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Iraq and Oil: Revenue-Sharing Among Regions

Author: Lionel Beehner
December 29, 2005

Introduction

As Iraq forms its first constitutionally mandated postwar government, one looming issue is how best to manage and share the country's energy resources and revenues. Most of Iraq's major oil fields are found in the north and south, which, respectively, are heavily Kurdish and Shiite, whereas Sunnis predominantly inhabit Iraq's oil-scarce center. This has led to friction over dividing the revenues. There also remains the issue of how to rebuild Iraq's oil infrastructure. In spite of its vast oil reserves, Iraq has had to import its energy needs. Smuggling, sabotage, and other security dilemmas have caused energy production to fall well short of its pre-war levels. Prior to the March 2003 invasion of Iraq, U.S. government officials predicted the postwar reconstruction could be financed by oil revenues. Experts say their calculations were grossly optimistic, given Iraq's poor machinery, lack of development, and political instability. Even major oil companies have been hesitant about investing in the country.

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What is the status of Iraq’s oil production?

Iraq is producing below 2 million barrels per day (bpd), a 10 percent drop from last year's average. (By comparison, in 1990, prior to the first Gulf War, oil output in Iraq was around 3 million bpd.) Oil exports hit a new two-year low in November. Current output has been hindered by a number of factors, including sabotage by insurgents, antiquated equipment, and ongoing legal disputes. Iraqi officials say oil output should increase in the coming years. Ibrahim Bahr al-Uloum, Iraq's oil minister, predicts that production should hit 3 million bpd by the end of next year, but Jamal Qureshi, an analyst with PFC Energy, told Reuters he expects output to either stay flat or fall to 1.7 million bpd in 2006.

How much oil is Iraq estimated to have?

Experts estimate Iraq's known oil reserves contain more than 110 billion barrels, the third largest in the world behind Saudi Arabia and Canada. Ahmed Chalabi, an Iraqi deputy prime minister, speaking at a November 11 Council on Foreign Relations meeting, said Iraq's oil reserves, which have not undergone any exploration since the 1960s, may be the world's largest. Antoine Halff, director of the Eurasia Group's gobal energy division, agrees with Chalabi's assessment. "I think it's real," he says. "Iraq has very attractive prospects from a geological standpoint." But despite Iraq's vast reserves, Iraq must import the bulk of its energy needs because of inadequate security and production infrastructures. Most of its oil is bought from neighboring states like Turkey and Kuwait at a cost of $2 billion to $3 billion per year.

Why are major oil companies not investing more in Iraq?

Iraq's poor security environment, experts say. Companies are reluctant to pay the high costs of protecting pipelines and refineries against insurgent attacks. "Almost all the money is going toward security, which leaves a lot to be desired," says Robert Mabro, president of the British-based Oxford Institute for Energy Studies. For example, at Iraq's largest oil refinery in the northern town of Beiji, production was recently suspended after truck drivers received death threats from insurgents. Another reason for the slow investment is Iraq's lack of political and legal stability. Major oil companies, Halff says, are waiting for Iraq's constitution and legal framework to be finalized. Issam al-Chalabi, Iraq's former oil minister, recently told the Associated Press that "nothing of substance from the large foreign oil companies is likely to happen in 2006." There is reportedly legislation in the works to create a central oil company in Iraq as early as next year.

Is there any outside investment in Iraq’s oil sector?

Yes, but mostly by smaller oil firms, which tend to be less risk-averse, experts say. "Their strategy is more venture-oriented, versus the major oil firms, which are inherently more conservative," Halff says. A number of firms, including Petoil and General Energy Corporation of Turkey and DNO of Norway, have recently signed so-called production-sharing agreements (PSAs) with the Kurds to explore and develop new oil and gas fields in Kurdistan. These agreements keep ownership of oil reserves in the hands of the state—or regional authorities, in this case—while providing foreign investors with legal protections if, for example, no oil was found or if global oil prices plummeted. According to a recent study by the Global Policy Forum, sixty out of Iraq's eighty known oil fields may be explored under PSAs, handing at least 64 percent of Iraq's known oil reserves over to foreign investors.

How is Iraq’s oil revenue to be distributed?

This is a complicated issue, about which the newly approved constitution is purposely ambiguous, experts say. According to Article 109, oil belongs to "all the Iraqi people in all the regions and provinces." Article 110 states that oil revenue shall be "distributed fairly in a manner compatible with the demographical distribution all over the country." However, there is some dispute, particularly among those who reside in the oil-rich regions of northern and southern Iraq, as to whether the constitution gives federal control to future oil fields or only to existing fields. Sunni Arab officials say it is unconstitutional for Kurds to bypass Baghdad and negotiate agreements on developing future oil fields directly with outside oil firms. Kurds, however, say the constitution implies that future fields fall under regional management and allows for some form of compensation for regions "unjustly deprived" under Saddam Hussein's rule, which includes Kurdistan. Further, they argue that under Article 111, whenever there is conflict between regional and federal laws, the constitution gives priority to regional authorities.

Jonathan Morrow, legal adviser with the United States Institute of Peace, says the Kurds are more interested in securing rights to manage their oil fields than simply reaping the profits. This includes the flexibility to negotiate PSAs with foreign firms. Part of the revenues from these agreements would then be sent to Baghdad, not the other way around. "It's a question of which direction does the check go," Morrow says. Many of these revenue-sharing disputes are expected to be addressed early next year when the government begins to propose amendments to the constitution. But Nathan Brown, an Islamic law expert with the Carnegie Endowment for International Peace, says nothing substantial will be changed on the subject of revenue-sharing. "[The parliament] won't agree to reopen this subject, something that's been so difficult to hammer out. It'll probably just tinker with some of the wording," he says.

Why did the government raise fuel prices in December 2005?

For a number of reasons, experts say. First, the current system of subsidies, which stretches back decades and currently costs Baghdad upwards of $5 billion per year, is overly generous, says Howar Ziad, Iraq's ambassador to Canada. "In the long run, this situation is untenable," he says. "You cannot have almost half of your budget going toward subsidizing oil." Second, the price increase is part of a larger debt-forgiveness deal with the International Monetary Fund, which demands that Iraq cut its fuel subsidies before agreeing to a $685 million loan. Third, the Iraqi government says the price hikes will help raise $500 million needed to spur investment and production in its underdeveloped oil industry. Finally, the higher fuel costs are expected to curb smuggling. Smugglers buy subsidized fuel in Iraq at artificially low prices and then re-export it to countries like Iran, Turkey, and Jordan. "Anywhere in the world where you have a country with deeply subsidized oil next to countries with higher prices, you're likely to see smuggling," Halff says. More than $2 billion-worth of gas and diesel-fuel supplies are reportedly smuggled out of Iraq every year.

What was the public reaction to the price hike?

The move ignited protests among many Iraqis, including Iraq's oil minister, who threatened to quit his post. A governor in the southern district of Misan said he would refuse to comply and raise gas prices. For Iraqis, a quarter of which live on less than $1 per day, the rise in prices will be economically painful, experts say. "Given Iraq's current situation, is this a priority?" Mabro asks. "If you want to mend the economy, the first thing to do is put resources into fixing the infrastructure and providing water and electricity. Once that's done, then you can turn your mind to macroeconomic issues like reducing subsidies." Iraqi officials, however, counter that these fuel subsidies mostly benefit Iraq's rich, not its poor. "Poor people don't have cars," Ahmed Chalabi told the Council on Foreign Relations. "Every time somebody fills their car with gas in Iraq, the government gives them a present of $30."

How much has the price of fuel increased?

Since the December 15 elections, the price of fuel has risen fivefold. Last summer, Iraqis were paying roughly five cents per gallon; now they pay close to sixty-five cents. Experts expect future hikes in 2006 will bring fuel prices in line with Persian Gulf norms, currently around $1 per gallon. Because of its heavy subsidies, "Iraq had the lowest gas prices in the world," an International Monetary Fund (IMF) spokesperson recently told the Los Angeles Times. Other petroleum products, including diesel, kerosene, and cooking gas, can also expect to see similar price increases in 2006.

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