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Tue 13 Dec 2011 02:28 PM

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Iraq can lead the Arab world if it gets its oil policy right

Oil will fund Iraq’s future: if al-Maliki only gets out of the way of foreign investment

Iraq can lead the Arab world if it gets its oil policy right
Iraq has the fourth largest proven oil reserves on the planet

US President Barack Obama and Iraqi Prime Minister Nouri
al-Maliki had many important issues to discuss this week in Washington: the
impending withdrawal of the last US troops from Iraq, the fragility of
democracy there, the looming presence of Iran on its border and so on.

But an item further down the agenda may well be the most
important factor in Iraq’s future: oil.

Iraq possesses the fourth largest proven oil reserves on the
planet. That treasure once made the country one of the most economically
developed in the region. If it can re-energise its petroleum industry, Iraq,
with its emerging democracy, can become the most advanced nation in the Arab
world.

Iraq hopes to increase its oil production from 2.7 million
barrels a day now to 13.5 million by 2018. Outside experts think even half that
is a stretch. In any case, a major production increase will require
significantly more investment by foreign companies, which have the expertise
and capital Iraq has lost through decades of war and turmoil. Their enthusiasm,
however, has been dampened by bureaucratic holdups, legal uncertainties and the
diminished state of Iraq’s pipelines, storage facilities, export terminals and
the like.

The red tape companies encounter in Iraq - when they apply
for employee visas, for example, or try to import equipment or seek payment -
seems to reflect attitudes rooted in the past. The oil industry was
nationalised in 1972, and the idea of excluding foreign companies still has
resonance, including within Maliki’s coalition government.

Iraq’s leadership has a choice: Either create an
administrative environment conducive to foreign investment or accept a slow
growth rate for oil production. The latter is bad for Iraq and the former
needn’t be. Offshore interests can’t be allowed to plunder Iraq’s reserves. But
in the 15 contracts the central government has signed so far, it has made
strong deals for itself.

The international companies working in the country, however,
have worries that Iraqi officials need to resolve. Iraq’s 2005 constitution
promised a hydrocarbon law that would settle who had the power to approve what
type of deal. Yet no such legislation exists because the central government and
the semi-autonomous Kurdish region in the north, which has oilfields only
recently being exploited, haven’t agreed on terms.

In August, Maliki’s Cabinet sent Parliament a draft law that
would let a federal council approve only technical-services agreements, the
type of contract the central government has granted. With these, companies are
compensated for costs plus a fee per barrel of oil produced. But the Kurds, in
their deals with 43 companies, have signed production-sharing arrangements, in
which the company is responsible for costs but gets a percentage of any oil
that is extracted. Contractors prefer such terms, which are higher risk but
potentially higher yield. They also seem to make more sense for the northern
oil deposits, which are generally fragmented and don’t offer the same ease of
production as the larger fields in the south.

In the absence of a law, Maliki’s government has deemed the
Kurds’ contracts illegal and banned companies that have signed them from
bidding for oil business in the rest of Iraq. Creating more uncertainty,
Baghdad, until earlier this year, denied such contractors the ability to export
the oil they produced in the Kurdish areas, limiting their sales to the
domestic market. For these reasons, the northern oilfields have attracted
mainly wildcatters and second-tier companies like Marathon Oil Corp (MRO) and
Hess Corp (HES)

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Having angered Kurdish authorities with its draft law, the
central government agreed to new negotiations. But Exxon Mobil Corp shook
things up in October when it became the first major oil company to sign with
the Kurds - sealing six exploration deals. It did so while also doing business
with the central government. In response, Baghdad not only blacklisted the
company from the next auction of exploration blocks in Iraq’s south, it
threatened to cancel the company’s 60 percent stake in developing the giant
West Qurna 1 oilfield, which is already producing 350,000 barrels a day. The US
oil giant’s move defied not only Baghdad but also the US government, which has
warned companies against signing contracts with the Kurds in the absence of a
legal framework.

Still, Exxon’s gambit could prove a positive catalyst, if
Maliki’s government makes the right decisions. Expelling the company from the
West Qurna 1 oilfield, or forcing it to choose between doing business with the
Kurds or the central government, could scare away other potential partners.
Baghdad would do better to support a hydrocarbon law that embraces production-
sharing contracts for the north and technical-services agreements for the
southern fields.

Many Baghdad officials worry that giving in on the issue
will feed the Kurds’ desire for more independence. It may. However, refusing to
legitimise the Kurdish contracts is already having that effect, while
perpetuating the legal uncertainty. The sooner that fussiness is resolved, the
sooner Iraq can get the help it needs to accelerate oil production.

Increasing output will generate the money Iraq requires to
renovate its oil infrastructure, which will allow still greater production.
Corroded pipelines need to be replaced. A system for bringing water, which
facilitates oil flow, from the Arabian Gulf to the oilfields needs to be
completed. New storage facilities and export terminals, replacing those
destroyed as long ago as the 1980s Iran-Iraq war, must be built.

The Iraqis estimate it may take $50bn in investments in
these systems to get production up to 6 million barrels per day. That money
will be hard to come by if the Maliki government keeps getting in the way of
foreign investment.

(This is a Bloomberg View piece.)

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