Production sharing agreements--mortgaging Iraq's oil wealth.

• Author: Muttitt, Greg

INTRODUCTION

OIL IS IRAQ'S MOST IMPORTANT ASSET, and the powerhouse of its economy. Handled correctly, it will be the basis of the country's future development.

But not only are Iraq's oil reserves huge in relation to the country's economy, they are also the third largest in the world, accounting for 10% of known world oil reserves. Furthermore, Iraq has the greatest unexplored potential of any country, with possible unknown reserves matching or exceeding the known reserves. In theory, Iraq should be a rich country.

However, the history of Iraq's oil industry has not been a positive one. Ever since Iraqi oil was discovered 80 years ago, it has been eagerly coveted by foreign companies and countries who have used a range of economic, political, legal and military measures to obtain access to it on generous terms. Conversely, during the three decades of national control over the industry, oil wealth was used to sustain a brutal dictatorship and its internal security apparatus, and to finance devastating wars with Iraq's neighbours.

Now, in 2005, Iraq's oil policy is once again going through radical change. Decisions made in the coming months will set the development trajectory of the next few decades and determine whether the Iraqi economy thrives or struggles.

In this essay, we will examine the implications of one key plank of Iraq's developing oil policy--the proposal that foreign companies should be given access to oil reserves through the mechanism of production sharing agreements.

IRAQ'S OIL POLICY

Although oil was excluded from the sweeping privatisations enacted by US administrator Paul Bremer in 2003, major moves to open the sector to multinational oil companies are now imminent.

A Petroleum Law has now been drafted by the Energy Council together with the Oil Ministry, and will be enacted soon after the elections in early 2006, assuming the Constitution is approved in the October referendum. According to officials in the Ministry, long-term contracts will be signed with foreign oil companies during the first nine months of 2006. (1) In order to achieve this goal, officials have stated that negotiations should begin with the companies during the second half of 2005 in parallel with the writing of the Petroleum Law, in order to be able to sign soon after the law is enacted. (2)

According to sources in the government, although some details are still being debated, the draft Petroleum Law specifies that while Iraq's currently producing fields should be developed by state-owned oil companies (under a reconstituted Iraq National Oil Company, INOC), all other fields should be developed by private companies through the contractual mechanism of production sharing agreements (PSAs), the mechanism favoured by the oil companies. (3)

Only 17 of Iraq's 80 known fields, and 40 billion of its 115 billion barrels of known reserves, are currently in production. (4) Thus the policy potentially allocates to foreign companies 64% of known reserves. If a further 100 billion barrels are found, as is widely predicted, the foreign companies would control 81% of the total, and if 200 billion were found, as some suggest, they would have 87%.

This policy has been some time in the planning and its roots lie in the US State Department prior to the 2003 invasion. In 2002, the State Department established its Future of Iraq project in which Iraqi exiles and members of the then opposition met with US officials to plan for the future of Iraq after regime change. The project's Oil and Energy subgroup, whose members included current Oil Minister Ibrahim Bahr al-Uloum, met four times between December 2002 and March 2003. The group argued that: (5)

[National oil companies] no longer serve the best interests of their countries. Rather, ... their inherent inefficiencies, born of their protection from competitive forces endowed by their monopoly status, cost the countries in which they survive billions of dollars. The subgroup went on to recommend production sharing agreements with favourable terms to attract the companies:

Key attractions of production sharing agreements to private oil companies are that although the reserves are owned by the state, accounting procedures permit the companies to book the reserves in their accounts, but, other things being equal, the most important feature from the perspective of private oil companies is that the government take is defined in the terms of the [PSA] and the oil companies are therefore protected under a PSA from future adverse legislation ... PSAs can induce many billions of dollars of foreign direct investment into Iraq, but only with the right terms, conditions, regulatory framework, laws, oil industry structure and perceived attitude to foreign participation. During his first period as Oil Minister under the Coalition Provisional Authority and the Iraqi Governing Council, Ibrahim Bahr al-Uloum told the Financial Times that he was preparing plans for the privatisation of Iraq's oil sector, but that no decision would be taken until after the 2005 elections. He commented that: "The Iraqi oil sector needs privatization, but it's a cultural issue", noting the difficulty of persuading the Iraqi people of such a policy. He further announced that he personally supported production-sharing agreements for oil development, giving priority to US oil companies "and European companies, probably." (6)

The first more concrete policy began with Interim Prime Minister Ayad Allawi in August 2004. He issued a set of guidelines to the Supreme Council for Oil Policy, from which the Council was to develop a full petroleum policy--a policy that would eventually develop into the Petroleum Law. Allawi's guidelines specified that existing fields would be developed by INOC and new fields by private companies through production sharing agreements; but he went considerably further, in a number of respects:

* New fields would be developed exclusively by private companies, with the policy ruling out any participation of INOC; (7)

* The Iraqi authorities should not spend time negotiating good deals with the companies, but should proceed quickly with terms that the companies will accept, while leaving open the possibility of later renegotiation; (8)

* INOC should be part-privatised. (9)

It is not known whether these details have been carried forward into the current draft oil policy.

In June 2005, Ministry officials announced that they were actively seeking discussions with multinational oil companies on the development of 11 oilfields in the south of Iraq. They held preliminary talks with BP, Chevron, Eni and Total. (10) The following month, the Ministry announced that alongside these direct discussions, it was also considering a licensing round in which oil companies would bid for production sharing agreements on both known fields and exploration blocks. (11)

PRODUCTION SHARING AGREEMENTS

The development of Iraq's oil industry began in the aftermath of the First World War while the country was occupied by Britain, under a League of Nations Mandate. In 1925, Iraq's British-installed monarch, King Faisal, signed a concession contract with the Turkish Petroleum Company. The contract had a clear colonial character. It was for a period of 75 years, over which terms were frozen. Combined with two further concessions granted in the 1930s, one to a subsidiary of the (by then renamed) Iraq Petroleum Company, and the other to a company that was subsequently bought out by it, IPC obtained rights to all of the oil in the entire country. Even the Iraqi call for a 20% participation share in the concession was denied, despite having been specified in earlier agreements.

Iraqi frustration at the unfair terms of the deal grew. In the 1950s the contract came under pressure. Through the 1950s and 1960s, disputes continued between the Iraqi government and IPC, centring mainly on three issues: Iraq's continued desire for a participation share; disagreements in the posted price set by IPC for selling Iraqi oil to its overseas associates (when IPC set it too low, Iraq was denied tax income); and IPC's apparent suppression of Iraqi production, in order to boost the oil price, and make the IPC member companies' production in Saudi Arabia and Iran more profitable.

Underpinning this was the question of whether the split of revenues between company and state was a fair one--an argument that was echoed in all of the major oil-producing countries at the time, most of which had similar deals with the multinational companies. Whether--as in post-revolutionary Iraq--the governments were themselves antagonistic to the foreign oil companies, or--as in Saudi Arabia and Iran--under pressure from nationalist movements within their countries, the 1950s, '60s and '70s saw successive renegotiations of the contracts, in the host countries' favour. The ultimate conclusion was the nationalization of their industries. In Iraq's case, 1961 saw the nationalization of the oil within 99.5% of the country that was not then in production; the remaining 0.5% containing the producing fields was nationalized in 1972, and the final pieces in 1975.

In Indonesia, a different path was followed. The status quo was maintained while relieving nationalist pressures. In the late 1960s, while contracts in the Middle East and elsewhere were being renegotiated, Indonesia introduced a new form of contract, the production sharing agreement.

An ingenious arrangement, PSAs appeared to shift the ownership of oil from companies to state, and invert the flow of payments. The mechanism is based on the division of the extracted oil into "cost oil", which is used to repay development and production costs, and the remaining "profit oil", which...