October 22, 2009

The Iraqi Oil and Gas Framework: Some Background

I’ve heard a lot about Iraqi oil and the important role this resource plays in international politics, but I’ve never been clear about exactly what the Iraqi oil laws were. If you also think this seems like a big debacle and want a bit more detail, walk with me through this. The Iraqi government has given cabinet approval to an agreement with two companies after delaying since June auctions in order to agree on current production levels, future outputs, and other details of a final contract. The bid by China’s CNPC and Britain’s BP to develop the southern oilfield in Rumaila is now thought to be three weeks from a signed agreement. This marks the first major oil agreement between the Iraqi government and foreign companies offered in competitive bidding since the fall of Saddam.

Although there have been fits and starts along the way, notably when Saddam briefly signed oil contracts with other countries in 1997 (these contracts were never implemented due to sanctions), the Iraqi government and people have strongly supported the nationalization of the oil industry for nearly 50 years.  The new Iraqi government, however, has supported a policy that is open to foreign investment and relinquishes much of the control and profits of oil wells.

The start of this policy shift can be traced back to the interim government between June 2004 and May 2005. Then-Prime Minister Ayad Allawi radically changed the way oil was developed in Iraq, including by launching a series of guidelines advocating for an increasingly privatized system, with a new Iraq National Oil Company (INOC) only retaining control of fields then currently in production. Furthermore, this INOC was to be partially privatized by selling equity. Dr. Allawi wrote:

Liberalization and privatization of down stream oil and gas, setting out rules and making incentives for production sharing arrangements in oil and gas, should be a way of increasing capital and attracting recent and advanced technology. Formation of a completely private Iraqi National Oil Cooperation and another one for gas lie at the heart of developing Iraq’s economic capabilities, maximizing revenues and encouraging private sector and foreign investment.

Not all of Dr. Allawi’s concepts came to pass. There was strong opposition to a privatized INOC and the public opinion pushed in favor of more regulations. However, despite the brevity of the government, this was the last time a post-Hussein government set an oil policy. Although the current government has many propositions floating around (which will be discussed at length later), the Allawi government view has become the default position on oil in Iraq.
One of the big reasons that there has been a push for privatization is a lack of capital—human and monetary—to rebuild these operations. In order to boost capacity, outside forces need to be brought in to help modernize the systems after years of technological isolation and warfare. Despite national pride, few in Iraq can really make the case that outside investment is not necessary.
The Iraqi Constitution (pdf) did offer some general guidelines for the development of Iraq’s oil.  Article 111 states that “oil and gas are owned by all the people of Iraq in all the regions and governorates.” This, at minimum, sets out the basic principle of resource-sharing around the country. The more important description comes in the next article:

Article 112:

First: The federal government, with the producing governorates and regional governments, shall undertake the management of oil and gas extracted from present fields, provided that it distributes its revenues in a fair manner in proportion to the population distribution in all parts of the country, specifying an allotment for a specified period for the damaged regions which were unjustly deprived of them by the former regime, and the regions that were damaged afterwards in a way that ensures balanced development in different areas of the country, and this shall be regulated by a law.

Second: The federal government, with the producing regional and governorate governments, shall together formulate the necessary strategic policies to develop the oil and gas wealth in a way that achieves the highest benefit to the Iraqi people using the most advanced techniques of the market principles and encouraging investment.  (Emphasis mine)

Although the Constitution sets out the principle of equitable division or profits and of developing resources, it leaves the actual conditions under which contracts can be awarded vague. It also does not specifically refer to undiscovered or undeveloped resources. This has big implications for foreign oil companies and exploration contracts. No Iraqi exploration contracts have been rewarded yet, so terms and conditions are still unknown and have not been nationally mandated in any way (the exception being under Kurdish law which opens up a whole host of problems, more later).  It is possible that when an oil law is actually passed it will allow for greater foreign investment in Iraqi oil fields.

The lack of a legal framework has allowed the Kurdish Regional Government (KRG) greater autonomy by parlaying the Constitution’s condition of local input into the authority to sign oil deals. The KRG passed the Oil and Gas Law of the Kurdistan Region (pdf) which outlines the KRG’s plan for multiple, public companies and the conditions under which it will cooperate with Baghdad amongst other guidelines.  Although the national government strongly opposes the KRG’s move, their only real solution is to blacklist firms who enter into contracts with the Kurds. Meanwhile, the KRG has been increasingly critical of Baghdad’s inaction and has alleged that the June auctions were illegal.

The situation does not look as if it will change anytime soon. With elections approaching, hopes have dimmed for getting any legislation passed before January.   That being said, the draft oil laws are expansive and problem-riddled. Although the Iraq Oil and Gas Law (IOGL) (pdf) is the most well known piece of legislation, it comes as part of a package that outlines:

  1. Managing investment in Iraq’s oil resources, specifically the industry’s upstream development;
  2. Revenue sharing among private companies, provinces, and the federal government;
  3. Restructuring the Ministry of Oil; and
  4. Reconstitution of the Iraq National Oil Company (INOC).

Each of these laws in turn refers to the others, so evaluating how the IOGL will work is fruitless until the restructuring of the oil ministry is complete. The INOC, in turn, could either control all of the oil resources in Iraq, or be a partially-privatized entity that only works in pre-discovered fields (if you want a good assessment of the INOC law look here). Without knowing the scope of operation, how can you decide its structure?

The central Iraqi government televised an auction for oil and gas fields in June. It did not go well.  Out of eight contracts to develop oil or gas fields, only one was successfully bid on. This was mainly due to bidders rejecting the Iraqi terms for development, which offered a flat fee rather than a share of the profits. This combined with background fears of instability and lack of institutional soundness led to very few companies accepting contracts. The Iraq government realized that the development of these fields should be a priority and has reassessed contracts for the upcoming auction on the 11th and 12th of December. The Iraqi government is now willing to pay companies more to develop the fields that will be rebid.

As international companies start filtering into Iraq to develop and explore for oil and gas fields, questions about the legal and societal framework they will operate in remain. Although operating in Iraq is a gamble, companies see a lucrative source of easy-to-extract oil waiting and are willing to accept uncertain, sub-optimal contracts to get a piece of the action. Let’s hope that the legal framework is decided upon soon and both sides are able to accurately assess contracts in the future.