Why Oil Won’t Be a Quick Fix
Edward C. Chow
From Victory to Success: An FP - Carnegie Special Report
Foreign Policy
July/August 2003
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
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