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IRAQ: Forbidden fields: Oil groups circle the prize of Iraq's vast reserves

by Roula Khalaf and Steve NegusThe Financial Times
March 19th, 2008

Royal Dutch Shell has been quietly working with Iraq's oil ministry over the past two years, advising it on how to increase the production of two oilfields. Under an agreement struck after the 2003 invasion, no one from the company, Europe's largest oil group, has set foot in the troubled country; instead, monthly face-to-face meetings with the oil ministry have been held in Amman, the Jordanian capital, and weekly contact has been maintained by video-link.


The Shell-financed project - and the attention showered on Baghdad - appears to be paying off: Shell is now negotiating a technical support agreement in which it will be compensated for helping upgrade production of producing fields. The oil company will again set up a team outside Iraq, helping, among other things, to bring new equipment into the country and training Iraqis in its use.

Shell is one of several international oil companies - including BP and the US groups ExxonMobil and Chevron - that have been tapping into Iraq's oil industry by remote control.

But now, five years after the invasion, the oil groups are hoping to take their involvement in the country to a new level. Baghdad, desperate to increase oil production yet starved of investment, is starting to dangle what the companies have been after all along: a chance to develop and later explore what may be the world's most promising untapped oil reserves. Indeed, as the companies gear up for technical support agreements, they are also registering to pre-qualify for the first bidding round of oil development contracts that are to be offered by Baghdad.

"The [initial projects] were done to work with the Iraqis, get a feeling for fields and build relationships and knowledge," says one oil executive, speaking of the assistance projects provided so far.

With parts of the global oil industry threatened with nationalisation and much of the Middle East still closed to foreign ownership of reserves, access to Iraq, with the world's third-largest oil reserves, has long been viewed as a huge prize. Although no decision has yet been made in Baghdad over the nature of the development or the eventual exploration contracts that will be on offer, Iraq could prove one of the rare countries in the region where companies will be allowed to claim reserves as their own. "This is the big frontier," says Raad Alkadiri, a senior director at Washington-based PFC Energy.

According to the oil ministry, only 27 out of 80 discovered fields are producing in Iraq, the result of decades of under-investment. A report by Wood Mackenzie, the consultancy, meanwhile says the scale of Iraq's remaining oil resources surpasses allother countries in the Middle East, including Saudi Arabia, and its high-quality reservoirs ensure that production costs would be very low.

But Iraq is also a dangerous frontier. Companies invited to invest in its oil industry - and satisfy Baghdad's plans at least to double oil production from the current 2.5m barrels a day - will be walking into a political, security and legislative minefield. Their involvement threatens to exacerbate the sectarian tensions that have torn the country apart since the US-led invasion.

International oil companies acknowledge that security, although better over the past year, will still need to improve significantly before workers are dispatched to Iraq. The weakness of the central government and its patchy control over the southern part of the country, home to 80 per cent of proved oil reserves, will also be taken into account. Perhaps most important, however, is that they could be entering a country with deep political fissures and lingering anger at foreign intervention, without clear legislation allowing for foreign participation.

Despite American pressure and government desperation, a law to regulate foreign access to the oil industry has languished in the Iraqi parliament, a victim of sectarian disputes, particularly between the Kurds and Arabs. Frustrated by the delays, and virtually giving up on a successful outcome, the oil ministry has now invited oil companies to pre-qualify for development of existing fields and says a cabinet decision will be enough to legitimise foreign participation. Later bidding rounds are envisaged for exploration contracts.

Officially, companies say they will insist on having new legislation in place before investing the billions of dollars that would be needed for development and exploration. Yet the absence of a law is not preventing them from embarking on negotiations.

"The companies are positioning themselves; they're playing the game and the oil ministry is trying to create a game for them to play," says Mr Alkadiri. "Of course you can hit a whole set of problems and the companies are aware of that and they will factor it in. But [outside Iraq] there are no such reserves in an unexplored territory."

Adding to the complications is uncertainty over who has the rights to sign contracts in Iraq. The Kurdish regional government, based in Irbil, claims that the constitution gives it power over its own resources within the borders of Kurdistan, while the government in Baghdad rejects this claim completely. It insists it has the sole constitutional authority to dispose of Iraq's oil resources.

A further difficulty is that oil is unevenly distributed throughout the ethnic regions of Iraq, with resources concentrated in the Shia south of the country and the Kurdish north. The minority Sunni Arabs, who formerly controlled the levers of power under Saddam Hussein, can boast few oil reserves in their ethnic areas. Their priority in negotiating in the new Iraq has been to ensure they receive their fair share of oil revenues.

But the competing expectations of Iraq's communities have never been confronted head on, and were sidestepped by the framers of the constitution, agreed in 2005, by means of ambiguous language.

Specifically, the constitution's article 112 says the "federal government, with the producing governorates and regional governments" should manage oil and gas, but only from "present" fields. The document's Article 115, meanwhile, declares that "all powers not stipulated in the exclusive powers of the federal government" belong to local or regional authorities.

The KRG has taken this to mean that the federal government has the conditional right to manage fields currently producing, but that a regional government such as itself has the power to manage exploration and the production from newly discovered fields. To exploit this loophole, the KRG has passed its own oil law, which allows it to sign contracts with foreign oil companies. It has signed such agreements with several (smaller) groups from Norway, Turkey, Austria, South Korea and other countries in the face of Baghdad's objections.

"In the Kurdistan region, there is a constitution and there is a law. We have two instruments that we can rely upon: the law and the constitution are a pair, and they're consistent and in harmony with each other in our case," says Ashti Hawrami, KRG oil minister.

Baghdad, however, has declared the KRG contracts illegal, blacklisting companies that deal with the Kurdistan region and, more recently, cancelling export deals with South Korean and Austrian groups that signed exploration deals with the KRG. This has kept bigger companies away from the north.

The Kurds' assertive attitude has heightened the Sunni Arabs' attachment to strong central control over the country's regions and their inclination towards economic nationalism. Their political leaders have pressed for the constitution to be rewritten to strengthen the federal government and reduce the powers of the KRG.

With no agreement on the constitution, the hydrocarbons legislation - which would set terms for foreign oil companies along with an agreement on the sharing of oil revenues locally - was controversial from the start. After months of wrangling, the Iraqi cabinet in February 2007 came to an agreement on a draft framework that did not include revenue-sharing legislation. Even that has not been passed by parliament.

Moreover, as talks over the oil law have dragged on, opposition to the production-sharing agreements (PSAs) favoured by western oil companies, once relatively muted, has grown among the majority Shia as well - underlining a resurgence in nationalism as much as a reaction to Kurdish unilateralism.

According to Hussein Shahristani, the oil minister, the cabinet's approval of a draft hydrocarbons law last year made no reference to PSAs, and what his ministry will offer companies are "model contracts" that would attempt to balance investors' expectations of financial return against domestic political concerns, not least the determination of Iraqis to maintain ownership and control of oil wealth. Kurdish officials, however, say the contracts envisaged by Baghdad are PSAs in all but name.

"What's happening is that various parties are jostling for position now rather than reaching agreement on the oil legislation," says Yahia Said, Iraq expert and Middle East director at Revenue Watch, a project at the London School of Economics. "The KRG is trying to move with as many facts on the ground as possible and the federal government is trying to show that it's in control."

Apotential flashpoint for the oil dispute between Kurds and Arabs is in the oil field of Kirkuk, the city that Kurds claim as part of their region but whose status is to be settled by a long-delayed referendum.

It is to minimise the risk of such confrontation that the US has put enormous pressure on Iraq's politicians to agree the hydrocarbons legislation. Judging it a crucial element for Iraqi stability, the Bush administration listed the oil law as one of the benchmarks the Baghdad government was expected to achieve as the US military surge helped to reduce violence over the past year. Even with the likelihood of an oil law approval fading, US officials continue to insist that it is essential for signing oil contracts with foreign groups.

For international oil companies, the hope is that as the negotiations proceed over the next year, Iraq's political and legislative landscape will gain more clarity. Iraqi experts, however, warn that the oil law may be dead and Baghdad's only choice, ironically, will be to fall back on legislation from the Saddam Hussein era. Although meant to protect the nationalised status of the industry, the legislation did not stop the previous regime from negotiating specific contracts with foreign companies, which were then agreed by the rubber-stamp parliament.

"The ministry might be able to get away with [contracts] by leaning on Saddam-era regulations. Saddam negotiated contracts that were not PSAs [the oil companies' preferred arrangement] but with Iraq the only remaining major resource in the world, companies will have to have some investment there," says Tariq Shafiq, a former director of Iraq's national oil company.

Shut out elsewhere, executives await the end of a long exile

Just months before US tanks rolled into Baghdad and Saddam Hussein was toppled, US government officials met allies from Iraq's opposition and decided it was in the country's interest for a new government to open its oil industry to foreign participation as quickly as possible, writes Dino Mahtani

The so called "Oil and Energy" working group of the US state department, which met four times in 2002 and 2003 and included influential Iraqi exiles, had put forward the idea as a crucial plank in Iraq's postwar reconstruction plans. Increased foreign participation in Iraq's oil industry, members argued, would help revitalise its most important economic lifeline - ravaged by years of neglect and underinvestment under Saddam's regime.

But it would also get US oil companies close to Iraq's reserves, which remain significantly under-exploited compared with those of other big producers and, according to some geologists, could hold the world's largest deposits, surpassing even those of Saudi Arabia.

The Middle East has largely been off-limits to international oil companies ever since a wave of oil industry nationalisation swept the region, starting in the 1950s. In Iraq's case, the military coup that forced out the British- and US-backed royal family in 1958 was followed by the gradual takeover over the next 14 years of the Iraq Petroleum Company, previously a concession that gave ownership of Iraq's oil reserves to a consortium dominated by US, British and French interests.

Access to Iraqi oil today would give western oil companies an important foothold in the Middle East, home to about 60 per cent of global oil reserves, at a time when resource nationalism is on the rise and companies are having trouble finding new oil reserves to replace those they exhaust. The reserves they claim are a main determinant of their stock prices.
Western oil executives had long been impatient with the reluctance of Middle Eastern countries to open up to foreign participation. This was summed up in 1999 by the US vice- president Dick Cheney (below), then a director at the oil fields services company Halliburton. "Even though companies are anxious for greater access there, progress continues to be slow," he said in a speech to the oil industry.


After the US invasion, American officials collaborated closely with their Iraqi political allies and oil industry executives. Many members of the Oil and Energy working group had pushed for production-sharing agreements to be introduced in Iraq after the invasion. These arrangements would allow companies to claim a share of the reserves produced as their own, at least for accounting purposes. In effect, such contracts would amount to a significant step in reversing Iraq's nationalisation process.

The oil industry was well-placed to lobby for such an arrangement. After the invasion, former executives of big multinationals acted as consultants to the new Iraqi oil ministry. The US then hand- picked oil ministry officials under the coalition provisional authority, which eventually handed over to the interim government of Iyad Allawi. This in turn advocated partly privatising Iraq's oil industry. When a transitional government came into place, the US backed Ahmad Chalabi - a man who famously said in 2002 that "US oil companies will have a big shot at Iraqi oil" - to chair Iraq's Energy Council.

Today, however, the openness of Iraq's oil industry to foreign participation is still in doubt, not only because of the security situation. Iraq has no national oil law in place. Its constitution is vague about the degree of control regional governments can exert over oil policy.

Iraqi officials know they will have the power to dictate terms to foreign oil companies. "Iraq is definitely in the driver's seat. They [the government] know they have one of the most prolific resources left in the world," says Bob Fryklund, vice-president of IHS, the international consultancy.

Energy producers such as Russia, Venezuela and Algeria have typified a new wave of resource nationalism, in effect expropriating foreign ownership of oil projects. In Libya, another country whose oil industry has only just opened up to foreign participation after years of sanctions, the government has now increased its take from all oil projects to an average of 95 per cent, from 81 per cent in 2000. Even in Kurdistan, where the regional authority has signed production-sharing agreements, the government's take of future oil produced is estimated at 87 per cent, says Mr Fryklund.

Oil industry executives say their companies will not invest if they do not get a significant part of "the upside", industry jargon for expected increases in production. But Tariq Shafiq, a former director of Iraq's national oil company, says companies would be prepared to accept variations of service contracts that pay companies fixed returns rather than rewarding them with control over reserves.

"Given how prolific Iraq is, the return to international oil companies [under service contracts] would be just as favourable as under investment [contracts]. And I believe the companies are aware of that," he says.




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