Middle East Economic Survey
VOL. XLIX
No 8
19-Feb
Iraq’s Draft Petroleum Law: An Independent Perspective
By Tariq Shafiq
The following paper was presented by Tariq Shafiq at a conference for Iraqi oil technocrats in 'Amman on 17 February. Mr Shafiq, a principal drafter of the petroleum law, is director of Petrolog & Associates, Chair Fertile Crescent Oil Company, and a former Executive Director and Vice Chairman of Iraq National Oil Company.
1.0 Introduction
1.1 Iraq may prove to have one of the largest petroleum resource bases in the world, with potential oil reserves in excess of 215bn barrels and proven reserves in the region of 115bn barrels, which puts it on par with Saudi Arabia. Moreover, its exploration and development costs are amongst the lowest in the Middle East. However, Iraq’s oil production has historically not matched its oil reserve capability and has not reflected low extraction costs. Its maximum production rate in any one year has not exceeded 3.5mn b/d, despite an exploration and development history stretching over nearly eight decades.
Iraq’s present proven reserves can support a production level of 10mn b/d and maintain it for a decade. Priority in the coming years should therefore be given to the rehabilitation and expansion of production capacity and not to exploration.
Planning oil field development to increase production capacity should be carried out in the framework of a composite master plan which examines the capacities of discovered and producing fields (including each producing formation within every field) from a technical and economic feasibility point of view. It should also take into consideration Iraq’s economic development plans and needs. This requires centralized policy and planning.
1.2 The finding cost per barrel of oil is estimated at: US Cent 0.5. The development cost per barrel of oil is estimated at: $0.5-1.0. This puts capital investment cost per 1mn barrels of production capacity at $3bn for the expansion of existing production facilities and $6bn at the oil field boundary. These figures may go to up to $4.5bn and $9bn if security requirements and the recent high inflation in the cost of oil equipment are taken into account. Operating costs per barrel are $1-2.
1.3 Today, Iraq’s production facilities are either, dilapidated, looted, sabotaged, or war-damaged to the extent that in September 2003, the country’s production rate fell to around 1mn b/d, in comparison to a pre-war level in March 2003 of some 2.8mn b/d. At the beginning of 2007, Iraq was producing around 2mn b/d and exporting around 1.5mn b/d, a rate which is declining.
Iraq’s oil industry was governed by the concession oil agreements until the early 1970s and by decrees and regulations thereafter. It is time Iraq had a petroleum law that sets out clear terms and conditions for proper oil and gas industry plans, policy and implementation.
2.0 The Draft Petroleum Law
2.1 On the invitation of the Iraqi Minister of Oil, Husain al-Shahristani, the Iraqi draft petroleum law was researched and drafted by a team of three independent Iraqi oil technocrats (including myself), who together have international, Middle East and Iraqi oil industry experience amounting to some 120 years. The Kurdistan Regional Government (KRG) Minister of Oil was also invited to join the team, but did not participate.
2.2 The law is based on Articles 111 and 112 of the new Iraqi constitution, seen in the light of Articles 2, 49, 109 and 110, which broadly define the authorities and responsibilities of the federal and provincial authorities within the petroleum sector.
In order to clarify the imprecise nature of these articles so as to work on the basis of a sound interpretation of them, legal advice was sought from an independent legal firm which gave an interpretation of Iraq’s constitutional articles governing oil and gas that was adopted by the Ministry of Oil. In the forthcoming review of the constitution, it is expected that the vast majority of Iraqi oil technocrats will vote for modification of Articles 111 and 112, governing the ownership of oil and gas and management of production, plans and strategic policy respectively, in the light of this legal interpretation. The draft petroleum law has been written on the basis of this legal interpretation, irrespective of whether the constitutional review takes place.
2.3 The overall objectives of the draft petroleum law are to optimize Iraq’s oil and gas exploitation, maximize return, and unite the country.
The draft law seeks uniform plans and policy throughout the country and requires the Oil Ministry to consult and participate with the provinces. The supervision of oil and gas operations is shared between the provinces and the Ministry. The decision-making process has built-in checks and balances to enhance transparency and fight corruption.
2.4 The law is investment friendly. It encourages private enterprise and welcomes international oil companies (IOCs) to work in partnership with the Iraq National Oil Company (INOC). The IOCs have a recognized role to play in the transfer of up-to-date state-of-the-art technology, the technical and managerial training of Iraqis, and in providing investment capital. Selection from pre-qualified companies will be made through tendering in a transparent and accountable process. Contract negotiations and decisions will be tasked to a high level Federal Oil and Gas Commission (FOGC), assisted by a negotiating entity and an independent advisory think tank. However, the function and task of the latter two bodies has been changed in the third and latest draft. Signature authority is vested in the Council of Ministers by the Council of Representatives (parliament).
To ensure proper communication and management as well as the participation of the provinces, INOC will be an independent holding company with affiliated regional operating companies with interrelated directorships. All discovered fields will be earmarked for INOC.
The Ministry of Oil will be tasked with the role of supervision and regulation, in addition to the preparation of plans and policy in cooperation with the provinces. The third draft had also tasked them and the regional government of Kurdistan with the role of negotiating oil and gas contracts.
3.0 The Negotiations
3.1 As highlighted above, the overall objective of the draft petroleum law is to optimize oil and gas exploitation, maximize return and unite the country. As such, the draft law was written by the drafting team to serve the interests of the nation as a whole and to apply equally to all parts of the country, with no provision for negotiation between the federal government and any one region, governorate or ethnic and sectarian group.
3.2 The petroleum draft law prepared by the drafting team was adopted by the Ministry of Oil without modification.
However, as differences between rival sectarian and ethnic parties in the country have widened, negotiations between the major parties ahead of debate among the members of the Council of Representatives have become the rule. The case of the draft petroleum law is no exception. Hard negotiations have been taking place, essentially, between KRG representatives and the rest of the members of the Ministerial Committee which was set up to examine and make recommendations on the draft petroleum law to the Council of Ministers. Once approved by the Council, the law would be passed to the Council of Representatives for ratification.
The KRG’s position, expressed in their published draft petroleum law, was based on a radical interpretation of Article 111 which categorizes oil and gas in Kurdistan as the property of the people of Kurdistan and not as an undivided asset of the whole Iraqi nation. The KRG petroleum law is designed to impose terms and conditions on the federal draft law, creating a large area for negotiation. As a result, the current third draft in my view includes material changes that weaken the built-in checks and balances which were carefully designed to ensure transparency and accountability. These changes do in fact compromise the interests of the nation as a whole, as explained below.
The Temporary Administrative Law (TAL) issued by the Coalition Provisional Authority (CPA) makes consultation or cooperation in the management of oil and gas resources between the federal government and the regions and governorates the only requirement, conditional on an agreed fair distribution of revenue. The constitution, however, requires consultation and cooperation in the management of resources. The Oil Ministry’s draft petroleum law goes beyond that by sharing management and decision-making with the regions and governorates. It has been drafted to serve the interests of the nation as a whole and to apply equally to all parts of the country, with no built in room for negotiation between the federal government and individual regions or governorates.
3.3 Negotiations did not start in earnest until the revenue sharing issue had been settled in principle.
The negotiations have been slow, proceeding in a stop and go fashion over the last five months. An important breakthrough occurred when a senior KRG minister stated at an oil conference in London on 8 December, 2006, that following a recent definitive agreement between the KRG and federal government negotiators on an acceptable scheme of oil revenue sharing, the KRG position on the interpretation of Articles 111 and 112 had changed and come into line with that of the central government. He added that in due course, following the building of mutual confidence, the KRG might consent to the redrafting of the relevant constitutional articles. This was regarded by those Iraqis present as a genuine gesture by the Iraqi Kurds acting in the common interest of the Iraqi nation.
Despite this declaration, however, the official KRG position remains that it has the authority to negotiate contracts with companies independently of the Federal Petroleum Commission and without the need to seek its approval.
Another difficult issue is the KRG’s production sharing agreements (PSA) contracts with small oil companies. These provide windfall profits well above the norm required by the current draft petroleum law, in the order of an internal discounted rate of return of 60-100%. The Oil Ministry has decreed them unacceptable and without any legal basis. Whether they are to be cancelled or, more likely, reviewed and brought into line with the terms of the federal petroleum law is another issue which has yet to be settled.
In my opinion, if the KRG maintains this position it would amount to a de facto rejection of Articles 111, 112 and other relevant articles of the constitution, which give the federal government the responsibility for the proper management of oil and gas resources. It would leave the door open for other regions and governorates to follow suit and set a damaging precedent. It could lead to a variety of contract terms and conditions and a potential lack of transparency, and accountability, as well as bypassing the checks and balances built into the Oil Ministry’s draft federal law.
However, recently a compromise solution has been reached which would allow the KRG to negotiate contracts with companies in the presence of a representative from the Oil Ministry and subject to the approval of the FOGC; and allow the KRG itself to renegotiate existing PSA contracts to bring them into conformity with the federal petroleum law, with their validity subject to the approval of the FOGC.
The content of the third draft petroleum law of mid-January was agreed by the negotiating committee but has not yet been approved by the decision makers in the KRG. They are seeking to defer final approval until a complete package is finalized that includes laws for the establishment of INOC, petroleum revenue distribution and the reorganization of the Ministry of Oil.
KRG approval has not been forthcoming despite the significant changes already made to the draft during negotiations, which have adversely affected the structure of checks and balances and include changes to the management of INOC. Among these are the following:
a. The original draft law did not restrict the appointment of the INOC board of directors rigidly to members from the provinces and federal government, as the latest draft seems to suggest. The original draft emphasized however, the need for INOC’s financial and commercial independence. Such restrictions on membership could adversely affect the independence and efficiency of INOC’s operational management.
b. The third draft also stipulates that oil and gas exploration and development programs need to be distributed geographically. However, while social justice may require this, nature unfortunately does not, as oil and gas are not equally distributed in all the provinces.
c. The role of the independent advisory professional body, named in the third draft as the Oil and Gas Independent Consultants Bureau (OGICB), has been considerably weakened and lacks transparency. Its former authority to examine all issues has been reduced to only those issues selected by the FOGC. The requirement that it should publish an annual report has been removed.
The term of its members has been reduced to one year from five and their appointment requires the unanimous approval of the members of the FPC; a most strange rule. The appointments of FOGC and OGICB members have been made to conform to Iraq’s sectarian and ethnic make up, an alarming instance of the politicization of the country’s most vital economic commodity instead of the independent and professional management that is badly needed.
d. The FOGC has been enlarged from 9 to 20 or 30 members, depending on future developments, which makes it better suited to act as a debating society than a body tasked with a vital decision-making role in optimizing the proper resource development of the nation. Moreover, while its size has been inflated, its role has been considerably weakened. In fact, the negotiating role of the FOGC via the OGICB with regard to Kurdistan has been removed and given to the KRG. This is an invitation to others to form regions so as to follow suit, risking the introduction of non-standardized practices which would neither encourage the major IOCs nor enhance the quality of negotiated contracts.
e. The conditions governing the grant of rights to enter into development and exploration contracts in the latest draft appear to emphasize the form over the substance of the contract. The draft recognizes the need to examine the contractor’s qualifications and to adhere to a form of negotiating process involving the use of model contracts, but does not examine the soundness of the terms and conditions agreed on. No contractor should be invited to bid unless it has been pre-qualified by the Oil Ministry in accordance with pre-set conditions and procedure. However, it is vital that the proposed terms and conditions should be examined by the FOGC and OGICB to ensure the maximum return to the state, as well as an adequate, fair and competitive rate of return for the contractor.
f. The checks and balances in the third draft are now insufficient to cope with Iraq’s internal political complications, leaving the jurisdiction of the authorities and the processes for granting rights open to political manipulation.
g. Further, and critically for the future of Iraq’s oil and gas industry, the draft would shift balance of power in the management of Iraq’s oil and gas resource alarmingly from the center to the regions.
h. The critical items that have been removed in the third draft are fundamental to professionalism, transparency and accountability. The principles are still there, but the mechanisms for enforcing them in Iraq’s current turbulent situation have been removed or circumvented.
I would like to emphasize that the third draft law is extremely disappointing, in the opinion of myself and of Farouk al-Kasim, another member of the drafting team.
4.0 Concluding Remarks
4.1 Without a central unified policy there will be differences and competition between INOC (producing and marketing its export oil to provide the state’s income) and the regions and governorates (prioritizing exploration for additional reserves that will not be required for many years to come), as well as friction and resentment between the haves and have-nots amongst the various regions and governorates.
Such developments would foster instability, which would discourage investment and contribute to fragmentation instead of promoting the uniformity of oil and gas practices and the unity of the nation.
The constitution entrusts the task of managing oil and gas resources to the federal government, not to a village, governorate or region. The initial draft law was drawn up with a view to unifying plans, policy and decision-making through the participation of the regions, governorates and the federal government at the center, without ignoring participation at the operating and supervisory level.
4.2 Instability would discourage serious IOCs, who have the knowledge, capital and markets Iraq requires. Iraq would then find itself resorting to speculators who promise more than they can deliver and minor companies which do not have the capability to develop the country’s giant oil fields.
4.3 IOCs, in my view, should aim for the urgently needed rehabilitation of infrastructure, the expansion of capacity at partially developed fields, improved reservoir performance and the development of the many discovered but as yet undelineated oil fields in partnerships with INOC, rather than opting for extensive exploration for unnecessary new oil. A stampede for exploration and development contracts at this particular juncture of Iraq’s political and economic development would be viewed as mortgaging the reserves of future generations. It would also fuel the view that the war was about oil.
4.4 A ‘tsunami’ of violence is currently engulfing Iraq, characterized by a widespread lack of security and law and order. This is accompanied by a lack of efficiency in government organizations and a near absence of institutional performance or sound management both at the center and, especially, in the provinces.
Action to reverse these damaging trends should be comprehensive in nature and coordinated in approach, and should put the welfare of the country above all other considerations. A healthy and robust oil industry would provide the revenue necessary for social and economic reform and the right environment for easing much of the above developments.
4.5 Last but not least I salute the actions of the Ministry of Oil and the negotiators of the federal government, who were put in the position of trying to reconcile two diametrically opposed views, those of the Ministry and of the KRG’s radical and unacceptable interpretation of the constitutional articles governing oil and gas ownership and management. Furthermore, they have not enjoyed the full backing of the federal government in their dealings with the KRG negotiators, who had all the backing and political support of their regional government.
Finally, I would appeal for a return to the spirit behind the 8 December declaration by the senior representative of the KRG as a genuine gesture by the Iraqi Kurdish nation acting in the interest of the Iraqi nation as a whole.