Middle East Economic Survey
VOL. LI
No 11
IRAQ
Iraq Petroleum Law: Problematic Issues And its Fate (2/2)
By Tariq Shafiq
Tariq Shafiq is a Petroleum Consultant, Director of Petrolog & Associates, and Chair, Fertile Crescent Oil Fields Development Company. The following paper was presented at a Conference on Iraq Oil Policy: A Review, at the Centre for Iraqi Researchers in Paris on 25-27 February (tshafiq4@aol.com). Part 1 was published last week.
3.2 The Power of the National Government Vs the Regions And Governorates
The Temporary Administration Law (TAL) was passed by the Central Provisional Administration (CPA). Under the principles of the TAL, the CPA divided Iraq into a federation of Regions and Governorates with powers at a time when they have no developed institutions, and which resulted in the weakening of the national federal government and paving the way for ethno-sectarian politics.
Ethno-sectarian alliance dominated the amendments to the draft constitution, which was prepared by a parliamentary committee of 50+ serving primarily the interests of the parties concerned rather than the nation and the citizen. It gave powers to the regions and governorates to nullify national laws in the event of conflict in areas of joint responsibility, and the KRG are applying it to the nation’s oil and gas resources.
The Oil and Gas Articles were subject to considerable amendments. The amended constitution was passed by Parliament conditional on a future revision, within four months from its first meeting, in the face of strong opposition. A committee was formed in 2006 which managed a revision by December which has not seen the light of day. In fact, the revised version of the Oil and Gas Articles 111 and 112 was in line with the legal interpretation given above. The committee made a total of 50 amendments.
Oddly enough, a leading KRG member declared the same month that the KRG had withdrawn its interpretation and consented to the MoO’s draft, only for this to be withdrawn possibly because the KRG’s political leaders seem to have decided otherwise.
3.3 Federated Regions and Governorates and Oil and Gas Resource Management
Iraq has proven reserves in excess of 115bn barrels, located in some 80 fields and 415 structural anomalies, estimated to contain in excess of 215bn barrels. However, neither the discovered fields nor the prospective structural anomalies are distributed evenly over the 18 Iraqi Governorates and quite a few straddle the borders. Basra, for example, contains over 50% of proven reserves. What is given to the KRG is bound to become another concession to be made to the other regions or governorates at the expense of optimum, efficient, transparent and unified oil and gas management.
Further, oil field distribution below ground does not follow surface borders. Iraq went to war with Kuwait partly because of the disputed Rumaila oil field production, which runs across the Iraq/Kuwait border. How many of Iraq’s 415 structural anomalies run across Regional and Governorate boundaries? What then would be the consequences?
Technical and economic planning of oil field production capacity building or expansion, among others, requires a feasibility examination of the individual fields, their reservoir pays and the total fields in a composite master plan, of the discovered, undeveloped or semi-developed, and producing fields, and taking into consideration the country’s development and economic needs. It should be based on optimal use of the proven reserve and examination of the requirement or otherwise of exploration for additional reserves.
The scarcity or even lack of hands-on human resources and institutions at the regional and provincial level are likely to result in imbalanced agreements in favor of the IOCs, far from satisfying the constitutional requirement of ‘highest benefits to the nation.’ There is ample evidence of this from some KRG oil and gas PSAs favouring the IOCs to the extent of granting a rate of return of the order of over 100% IRR. Indeed multiple windfall profit.
Highest benefit to the nation could only come from national oil operations. In Iraq, the investment per developed barrel is of the order of $1-2 brings in a return from a future price floor of over $55/B. It is illogical to leave such highly profitable business solely to the IOCs. Realizing Iraq is near the bottom of some 169 countries surveyed, accountability and transparency would prove difficult to expect from the embryonic regional and provincial governments, lacking institutions. A growing dependence on IOCs and a diminishing or absent role of INOC deprives the state of economic independence and puts it at serious risk when conflict of interest arises between IOCs’ own obligation towards its shareholders or nationality and its obligations towards the host country.
4.0 PSA and Future Trends
IOCs consider PSAs the more desirable model contract as it provides the ability to book reserves, expedite payment of cost, pay back cost and profit in crude oil supply; and it contains all the rights and obligations in one detailed contract document which may shield the IOCs from future rules and regulations. The PSA contract has been chosen as the only model contract by an Iraqi oil team assigned by the US State Department to draft recommendations for the oil policy in the new era post-March 2003. It was adopted as the only model by the prime minister of the first Iraqi government post-March 2003 and was hailed by the KRG as the only model for all conditions. Clearly the PSA model is a manifestation of exogenous influences.
Contrary to the claim that it is a widespread model, it serves a marginal volume of oil and gas reserves compared to the reserves under the management of the NOCs worldwide. In Iraq the PSA model has become divisive, in an already divided country. However, wholesale PSAs covering most of Iraq’s oil potential of 215bn barrels would, in essence, mortgage Iraq’s future assets and bring about future economic dependence of the regions, governorates and the federal state on the IOCs’ check. As such it would certainly contravene Iraq’s sovereignty. Announced and applied at this time, when the country is in desperate need of peace, unity and stability amongst its factions is most unwise.
The PSA is applicable to risky exploration followed by development requiring generally a long-term duration but not to development of discovered oil fields. However, Iraq’s discovery success is 7 out of 10 and the historical finding cost per barrel is only a fraction of a cent. This cost could have risen by the recent high inflationary trend and likely future discoveries of smaller size oil field, but it remains only a fraction of a dollar. Consequently, a high return for the exploration risk usually demanded in a PSA is not justifiable.
Service contracts with or without investment in the form of technical and managerial services, as the name implies, leave the state’s sovereignty intact. IOCs are generally paid back in cash not in kind, though crude oil short or long-term entitlement remains an option. NOCs are the Majors of the day whose contribution to their countries and to the global community would be much enhanced through the use of latest state-of-the-art technology and management. The IOCs have and can provide both as services in exchange for cash and purchase contracts, which could well be the better model, under a culture which no longer should or need IOCs or NOCs to replace either.
5.0 Concluding Remarks
The present impasse we have reached with regard to the Petroleum Law is a result of the stresses and strains from within and without what has become a failed state, that is Iraq today. Externally, the dominance of exogenous politics has been evident. Iraq’s concession agreements held by the British, French, Dutch and Americans were the product of the First World War. The invitation of the IOCs to Iraq by Saddam’s government in the 1990s was the product of the isolation of his government and the many years of sanctions. While the First World War was not fought over Middle Eastern oil, oil concessions became the war loot for the victorious powers.
Iraq’s enormous proven and potential oil is the only major, practically untapped oil resource, making Iraq a tempting target for the oil consuming powers and their IOCs. The dismal lack of planning post-invasion, the looting, chaos and sabotage of Iraq’s institutions, the dissolution of the army and police and the adoption of ethno-sectarian politics as a basis for governance have transformed Iraq into a ‘failed state’, characterized by a central government so weak and ineffective that it has little practical control over much of its territory.
The original first Petroleum Law has been modified to such an extent that I and my colleague Farouq al-Kasim regretfully believe that it no longer provides for professional standards of optimization, efficiency, accountability and transparency, nor is it in keeping with the national interest nor maintains the unity of the nation. That the national Ministry of Oil has accepted these changes can only be interpreted as having done so reluctantly and under significant pressure.
The stalemate with regards to reaching an agreement between the KRG and the national government on Iraq’s Petroleum Law is symptomatic of the divisive and destructive elements which now characterize the failed state. Unless the major political players recognize this, and act genuinely to live in peace with each other and to eradicate these divisive and destructive elements, the Petroleum Law may remain shelved and Iraq’s oil industry continue to stagnate and deteriorate further.
The present corrective action by the minister of oil to go for a management and technical service contract with the IOCs is certainly a welcome one. It may, however, only safeguard production from declining or may permit a marginal improvement as long as these elements causing Iraq’s failed state status remain. Co-operation between INOC, the Majors of the day, and the IOCs with their latest state-of-the-art technology and know-how, on a service contract basis, should provide the model for the future development of Iraq’s proven reserves.
Grant of rights for exploration to unfold further reserves is, in the first place, not needed for years to come. The government’s regulatory and supervisory resources cannot cope while active fast-track field development takes priority. The MoO would be fully occupied by the enormous task of technical and commercial auditing, among its many regulatory and supervisory functions. A contract model for exploration should become a minor issue. After all, a PSA is not the only model if a service contract is judged unsuitable. Furthermore, while there was general consensus during the provisional government prior to 2005 that grant of rights for long-term oil and gas contracts should not be made, can we say, in all honesty, that to-days’ Iraq government in its failed estate is qualified to grant long term contracts?
The return by the KRG and other players to the principles of a united nation governed in peace and stability and adopting a federation model which enjoys the advantages of decentralization without the disadvantages of a divisive ethno-sectarian politics, would expedite the chances of returning to a healthy state where the government is capable of managing the affairs of the country and nation. Only then, Iraq’s Petroleum Law would have the chance of a revival, provided that professional amendments are made and in the light of positive constitutional revisions. The Iraqi nation’s deep routed culture remains the only safeguard for the country’s return to normality.