Middle East Economic Survey
VOL. XLIX
No 23
IRAQ
Oil Industry Implications Of Iraq’s Constitutional Articles 108, 109 & 111 Governing Oil & Gas Assets: A Call to Reconsider
By Tariq Shafiq
The following article was written for MEES by Tariq Shafiq, Founding Executive Director, Iraq National Oil Company (INOC), Director, Petrolog & Associates, and Chair, Fertile Crescent Oil Development Co (based in Baghdad).
1. Constitutional Articles Governing Oil and Gas Assets
Article 108*1
states that “oil and gas are the property of the nation (people) of all the
Regions and Governorates”.
Article109* states:
1st “The Federal government development will administer (manage) the production of oil and gas fields in cooperation (consultation) with the governments of the producing Regions or Governorates,” “provided that the revenues will be distributed in a manner compatible with the demographical distribution all over the country.”
2nd “The Federal government and the governments of the producing Regions and Governorates in cooperation (in consultation or together) will draw up the necessary strategic policies to develop oil and gas assets (wealth) to achieve the greatest benefit to the Iraqi people, based on the most modern market technology and encouraging investments.”
Articles 108 and 109 fall
under the exclusive powers of the Federal Government, hence the choice of
words in the translation is affected accordingly, as in the possible use of
‘consultation’ rather than ‘cooperation’ or ‘jointly’.
Article 111* states that, “All that is not written in the exclusive powers of the Federal government falls under the authority of the Regions and all that is not written in the exclusive powers of the Federal authority is in the authority of the of the Regions and Governorates. In case of disputes on matters that fall under powers common (shared) between the Federal government and the governments of the Regions and Governorates the priority will be given to the latter.”
1. The above articles 108*, 109*, and 111*, have been changed to 111, 112 and 115 respectively.
2. Technical Facts
There are in Iraq some 530
structural anomalies. Some 115 have been drilled to-date. Of these, 80 fields
have today proven oil reserves of some 115bn barrels. The 415 unexplored
structural anomalies are estimated to have in excess of 215bn barrels.
Present production is 2mn b/d,
of which the export is 1.5mn b/d. Historical production high was 3.5mn b/d in
1979 and production prior to March 2003 war was 2.8mn b/d.
Finding and development cost
per barrel of oil is estimated at $1, which is equivalent to around $ 5,000
per 1 b/d production rate (365 barrels per year) and operating production cost
is $1.0-1.5/B.
Present proven reserves can
support a production rate of 10mn b/d which can be maintained for over 8 years
before it starts its decline.
Building Iraq’s current
production rate to a peak of 10mn b/d and maintaining the plateau for eight
years would require annual depletion rate of 4% at the beginning, rising to
5.3% when it would be allowed to decline in order to maintain the sound
depletion rate of 4-5%. Theoretically, if it is allowed to decline, the oil
production rate would have reached 6.4mn b/d by the end of 25th year of
production when the country’s reserves would have declined to around 40bn
barrels, from the present 115bn barrels at the start of the build-up of
production capacity which is still a few times of the North Sea or Caspian
reserves.
The 10mn b/d plateau could be
raised to 12+mn b/d, with the addition of new reserves to maintain the sound
depletion rate of 4-5%. However, it would take Iraq over a decade or even two
to reach a production rate of 10mn b/d.
Contrary to the generally held concept that exploration activities are required at all times at least to replenish the reserves which have been produced, Iraq’s case is unfortunately and sadly unique. Iraq’s production rate has never been commensurate with its proven reserves over the past decades throughout the Iraq Petroleum Company (IPC) concessionary era or the nationalized era that followed since the 1970s.
The IPC parents had obligations elsewhere in the Middle East to develop, hence they limited production in each country to a low 1% annual depletion rate. And, they considered other countries safer to invest in than Iraq, which pursued radical policies after the issuing of Law 80 in 1961 which enforced unilateral relinquishment of the unexplored areas and undeveloped discoveries. INOC, since then, adopted inherited practices including low production depletion rate. Having to rebuild production capacity from where they started repeatedly, because of the numerous Gulf wars, while oil reserves continued to accumulate, resulted in hugely disproportionate reserves to production ratio.
Iraq today has, on a global basis, the highest proven reserves or total oil resource reserves to production ratio (a measure of life expectancy) of 157 years and 452 years respectively (when adding the potential to the proven reserve). At a production rate of 5mn b/d it would still take 62 years and 180 years respectively. Couldn’t Iraq then hold on unnecessary long-term exploration production-sharing agreement (PSA) contracts for a few years or at least until stability prevails and big powers’ pressure subsided? In the meantime, the industry can concentrate its capital investment and limited human resources on production capacity growth to bring in the necessary revenue.
Major producers outside the Middle East keep reserves-to-production ratios at a fraction of Iraq’s: UK at 6, Norway 8, Denmark 9, US 11 and Russia at 21 years, according to the statistics at the beginning of 2005. Russia’s production rate was 9.4mn b/d with oil reserves of 72bn barrels which corresponds to an annual depletion rate of 5%.
This does not mean, however, no exploration activities should be carried out to enhance the understanding of the geological knowledge and enrich the oil and gas prospectivity. Such exploration activity would be part of the comprehensive and unified planning for exploitation and development of the whole country. But, it would be limited to a scale far smaller than the uncoordinated competing numerous exploration ventures by IOCs in the various regions and governorates which are expected under the present constitutional articles. In fact Kurdistan had already started and a few other Governorates are at the beginning of the road, following suit.
3. Planning Oilfields Development
Planning oilfields development for production capacity growth is carried out on a composite master plan which examines the capacities of the discovered and producing fields (including each and every producing formation within each field) from technical and economic feasibility points of view. In the meantime, it takes into consideration Iraq’s economic development plans and needs. The choice of the plan for execution must ensure:
Optimal use of proven reserves
which are housed in numerous and different locations throughout the rich
governorates and regions.
Optimal oil fields development
cost plus cost of any additional or replaced major pipeline carriers and
export terminal capacities.
Catering for future additional
potential reserves as and when needed.
Securing investment capital and the managerial capability of the national effort (be it the ministry and/or INOC) and deciding on the role and number of the complimentary international oil companies (IOCs).
Such comprehensive and integrated planning could not be realized in the absence of a centralized, coordinated and unified oil policy mechanism and the whole country’s data base. It is best accomplished by the central authority, Ministry of Oil (MoO) and/or a High Energy Commission working jointly with the MoO and in consultation with a think tank and qualified non-governmental organizations (NGOs) from the various regions and governorates, chosen, though, on merits.
4. Management Of Oilfield Exploration/Development In The Light Of The Present Constitutional Articles
Without a central unified
policy there will be disharmony and competition between INOC (operating on
production and marketing its export oil to provide the state’s income) and the
Regions and Governorates (operating on exploration for unneeded additional
reserves), and among the various Regions and Governorates, with disharmony and
envy between the haves and have-nots. This would lead to an unhealthy oil
industry, causing instability and damaging consequences contributing to the
fragmentation of the country.
Instability would discourage
the serious major IOCs with knowledge, capital and markets from engaging in
Iraq’s oil industry development. Iraq would then find itself accepting the
speculators and minor independents with more promises than they can deliver.
Lack of experienced oil
personnel of managerial quality at the regional level and absence of unified
Ministry of Oil model contractual terms and agreements are likely to lead to
inferior oil and gas agreements with the more knowledgeable IOCs, which is, in
itself, a failure as it does not satisfy the constitutional requirement of
“ensuring highest benefits to the nation”. Worse yet is the likelihood that
accountability and transparency might prove difficult to expect from the
embryonic Regional governments and Governorates lacking institutions and
traditions. Furthermore, contracts enacted under such conditions of unfair
terms due to gross disparity between the parties would be consider nul and
void under the Unidroit (International Institute for the Unification of
Private Law) principles of international commercial contracts which establish
contract law principles.
Highest benefit from produced
oil could only come from a national oil operation where direct investment of
$1 per developed barrel brings in a return of over $55 in today’s market,
which is unlikely to fall below $35-40 to the end of the decade and beyond. It
is illogical to leave such a highly profitable business solely to the IOCs.
The interpretation of the
constitutional paragraph, “latest technology of the market principles and
investment promotion”, taken out of its context of “ensuring the greatest
benefit to the nation”, a wholesale of Iraq’s future oil riches is expected to
go to IOCs sole operations, effectively denationalizing Iraq’s oil and gas
assets. This would take Iraq back to the concessionary era with all its
drawbacks, including serious infringement of Iraq’s sovereignty for its near
total financial dependence then on IOCs.
While IOCs can achieve many
positive mutual benefits, including among others fast track and sound
development, unchecked production of competing IOCs leads to excessive
production causing price deterioration and market instability. This is neither
in Iraq’s interest as a major producer, nor in compliance with Iraq’s
obligation towards OPEC.
As a long-term consequence of the application of Articles 109 and 111, the oil and gas rich Regions and Governorates would lead to their exclusive future control over nearly two thirds of Iraq’s oil. And, as the oil reserves from the producing fields decline, and new reserves of the Regions and the Governorates build-up, the latter would have increasingly greater economic power than the Federal government.
5. A Balanced Oil Policy
Reinstating INOC, which has
proven success in the past (it built production capacity to over 3.5mn b/d
from 1.5mn b/d in a few years and added oil reserves at the rate of 6+bn
barrels per year during the 70s). As long as Iraq’s economy remains dependent
on oil income, it is absolutely necessary to establish a national state-owned
oil industry, which should be given the administrative and financial
independence to command a pivotal role in the development of the country’s oil
industry. It would ensure orderly exploration and developments (E&D)
operations, decisions based on technical and commercial priorities, and
optimum flow of income to the treasury.
Large investment capital for
future oil and gas development should not give credence to substituting
national operation by IOCs. To build a production capacity of one barrel per
day (365 barrels per year) costs around $5,000. The oil industry elsewhere was
built by the IOCs through loans to the extent of 80-90% of the required
investment capital. A borrowed capital of $5,000 to build a rate of a barrel
of oil per day could be paid in less than 100 days of production in today’s
market price. A bridge loan under such circumstances would be fairly easily
obtained. And, the case would not be far different under a market of $35-40/B
under such price eventuality. Thus, while capital investment for fast track
oil development coming from IOCs has credence, its benefit should not be
exaggerated.
Partnership between the
national oil industry (INOC) and IOCs is the best balanced policy option for
expediting the building of Iraq’s oil industry to dimensions commensurate with
its huge resource base. This is preferable to the disadvantages of sole
operations of IOCs, regardless of contractual form. Partnership with INOC is
also the preferred route of the major oil companies. It provides transfer of
technology and management, eases capital investment requirement and ensures
orderly development and marketing oil export. However, there is no universal
contractual form, being PSA or any other. Different situations demands
suitable contractual forms under different market and competitive
circumstances, be it a PSA or buyback, other service type contracts or tax and
royalty contractual forms.
Today, Iraq’s oil industry
limitations inhibiting fast track oilfield capacity development (clearly,
apart from the lack of security, instability and absence of a government in
full control of the country), are caused by insufficient oil experienced
management personnel and the lack of up-to-date state-of-the-art technology.
An active INOC working jointly with IOCs on oil field development provides a
solution to technology and management limitations and a balanced approach
between total state oil monopoly and a free market controlled by IOCs.
Growing dependence on IOCs, in
a diminishing or absent role for INOC, deprives the state from economic
independence and puts it at serious risk during circumstances when the IOCs’
obligations toward its shareholders or nationality might have to override
Iraq’s national interest.
Upstream oil exploration and
development is capital intensive. It would be wasteful to use it as a means of
creating employment in the Regions and Governorates. Oil and gas are the
assets of all the people. It should remain the best tool in the hands of the
state for generating capital to the nation as a whole. However, many of its
technical and commercial arms such as drilling, seismic/gravity/magnetic
surveying, well-bore examination by various tools and testing operations could
be privatized to create investment opportunities and employment for the
Regions and Governorates. Likewise, many phases of the downstream operations
could be privatized, such as distribution and even refining. However, proper
planning along a reasonable time scale and preservation of labor rights should
be upheld.
Additionally, “local content”
(obligations on IOCs to carve some of the industry’s functions to nationals to
lessen total dependence and provide wealth and employment for the locals)
ought to be adopted and enforced as obligatory contractual policy. “Local
content” accounts to 51% in Iran and Russia and 70% in Norway. It has worked
to the mutual benefit of IOCs and host countries. It has been accepted
elsewhere and there is no reason not to adopt it in Iraq. However, like
everything new, it should be built gradually in accordance to rules and
regulations to avoid abuse.
Internal power politics
exhibiting itself in appointments based on sectarian and ethnic divisions, not
on merit, and the politicization of oil policy and management are bound to
obstruct the development of an efficient, transparent and accountable Iraq oil
industry. A corrected course of action and the appointment of well-qualified
oil technocrats are badly needed to rectify much of the wrong doings of the
present trend.
The constitution, that is the articles governing oil and gas, has been dictated by the heads of the ruling political parties, and changes to the draft prepared by the parliamentary drafting committee were made in isolation from the managerial, technical and economic realities of the oil business. A corrected course of action to modify the present constitutional articles governing management and strategic policy making is badly needed in order to create the right conditions for an efficient, growing, transparent and accountable oil industry that does justice to Iraq’s present huge proven and potential reserves. In turn, this would truly create the conducive conditions to help realize the overriding article 108 that “oil and gas are the property of the nation (people) of all the Regions and Governorates”.
6. Corrective Measures
The application of articles 109 and 111 as illustrated and stated above, would lead to serious damaging consequences and cannot achieve the equitable distribution of wealth and benefits among the entire nation demanded by article 108. It would not ensure the highest benefit to the nation unless corrective measures are taken which should include, among others:
Separating the two factors of (A) management of the oil industry from (B) revenue distribution, by breaking the linkage between the two provided in Article 109. The former factor, (A), ought to be re-examined and so worded in such a way as to create and optimize an Iraqi oil industry that would bring in the greatest return commensurate with its natural richness, and which could put it on par with the world leader, Saudi Arabia. Treatment of the latter factor, (B), ought to be based on equity, fairness and the needs of each of the Governorates and Regions in the context of the economic and social development of the country and the nation, rather than on ethnic or sectarian basis or on the temptation of the Regions and Governorates to control the underground mineral resources under their surface. These mineral resources are not owned by their surface proprietor. Article 108 resolves this issue. Corrective measures ought to be considered to avoid the inevitable and seriously damaging consequences. The wording should also be carefully chosen to clear up the confusion of the present imprecise text. Criteria should include:
Application of a unified oil
plan and policy free from uncalled for contradictory competing plans between
the Federal government and the governments of the Regions and Governorates,
and among the Regions and Governorates.
Adoption of a hydrocarbon law
which sets out the foundation for a national oil company as the principle
operator in the country under sound health and safety rules and technical and
commercial codes of practice to explore and develop oil and gas in all the
Regions and Governorates, with transparency, accountability and efficiency.
INOC working independently and jointly with IOCs on internationally accepted and balanced contractual modes with “local content” that ensure greatest benefit to the nation, encourage private enterprise and permit an assured reward to IOCs, governed by clear rules and regulations, under a secure and stable social and political environment.
A radical solution to truly
satisfy the objective of article 108 and set Iraq’s oil and gas industry on a
correct path, therefore, requires the inclusion in article 109 of “exploration
operation” to unfold and develop Iraq’s huge oil and gas resource potential,
in addition to the management of production operations.
Article 109 should then read as follows: “The Federal government shall manage the oil and gas production of the discovered and producing fields as well as the exploration and production operations necessary to unfold the potential oil and gas resource.” This implies eliminating articles 111, which allocate future exploration to the governments of the Regions and Governorates and give them the right to overrule the Federal government in case of differences or disputes.
It is neither correct nor practical for a part (any part of the nation) to rule the whole nation. Consultation and/or representation in policy making and management should provide the logical solution.
Making the national oil
company (INOC) a parent company with operating oil companies in the Regions
(the nucleus for this in fact already exists; the North and South Oil
Companies) whose directors could become members of the board of INOC, provides
an effective role for the Regions and Governorates in the whole country’s oil
and gas operations jointly with the Federal government.
In order to have efficient
development of the oil industry “ensuring highest benefit to the nation” it is
necessary that a reference be made in the constitution to legislate a
hydrocarbon law which endorses, among others, the allocation of the upstream
and down operations and related commercial aspects, to a national oil company
(INOC), while the Ministry of Oil and a Higher Energy Commission focus on
strategic plans, policy and overall regulatory supervision.
Oil policy by the Ministry of
Oil should be made in consultation with the Regions and Governorates through a
consultative body from among relevant NGOs and oil technocrats having
representation from the Regions and Governorates. The policy should then be
reviewed for approval by the cabinet, which, after all, represents the will of
the elected members of Parliament from all the regions.
Negotiated oil and gas agreements with IOCs, oil and gas related strategic projects with other countries and between the regions and governorates, in order to become valid, should have the approval of Parliament in order to ensure that their terms and conditions satisfy the hydrocarbon law, constitutional criteria of article 108, and satisfy acceptance by the representatives of all the Regions, Governorates and the nation as a whole.
Leaving the constitutional terms unchanged, the Regions and Governorates’ likely course would be to go down the route of indiscriminate PSAs and second rate oil companies and the damaging consequences enumerated above. This would also be regarded by critics as inviting privatization of the nation’s very livelihood through the back door; a policy known to be absolutely unacceptable by the nation.