Iraq Needs to Prime the Pump

Until the country decides on a unified policy, Big Oil will hold back -- and the risk of regions breaking away will increase

By Stanley Reed

On Nov. 29, DNO, a small Norwegian company, began drilling an exploratory oil well in a production-sharing agreement with the Kurdish regional government in northern Iraq. Although the Tawke field is likely to prove relatively small, DNO Chief Executive Helge Eide says the project "could be an early beginning" to foreign oil companies resuming work in Iraq.

Certainly, the DNO deal increases pressure on the Iraqis to devise a solution to the development and control of the country's huge oil and gas reserves. Otherwise, regional governments will be tempted to go their own way, as the Kurds already seem to be doing.

The BPs and Exxons are not going to rush in and sign deals with regional governments in Iraq -- at least, not right away. But small companies could snap up interesting exploration acreage. And regional or provincial governments, such as the Kurds or independence-minded politicians in the southern city of Basra, could be tempted to seize oil assets to fund their own local governments and fuel the breakup of Iraq.

For all of these reasons, agreeing on an oil policy will be one of the key tasks facing Iraq's politicians following the elections scheduled for Dec. 15. That vote will occur at a time when the likelihood of a substantial U.S. withdrawal in the next two or three years is increasing. "Oil is absolutely crucial," says Phebe Marr, an Iraq specialist at the U.S. Institute of Peace, a Washington, D.C., think tank.


  Despite claiming the world's second-largest oil reserves, after Saudi Arabia, Iraq has seen its production flag from a postwar peak of 2.45 million barrels per day in April, 2004, to 1.8 million in November, as bad management, rundown equipment, and sabotage exact their toll. Rehabilitating Iraq's existing fields -- let alone reaching their potential of perhaps 6 million bbl a day -- requires that major political groups agree on how to develop and share the oil wealth. Otherwise, the major oil companies, as well as service providers such as Schlumberger (SLB ), are unlikely to put in the money or technology that Iraq needs.

The majors covet Iraq's reserves, but they don't want to put their personnel at risk. "And they want a contract that is legally strong enough to stand the tides of shifting politics for years and decades to come," says Jamal Qureshi, an analyst at consultancy PFC Energy, based in Washington, D.C.

The Iraqi constitution, which was recently approved by referendum, is too vague on questions of regional vs. national authority to give them sufficient comfort to sign a deal. The constitution gives the central government the authority to manage existing oil fields, but leaves the control of new production up for grabs.

As a consequence, companies such as BP (BP ) are limiting their activities to training Iraqi technicians at offsite locations such as Amman, Jordan. In a recent article in the Middle East Economic Survey, an oil newsletter, Issam Chalabi, a former Iraqi oil minister, said that the Iraqi constitution had "created an anomaly that can only bring havoc to the industry and abort its development." Chalabi said he doubted that Iraqi oil production would reach 3.5 million barrels per day before 2009.


  Could the Dec. 15 elections change the picture? It doesn't look promising. Most observers think the two groups that currently dominate Iraqi politics -- the Shia United Iraqi Alliance and the Kurds -- will come out on top again. It will be up to whoever wins to forge a national reconciliation that can help undercut the insurgency.

But the Shia religious parties, which dominate the current government, are using their hold on key institutions such as the Interior Ministry to exact revenge for the brutalities suffered under Saddam. Shia militias have infiltrated the police, and death squads -- suspected to be made up of militia members -- have been assassinating former regime figures and influential Sunnis in Baghdad. Despite the plethora of elections, "violence has become the main tool of politics," says Toby Dodge, an Iraq specialist at Queen Mary College in London.

Despairing of ever having an effective central government in Baghdad, Iraqi politicians are shoring up regional bases. That's true of the Kurds, who have a quasi-independent state in the north, and oil could play a key role in boosting their autonomy.

"Why should we just sit around and wait while the rest of Iraq goes through this chaos?" says Bayan Sami Abdul Rahman, the Kurdish regional government's representative in London. The Kurds could produce oil in their enclave, ship it out through Turkey, and have a new source of revenue.


  The Supreme Council for the Islamic Revolution in Iraq (SCIRI), one of the two key Shia religious parties, is also beginning to pursue a regional strategy. SCIRI's leader, Abdul Aziz al Hakim, wants to carve out a Shia enclave consisting of nine southern provinces. To bolster his power, al Hakim has his eye on the southern Rumaila oil fields that now account for most of Iraq's production. Al Hakim, whose group is relatively weak in the Basra area where the oil fields are, is promoting his vision of a bigger Shia area in part to trump the Basra locals.

The danger is that the fight over resources could help fuel Iraq's dissolution. The Kurds would seize the fields around the disputed city of Kirkuk in the North, and southern Shia groups would try to control the benefits flowing from Rumaila. The central government in Baghdad, and the Sunni triangle to its north and west, would be shut out. And the oil wealth would continue to be managed inefficiently.

As in so many other areas, Iraqis would be better off compromising than fighting over the future of the oil industry. But that doesn't mean they will.

Reed is BusinessWeek's London bureau chief

Edited by Rose Brady

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