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CIAO DATE: 09/03
Foreign Policy
From Victory to Success: An FP-Carnegie Special Report
Why Oil Won’t Be a Quick Fix
Edward C. Chow*
This time it’s not colonialism or avaricious dictatorship. This time, Iraq’s oil income will benefit the Iraqi people. So promise U.S. President George W. Bush and British Prime Minister Tony Blair. How will the Iraqi people and outside observers know if this promise is being upheld?
To avoid bribe-borne or crony-cooked deals and unfair pricing, the new oil policy in Iraq must foster transparency and maximum international competition.
The initial goal is to return Iraq’s production to at least 2 million barrels a day. To do so requires repair and safe restart of production, refining, distribution, and export facilities. It should take a year or so. To the extent that American taxpayers pay for this immediate work, it deserves to be performed primarily by American oil service contractors.
However, 2 million barrels a day, earning around $15 billion annually, will not yield a financial surplus to Iraq. These figures are far below the uninformed and wildly inflated prewar estimates used to justify the argument that Iraqi oil would magically pay for the costs of the country’s reconstruction. Much of this $15 billion must be reinvested in the oil fields to modernize and upgrade facilities damaged by two decades of war and economic sanctions. All told, reviving and sustaining a capacity of 2 million to 3 million barrels a day will require an investment of perhaps $30 billion to $40 billion.
The longer term goal is more challenging—to reach and sustain production of 5 million barrels per day (or more). Iraq has the second-largest known reserves in the world—over a hundred billion barrels of oil. But to raise production Iraq must not only revitalize existing fields and associated facilities but also explore and develop new fields and construct new installations for processing and export. Such risky megaprojects can easily cost tens of billion dollars each.
If these large projects have to wait to be funded by existing oil income, they will be delayed for many years. A more timely solution is to invite international oil companies to invest in exploration and production, particularly of new fields. Such a role is entirely legitimate for the international oil industry and capital markets: to take on the risk of investment for an equity rate of return so that public funds do not have to be expended for the development of natural resources.
However, such investment won’t be forthcoming, or at beneficial rates to Iraqis, until Iraq’s political system is stable enough to give investors confidence that future tumult will not cancel their contracts or otherwise harm them. The location of Iraq’s major oil fields primarily in the traditionally Kurdish north and the largely Shia south highlights both the challenge of ensuring political stability and of devising equitable distribution of oil income in Iraq’s diverse society.
The rush to bring new oil production on line must not prompt outsiders such as the U.S. government and contractors, or Iraqi elites, to make fundamental decisions, including on privatization, before the larger political structure is stabilized. Better to let the Iraqi political process mature and market forces work than to rush to create an inviting but unstable investment climate for oil in Iraq.
World-class petroleum contracts of the scale called for in Iraq take years to conclude. Witness recent experiences in highly sensitive political environments such as Russia, Kuwait, and Saudi Arabia. More than a decade after Kuwait reopened itself to international investment in energy sector development, it has yet to reach a single agreement with foreign businesses on major contracts. Even if the contract process in Iraq is handled in an orderly, businesslike manner, it will be more than five years before substantial increases in Iraq’s oil production can start flowing from new investments.
Such investments could help bring oil production capacity in Iraq to 5 million or 6 million barrels per day in 10 years. Other major producing countries, especially those in the Organization of Petroleum Exporting Countries and the Persian Gulf, will respond to avoid losing so much market share to Iraq. These major oil producers have underinvested in production capacity by mismanaging their oil income and by continuing to exclude oil companies from operating in their countries on equitable terms. The right Iraqi model would then spawn wider benefits, but only if it is developed through an open domestic political process and not as a result of external pressures.
Notes
Note *: Edward C. Chow, a former executive at the Chevron Corporation, is a visiting scholar at the Carnegie Endowment. Back