To say that the performance of the Iraqi oil sector over the past four and a half years has been disappointing is something of an understatement. In the run up to the 2003 war that overthrew Saddam Hussein’s regime, expectations in Washington were high that production and exports would not only recover quickly to their pre-conflict levels, but that the stellar targets that Iraqis themselves had claimed were possible since the 1970s would finally be achieved. These hopes went well beyond the neo-conservatives architects of the war within the Bush Administration who saw rapid increases in Iraqi output as a means to fund the rapid economic and political reconstruction of the country. Their Iraqi allies too held similar hopes. Even Iraqi oil technocrats, who were fully aware of the scale of the rebuilding task that lay ahead, were caught up in the euphoric predictions of what would be achieved with the removal of Saddam Hussein’s regime and the international sanctions that had crippled Iraq since 1990.
The experience since 2003 has been in sharp contrast to these hopes. Far from rising rapidly, Iraqi oil production has fallen and the sector has stagnated. As has been the case with the overall US-led venture to transform Iraq, the performance of the sector has suffered from a combination of unrealistic expectations, poor planning and management, violence and the overall deterioration of the political process. As Iraq’s main source of income, the sector has not been protected or developed; instead it has been fought over by rival political factions seeking to control the resource for themselves. Oil and gas operations have also become one of the main battle grounds for the dispute between different political parties and communities over the future shape of the state and the relationship between federal and regional governments. These factors have had a corrosive effect on the performance of the oil and gas sector and on the prospects for foreign investment, and unless there is a major shift in the political dynamics in the country, they will continue to pose a major obstacle for any significant improvement in the production and export picture in the future. Indeed, oil the glue that will hold Iraq together, but if mismanaged, it can also be the key ingredient that will facilitate the collapse of the country.
No-one doubt Iraq’s oil potential. With roughly 115 billion barrels of proven reserves, it is second only to Saudi Arabia among the OPEC producers, and its actual potential may far exceed the current reserve figure. Years of war, political disputes and sanctions have combined to limit exploration within the country, leading some experts familiar with the geology of Iraq to speculate that proven reserves could double once modern techniques are applied. Even with its present reserve base, there have long been high hopes that Iraq could significantly increase its output of crude oil. Even at its highest levels of output (around 3.3 million b/d), Iraq’s reserves to production ratio was on the low side compared to other OPEC states, and the potential to increase production has long been understood. Plans for an incremental increase of output to 6 million b/d within 10 years have been in place since they were drawn up in the late 1970s, and have been revived periodically ever since. They provided the underpinnings for the Iraqi government’s investment scheme in the late 1990s, when production sharing agreements were offered to international oil companies (IOCs) for the first time since the Iraqi government nationalized its assets in 1972. And it was these same blueprints that prompted heady pre-war speculation by senior Bush Administration officials who believed that Iraqi exports would be sufficient to pay for the reconstruction on the country (then Deputy Defense Secretary Paul Wolfowitz confidently estimated on the eve of the war that Iraqi oil export receipts would total as much as $100 billion between 2003 and 2006). Operation Iraq Freedom, as the military campaign was known, was not, as many critics have alleged, fought to control Iraq’s oil. But the resource did play a significant part in the Administration’s thinking about how to fund post-war reconstruction (both political and economic) and limit the burden on US taxpayers.
As with most other parts of the US plan, pre-war hopes and post-war realities have been vastly divergent. The rapid rise in oil production failed to materialize. After an initial recovery to just under 2.5 million b/d by the end of 2003, production actually fell for much of 2004 and 2005, reaching a low point of around 1.6 million b/d in January 2006. Thereafter it rose again, hitting a high of 2.4 million b/d in September 2006, only for production to slide again afterwards. Thus, even at its best, output has been almost 1 million b/d off historic highs, and it has yet to get anywhere near the 3 million b/d target that Bush Administration officials predicted that it would reach by the end of 2003 (a target figure that Iraqi officials have repeatedly said they would soon achieve ever since).
The various factors that have stymied Iraqi oil production were evident almost immediately after Saddam Hussein’s regime was unseated. Although the Oil Ministry was one of few government buildings protected by US troops during the looting that followed the regime’s fall—a controversial decision that did little to convince skeptics that Iraq’s hydrocarbon wealth was not the main aim of the campaign—oil sector infrastructure throughout the country was badly damaged. Meanwhile, political upheavals and the dismantling of Iraq’s state institutions by its US overlords in the weeks that followed destroyed much of the operational and management capability that remained in the Oil Ministry and in the country more generally.
Under these circumstances, the job of repairing the damage wrought on the Iraqi sector during and after the war became the immediate priority, rather than preparing for a more ambitious expansion of output. But even this project—known as Restore Iraqi Oil (RIO)—faced insurmountable obstacles, and provided an insight into the problems that the industry has faced ever since. Envisaged as the first of a three-phase plan designed ultimately to reach the long-held 6 million b/d target, the focus of the $2 billion RIO operation was 260 upstream and downstream projects that it was hoped would bring Iraqi production back to 3 million b/d by 2004 and domestic refining to the levels reached in Q1 2003. However, RIO quickly ran into problems, resulting in cost overruns and a forced downsizing of the project scope by early 2004. The focus shifted almost exclusively to sustaining existing exports and refining levels in the short term, which were well below the initial RIO target goals. This robbed Iraq of the necessary foundations for phase two of the plan, which was designed to expand output beyond the 3 million b/d target, and put phase three—attracting IOC investment in the upstream and downstream—well beyond reach.
The experience of project RIO is instructive because many of the same difficulties that undermined it continue to hamper the sector today. While there has been many allegations about the deficiencies of KBR, the US service company that was awarded the no-compete bid to run RIO, a significant number of the problems that undid the project lay closer to home in Iraq. The unanticipated deterioration in the security environment, which left the oil sector an attractive and easy target for insurgents, certainly added to the burdens faced by the Oil Ministry and the US contractor. Perhaps more detrimental still were the deficiencies of the Oil Ministry itself, where technocratic standards were lower than anticipated..
This personnel problem has proven to be one of the biggest obstacles to reviving the Iraqi oil sector, and it is only likely to get worse in the medium term. Up to the late 1980s, Iraq had developed one of the most able cadres of oil technocrats in the Middle East, partly the product of the legacy of the Iraq Petroleum Company and partly as a result of the government’s emphasis on foreign education and training—often in the United Kingdom—for its best and brightest. The financial squeeze of the late 1980s and more importantly the crushing sanctions that followed the 1990 invasion of Kuwait put an end to training abroad and undermined local education standards, robbing subsequent generations of Iraqi technocrats of the technical and sector experience enjoyed by their senior colleagues. By 2003, age and the consequences of the embargo had denuded the Ministry of some of its most experienced staff.
The political upheavals that followed the war only exacerbated theses problem, further diminishing the Ministry’s technocratic capabilities. The war itself led to the flight of some senior staff, and more still were removed as part of the process of de-Baathification instituted by the Coalition Provision Authority (CPA) that governed Iraq immediately after the war. At the same time, the Ministry became a battle ground between rival political factions, each keen to ensure access to Iraq’s most valuable resource for their own parties. The result has been regular upheavals in Ministry personnel, not just at ministerial level (there have been five ministers since April 2003; six if Thamir Ghadhban’s tenure as head of oil policy from April-September 2003 is included) but also in the operationally crucial director-general posts and below. Among the latter group, the number with outstanding technical or significant international expertise has dwindled to a mere handful, and further precipitous declines are likely. Little has been done over the past four years to compensate for this shortfall. Periodic proposals to rebuild and improve local training facilities have failed to get off the ground, and while the more than 40 MOUs that the Ministry has signed with IOCs have all included a technical training component, these programs have often been limited in scope and hampered by the fact that security concerns mean that they have to be conducted outside of Iraq.
The demise of technocratic influence within the Ministry that has accompanied the decline in standards has shifted priorities away from sectoral issues towards more nakedly political concerns. Appointments to senior positions has become far more politicized, reflecting the government’s emphasis on ethnic and sectarian quotas over efficiency, and the determination of different political factions to control directly their access to the country’s main resource. Each party has sought to position loyalists in important positions, and competition over different posts has undermined the working of the ministry. Political struggles have also played out at a local operational level, with Islamist Shia parties seeking to control Southern Oil Company (which is responsible for upstream operations in Iraq’s southern fileds) while the Kurds have asserted gradual control over the Northern Oil Company. Iraq’s oil exports have also been a focus of rivalry, not only at the ministerial level (where Fadhila has sought to establish a lock on the State Oil Marketing Organization to the detriment of its efficiency) but also locally, particularly in the south where valuable smuggling operations have been fought over.
This politicization of the ministry has been extremely damaging for the Iraqi sector, not just as a result of the corruption that has attended it, but also because it has hampered effective decision-making. Strategic planning and complex project management capabilities, already significantly eroded as a result of post-war de-Baathification, have declined further. Meanwhile, policy-making has been complicated by rival agendas, not just within the Ministry, but between senior officials there and their counterparts in the increasingly independent northern and southern operating companies. Both companies now operate as effective fiefdoms of their senior management, with decisions often taken independently of policy-makers in Baghdad. This is especially the case with SOC, which is responsible for the bulk of Iraqi production and exports. In NOC, insecurity and an absence of dynamic management have taken a severe toll. Both operating companies, and the industry as a whole, have also suffered from a lack of capital investment. Political disputes in Baghdad and battles for authority over spending between various ministries meant that the Oil Ministry spent only 3% of its $3.5 billion capital budget in 2006. This year has been a little better, but not significantly so, not least because of increased scrutiny by anti-corruption officials has complicated ministry spending procedures further.
The problems witnessed within the Oil Ministry are a reflection of a more general political deterioration in Iraq over the past four years. For all of the White House’s efforts to highlight progress, the trajectory of Iraqi politics has gone in the opposite direction. Elections, referenda and constitution-writing have done nothing to make the Iraqi government more cohesive or effective. On the contrary, these processes have exacerbated destructive ethnic and sectarian schisms as key factions have taken advantage of the Bush Administration’s emphasis on deadlines to push their own parochial agendas, irrespective of the costs to the stability of Iraq and the welfare of its citizens.
The experience of the Iraqi oil sector points to one of the most damaging failures of post-war Iraq: the absence of effective governance. A prolonged institutional vacuum, combined with the abiding US focus on politics within the secure confines of the “Green Zone,” has resulted in the effective collapse of the Iraqi state. Ministries have become party fiefdoms, operating at the behest of and in the interests of their political masters. As a result, the delivery of services on a national scale has broken down, leaving ad hoc local institutions to attempt unsuccessfully to fill the gap. Meanwhile, attempts to revamp the security forces (especially the police) have been undermined by the infiltration of various party militias into their ranks. Thus, the state’s monopoly over force has been destroyed: the government faces not only a plethora of armed factions linked to different political factions, but also a security force the ranks of which often owe allegiance to political leaders or factions rather than to the state and the formal chain of command.
The result has been a duality of politics, as the formal government of the country has become divorced from the realities of governance on the ground. The authority of the national government based in the Green Zone—where the executive, the legislature and increasingly many of the ministries reside—has diminished over time, resulting in a significant contraction of the power of the state. The government is now sustained by little else other than the US military presence that protects it and the legitimacy that Washington’s interaction with the formal state institutions has bestowed upon them. Successive governments—and more importantly, the fractious parties that have controlled them—have leveraged this relationship to protect and enhance their control over the formal political process and to bolster their own narrow agendas. At the same time, the Bush Administration’s need to demonstrate success to its own domestic audience has weakened its resolve to hold these Iraqi factions to account over their failure to govern and their reluctance to promote national reconciliation. The result has been a government that is increasingly unaccountable, sustained by a powerful occupying force whose own political masters are tied to the fate of their chosen Iraqi allies, and which is overseeing the collapse of the state it is tasked to run.
The US involvement in Iraq has also impacted politics in a more fundamental way, by altering the overall foundations of political participation and government. US officials have consistently seen Iraq as an amalgam of three largely monolithic ethnic and sectarian groups, and as a result they have clung rigidly to the notion that establishing political balance between them is the key to ensuring long-term stability in the country. The Interim Governing Council, established by the CPA in June 2003, was modeled on this view, thereby becoming the first institution in modern Iraqi political history to use ethnic and sectarian quotas as its formal organizing principle, and all subsequent national institutions and political frameworks have rested on this approach.
There is no doubt that ethnic and sectarian politics have been important factors in Iraqi politics, and have represented a rival view of the state to the nationalist program promoted by successive Iraqi governments for much of the 20th century. However, the extent to which ethnic and sectarian considerations were elevated post-war—and the persistent view that Saddam Hussein’s regime was exclusively Sunni—reflected Washington’s lack of understanding of Iraq. US decision-makers were also heavily influenced by the agendas of its closest Iraqi allies, namely the Kurdish and Islamist Shia parties that were formerly in exile and which explicitly espoused an ethnic/sectarian program.
Since being elevated to power, these parties have doggedly sought to consolidate their new found ascendency by enshrining the newly appropriated quota system that left them dominant. In doing so, they have significantly altered the character of Iraqi politics, promoting ethnic and sectarian identity above all else as the principal vehicle for political participation. Secular nationalism, while it may enjoy residual support among many Iraqis, has lost ground as parties promoting communal agendas have established a lock on formal political institutions. Washington’s propensity to deal primarily with its long-standing allies, its reluctance from the start to reach out to home-grown political groups (a disinclination that was encouraged by the newly returned parties) and its refusal to move beyond the ethnic/sectarian prism, have all reinforced this transformation.
This change in the character of politics has gone beyond just simply an altered basis for political organization. It has also threatened to erode the cohesion of the Iraq state, as both Kurdish and key Islamist Shia parties have promoted alternative governance models that better suit their parochial interests. While Islamist Sunni and secularist groups continue to see virtue in a state managed by a strong central government, Islamist Shia group and the Kurds have increasingly promoted alternatives that would give far more power to regional governments. For the Kurds, this policy is a simple recognition of reality: the Kurdistan Regional Government (KRG) has enjoyed quasi-independence since the area was secured by allied forces in 1991, and Kurdish leaders since then have never made any secret of the fact that they have no intention of relinquishing any of their hard-won autonomy. However, in the past three years some Islamist Shia groups—especially the Supreme Islamic Council in Iraq (SICI—formerly SCIRI)—have also climbed on the regional bandwagon. Faced with an upsurge in sectarian violence and drawn by the appeal of controlling a more manageable, religiously homogenous, oil-rich region, these Shia factions have begun to promote a version of the KRG for themselves in southern Iraq.
This convergence of Islamist Shia and Kurdish views has shaped the course of politics in Iraq over the past four years, and with it the ongoing debate over the appropriate structure of the hydrocarbon sector. Using their electoral dominance and their close relationship with the United States, the Kurds and SICI (in the guise of the United Iraqi Alliance) have successfully established the framework for a much more loosely based federal structure in Iraq. The 2005 Constitution was particularly important in this regard. Shaped primarily by Kurdish and Islamist Shia officials, the Constitution significantly reduced the authority of the central government, robbing it of key privileges such as its monopoly over force, much of its judicial power and its unrestricted authority over the oil sector. Although it was ratified by a national referendum, the document remains controversial, not just among Islamist Sunnis and secularists who opposed it, but also among some Islamist Shia parties to the UIA. However, efforts to amend the text in order to restore power to the central government, including in the oil sector, have foundered, with both the Kurds and SICI putting up stout opposition to any changes that would jeopardize their long-term political ambitions.
As a result, the rival visions of the state have been thrown into sharper relief, and over time they have become increasingly difficult to accommodate. Islamist Sunni demands for government by consensus and a strong role for Baghdad are falling on the deaf ears of both Islamist Shia leaders determined to maintain the privileges of majority rule and Kurds seeking even greater autonomy and the evisceration of the central government (which they see as a long-term guarantee of their independence). With none of these groups are willing to compromise, and with their leadership consumed by parochialism, efforts at national unity government have failed and the dangers of internecine violence, both between and within the different communities, has risen.
This is the context in which the debate about the structure of the Iraqi oil industry and foreign investment is taking place. All the main factions realize that control over the sector is crucial to their ambitions and will be a key determinant of the eventual shape of the Iraqi state. And it is for precisely these reasons that compromise on a Hydrocarbon Law has been so difficult to reach. The process has been complicated further by ambiguities in the Constitution (especially Article 112) and in the initial draft of the hydrocarbon legislation agreed by the Iraqi cabinet in February 2007. In both cases, the lack of clarity was designed to mask the absence of political accord between Kurdish and Arab leaders, but in failing to resolve the disagreements and by leaving the text imprecise, it has made the factional quarrel more intractable.
Reduced to its most basic, the essential dispute is over where ultimate authority for management of the sector—including contractual design, negotiation of licenses, policy-making and revenue-sharing—ultimately lies. For the Kurds, the answer is clear: regional law is paramount, mandated by the Constitution in Articles 110 and 115. They insist that the Hydrocarbon Law must respect this fact and therefore the regional legislation that the KRG has passed. By contrast, the Arab Iraqi parties, Islamist Shia included, have sought to protect the influence of the central government both in managing the sector and distributing oil revenue. Thus far, neither has been willing to yield, resulting in confusion over text and procedures. At least three different versions of the law were in circulation in late August: the somewhat ambiguous February draft; a cabinet legal committee amended draft delivered to Parliament in July, which restores much of the central government’s authority; and a subsequent compromise version the contents of which have still not been divulged. US efforts to force the legislation through have produced little progress, and while Iraqi officials remain upbeat that Parliament will debate and pass the law by the end of the year, the depth of the disputes between the rival parties may militate against that.
Moreover, the parliamentary debate, if and when it happens, could throw up additional problems that will force additional revisions to be included in the final legislation. It is not only demands for greater regional authority that could spark a backlash; the proposed terms for foreign investment also look set to face opposition. Public commentary on the law by its opponents, including influential former technocrats, has stoked a wave of resource nationalism within parliament and beyond. The main focus of criticism has been the draft law’s promotion of production sharing agreements, which many Iraqis confuse with concession agreements. The inclusion of these terms, and the general misunderstanding of them, have reignited latent suspicions that the 2003 war was principally aimed at establishing US and UK control over Iraq’s oil resources. Senior members of parliament have made it clear that these terms will need to be amended if the law is to be passed, with some form of technical service agreement the most likely recourse in the medium term.
How much this dampens the ardor of IOCs seeking to invest in Iraq remains to be seen. Early signs suggest that their appetite remains undiminished: the country is still seen as one of the last great resource opportunities in the world, and the prospect of it opening up to investment—no matter what the initial terms—is appealing. But this enthusiasm could yet run into a host of practical obstacles that delay a major in-flow of funds into the Iraqi sector. The most obvious impediment is the security situation in the center and south of the country, which still poses unacceptable duty-of-care risks that will deter operations by western IOCs. The south in particular has seen an upsurge of violence over the past year, as rival militias vie for local control in various town and governorates. These are unlikely to die down, particularly if the prospect of regionalism becomes more likely, and any prominent moves by IOCs before the situation has stabilized will undoubtedly make them a target in these ongoing clashes.
Another factor dampening the investment climate is the lack of functioning institutions and the absence of rule of law. Both these things will make protecting long-term investments and guaranteeing the repatriation of profits much more difficult for IOCs. There is no doubt that IOCs have a great deal of experience operating in hostile environments, but with Iraq increasingly slipping towards becoming a failed state, and with the potential for legal ambiguity and even rival government authorities (especially if regionalism occurs in an ad hoc fashion), the challenges faces the companies will be significant.
Even if the state does not collapse, there is still the battle for negotiating and licensing authority that is shaping up between the Oil Ministry and the as-yet-revived INOC. Legislation to clearly define the respective roles of the two institutions has yet to be complete, and is being drafted in competition to each other rather than in coordination. In the meantime, each is seeking to convince IOCs that it will win the day, and that in the interim the companies should begin establishing relationships with its personnel.
Ultimately, these factors will not deter all investment. A host of IOCs have indicated their serious intention to do business in Iraq. But until the security and the political questions are resolved, the estimated $20-45 billion that the Iraqi sector needs if it is to raise its output capacity significantly is unlikely to materialize. These impediments are likely to take time—possibly years—before they are solved to the satisfaction of most IOCs, and in the interim Iraq could well witness a further upsurge in violence. Consequently, the Iraqi oil sector remains much as it has always been: full of potential, eyed enviously by IOCs, but out of reach by virtue of politics and war.
JIME Center. All rights reserved.