Issue No. 91

Mr. Tariq Shafiq*

IRAQ OIL PLANS AND POLICY

Contents:-
1- Historical Background
2- Iraq Oil in a Global Context
3- Iraq Oil Policy
4- Iraq National Oil Company

The history of Iraq oil and its industry is an interesting one though itis sad in some respects. The oil concession agreements were the product of the First World War and the invitations for the return of the IOCs to work in partnership with a government establishment, though a healthy road to pursue, were the product of the Gulf war and the UN sanctions. In the new era, post Saddam regime, new plans and policies for a democratic market based society are in the making. Oil plans and policy guidelines had been prepared by the previous transition government of Dr Alawi without success and are expected to be in the making by the present government. Tentative plans and policy have been applied through entry into memoranda of understanding (MOU's), which are un-committed, with the international oil companies (IOC's). There is however fear that oil and gas agreements based on such MOU's could have latent prejudicial effects unless eventually strict and transparent tendering process, which derive their legitimacy from a petroleum law, are eventually adapted and applied. However, it is expected that policy and hydrocarbon law would undergo due democratic processes. Two years have passed in a turbulent war-like atmosphere during which Ministry of Oil senior management issued statements indicative of oil plans and policy. This paper suggests oil plans and policy guidelines.They are intended as suggestions for deliberation and discussion.

1. Historical Background
* For over 5,000 years, the town of Hit has been known for its natural bitumen seepage. Herodotus wrote about its use in the building of the walls of Babylon. The Old Testament mentions its use in the form of slime as mortar in the Tower of Babylon.
* Al-Nar Al-Azalia ('the Eternal Fire') is the name that has been given since antiquity to the fire caused by gas seepage as it ignites at the surface at Baba Dome of Kirkuk.
* Years 1911-1914 witnessed Gulbenkian and the formation of the Turkish Petroleum Company (TPC) leading to the formation of the Iraq Petroleum Company and Associated Companies: MPC and BPC covering practically all Iraq.
* In June 1914, TPC concessions granted by a senior Ottoman Minister
* The San Remo Conference of April 1920 set the formal outline of an oil concession in Iraq. British Anglo Persian Oil Company (BP) and the French CFP obtained Iraq government endorsement in March 1925 in support of Iraq to retain Mosul. San Remo stipulated 20% share for Iraq which remained unfulfilled.
* October 1927, saw Kirkuk discovery in commercial quantities, preceded by the drilling of the first well in Iraq Chia Surkh-1 in 1903.
* 1928 saw the American entry into the IPC agreement conditional on the Red Line Agreement which was revoked years later by the Americans.
* IPC shares were finalized on the basis of: 23 1/2 BP, CFP (Total), Shell, Esso (Exxon) & Mobil and 5% Gulbenkian, in March 1931.
* IPC extended its area to cover all Iraq and share it with its associates MPC (1930) and BPC (1938) for duration of 75 years without relinquishment.

2.Iraq Oil In A Global Context
The following table uses generally accepted reserves and cumulative production figures for January 2004 but potential reserves were estimated at 20% of proven oil reserve while allowing Petroloq and Associates studied estimate of 216 Billion barrels (Bb) for Iraq's potential discoverable reserves. The table provides a conceptual example of Iraq oil reserves in a global context for the case where world proven reserves have been upgraded from its assumed 35% average recovery to 50%, which is well within the grasp of today's oil field management technology. However, the conceptual conclusions derived herein remain valid in other scenarios where such proven reserves are not upgraded.

Table 1. Proven Oil Resource Base
Recovery Assumed 50% + Potential
 

All Figures are in Bb.

The conceptual conclusions derived from Table 1 may be summarized as follows:
1. Iraq's cumulative oil production to-date is only a small fraction. Some 8%, of Iraq’s oil resource base puts Iraq whose oil production started seven decades ago not far more than the UAE whose oil production had started some three decades ago.
2. Iraq's oil reserve is on par with the world leader Saudi Arabia and its oil resource base is not far behind.
3. Iraq's oil resource base may constitute 30% of the total Middle East Major five producers and some 21% of World total reserve.
4. Iraq and the ME Majors, whose production thus far is only 22% of their total reserve resource, will be able to sustain upward production rates for many years to come.
5. With total production at 8% of Iraq proven reserves can continue its upward production rate to10 mbpd and beyond to12 mbpd plowing in part of its potential reserves. While other ME Majors would have passed their reserve midpoint and started to decline.
6. Iraq, however, is a founding member of OPEC and rightly adopts its policy of crude oil price stabilization and conservation through control of its production and export. Thus far and perhaps until Iraq production reaches its post maximum of 3.5 mbpd, it may remain outside OPEC production quota. Thereafter, Iraq would have to choose between price and volume. OPEC quota could then be a limiting factor against Iraq open production policy, especially when there are IOCs who need to produce to optimum capacity to enhance the return on their investment. Iraq oil reserves are of the order of 330 Bb. It would take Iraq 300 years to exhaust its rehabilitated production of 3mbpd, 180 years at 5 mbpd and 90 years at 10 mbpd!

3. Iraq Oil Policy
The oil industry is the most efficient wealth-creating instrument. Iraq's oil industry's Low discovery cost in the order of US Cent 0.5 per Barrel and development cost of some US 0.5-1.0 per barrel), in accordance with Petroloq & Associates studies, provide high income, indeed, at all levels of oil prices and especially from oil prices in the bracket of $22-28 and above into $50-60 today.
Thus, with the near total dependence of the State on oil income, simple logic dictates the requirement for a pivotal State owned oil industry having the National Oil Company as its commercial and technical operating arm, especially in view of its highly successful past, and as generally practiced in most of the major oil producing countries. INOC accomplished capacity build-up from 1.5 mbpd in the early 70's to 3.5 mbpd by 1979 and a discovery rate in excess of 6 Bb per year (over 1972-1977), which matches total discovery in the rest of the world best records.
However, in view of Iraq's desperate need for fast track oil development, up-to-date technology transfer, training of its personnel, and large capital investment, at a time when the country is in dire need of capital income, it is logical to permit a wise degree of involvement of the IOCs working jointly with INOC. IOCs may well be invited to work independently from INOC on risky exploration if this can prove to be in the better interest of the State, however, always with a 'local content'. The latter case may well be very limited due to Iraq's need first is production capacity growth rather than oil exploration due to availability of ample proven reserves which can support up to 10 million barrels per day (mbpd). Capacity growth in turn would be limited to the country's economic and social capital development requirement and the ministry of oil's capability for regulatory and supervisory duties.
At this juncture, it would be appropriate to run through a review of relevant oil concessionary history in Iraq to gain some insight into successes and lessons from the past.
The major international oil companies in the Middle East established the largest industry, and at times the only industry, in any one oil-producing country. They demonstrated a high degree of efficiency unmatched in any one country. They became the largest provider of revenue to the State and gained great economic and political power. However, they formed distinctive enclaves, foreign and privileged and, thus, the terms 'concession' and 'concessionaire' developed derogatory implications. As a result they became further associated with the colonial era, as the Middle East major oil producing countries were under direct or indirect foreign influence.
The history of the Iraq Petroleum Company's (IPC) formation and the way that shares were distributed between the British, French, Dutch and American companies, is evidence of the role of politics in the Middle East, in acquiring oil concession rights during and in the aftermath of the First World War.
The major oil concessions had common ownership, which permitted effective control and common features. Examples of the latter are:
* Extended periods of exploration and exploitation: the IPC in Iraq had 75 years, KOC in Kuwait 92 years, Aramco in Saudi Arabia 66 years.
* Frozen terms over the long life of the concession.
* Large concessionary areas without relinquishment: most of Iran, almost all of Iraq and Saudi Arabia and all of Kuwait, Bahrain and Qatar.
* Exclusive rights for the concessionaire to carry out operations without sufficient obligations governing the exercise of these rights, in contrast to the absence of some basic government rights in vital matters such as tax and royalty, company plans and application of best oil industry practices.
Most of these features, however, changed during the 1950s, 1960s and 1970s, under changing circumstances and collective pressure from the host countries through OPEC. Nationalization through gradual share acquisition by the others, members of OPEC, was achieved by the late '60s and early '70s as a result of collective bargaining power under OPEC's umbrella, with the exception of Iraq, which was negotiating outside of OPEC. Iraq nationalized its oil industry in the early 70's as a result accumulation of unresolved disputes but mainly as a consequence to precipitations of law No. 80 of 1961.
Iraq's failure to reach a negotiated agreement was due to its acting singly and adopting confrontational demands which led to unilateral legislative action to enforce relinquishment of 99.5% of the concession area through Law No. 80 in 1961. Law No. 20 followed in 1970, which made it illegal to give up an additional 0.5% of producing acreage to the Companies (permitted originally in Law 80), and closed the door against any possible negotiated settlement which left Iraq's oil industry frozen.
Middle East concessionary agreements could not live out their term, since from the start they were not balanced, and some clauses (Iraq 20% participation as an example) were so written as to make their application impossible. The agreements were passed under duress just after the First World War, when the national governments of the day were being established or were in the process of gaining their full sovereignty. The Companies often took corrective concessionary measures a little late when the damage had already been done.
Most countries pursued monopoly of the State over the oil industry while only few have permitted partnerships with the international oil companies. The return of the IOCs in Saudi Arabia has been limited to the E&P of gas, not oil, in Iran only under Service Contract of Buy-back terms, while in Iraq invitation to the IOCs, during Saddam era, has fluctuated between Production Sharing Agreement (PSA) and Buy-back contract since mid '90s.
Iraq was no different from the majority in this respect as it established a national oil company in 1964. But, it was closed years later and the company's functions were taken over by the Ministry of Oil in the late 80's.
However, the international oil companies, including many from among the Majors, flocked to Baghdad upon the invitation of the Iraqi Government post the Gulf War over the years until the end of the Saddam regime in March 2003. Only the Chinese and the Soviets had signed agreements, while the remainder had draft agreements, but none had carried out operations on the ground due to UN-enforced sanctions. A further 'legacy' of Saddam's regime left Iraq with potential disputes with former countries.
Under the present Iraq turbulent circumstances, there is consensus amongst Iraqis, the government and the wise among the IOCs, not to enter into long term oil exploration or production agreements until such a time when there is a legally and democratically elected government, recognized by the international community, with a Constitution and a Petroleum Law in place. The international oil companies not only recognize this, but go beyond it where most of them would prefer socially and politically stable regimes to deal with as they recognize the added risks resulting from instability. Attempts to short cut or bypass this would face failure in the medium or long term.
 

Below are suggested Plans and Oil Policy which aim at optimizing Iraq fast track oil resource development:
1. It is in the national best interest that the Ministry of Oil, especially in the absence yet of due democratic processes in making policy, consults with an Iraqi think tank, made up of competent national oil technocrats, in an atmosphere of constructive debate. Rules and procedures for incorporating advice and consultation from the think tank ought to be worked out and selection should be based solely on merit and absence of conflict of interest.
2. It is important in such an exercise that constructive dialogue is encouraged, and opinions expressed without discrimination or incrimination, in order to arrive at an optimal oil policy.
3. Oil policy and plans must ensure optimum benefits to the nation, which is the rightful proprietor of this depleting asset. They should be prepared with the utmost care and diligence over a sufficient period of time in order to allow for constructive debate.
4. 'The hydrocarbon resources are inalienable and imperceptible property of the State,' to quote from the old INOC Charter. In other words, petroleum is a non-renewable depleting asset, meriting conservation, optimum fiscal reward, as well as among other things, participation of the national oil company and inclusion of the 'national content', which should be built into every contract, with IOC's limited to the extent of the competitiveness of Iraq oil exploration and development.
5. Such 'national content' should promote and/or build:
* Participation of national private oil companies, services and manufacturing industries.
* Transfer of knowledge, management and technology.
* Local research and technical institutions.
The above elements of national content have already been applied in major national oil industries such as that of Norway, Iran and Russia to the extent of 51%.
6. For the above reasons and in order to compensate for petroleum depletion as a source of income, investment in other economic endeavors should be made to ensure continuity of income from other resources. Once this is achieved, there is room for lesser dependence on a State upstream oil monopoly.
7. Ensure oil and gas conservation practices and give due regard to health, safety and environment protection throughout the exploration and exploitation and related operations.
8. Encourage gas development and give it a prominent role in meeting at least the domestic energy consumption needs.
9. Partnership of the national oil industry with the IOCs is the best option that would expedite building Iraq oil industry to dimensions commensurate with its huge resource base, catching up with the latest state-of-the-art technology and management, acquiring the necessary investment capital, and speeding up the realization of benefits through efficiency and healthy co-operation.
10. International Oil Companies and foreign contractors require stability and security, law and order, assurance for the safety of their personnel and capital investment and a fair return on their investment, among other legitimate requirements.
11. 'Managing the hydrocarbon resource of Iraq, which belongs to all the people of all the regions and governorates of Iraq, in consultation with the governments of the regions and administrations of the governorates, and distributing the revenues resulting from their sale through the national budget in an equitable manner proportional to population throughout the country, and with due regard for areas that were unjustly deprived of these revenues by the previous regime, for dealing with their situation in a positive way, for their needs, and for the degree of development of the different areas of the country,' in accordance with the law for administration during the transition period. However, a reasonable degree of devolution of power should prove necessary while issuing licenses, tendering, and negotiating agreements should remain the prerogative of the central organization. .
12. Oil and gas laws, in a hydrocarbon law, and regulations should derive their legitimacy from a constitution enacted through due international, democratic and legal process. However, in the interim period, there is consensus of opinion that rehabilitation of the petroleum production system and its restoration to past levels, and ongoing production and development operations of short term consequence by the Ministry of Oil and its contractors, are allowed to proceed.
13. Contractual modes can be one of many suitable forms which include: Buy-back, other forms of Service contracts and Production Sharing Agreements which preserve the ownership of the state for the petroleum resource in the ground. Each may be more suitable than the others for particular circumstances. Production Sharing, though, appears to have wider and more favorable acceptance by the International Oil Companies and host countries. The most important criteria, however, in all forms remains: the fiscal return to both parties, share to each party, the extent of national content and degree of other economic and fringe benefits to the nation, the degree of control of the government to exercise and maintain administration and supervision without infringing on the company's rights to carry out its operation effectively and efficiently.
14.Tendering should be the only process for selecting companies interested in working on E&D and related projects. Tenders should be comprehensive and announced to a well defined time schedule. This should involve general information and meetings with interested parties. Interested bidders should submit pre-qualifications, as only pre-qualified parties should be invited to bid. They should be given equal opportunity to access comprehensive database. Bids should be evaluated, and short listed bidders be given a fair chance for discussions leading to selection of the winner. The procedure, evaluation, discussions and decision-making should be fair and transparent. Assigning a payable fee to the bids and access to database is advisable to eliminate the less serious parties and improve the quality of the bids.
15. Agreements between the state organization and the international oil companies must be written and applied in good faith, and, need to be balanced and fair in order to reduce potential disputes and endure the test of time. They may permit reviews in the light of justified changes in circumstances governing taxation, royalty, and profitability and market conditions amongst others.
16. No member of a consortium should have incompatible interests with the other members or with the host country's vital oil industry's objectives, which could curtail its investment and retard the consortium's E&D obligations.
17. In view of Iraq present high oil proven reserve which is capable of building up to 10 mbpd which may require almost two decades to achieve and Iraq urgent need for production growth while the country is in dire need for capital investment production capacity should be based on existing proven reserves. Risky exploration should take second priority especially where IOC's involvement is desirable but their required reward is correspondingly high and contracts are for long duration which may best be deferred under the present transition period in Iraq history.
18. Production capacity growth is best economically achieved in the medium term from the presently developed and producing oil fields which have other multiple producing formations beside the main pays, which have been the only developed formation, and through the use of enhanced oil industry management to optimize the recovery from the main pays and to correct their damage, wherever possible.
19. Last but not least, oil policy, plans and organizations ought to be as dynamic as the technical and marketing nature of the industry. They ought to be depoliticized and appointments should be solely on merit. Transparency and accountability must be upper most.
 

You will note that I have excluded privatization of the oil upstream as a means to raise capital or provide benefits, for the following reasons:
1. Privatization is equated today with de-nationalization, whether partially or 100%. Iraq's economy is almost totally dependent on its oil income. With decision-making for exploration, production and exports in the hands of the multinationals, Iraq's economy and its government's decisions would be at the mercy of the multinationals, whose interests are naturally first to their shareholders. This is the case in addition to the numerous disadvantages of the kind discussed previously, mainly, possible incompatibility with the national interest under future conditions and potential use of their power to slow activities or switch supply to other countries when it best serves their interests.
2. There is no particular advantage gained from privatization by way of investment capital, technology, or efficiency that cannot be obtained from othercontractual arrangements.
3. Decisions made over the characteristics of the deposits and their source-base depends not only on economic or technological criteria, but also on political, historical and cultural considerations. The very overwhelming majority of the hundreds of Iraqi oil technocrats are against privatization of the upstream oil industry.
4. Finally, denationalization runs against the grain of almost every Iraqi - this is a significant consideration in any future democratic Iraq.
The last Prime Minister, Dr Ayad Alawi, made efforts at formulating an oil policy which have been abandoned in due course.
* He intended to remove the E&D and related operations from the ministry and allocate it to a newly established INOC, whose operations, however, are limited to existing oil producing fields, with the prospect of its partial privatization with shares.
* He emphasized expediting the entry of IOCs to start developing Iraq's undeveloped fields on a modified type of PSA that bars any government entity becoming a party in the PSA, resulting in transferring decision making on oil field development and consequently Iraq's treasury future income to rest in the IOCs or private companies' hands, and in so doing loose control over price stabilization and production control, at a time when Iraq would still be depending mainly on the oil income.
* He called for cutting out the negotiating time that goes into optimizing contract terms and conditions, assuming that what may not be gained but given to other countries can be extracted later on the basis of the most favored nation clause. But, this clause existed during the concessionary contracts era when the Majors dominated the concession agreements, in an oligarchic market which had common terms and conditions, so that improvement in any one country was passed on to the others. Today's agreements in different countries are not necessarily similar, and the players and host countries have multiplied in number. After all, the terms and conditions of each contract are unique to the country and to particular exploration and development, and rewards reflect associated costs and risks, amongst others.
* To his credit, however, he appreciated and promoted the requirement for a vital policy issue: 'Local content' is to be encouraged in order to develop Iraqi private enterprise where he even suggested preferential treatment to Iraqi service companies.
* However, his vital policy lines would have run counter to the terms of the Transitional Administrative Law (TAL) annex that governs the transitional governments, since it prohibites contracts that impact the long-term development of the country, with the exception of negotiating debt reductions.

4. Iraq National Oil Company (INOC)
Since mid 60's, national oil industry in the Middle East has been managed under a similar organizational pattern in which the ministry has made policy and carried out the administrative and supervisory role while the national oil company undertook the E&D operations with the exception of Iraq since the late 80's when the ministry took over INOC operating companies and functions. However, INOC charter at the time gave it financial and administrative independence and functions over the upstream (with monopoly) and downstream outside and inside the country (where there was no other government monopoly in case of the latter) and allowed it to form subsidiaries and enter into joint ventures with others, among other wide scope terms and conditions subject to adherence to Government general oil policy.

INOC Charter
INOC was established by law No.11 of 1964 with the objective of:
* 'Establishing a national oil industry that would serve as basis for future oil exploitation activities in the areas of which the rights of exploitation have been restored to the State by Law No. 80 of 1961.'
* 'Laying down of the ground work necessary for the growth and development of the industry so as to create an advanced oil economy not limited in scope to exploration of crude oil but extending to effective engagement in the various phases of the oil industry.'
Its Law stipulated that:
* In view of the importance of the oil reserves of which the rights of exploitation are expected to be granted to the National Oil Company, the law has stipulated that the Company's capital shall be purely governmental, in keeping with the principle of sovereignty over mineral resources of the State that are natural monopolies. This, however, shall not preclude the Company, acting within statuary frame work, from making use of other capital, domestic or foreign, through loans or through partnership of various forms of business cooperation with concerns or organizations concerned with oil development, should this be warranted by the magnitude of capital needed, marketing exigencies or the technological requirement of construction.
* Further, since it is necessary that the Company enjoys financial and administrative independence for it to be able to perform most efficiently its diverse and steadily-growing task so as to achieve the purposes for which it is established, the law has stressed the Company's independence in those spheres.
However, since the early 70's the oil industry had been nationalized and all the country has come under the jurisdiction of INOC. These are objectives and stipulations which remain valid today as they were then, however, not without some modification in line with the country's market oriented policy.
 

Accordingly, the following principles are being suggested for a future INOC charter.
1. INOC should be a fully State owned independent company (administratively and financially), entrusted with the task of managing and developing Iraq's upstream and downstream petroleum industry in all its phases inside and outside the country, but not including manufacturing and petrochemical industry.
2. NOC should perform its duties and obligations in accordance with the State petroleum policy. Proper interpretation of adherence to government policy should remain the prerogative of the minister of oil. However, when in difference the matter should be resolved by the Higher Petroleum Council of Ministers.
3. The present operating oil and refining companies should be detached from the Ministry of Oil and attached to INOC.
4. INOC should have an independent Board of Directors made up of members from among the Heads of the operating North and South oil companies and Refining directorate, and others from among Iraqi quality petroleum technocrats or exceptional and successful managerial quality persons. The Chairman and Managing Director should have ministerial status.
5. The Government should allocate INOC a capital budget and be allowed to borrow from the domestic or foreign markets. The first budget should be commensurate with one year's operation plus capital investment required for its first year of operation (as is the case normally). It may then be taxed in such a way as to leave it a return commensurate with commonly acceptable management fee, or be allowed a fixed fee on each barrel produced during a transition period (say five years). Thereafter, it should be taxed on the same basis as the IOCs operating in the country.
6. The Company, for the purpose of achieving its objectives should have the right to establish companies inside and outside the country, singly or jointly with other parties, or participate in existing companies.
7. The Company should be granted exemptions from all taxes and duties in respect of the performance of its functions, which are customarily granted to IOCs in host countries.
8. However, petroleum resources shall remain to be the inalienable and imperceptible property of the State.
In line with the country's market based economy INOC and the Ministry of Oil, should examine and recommend, in consultation of the think tank, to the Higher Petroleum Council of Ministers, possible partial or total privatization (with safeguards to the employees) of some of the downstream and non-pivotal upstream companies, which may include the maintenance and/or services but not the main operating oil companies or strategic functions such as the pipeline transportation.
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* Petroleum techno-economic consultant ,Chair Fertile Crescent Oil Company and al-Mansour Petroleum Consulting Company, former executive director & vice chairman of Iraq National Oil Company