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Iraq Can Lead the Arab World If It Gets Oil Policy Right: View

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U.S. President Barack Obama and Iraqi Prime Minister Nouri al-Maliki had many important issues to discuss yesterday in Washington: the impending withdrawal of the last U.S. 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-energize 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 nationalized in 1972, and the idea of excluding foreign companies still has resonance, including within Maliki’s coalition government.

Time to Decide

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)

Shake Things Up

Having angered Kurdish authorities with its draft law, the central government agreed to new negotiations. But Exxon Mobil Corp. (XOM) 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 U.S. oil giant’s move defied not only Baghdad but also the U.S. 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 legitimize the Kurdish contracts is already having that effect, while perpetuating the legal uncertainty. The sooner that fuzziness 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 Persian 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 $50 billion 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.

To contact the Bloomberg View editorial board: view@bloomberg.net.

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