Mr Shafiq is Director of Petrolog & Associates and Chair of Fertile Crescent Oil Fields Development Company. This is an edited version of a paper he presented at the IEA’s Iraq Energy Outlook workshop on 4 May in Istanbul. For a copy of the full paper, please e-mail the author directly (tshafiq4@aol.com).

Iraq has an unmatched wealth of culture, oil, water (although perhaps not so in the future) and soil. Its history goes back 12,000 years. It is the cradle of civilization, known as Mesopotamia, and derives its name from its two rivers, the Euphrates and Tigris, along which one of the richest oil and gas resources is deposited.

Iraq may prove to have one of the greatest endowed petroleum resource bases in the world, with potential oil reserves in excess of 215bn barrels and ultimate proven reserves in the region of 150bn barrels. Moreover, its finding and development costs are low, amongst the lowest in the Middle East. However, its historical maximum production rate in any one year has not exceeded 3.5mn b/d.

Iraq’s Oil In A Global Context (Bn Barrels, except where indicated)

* Production post ‘peak oil’ (ie when production starts declining, which is at or around the mid-point of the reserves).

Iraq post-March 2003 inherited a production capacity of 2.8mn b/d and a reserve base estimated at some 410bn barrels (Bb), remaining reserves of some 380bn barrels, and a potential contribution to the global energy market of some 174bn barrels, before its peak sets in. Its proven reserves amount to 115bn+ barrels, and it is capable of producing 10mn b/d and beyond to 12mn+ b/d, when fed with additional new reserves at an annual rate of some 3bn barrels from its huge potential reserves. However, Iraq has been since undergoing difficult economic and geopolitical circumstances, which include failed state conditions and power struggles, especially involving the Kurdistan Regional Government (KRG), which legislated its own petroleum law and constitution, and pursues the granting of exploration and development rights independently from central government’s oil plans and policies.

Iraq’s politically motivated decision making and confrontational oil policy following the July 1958 overthrow of the monarchy, during the Ba'th Party takeover post-1968, during the nationalized era and years of sanctions and unnecessary and destructive wars, has proven to be a serious impediment to the development of Iraq’s oil industry and achievement of its real production potential. However, in the 1970s following nationalization, Iraq achieved a historical maximum production rate of 3.5mn b/d and reserve additions at a world record of 6bn+ per year. Today, Iraq’s production rate is around 3mn b/d, as part of a plan to build 12-13.5mn b/d from 11 service contracts with international oil companies in seven years from 2009, whose reserves at the time were estimated at 83bn barrels, though there are serious challenges to overcome.

Production Growth

Iraq is endowed with large enough oil and gas resources to be on a par with Saudi Arabia. However, neither its past nor present developed production capacity has been commensurate with the wealth of its reserves. Iraq’s truncated production history is a witness to its geopolitical history, and illustrates how oil and politics are intertwined.

In 1928, Iraq’s oil production began at 2,800 b/d with the major discovery of the supergiant Kirkuk oil field in 1927. Export in commercial quantities had to await the completion of pipelines and terminal installations to the Mediterranean in 1934. By 1935, production reached a level of 78,010 b/d, which amounted to half the production level of Iran, which began to export in 1913 and was Iraq’s only rival at the time. By 1938, crude oil production commenced in Saudi Arabia, which overtook Iraq by 1946 at a rate of 164,200 b/d, while Iraq was producing at a rate of 101,800 b/d. Throughout the 1940s, Iran’s leader position gave way to Saudi Arabia. Iraq’s share, however, reversed its decline, assuming a 22% share in 1955, but only as a result of Iran’s production stoppage during the nationalisation crisis of 1950-54. Kuwait’s share (50% BP) also increased to a record high of 35.5% in 1955.

Iraq’s production, which maintained its share reasonably well until 1960 (when it reached 19%), began its decline as a result of the majors switching away from Iraq (which was a crisis area as a result of the forced relinquishment of Law 80), to supply areas where they had larger interests, thus giving way to Iran (40% BP share) and Saudi Arabia (Aramco partners). Iraq’s production was 1mn b/d when Saudi Arabia’s was 1.5mn b/d in 1961. Iraq’s production doubled to 2mn b/d when Saudi Arabia’s climbed to 8.5mn b/d, and when Iraq reached its historical maximum of 3.5mn b/d, Saudi Arabia produced 10mn b/d.

The lack of incentive for investment by the Iraq Petroleum Company (IPC) in Iraq continued until its nationalization in 1972-75. Thus, Iraq lost out on the fast growth years during the boom for the late 1960s and 1970s. It had barely doubled its production during the period 1960-74, whilst Saudi Arabia had grown six and a half times and Iran five and two-third times the rate of Iraq. Kuwait’s declining share was entirely due to the conservation policy adopted by the government.

Concession Agreements

Middle East concession agreements with international oil companies (IOCs) did not live out their term, since from the start they were not balanced, and some clauses (Iraq’s 20% participation, for example) were written in bad faith, making their application impossible. The agreements were passed under duress just after the First World War, when the national governments of the day were being established or were in the process of gaining their full sovereignty.

The concession IOCs were technically and economically superior and had little, if any, communications with local governments and people. They formed economic and technical enclaves devoid of today’s vital local content or tangible return to the nation. With the emancipation of the nations and OPEC’s creation, decision-making to set posted prices transferred to the governments, and tax and royalty increased to a point where nationalization through partial or total share transfer largely brought to an end the concession era, through negotiation. Iraq, though, was the exception.

The oil concession agreements in the Middle East were the product of the First World War. The return of the oil companies to Iraq appears to be the product of the Gulf Wars, the sanctions and the politically motivated move by the Ba'th in inviting the IOCs and the dilapidated or destroyed Iraqi infrastructure, institutions and human resources. Can agreements in Iraq under such circumstances be balanced? Will they endure the test of time under changed circumstances?

The New Era Post-March 2003: Prospects Or Limitations?

Iraq has held three bidding rounds and the fourth is in hand. The first two, in June and December 2009, saw 11 long term oil development service contracts awarded to the world’s largest oil companies, including ExxonMobil, Royal Dutch Shell, BP and CNPC which commits to increasing Iraq’s oil production capacity from around 2mn b/d to more than 13.5mn b/d in seven years. A third bidding round, held in October 2010, awarded three gas fields development contracts. The fourth is being awarded, with companies competing for 12 oil and gas (mostly gas) exploration and development service contracts.

The decision making process, though, has resembled that for production sharing agreements (PSAs), and more so in the fourth round than in the first three. It stands to reason that where the service contractor is the investor the ultimate decision can only be jointly made, and the PSA caters for such joint decision making. The above long term service contracts were the result of a failure or a radical change of plans and policy to negotiate technical service contracts (TSCs) of short duration, applicable to the further development of the major super-giant oil fields already long in production.

The serious problems of the concessionary era have provided lessons to consider. Old timers learned from the concessionary period of the dangers of becoming isolated economic enclaves. Local contents clauses of this current era assist not only in the transfer of technology but also in the creation and promotion of national enterprise: carries out many tasks locally saves cost and integrates IOCs with the community. Local content today commits up to 70% to national enterprises.

Iraq has a history of three and a half decades of state-owned national oil and gas development, as is the case with most of the other major oil producing countries in the Middle East. The concept of privatization goes against the national culture for most Iraqis. Service contracts are generally designed for some five years. Iraq’s service contracts of 20-25 years for the further development of major oil fields is a challenge to the national culture, especially when they do not include a local content clause.

Iraq’s average recovery of reserves has been in the region of 25-31%, whilst technology elsewhere has achieved 50-70%. The Iraq of today lacks state of the art technology and know-how in a new era which is characterized by embryonic government and management based on ethno-sectarian divides; a context which justifies and welcomes the IOCs’ know-how under the service contract model. However, the absence of a national oil company (NOC) to partner with the IOCs is a serious shortcoming. It is contrary to the draft petroleum law and generally accepted practice. The days are long gone when the Ministry of Oil can carry out the technical and commercial role of an NOC in addition to regulatory and supervisory functions.

NOCs in this era have the bulk of the world’s reserves. They are the majors of the day, whose contribution to their countries and to the global community would be much enhanced through the acquisition of state of the art technology and management. The IOCs have and can provide services, in the interest of an efficient oil interest in exchange for cash or crude, which could well be the better model under a new culture which welcomes their coexistence and cooperation.

With a constitution written in vague language, the articles which govern oil and gas management have already been indoctrinated by the heads of the influential political parties in a compromise process called ‘muhasasa’. The KRG managed to introduce modifications, giving regions powers that weakened the role of central government, in language which has enabled dual interpretations and which has lead to a two-track oil and gas policy. Today, the KRG has its own constitution and petroleum law, and has been granting exploration and development rights to IOCs and carrying out their execution unilaterally. The KRG has enacted some 48 PSAs over blocks that in many instances are beyond their official three governorates’ boundaries.

The KRG plans to produce 1mn b/d in the immediate future from estimated reserves potential of some 45bn barrels, while the central Ministry of Oil has enacted 12 contracts, 11 of which commit three-quarters of the proven reserves, to take its production rate to 12-13.5mn b/d in seven years. However, neither the oil ministry’s service contracts nor the PSAs of the KRG have been granted the approval of the only legitimate representative body, the parliament. This is bound to leave the contracts with insufficient legal cover.

Production Profiles For 10Mn B/D And 12Mn B/D

Can Iraq Build A Production Capacity Of 12-13Mn B/D?

If Iraq’s oil and gas production capacity can truly achieve a production rate in accordance with the combined current plans of the KRG and the central government of the order of 13-14.5mn b/d in less than seven years, this will make Iraq the economy which is the world’s most dependent on oil rent, with all its negative consequences. In the meantime it is bound to upset OPEC’s planning for the stability of the world’s oil market.

At an annual depletion rate of 4-5%, Iraq can continue its production expansion to 10mn b/d and beyond to 12mn b/d, conditional on adding in new potential reserves so as not to exceed this depletion rate. The IOCs’ commitments to sustaining a 12mn b/d peak from 83bn barrels can only be achieved at a higher cost and potentially damaging recovery.

Is It Wise?

Iraq is a founding member of OPEC and rightly adopts a policy of crude oil price stabilization and conservation. An open exploration and production policy under PSA and service contracts, employing IOC technical support on a fee basis per daily barrel of built capacity, would create the problem of having to pay IOCs’ fees if and when production is capped below the incremental built production capacity. Iraq would have to pay penalties to IOCs for their unproduced capacity to live under an OPEC quota system. Undoubtedly Iraq’s quota in OPEC cannot under any circumstances accommodate such an ambitious export rate even under the most bullish future market. As such it is unwise, unless Iraq is accounting for a future emergency of catastrophic dimensions and planning to play the role of swing producer, competing with Saudi Arabia, on the assumption that Iraq’s economy can accommodate such role.

Planning oil field development for production capacity growth ought to be carried out under a composite master plan, which sets out uniform development specifications and examines the capacities of the discovered and producing fields (including each and every producing formation within each field) from a technical and economic feasibility point of view. In the meantime, it should take into consideration Iraq’s economic development needs and accordingly its plans. This necessitates centralization of policy and planning.

Iraq’s constitution, despite its weakness, did state the requirement for common oil and gas strategic plans and policy and optimum return to the nation for this generation and the generations to come, for this national oil and gas asset. In this light, the existing service contracts and PSAs ought to be put to a rigorous examination to ensure conformity with these criteria under one petroleum law and associated regulations.

I am glad to learn from statements by some Iraqi decision makers of the government’s intention to modify the plateau levels and extend the production pace to a more practical level commensurate with the time necessary for building the necessary infrastructure. The negotiation, though, will prove cumbersome.

The post-March 2003 era, which is already over nine years old, has seen the Iraqi oil industry placed on a track towards a global significance commensurate with the richness of its reserves, but not without some impact from past impediments and future challenges due to the nature of politicization, ethno-sectarian practices and failed state weaknesses.

The return by the KRG and other players to the principles of a united nation, governed in peace and stability and adopting a federal model that enjoys the advantages of decentralization without the disadvantages of divisive ethno-sectarian politics, would expedite the chances of moving towards a healthy oil industry and a state where the government is capable of managing effectively the affairs of the country and the nation.

The Iraqi nation’s deep rooted culture remains the real safeguard for the country’s long term return to normality.