Financial Times: Will the tap open? Why oil groups dream of the day they can enter Iraq

By Carola Hoyos and Roula Khalaf: Published: December 8 2006 02:00 | Last updated: December 8 2006 02:00

American troops stood by as government offices in Baghdad were torched and looted after the city’s fall in April 2003, a chaotic beginning to the flawed US-led campaign in Iraq. But one imposing concrete building was accorded special treatment.

Ringed with barbed wire, with dozens of US tanks guarding the entrance and American soldiers perched on roofs, the oil ministry emerged unscathed from the post-invasion mayhem. US officials insisted at the time that their objective was to safeguard the centre of Iraq’s vital resources. The US military’s actions, however, fed the conspiracy theory that the toppling of Saddam Hussein was itself designed to gain control of Iraqi oil.

Whatever the motives, the turmoil now sweeping the country has caught up with Iraq’s oil industry. The sector has been devastated by violence, a lack of investment and rampant corruption. Production has not regained pre-invasion levels.

While the stability of Iraq under the former regime had been buttressed by oil revenues, today the struggle for control over these resources – the third largest petroleum reserves in the world, after Saudi Arabia and Iran – is threatening to tear the country apart. An uneven distribution of reserves has exacerbated discord among Iraq’s three main communities – the majority Shia and minority Sunni Arabs and Kurds – over the political destiny of Iraq.

As it strains to contain the sectarian bloodshed and ease the departure of its own troops from Iraq, the US has been exerting pressure on Iraqi leaders to pass a hydrocarbons law that would more fairly regulate the distribution of oil revenues and close some of the sectarian rifts. Political squabbles have overshadowed what could be the historic aspect of the legislation: although the previous regime had moved towards opening up the sector, in order to encourage oil companies to break United Nations sanctions, the law is expected finally to reverse the 1972 nationalisation of the industry.

According to drafts now circulating, it would allow various forms of foreign partnership, possibly including production-sharing agreements. Such contracts are preferred by oil companies, allowing them to hedge the risk of cost overruns and giving them greater scope for gain if oil prices rise.

While the passing of the legislation by the Iraqi parliament would provide a welcome legal framework for big international oil companies, executives acknowledge that investment is still far off. “The whole industry is interested in Iraq, including us,” says a BP official. But, echoing concerns expressed by other companies, he adds: “The security situation would have to improve dramatically if oil companies like us were to commit themselves to long-term exploration and production.”

While international oil companies are used to working in troubled environments, from rebel attacks in Nigeria to general strikes in Venezuela, the conflict in Iraq not only dwarfs anything they have had to deal with in recent history but has also been on a steady escalation, putting into question the very existence of the Iraqi state.

Unlike Algeria’s civil war in the 1990s – where the survival of the state apparatus, backed by a powerful army, helped attract oil and gas investment – Iraq is run by a weak central government whose authority is challenged by local militias and political groups.

“To look into future [Iraqi oil] policy is to look into the unknown,” argued Walid Khadduri, an expert on the country’s resource sector, told a recent London conference. “You can’t discuss future oil policy before knowing what will happen in the south of the country [home to most of Iraq’s oil wealth], who will control the south, whether it’sone national party or even local Shiaparties.”

According to the Iraq Study Group, the US bipartisan commission that this week recommended a radical change of course for America in Iraq, the country is producing only 2.2m barrels a day and exporting about 1.5m b/d. This is below the Iraqi government’s target of 2.5m b/d and falls far short of the sector’s vast potential.

Another recent report, by the oil ministry’s general inspectorate, found that Iraq had lost more than $24.7bn (£12.6bn, €18.6bn) of potential oil revenues over the past three years because of political instability and violence, including the sabotage of pipelines.

From a global perspective, Iraq’s oil is becoming increasingly important to overall supply as demand accelerates, from China in particular, and output from fields in the US, Europe and parts of Asia slows with their advancing age. According to the International Energy Agency, the developed countries’ watchdog on the issue, Iraq would have to increase its oil production by 4.9 per cent each year until 2030 to meet the world’s oil demand, which is expected to jump to 116m b/d from 85m b/d.

Big oil multinationals struggling to increase their own production and add to reserves have been desperate to be given a chance to develop Iraq’s oilfields. The country has 115bn barrels of estimated reserves and only 22 out of 87 known fields are on stream. Large tracts of Iraq remain little explored,

Big oil companies have enjoyed record profits from their global operations in the past two to three years. But the groups are finding themselves increasingly squeezed out of promising projects that could bolster their proved reserves. The reserves figures on their balance sheets are seen as one of the main indicators of oil companies’ future viability. But a trend towards resource nationalism has seen governments, such as in Venezuela and Russia, wresting control of important fields away from foreign operators. Saudi Arabia, Kuwait and Mexico, which own the world’s three biggest individual oilfields, have kept their doors shut.

The big groups are therefore seeking to prepare for the day when they will be able to enter Iraq, trying to create closer relationships with Iraqi officials and to gain information about oilfields in ways that do not require visits to the country. BP and Royal Dutch Shell agreed to provide free assessments of the geological, technical and other data on Iraq’s two main oilfields, Kirkuk in the north and Rumaila in the south. This has helped them catch up with competitors such as Total, which may have gained access to such data when they negotiated contracts with the Saddam regime. Others such as Chevron have forged relationships and gleaned information by organising training sessions for Iraqi engineers outside Iraq.

There has also been concerted lobbying, some of which came to light during Australia’s ongoing official inquiry into kickbacks the Australian Wheat Board is alleged to have paid during the Saddam era. Documents published by the inquiry of meetings among diplomats, business executives and lobbyists show that companies such as BHP Billiton, the Anglo-Australian mining and oil group, actively lobbied the US and UK after the invasion in the hope of securing contracts for Iraqi oilfields.

Sir Malcolm Rifkind MP, a former Conservative minister, advised BHP and a Netherlands subsidiary that “it was critical to register the BHPBilliton/British Dutch/Tigris interest early with the US administration”, according to minutes of a May 19 2003 meeting in London. At a separate meeting he attended that day, the Foreign Office was recorded as saying that “US administrators in Iraq were already rehabilitating existing oilfields”. The US was “reported to have told the UK ‘not to behave like the English’ but rather tell the administration if it has particular interests”, the minutes show. Sir Malcolm declined to comment.

Yet it might be Russian, Chinese and Indian oil groups that stand to benefit first from Iraqi oil, given their apparently greater willingness to take on the security risk. Hussein Shahrastani, Iraq’s oil minister, recently embarked on a tour of Asia, holding meetings with China’s four biggest energy companies. He said concerns over security did not come up.

Leonid Fedun, vice-president of Russia’s Lukoil, which is looking to renew the commitment it once secured from the Ba’athist regime to develop Iraq’s giant West Qurna field, also suggests violence is no deterrent. “Unlike western companies, we are willing to work under any circumstances,” he says. “It looks like Russians have a different definition of risk.” He notes that Vagit Alekperov, Lukoil’s president, has been to Baghdad several times in the past two years – a claim not one leader of a western oil company could match.

Analysts say that it is partly Lukoil’s experience in Iraq that attracted the interest of ConocoPhillips, the third-largest US energy group. Conoco-Phillips paid nearly $2bn for the Russian government’s 7.59 per cent Lukoil stake, which it has since boosted to 20 per cent even while Russia has become an increasingly treacherous location for international oil companies.

Some western oil executives say that if a legal framework for investment emerges, the west’s energy companies might begin by investing in the relatively stable and underexplored Kurdish north. Groups such as Norway’s DNO are drilling for oil in the Kurdish regions. Canada’s K Petroleum and the UK’s Sterling Energy have signed agreements for field studies.

But such contracts are part of the political controversy that has been holding up parliamentary approval of the hydrocarbons law. The Kurdish region has been asserting its right to develop new fields, based on the ambiguous wording of the Iraqi constitution adopted in October 2005.

The constitution says the central government should be allowed to control existing oilfields but remains vague on who should control newly developed ones. Kurdish officials argue that other parts of the constitution give regional governments all powers not explicitly granted to the federal government. The central government, led by a Shia coalition, says the issue has yet to be resolved. Mr Shahrastani has warned that Baghdad did not see itself as bound by contracts agreed between international companies and the Kurdistan authorities.

The politics of oil have also pitted the Sunni Arabs, concentrated in the oil-poorer centre of the country, against Shia parties that are dominant in the south, home to 60-70 per cent of Iraq’s oil reserves. The Sunni voted against the constitution in a referendum last year partly because of a clause allowing the creation of federal regions, which the Sunni fear could lead to the break-up of the country and deprive them of a share of oil revenues.

Kurdish aspirations for control of the northern city of Kirkuk, whose surrounding fields account for nearly 10 per cent of total oil reserves, form another explosive issue that is also fiercely contested by Sunni Arabs.

Indeed, analysts warn that the lethal mix of sectarian politics and disputes over oil should make the most adventurous oil companies cautious. If violence continues to escalate, the risk of a gradual disintegration of the country into separate Shia, Kurdish and Sunni Arab parts will mount, rendering irrelevant any legal framework approved by parliament.

Raad al-Kadiri, director for the Middle East and North Africa at PFC Energy, a Washington-based industry consultancy, says that even if oil legislation is agreed and at least some of the political disputes over oil are settled, foreign investors might still not feel sufficiently protected.

“When we talk about legislation we talk about civilised politics in four square miles of Baghdad, which has less and less relevance to what happens outside,” he says, referring to the heavily guarded Green Zone, home to government offices. “It’s not clear what will happen in Iraq . . . and that pushes oil and gas investments way back.”

Additional reporting by Steve Negus

Copyright The Financial Times Limited 2006

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