What Is Happening To Iraqi Oil?

By Issam Al-Chalabi

The views contained in this paper were expressed to the participants in the 26^th International Oil & Money Conference held in London on 20-21 September 2005. Mr Chalabi, who has written this paper for publication by MEES, is a former Iraqi Oil Minister (1987-90) and former president of Iraq National Oil Company.

It is common knowledge that Iraq has the second-largest proven oil reserves in the world, with no less then 112bn barrels, and probable reserves of around 250bn barrels. But why is that Iraqi oil does not account for more than a fraction of global oil supply? In fact Iraq has made no more than 2.5mn b/d of its oil available to the world market for almost 25 years, with the exception of a few spells when exports exceeded that.

In order to understand the current situation of the Iraqi oil industry and its future outlook, we need to go back to the past. Iraqi oil was discovered in 1927 when the first oil well was drilled in Kirkuk; but there was much delay in getting it to the world market through the Mediterranean due to conflicts of interest between the British and the French – who held the UN mandates over Iraq and Syria respectively. Later, during the Second World War, Iraq revolted against the British. Exports were again halted in the late 1940s during the first war in Palestine. Only after the discovery of Rumaila oilfield in the southern part of Iraq in the early 1950s did exports start to rise – and also after the crisis over nationalization in Iran. Iraq in the 1950s enjoyed a period of diversified and successful construction programs, covering many projects. Iraq then issued law No 80 in 1961 that confiscated over 99% of Iraqi land not being explored by the international oil companies (IOCs) which had held the concessions since 1925. All exploration and development programs were stopped. After the 17-30 July 1968 revolution, the relationship remained tense and culminated in the nationalization of the assets and operations of the Iraq Petroleum Company (IPC) in June 1972, and then all other foreign assets by 1975.

Thanks to the first and second oil price increases of 1973 and 1979, Iraq utilized a good amount of its revenue in building its oil industry, both upstream and downstream, with proven oil reserves rising considerably due to some major discoveries of super-giant fields like Majnoon, Nahr 'Umar, Halfaiya, West Qurna, East Baghdad and others. Iraqi oil production peaked in 1979, with exports reaching around 3.5mn b/d and production capacity of around 3.8mn b/d. This continued until September 1980 when the 1980-88 Iraq-Iran war broke out.

Iraq-Iran War

The eight-year-long war inflicted severe damage to almost all export, production, refining, gas-processing and distribution facilities and networks. Exports were limited to those through the first Iraq-Turkey pipeline – around 600,000 b/d, with production falling down to 800,000 b/d.

Despite the heavy toll of the war and concentration of all efforts on repairing damaged installation, Iraq’s oil industry gradually started to recover. Iraq was able to complete: three major refineries within the Baiji complex (total of 290,000 b/d); the second Iraq-Turkey pipeline to bring export capacity to over 1.5 b/d, in two stages in 1987; the Iraq-Pipeline through Saudi Arabia in 1990, in two stages with total capacity of 1.6mn b/d; the south gas project; the north gas project; and many other projects, upstream and downstream. In 1990, Iraq’s proven oil reserves reached 106bn barrels.

As the years went by and especially after the end of the war in August 1988, production and export figures started to climb again. By July 1990, actual production was around 3.2mn b/d, with total capacity climbing to almost 3.8mn b/d; but still the actual production and export remained below that of 1979.

Invasion Of Kuwait

When Iraq invaded Kuwait on 2 August 1990, all exports were stopped and production was limited to supplying local refineries with no more than 300,000 b/d. Until December 1997, actual production hovered around 500,000-600,000 b/d due to the imposition of UN sanction on Iraq in August 1990.

The oil industry had hardly recovered from the Iraq-Iran war when the second Gulf War led by the US began in January 1991. Oil facilities were again the direct targets of heavy bombardment, resulting in damage that, in many cases, was even more severe than that inflicted during the Iraq-Iran War. In certain installations, damage was as great as 90%. But Iraqi oil workers and engineers were able to repair, cannibalize and maintain most of the facilities, bringing the refineries, as well as power generation and distribution networks, back into operation – with certain limitations and with the production of low-quality products – within two-to-three months of the end military activities. The Iraqis were able to resume the use of oil products, water, power and other utilities with limited constraints (compare that with the current situation in Iraq since after the US-led war of 2003).

Once the UN oil-for-food program was initiated in December 1996, oil production started to climb, as did exports, although they were limited by a ceiling for over 18 months. Once that ceiling was lifted in 1999, Iraq increased its production and exports as follows:

(Mn B/D)

Year	Production	Exports
2000	2.63	2.08
2001	2.61	2.02
2002	2.25	1.63

During certain short periods, the production figures were 2.8-3.0mn b/d and exports were up to 2-5mn b/d.

Those figures were admittedly detrimental to the oil industry and particularly to the state of the reservoirs, since Iraq almost halted its maintenance, drilling and upgrading programs due to the sanctions, a state of affairs that continued until March 2003, and also due to the over-production policy that was adopted in order to maximize oil revenues.

Deteriorating Oil Industry

The UN, from 1998 onwards, issued many reports warning of the deteriorating situation in Iraq’s oil industry. But Iraq was being shut off from the outside world and companies were not willing to cooperate for fear of being in violation of sanctions. The Sanctions Committee in New York was very reluctant to allow many materials, equipment and chemicals to go to Iraq on the assumption that they could be of multiple uses.

In its report of June 1998 the UN said that the Iraqi oil industry was in a lamentable state. It said that “thanks to over-production policies, 20% of wells have been irreparably damaged”. And in its July 1999 report it said: “Productivity of existing oil wells has been seriously reduced, in some cases irreparably. Decline of 2% has resulted in new fields and up to 15% in old fields, as in Kirkuk.”

The Third Gulf War Of 2003

The oil facilities this time escaped direct bombing and they were not considered direct targets. Only about seven oil wells in Rumaila were damaged and were set on fire for unknown reasons, and the pipeline complex near Baiji refineries at al-Fatha and Haditha crude oil tank farm were bombed.

Some have said that the aim of the multinational forces was to protect Iraqi oil. In my opinion, that is untrue.

What happened was that the Ministry of Oil headquarters in Baghdad was provided with protection by US-led forces, but only after two days of limited ransacking and the theft of some documents and computer hardware and software. The real damage happened in almost all other production facilities in the south and the north including the South Oil Company (SOC) and North Oil Company (NOC) headquarters where looting, ransacking and burning continued for several weeks without any kind of protection, despite the presence of the occupation forces nearby. Even the Habibiya center in Baghdad was looted and all its storage of documents, well logs and other records, along with equipment and vehicles, were destroyed, including those belonging to Schlumberger which had managed to maintain a non-working service center throughout the 1990s. The refineries within their fences were saved, but mostly thanks to Iraqi workers who courageously defended the facilities against attacks by hooligans. The occupation forces later provided protection. 

In June 2003, Iraq resumed limited oil production and crude stored at the Ceyhan oil terminal in Turkey was sold through auction. Iraqi oil by then had entered a new phase that some has expected to be a promising one!

Current State of the Industry

Almost 30 months after the occupation of Iraq, we can describe the current state of the oil industry briefly as follows:

          The rehabilitation program (RIO I, RIO II) initiated by the US through some of its companies has not resulted in notable improvements. There are still some projects initiated in June 2003 that await completion.

          The Ministry of Oil, for its part, has had limited success in rehabilitation and maintenance due to security reasons, lack of funds, foreign EPC companies leaving the country, bureaucracy and other reasons.

          There has been only a limited program to assess the status of reservoirs. One major study, expected to be completed in early 2006, relates to Kirkuk and Rumaila oilfields.

          There has been very limited drilling and workover activities for the oil wells.

          Most water-injection and wet crude facilities await rehabilitation.

          Sabotage of pipelines continues, particularly in the center and north, despite all military efforts and the hundreds of millions of dollars spent to protect them.

          Refineries are operating at 60-70% of their capacities due to lack of major maintenance and disruption of supplies through pipeline sabotage.

          Shortage of fuel has resulted in a black market controlled by mafia and gangsters causing prices to increase, in some cases to 50 times the official prices. Rationing and alternative car movement schedules continue, but Iraqis still have to wait for hours to get their rations.

          Since June 2003, Iraq has been importing gasoline, gas oil, LPG and kerosene, costing now over $300mn a month. Iraq must have spent over $6bn so far, and imports are expected to continue for another three years at least. There have also been claims of corrupt deals involving this trade.

          Smuggling, particularly through the narrow Shatt al-Arab and Khor al-Zubair continue, despite the presence of multinational and Iraqi forces. It is said that many groups, political and otherwise, are benefiting from this lucrative trade.

          The Ministry of Oil has awarded a few EP projects within Daura and Basra refineries, but has experienced long delays in the awarding process, the opening of letters of credit and contract execution. None is expected to be completed before 2007.

          The Ministry of Oil has undergone continuous changes in structure and personnel, resulting in disruption and discontinuity.

As for production and exports, senior US officials expected immediately after the war that by end-2003 Iraq’s production would rise to at least 3mn b/d; but so far the figures have been as follows:

(Mn B/D)

Year	Production	Exports
2003	1.55	1.00
2004	2.00	1.55
2005	1.80	1.40

Hence a decline has been the pattern. Iraq, with current world oil prices, is losing billions of dollars that might have substituted for the need for grants, loans and accumulating debts.

Upstream Development Plans

For over 25 years, there were plans on the table to develop crude oil production capacity to 5.5-6.0mn b/d. The plans have been interrupted by three wars, 13 years of sanctions, and continuous chaos, lawlessness and anarchy since March 2003.

In 1979, Iraq issued tender documents to develop five super-giant fields, Majnoon, Nahr 'Umar, West Qurna, Halfaiya and East Baghdad. The tender documents were prepared jointly with international and national oil companies and were based on EPC. Some contracts were signed for drilling hundreds of wells in West Qurna with Technoexport of Moscow, and expansion of the al-Bakr terminal (now Basra Oil Terminal) with the US Brown and Root (now KBR). These plans were put on hold when the Iraq-Iran started in September 1980.

There was a revival of the same plans in March 1990, with the aim of carrying them out with the participation of IOCs and NOCs under a buyback model. Again, there was a good response, but the plan was frozen when Iraq invaded Kuwait in August 1990.

In May 1991, a few months, after the second Gulf War, Iraq called upon Total and Elf of France to discuss possible plan to develop Majnoon and Nahr 'Umar (later called Ben 'Umar) fields on a production-sharing basis (MEES, 4 November 1991). Although discussions reached almost a final draft by 2000, no contract was signed.

Iraq continued discussions throughout the 1990s with many other companies of different nationalities which resulted in a number of contracts, as with Lukoil of Russia in 1997 (MEES, 31 March 1997, 16 April 1997) for the second phase of West Qurna and al-Waha-CNPC of China  in 1997 (MEES, 9 June 1997) for al-Ahdab and over 10 other contracts and agreements, including ONGC of India, Pertamina, Sonatrach and Petrovietnam; but none of these contracts and agreements has been implemented. The Saddam regime terminated the contract with Lukoil in December 2002 (MEES, 16 December 2002). All agreements are now on hold and it is expected that they will be renegotiated at a later stage by the new regime in Iraq.

Various statements were made after the 2003 war on upstream development plans, but all suggestions and expectations seem to be moving in a dark tunnel.

For the plan to upgrade production to its pre-1990 level of around 3.5mn b/d, there has been very limited progress. Despite the fact that the Ministry of Oil issued tender documents on an E&P basis to develop a number of small fields (such as Khormala, Himrin, Subba and Luhais) only Khormala has entered into an execution stage with Turkey’s Avrasya and Iraq’s KAR as the E&P contractor (MEES, 6 December 2004). The others await award, signature or opening of letters of credit. Khormala should add about 50,000 b/d – but not earlier than mid-2007, even if the State Company for Oil Projects (SCOP) can carry out construction in time*.

No IOC Role Soon

As for any role for IOCs and NOCs, none should be expected in the short or even medium term. It is the consensus of all concerned parties that having security and stability is by far the most serious concern and that seems to be a function of the political process and the presence as well as the role of the occupation forces. Simultaneously it is essential that dealings be handled through a permanent institution and not interim or transitional governments and parliaments, changing every few months. If the proposed draft constitution, to be put to a referendum on 15 October, is endorsed, then there will be new elections far a new parliament on 15 December. But if the draft constitution is rejected, then there will be elections for yet another interim parliament.

So in order to attract foreign companies in long-term deals there will be a need for:

   A new permanent government to be set up next February after the elections in December. This could again be another interim government if the constitution is rejected and in that case there will be a new referendum and elections around mid-2006.

  A new Hydrocarbon Law that will introduce the possibility of foreign investment and participation of IOCs and NOCs. Such a step might take quite some time, as in the case of Kuwait where Project Kuwait has been discussed for over 10 years and is still delayed by conflict between the government and parliament.

   All necessary fiscal and legal laws to guarantee foreign involvement.

   Restructuring of the Ministry of Oil and the re-establishment of Iraq National Oil Co (INOC).

   A clear oil policy that outlines the basic principles and modes to be followed for development, production-sharing, buyback, development and production, service contracts etc or possibly a combination for various fields.

   Specific priorities, with super-giant fields at the top of the list. Iraq in the past identified 33 oilfields for developments. But there will be a conflict on this issue among the proposed regions and provinces in Iraq. Iraq will certainly face a major problem of shortage of experienced technical, legal and financial staff to handle the preparation of the contracts and later their management. Iraq might need to adopt a policy of hiring consultants to assist the Ministry.

The above will depend entirely on the new constitution under discussion. The relevant articles to the oil and gas industries seem to contain the seeds for conflicts and possible fragmentation, and hence a possible delay to proposed developments:

“Article 109

 Oil and gas is the property of all the Iraqi people in all the regions and provinces.

“Article 110

 First– The federal government will administer oil and gas extracted from current fields in cooperation with the governments of the producing regions and provinces on condition that the revenues will be distributed fairly in a manner compatible with the demographical distribution all over the country. A quota should be defined for a specified time for (affected) regions that were deprived in an unfair way by the former regime later on, in a way to ensure balanced development in different parts of the country. This should be regulated by law.

 Second– The federal government and the governments of the producing regions and provinces together will draw up the necessary strategic policies to develop oil and gas wealth to bring the greatest benefit for the Iraqi people, relying on the most modern techniques of market principles and encouraging investment.

“Article 112

All that is not written in the exclusive powers of the federal authorities is within the authority of the regions (and the provinces that didn’t make it into a region). In other powers shared between the federal government and the regions, the priority will be given to the region’s law in case of dispute.”

The above oil articles in the draft constitution have created an anomaly that can only bring havoc to the industry and abort its development. Oil policies have to be decided by the central government with consultations with the regions and provinces.**

In conclusion, I expect that in the short term, Iraqi oil production will continue around 1.8-2.0mn b/d, with exports at an annual average of 1.5mn b/d for the next two years. I doubt if Iraqi oil production will reach 3.5mn b/d before 2009. Nor will there be a major hike to 6.0mn b/d, through the involvement of IOCs and NOCs, before 2012-14.

This might be considered as a pessimistic outlook. I certainly hope I will be proven wrong and that better expectations can materialize for the sake of the Iraqi people.

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*   Senior Iraqi officials claim that only about 27% of money allocated has actually been spent on reconstruction. Security has absorbed most of it. In an interview at Al Hurra TV channel, broadcast on 28 September 2005, the Minister of Electricity, Muhsin Shlash, said that only about $800mn out of about $6.3bn allocated for the power sector had been spent on contracts for power projects, but even that was poorly administrated due to corrupt deals.

**        Media reports quoted on 1 October 'Umar Fatah, Iraqi Kurdistan Prime Minister, speaking in Singapore, as saying that the Kurdish authorities would control oil in the north, including exports, concessions and oil development, and not the central government.