are negotiated and concluded with IOCs and should be approved by parliament as well.

Article 2 excludes from the scope of the draft law several major oil and gas activities -- for example, the refining of petroleum, its industrial utilisation, as well as the storage, transport and distribution of petroleum products. The wisdom of this shortcoming is not apparent because all such activities are interrelated and the exclusion of some may leave loopholes open for possible corruption. If these interrelated activities cannot be included in the draft oil law, they should be organised and legislated in a separate law.

Article 6 establishes the Iraq National Oil Company (INOC) as a holding company fully owned by the Iraqi government, its scope of operations defined. One aspect is for the company to carry out exploration and production operations in new areas on a competitive basis with foreign companies. Article 6 clearly leaves out a long-established clause which is usually embedded in hydrocarbon laws and gives priority to the national oil company in case of equal competitive standing with foreign companies.

We now come to the most crucial condition guaranteeing healthy management of the oil and gas sector: the free and independent decision of those Iraqi officials who are to negotiate and contract with IOCs. The model contract that will be approved by the law is designed in such a way that leaves many blank spaces to be filled later. In fact, these blanks are the most crucial clauses because they cover such vital matters as production bonuses, the amount of investment to be spent on operations, the periods of each exploration and production phase, the amount of oil produced to be allocated to the foreign company for cost recovery, the period over which such costs will be recovered, the portion of total production to be obtained by the foreign company as profit (known as equity oil), the basis of sharing natural gas as well as the pricing of portions needed for domestic consumption out of the foreign company's share, and the amount of oil that is to be obtained by the Iraq government in compensation for the depletion of its national wealth (known as royalties), becoming due regardless of loss and profit after production.

There are countless such crucial matters that are left to the discretion and integrity of Iraqi negotiators, including, at the beginning, the selection of those IOCs that are to be included in a shortlist and exclusively allowed to apply for exploration and production rights.

Article 10 sets up the mechanisms of negotiation and contracting for granting rights to explore and produce oil and gas. These responsibilities are distributed among several bodies of the executive authority, on both national and regional levels. Once initial procedures are complete, the contract must be submitted to the FCOG within 30 days from the day of signing. The FCOG, if it so decides, would then submit the contract to the "Panel of Independent Advisors" for analysis on the extent of its compliance with model contracts approved by the FCOG. If the executive body that negotiated the initial contract, being the Oil Ministry, INOC or regional authority, does not receive an objection from the FCOG within 60 days of receipt of the initial contract, the contract remains valid. This mechanism clearly assumes that the initial contract is valid unless the FCOG expresses its objection within 60 days by two-thirds majority, which may be difficult to secure in many cases.

This is a very rigid and inefficient way of handling the contracting process. The time allowed is too tight, squeezing the whole decision-making process into 90 days. In practice, it often takes much longer. Contract compliance with approved models is only a formal step -- clearly inadequate given the vital items that have to be negotiated. Such hastily concluded contracts can only give rise to problems, leaving real power in the hands of select Iraqi negotiators and IOCs, with increased possibility for corruption.

The fragmentation of the contracting process between federal and regional authorities, which is strongly favoured by the Kurdistan regional government, is an inefficient system. It allows IOCs to manoeuvre and play Iraqi regions against each other. The most recent experience in this regard proved a complete failure -- Sudan. Like Iraq, there was disagreement between the north and south over the distribution of Sudan's oil wealth, 80 per cent of which lies in the south. This prompted the government of southern Sudan to contract the UK White Nile Company to operate in a certain area that was also contracted by the national government to the French company Total. Conflicting claims were not resolved until the National Petroleum Commission was established in June 2007, representing Khartoum and Juba equally, ordering the White Nile Company to halt its activities and leave Sudan.

In light of the above, it is almost impossible for an Iraqi civil servant to freely and impartially select the best IOCs to deal with and get fair and just contractual terms for Iraq. It is now common knowledge that nothing of importance is done in Iraq without the approval of the US as an occupying power. The bottom line is, therefore, that the mere presence of US troops on Iraqi soil almost guarantees that this law will be a bad one.

* The writer is a consultant on energy and petroleum economics.