Thomas W. Donovan, Esq.
Mr. Donovan, a corporate attorney practicing oil and gas law in Iraq, is managing partner of the Iraq Law Alliance, PLLC.
The past two years have seen unprecedented activity in the upstream oil and gas industry in Iraq. In 2009, the generally successful first and second bid rounds took place, in which the majority of the ultimate producing fields were awarded to international oil companies, with the government of Iraq maintaining significant control and remuneration. In 2010, free and fair elections took place in Iraq, with the management of the oil industry as a key issue. A third bid round is now scheduled, focusing solely on natural gas. With this needed political and electoral security, the upstream industry may now be reorganized from its notoriously under-developed potential into a modern twentieth-century OPEC partner country.
However, following these generally successful March 2010 elections, the Iraqi upstream oil and gas industry remains based upon dubious legal and constitutional foundations. It is an argument between the new 2005 Sovereign Government of Iraq Constitution, which provides for reform and development while simultaneously being burdened by outdated socialist-based oil and gas laws. At the core of the dichotomy is an inadequate legal framework based in a socialist-nationalist era in dire need of revision. Various political groups have differed strongly over how to reform a number of key issues with respect to a potential new gas and oil law that remains in draft form and not passed by parliament.1 These issues include the proper role and powers of federal and regional authorities in regulating oil and gas development, the terms and extent of potential foreign participation in the oil and gas sectors, and proposed formulas and mechanisms for equitably sharing oil and as revenue. However, despite the successful bid rounds, the reorganization of the upstream oil and gas industry remains, at best, unsettled, while everyone is in agreement that capitalizing on the potential remains one of the most salient issues facing the modern government of Iraq.
BACKGROUND
Since the fall of the Saddam Hussein regime in 2003, the upstream industry in Iraq has been the least affected by the changes implemented by the Coalition Provisional Authority, the interim Iraqi government, and the current sovereign government. No legislative changes were introduced under the Coalitional Provisional Authority, and legislative initiatives advanced by the current government of Iraq have stalled due to unresolved political issues arising between the Kurdistan Regional Government and the federal government under the new constitution. Furthermore, the Ministry of Oil has retained a number of experienced oil technocrats, even while other ministries in the government were distributed to, and overtaken by, loyalists of the various parties with little experience in the industries for which they are now tasked with developing policy. As a result, the upstream oil and gas industries are the least changed by recent events and continue to be regulated by Saddam-era laws, even as they move forward towards industry-wide reform and the reengagement of foreign investment.
PETROLEUM CAPACITY
At present, crude oil is the source of over 90 percent of Iraq’s domestic energy consumption, and oil exports generate over 90 percent of Iraqi government revenue. Iraq’s vulnerability was made clear during the recent global recession. In October 2009, the government of Iraq prepared its proposed 2010 budget, which includes a deficit of more than $15 billion for the second straight year because of lower global oil prices and stagnant production and export levels in Iraq.2 According to the Oil and Gas Journal, Iraq has the world’s third-largest proven oil reserves, estimated at 115 billion barrels. At current prices, that is valued at $9.5 trillion. Also, the U.S. Geological Survey’s median estimate for additional oil reserves in Iraq is approximately 45 billion barrels.3
According to dated publicly available surveys, Iraq has 28 giant fields, which contain an estimated 12 percent of proven global reserves. Some of the fields were discovered as early as the Ottoman Empire. The largest giant field is Rumaila,
located near Basrah in the south of Iraq. Also in the Basrah Governorate is the giant field of Qurna (also called West Qurna or Qurna I & II). The Majnoon field in the north is the third largest giant in Iraq. Each of these fields in its individual capacity is estimated to be between the third and ninth largest fields in the world.
The extraordinary size of these fields and their highly sustained productivity are due to a large subterranean geological structure sourced from a prolific geological formation into a highly permeable reservoir. While this geological structure is common throughout the Middle East and especially the Mesopotamia region, it today contains one of the largest amounts of known reserves in the world. These special sedimentary properties prove that the ultimate recovery (ability to extract a high percentage from the giant field) and success rate (the number of successful wells completed, divided by the number of wells drilled) is also one of the highest in the world. Moreover, these giant fields are in proximity to a usable port for offloading via pipeline in Umm Qasr (located on the Persian Gulf in the disputed Shatt Al Arab waterway) compared to other giant fields in the North Slope of Alaska or Central Asia. This proximity to a port and the high success and recovery rates, along with the superb geological properties of the petroleum itself, contribute to a highly profitable situational endeavor for any international oil corporation capable of laying out the significant capital to develop the area as well as tolerate the sizable risks associated with an Iraqi investment.
Understandably, this profitable off-loading potential has attracted large and well-known international competitors. Of bidding consortia, the majority were, in fact, Chinese. Once added to overall demand from mainland China, Chinese corporate interests are now the largest foreign investor in Iraq and the largest developer and consumer of upstream petroleum in Iraq.
Current Iraqi plans call for the expansion of oil production to the level of four million barrels per day (mb/d) by 2013 and then upward to six mb/d by 2017. The current oil minister estimated in April 2009 that Iraq will need to attract $50 billion in investment to expand oil-production capacity to such levels.4 One of the most salient issues remains the large amount of investment and development these fields will actually require. While the extent of the dilapidation is not entirely known, what is certain is that little or no recent substantial repair, upgrades, investment or outlay of resources have been expended on the oil fields that were the subject of the first and second bid rounds.
International investors are seeking contract terms that will balance the attractiveness of Iraq’s abundant oil supply with persistent uncertainties surrounding the country’s legal regime. Many international oil companies, especially those in risk-averse Western countries, will avoid the Iraqi fields until a predictable legal regime is in place that provides safeguards for oil contracts. The passage of a federal oil and gas law would provide such safeguards and thus have a positive effect on Iraq’s oil sector. In 2009, the U.S. ambassador to Iraq, Christopher Hill, predicted that proposed legislation would not be considered prior to national elections, which were held in March 2010.5 However, with the current political stalemate in which no government has been formed, such passage is not imminent.
UNSETTLED LEGAL ISSUES
Notwithstanding the eventual productivity of the Iraqi upstream potential, there remain several legal and political risks that cannot be ignored. These risks remain, like everything in Iraq, unduly burdensome as compared to other developing democracies. Such issues as the security situation, the Kurdish political divisions, the dubious legal structure of the petroleum regime itself, and the specific legal inconsistencies with the production-sharing contracts signed by international oil companies (IOCs) in the 2009 bid rounds add to the extremely high legal and political risk.
Any discussion of the development of the Iraqi upstream petroleum industry cannot underestimate the distinction in legal treatment between the areas of federal Iraq and the semi-autonomous area under the rule of the Kurdistan Regional Government (KRG). Despite the 2005 federal Iraqi Constitution, which contains ambiguous language to the contrary, the KRG today formulates and governs upstream petroleum production in the provinces under its control, namely Dohuk, Erbil and Sulaymaniyah. Production exportation from the KRG began in 2009, ceased in 2010 and is today an unsettled issue. In possible contravention of the law, all licensing, monitoring and contractual negotiations are done between the KRG and the international oil corporations without involvement or oversight from federal Iraq.
The KRG issued a comprehensive petroleum law well before it began production in 2009, granted concessions in a profit-sharing capacity with foreign operators, and has today many medium-size petroleum corporations active within its borders. While production and development are still in the early stages, the international corporations have a tangible interest in the development and further estrangement of the KRG from federal Iraq. Unlike the KRG, federal Iraq has been acting without a comprehenisve oil law since the sovereign government of Iraq has been in existence. The environmental and legal underpinnings of upstream production are instead grounded in the laws that remain in force from the previous regimes. These authoritarian and socialist structures created a nationalist monopoly on the production of oil and only allowed the involvement of foreign companies if the Iraqi parliament (Council of Representatives) specified an exception (Law 97 of 1967). In the absence of direct approval by parliament, and incorporating a strict interpretation of Law 97, every IOC in Iraq that was successful in the 2009 bid rounds would need a specific vote in parliament to operate in Iraq legally. If there is no such authorizing vote, their presence is arguably illegal under Iraqi domestic law.
This unsettled issue regarding Iraqi petroleum jurisprudence has been challenged in federal Iraqi court by former parliamentarian Sheda Mosawi. She argues that the prime minister and the oil minister had begun without parliament’s approval to decide the nation’s petroleum policy through their licensing efforts in the first and second bid rounds. Mosawi’s contentions are that oil policies, contracts and licenses should be approved in greater concert with the regional governorates (which includes her native Basrah Governorate) as well as the federal parliament. In Mosawi’s view, and in a strict and literal reading of Law 97 of 1967, all contracts between Iraq’s Ministry of Oil and any third parties must obtain a separate vote of approval from parliament to prove them to be binding, legal and enforceable under Iraqi law.
2009 AND 2010 BID ROUNDS
Between June 2009 (first bid round) and February 2010 (second bid round), the Iraqi Ministry of Oil announced the award of service contracts to develop Iraq’s existing and known oil fields. The results of the tender were broadcast live on Iraqi television. As discussed above, the awards did not include the Kurdish-controlled areas. All contracts from the Ministry of Oil needed to be approved by the Council of Ministers (a group of selected ministers) and possibly the Council of Representatives (parliament). Even though these bid rounds are still unsettled, recently a third bid round was announced exclusively for natural gas in federal Iraq. If all contracts awarded during the 2009 and 2010 bid rounds reach their stated target-plateau production, this will increase Iraqi production from today’s 2.5 mb/d by 9.4 mb/d to a total of 11.9 mb/d, comparable to current Saudi declared capacity of 12.5 mb/d.
SIGNIFICANCE OF MARCH 2010 ELECTIONS
On December 6, 2009, after months of negotiations, Iraq’s Council of Representatives (CoR) approved the Elections Law. The new law increased the number of seats in the CoR from 275 to 325.6 It also changed the method by which Iraqis voted in the March 2010 elections. For the first time, Iraqis voted for a specific individual candidate who was associated with a particular faction or bloc rather than simply voting for a faction or bloc that would later chose the candidate. The election resulted in Iyad Allawi’s Iraqiya bloc being declared the winner by the slimmest of margins. The secular Shia Allawi galvanized the votes of millions of Sunnis who had boycotted the lastparliamentary elections, in 2005, to build his edge of 91 to 89 seats over his nearest rival, Nouri Al-Maliki. Because of his narrow two-seat advantage in the new parliament, Allawi will most likely get 30 days in which to form a broader coalition to reach the required 163-seat majority. As a result, Allawi will likely have to make concessions regarding key issues affecting the potential oil and gas law. The extent to which the 45 Kurdish representatives will support Allawi will depend on what further assurances they receive on cementing the semi-autonomy of the KRG and on granting this area the constitutional ability to negotiate and contract directly with international oil companies.
Iraqi Field | Company | Home Country | Region | Company Type | % Share in Field | Production Increase Share | Service Fee $ per bbl | Gross Revenue at Plateau ($ bn p.a.) |
Manjoon | Shell | UK | UK | Public | 45.00 | 0.7875 | 1.39 | 0.400 |
Petronas | Malaysia | Asia | State | 30.00 | 0.525 | 1.39 | 0.266 | |
Halfaya | CNPC | China | Asia | State | 37.50 | 0.525 | 1.39 | 0.102 |
Petronas | Malaysia | Asia | State | 18.75 | 0.099 | 1.40 | 0.051 | |
Total | France | Europe | Public | 18.75 | 0.099 | 1.39 | 0.051 | |
Rumaila | BP | UK | UK | Public | 37.50 | 0.7125 | 2.00 | 0.520 |
CNPC | China | Asia | State | 37.50 | 0.7125 | 1.39 | 0.520 | |
Zubair | ENI | Italy | Europe | Public | 32.81 | 0.328 | 2.00 | 0.240 |
Occidental | U.S. | U.S. | Public | 23.44 | 0.2344 | 2.00 | 0.171 | |
KOGAS | Korea | Asia | State | 18.75 | 0.1875 | 2.00 | 0.137 | |
West Qurna 2 | Lukoil | Russia | Russia | State | 56.25 | 1.0125 | 1.15 | 0.425 |
Statoil | Norway | Europe | Public | 18.75 | 0.3375 | 1.15 | 0.142 | |
Badra | Gazprom | Russia | Russia | State | 30.00 | 0.051 | 5.50 | 0.102 |
Petronas | Malaysia | Asia | State | 15.00 | 0.0255 | 5.50 | 0.051 | |
KOGAS | Korea | Asia | State | 23.00 | 0.03825 | 5.50 | 0.077 | |
TPAO | Turkey | Asia | State | 8.00 | 0.01275 | 5.50 | 0.026 | |
West Qurna 1 | Exxon | U.S. | U.S. | Public | 60.00 | 1.2276 | 1.90 | 0.851 |
Shell | UK | UK | Public | 15.00 | 0.3069 | 1.90 | 0.213 |
The Iraqi constitution does theoretically allow for the governorates and the semi-autonomous KRG to be involved in developing new oil resources. Article 108 states that “oil and gas are the ownership of all the peoples of Iraq in all the regions and governorates,” while Article 109 tasks the federal government with “the management of oil and gas extracted from current fields.” This language has led to contention over what constitutes a “new” or an “existing” resource, a question that has profound ramifications for the ultimate control of future oil revenue.
A highly decentralized structure is favored by the Kurds and many Shia (particularly supporters of the National Iraqi Alliance). It is, however, anathema to Sunnis, first, because Sunni Arabs are generally Iraqi nationalists, and, second, because there is generally no economically feasible and cohesive “Sunni region.” Iraq’s vast energy resources are in the Kurdish and Shia regions.7 There are considerable resources in and around Baghdad (the so-called “Baghdad Field”), but their capacity is smaller than that of the giant fields in the southern part of Iraq, especially in the Basrah Governorate. Due to this disparity, the Baghdad Field was not part of the first or second bid rounds. Thus, to satisfy his Sunni followers, Allawi may have to distribute revenue per capita based on population, as opposed to production.
Already, Allawi has been in talks with members of the Kurdish Alliance, who hold 43 seats.8 The KRG comprises two main political groups: the Kurdistan Democratic Party and the Patriotic Union of Kurdistan. Both interpret the Iraqi constitution to give the regions full control over resources on their territory.9 The KRG prefers privatizing the existing nationalized oil and gas resources, believing that Iraq cannot go it alone and needs to depend partially, if not completely, on the development of its natural resources by international oil companies. In fact, the KRG has already ventured out alone and started signing production-sharing agreements (PSAs) with several IOCs without presenting them to the federal oil ministry in Baghdad.10 Shortly after the election results were announced, Iyad Allawi said he would honor deals signed with global oil majors in recent months.11
On the other hand, nationalist groups assert that this is a requirement of the constitutional principle of public ownership, even though almost every country asserts public ownership of oil resources, regardless of the contracting method used for exploitation. The National Iraqi Alliance, partially led by Shia clerics, believes that Iraq’s natural resources and upstream and downstream production should stay nationalized, with revenues distributed on a per capita basis. They argue that Iraq should develop its own oil and gas resources with overseas technical help. However, they do not agree with bringing in the foreign IOCs as partners in this process.
Senior members of Iraq’s oil industry argue that a national oil company could reduce political tensions by centralizing revenues and reducing regional or local claims to a percentage of the revenue derived from production. On this point, Allawi said he would like a hydrocarbons council of experts similar to one he instituted as prime minister to oversee the sector, rather than just the oil minister. “We want to have, ultimately, the ministry as a regulator rather than an operator, and the operations should be handled by the private sector and the investors,” Allawi said.12 Given Kurdistan’s status as a semi-autonomous region, Allawi may be able to make a special compromise that would not be feasible for any other region. For example, the KRG may be allowed to enter into PSAs and have more direct control over its oil operations, whereas oil extraction for the rest of the nation could be handled more directly by a national oil company, and revenues could be distributed by population.
CONCLUSION
National legislation that addresses revenue distribution between the government of Iraq and the provinces is considered key to reconciliation and to the realization of the full benefits from Iraqi oil exports. As the above analysis indicates, Allawi will almost certainly have to make concessions to the Kurdistan Regional Government and other groups, such as the National Iraqi Alliance, to establish a governing body. What concessions and promises are made behind closed doors will mark the future of the upstream oil industry in Iraq. For, without a clearly defined road map to develop, transport and capitalize this resource, political instability in Iraq will likely remain constant or even worsen. Whatever the course, Allawi, with the assistance of the Council of Representatives must move forward with passage of the comprehensive draft petroleum legislation, which has been stalled in parliament for nearly three years. Without its passage, the only certainty in the upstream production sector of Iraq’s economy is uncertainty. And with this uncertainty, the disproportionately high risks to security, legality and political stability may ultimately impede the crucial international investment upon which Iraq’s development is dependent.
2 U.S. Department of State, Iraq Weekly Status Report. October 28, 2009.
3 Sonia Verma, “Iraq Could Have Largest Oil Reserves in the World,” Times of London , May 20, 2008.
4 Congressional Research Service, “Iraq: Oil and Gas Legislation, Revenue Sharing, and U.S. Policy,” November 3, 2009, p. 1.
5 Testimony of U.S. Ambassador to Iraq before the House Foreign Affairs Committee, September 10, 2009.
6 Including 8 seats for minorities (5 for Christians and 1 each for Mandaeans, Shabak, and Yazidis).
7 Iraq’s current proven reserves are concentrated largely (65% or more) in southern Iraq, particularly in the southernmost governorate of Al Basrah. Large proven oil resources also are located in the northern governorate of Al Tamim near the disputed city of Kirkuk.
8 Timothy Williams and Rod Norland, “Allawi Victory in Iraq Sets Up Period of Uncertainty,” The New York Times, March 26, 2010.
9 Economist Intelligence Unit, Country Report: Iraq (October 2009), pp. 1-3.
10 Production-sharing agreements (PSAs) are a common type of contract signed between a government and a resource-extraction company (or group of companies) determining how much of the production (usually oil) extracted from the country each will receive.
11 Khalid al-Ansary & Jim Loney, “Iraq Oil Law a Priority, PM Hopeful Allawi Says,” Reuters, March 31, 2010.
12 Ibid.
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