Iraq’s Petroleum: Challenges of Managing the Plenty

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Iraq’s Petroleum Upstream Development
and the Challenges of Managing the Plenty

Extended Abstract based on PowerPoint presentation delivered before the Natural Resource Charter -NRC Annual Conference “Investing Natural Resource Wealth for Sustainable Prosperity” hosted by the Arab Fund for Economic and Social Development-AFSED, held in Kuwait on 6-7 May 2013.

Acknowledgement: I am thankful to Professor Paul Collier, Blavatnik School of Government, University of Oxford, Member of NRC Technical Advisory Group and to Mr Abdulatif Al-Hamad, Chairman, AFESD, Member of NRC Oversight Board for their kind joint invitation, and to their competent staff for profoundly helping with the logistics of my participation.

The contents of my presentation are my own responsibility as independent consultant and scholar and thus do not represent the views and positions of NRC, AFESD or any Iraqi entity.

Since November 2008 Iraq upstream petroleum sub-sector witnessed many serious, unprecedented but interrelated developments: A grand opening to foreign investment; formulation of a new hybrid basic model for long term service contracts; offer the most prized petroleum fields in a short period of time; concluding many contracts through four bid rounds, and more under consideration; formal willingness for transparency measures and compliance to known international standard (EITI); and finally the formulation and adoption of the first ever Integrated National Energy Strategy-INES (Slide nr.3).

The Iraqi case present serious management of the plenty in every aspects: massive development efforts; require massive capital investment; generating massive influx of revenues, some of which will be earmarked for massive payments to the IOCs for cost recovery and remuneration fees, while the rest would finance massive state annual budgets; thus generating massive consequences on main macroeconomics parameters and sustainable development in the country.

Successful or otherwise the Iraqi case would have serious ramifications for the political economy of relationships between host governments and IOCs, and thus entails constant monitoring and professional objective and independent analysis.

Contractually, the concluded deals would uplift oil production capacity to an unprecedented level at unusual short pace. However, professional debate and different studies appeared to have impacted the official view to endorse lower, more feasible and realistic targets. This is expressed by three options comprising deferent plateau targets and time horizons that were considered by the recently finalised Integrated National Energy Strategy (INES).
The paper argues that with the apparent absence of sound national planning and development policy, even the lowest production target would deepen the dependency on oil, further the structural imbalances of the economy and entrench the challenges of the rentier economy to the detriments of sustainable development. Absorptive capacity limitation, Dutch disease and resource curse are likely to persist and thus confront and undermine the national efforts on the socio-economic development.

On the other hand Iraq needs significant capital for both investment and consumption purposes, and oil export revenues, currently and for long time to come, are the only source for securing the needed capital. But this implies serious vulnerability of the economy to external shocks.

Part one of the paper (Slides 4: 10) addresses the main parameters of this Big-Push Strategy by outlining the outcomes of the conducted bid rounds in terms of their contracted oil production plateau targets and related time-horizons focusing on both the brown and green oilfields. During the first two bid rounds and one direct deal the Ministry signed 12 LTSCs covering 14 oilfields. The combined proven reserves of these fields amounts to 67 billion barrels representing 58.5% of the country’s proven reserves at that time. When these oilfields are developed as contracted, their total plateau target would increase from 1.7 mbd to 12.3 mbd by 2017. Moreover, three gas fields were contracted in bid round three and four exploration blocks were contracted in bid round four. Currently, there are planes for fifth bid round covering another exploration blocks; the Nassiriya Integrated Project-NIP covering the development of a field with 4.4 billion barrel of proven reserves and construction of a refinery with 300 kbd capacity; the Kirkuk oil fields, and many others oilfields. If production from all these added up total production could reach 13 mbd
Many oil professionals questioned the feasibility, attainability and sustainability of such a plateau production at such a pace. Iraq in cooperation with and partial financing from the World Bank commissioned two years ago an international consulting company (Booz & Co) to conduct a study on the matter. Accordingly, the authorities, as one 7 May 2013, are finalizing the INES comprising three scenarios of 13 mbd, 9 mbd and 6 mbd with different plateau production periods. There are strong evidences suggesting Iraq would adopt the 9 mbd, and this obviously entails renegotiating all or most of the signed LTSCs. Actually, such renegotiations has begun with two contracts, WQ2 and Zubair, were concluded.

Significant part of oil would go for export and thus expansion of export capacities and diversification of export outlets become imperative to give Iraq more flexibility and security. For this purpose Iraq plans on enhancing the access to the Mediterranean, the Red Sea and Arabian Gulf commensurate with the three major markets for its crude: Asia, Europe and the Americas (Slide .

Increased oil production and export together with improved oil prices had contributed to enhance oil export revenues, which in turn led to an unprecedented scale of the annual state budgets. Expenditures almost doubled between 2009 and 2013 thus depending heavily on oil export revenues (Slide 10). Over these five years allocations for operating budget averaged to 68% (usually fully spent) with the remaining 32% for investment (actually partially spent). Budget allocations for “Energy” and for “Security and Defence” are the highest at the expense of other economic and social sectors. 2013 budget allocates 21.3% for energy and 14.2% for security and defence while the real economy sectors get much less with industry has 1.2% and agriculture has 1.9%.

With production capacity of 9 mbd or even 6 mbd this would generate very significant influx of petroleum export revenues and this could present the country with the challenges of properly managing such inflow of revenues.
Accordingly, Iraq might face four very different situations/scenarios: Honeymoon, Delicate Balance, Risky and Nightmare depending on the state of the world economy and global energy balance. This second part of the paper calls upon the Iraqi high decision makers to begin immediately formulating proactive “Multiple Coping Strategies-MCS” to prepare for the eventualities of these four possible situations (Slides 11:13). MCS proposal and framework go beyond upstream petroleum sub-sector but it is absolutely necessary to ensure and emphasis the required harmonisation of energy strategy with national development planes and related planning at national level. Accordingly, this part provides conceptual analytical framework for an on-going institutional arrangement entrusted with identifying the characteristics and dynamics of each situation; discuss viable policy options to manage and mitigates related consequences and suggest required institutional, legal and good governance frameworks to insure proper management of the generated oil revenues.

Transparency is a fundamental component of the above mentioned governance structure. Therefore, part three of the paper discusses the Iraqi case within the frameworks of the NRC and EITI (Slides 14 & 15). For this purpose the paper introduces and argues for functioning “Transparency of Value Cycle-TVC” paradigm covering the actual flow of resources and revenues focusing on three important interconnected clusters: payments and investment by IOCs; increase in production and revenues for the country; payment by the country to the IOCs for cost recovery and remuneration fees, and finally after the payment of the IOCs the due taxes, the share of the State partner and other payments the IOCs reinvest the remaining amounts in the field and so goes the cycle. And since each of the Iraqi LTSCs extends well over 20 years duration the TVC becomes important annual component of transparency reporting that requires constant monitoring and verification by well-established and competent Iraqi entity (IEITI). For Iraq and other developing countries TVC is useful framework to ensure real, accurate and comprehensive transparency in the upstream petroleum and other extractive industries.

The five components of the “Value Chain” adopted by the Extractive Industry Transparency Initiative-EITI correspond in fact to the “Precepts” number 3 through number 10 of the NRC framework. Though Iraq is progressing in its compliance to the EITI Standard, the country has a long way to go in its compliance with requirements of the NRC /EITI frameworks, especially with regards to utilizing the depleting petroleum resources for the economic and social sustainable development in the country.

Finally, the presentation concludes by summarizing the main challenges facing Iraq and grouped them in 10 categories, asserting they could impact the development of upstream petroleum development and consequently the growth and prospects of Iraqi economy (Slide 16).