Iraq Is Ill-Equipped to Exploit Huge Oil Reserves

By Peter S. Goodman
Washington Post Foreign Service
http://www.washingtonpost.com/
Wednesday, June 4, 2003; Page A01

BASRA, Iraq -- An enormous reservoir of petroleum almost certainly lies beneath the Majnoon oil field, a blank expanse of pale sand near the Iranian border. Under Saddam Hussein, Majnoon was the linchpin of an ambitious plan to expand Iraq's oil industry. Its promise captured the attention of French oil giant Total SA, which tentatively agreed to sink nearly $5 billion into extracting its treasure.

But now Majnoon is deserted, save for prowling looters and armed robbers. The road to the nearby city of Basra is blocked by razor wire. Though the field remains a crucial component of Iraq's vast potential, it has also come to symbolize the profound uncertainties that confront this country and the U.S. forces in control of it as they seek to turn oil in the ground into cash in hand -- enough to pay for Iraq's reconstruction and sustain a future government.

Like Iraq itself, Majnoon has abundant oil waiting to be tapped and global energy companies eager to lend capital and expertise for a share of the spoils. But even though the United Nations lifted the sanctions that barred most exports of Iraqi oil for more than a decade, considerable barriers remain. No government exists to sanction contracts, develop new fields or determine whether old deals are still valid. No codes are in place for foreign investment. Data about the Majnoon oil are scarce, and key export facilities are battered by years of war and neglect.

The country with the second-largest proven oil reserves in the world has become a frontier, one to be traversed cautiously.

"All the big oil companies are interested to go back into Iraq, provided that the legal government is willing to increase its protection and accept foreign investment, Alain Lechevalier, Total's vice president for the Middle East, said by phone from Paris. "This means a lot of stability that presently I don't forecast for two to three years. Nobody is going to pour $5 billion into Iraq with no stability in the regime."

Still, with an estimated 112 billion barrels of oil at stake, no company in the oil business can afford to give Iraq a pass. Neither can policymakers and economists ignore the impact of its return to the ranks of exporters, which is expected this year when enough pipelines and pumping stations are fixed.

Much of the oil is close to the surface and easily tapped, requiring fewer wells than in other petroleum-producing parts of the world. The derricks that proliferate in Texas, pumping oil from wells reluctant to yield it, are generally unknown here.

The exploitation of Iraq's oil is at a relatively early stage. Only 15 of its 73 fields are developed, and no major exploration has been conducted since the beginning of the war with Iran in 1980. Some experts have suggested that Iraq's remote western desert could hold as much as 100 billion barrels.

"That's why these companies are so eager to get in," said Jasem Khalid Sadoun, chairman and managing director of Alshall Consulting and Investment in Kuwait City. "You will see a real war to get in there and try to explore for more oil. Iraq seems to be the most viable oil project in the world."

Iraq was producing about 2.5 million barrels of crude oil a day before the war, a rate slightly higher than Kuwait's. Before the 1991 Persian Gulf War, it was producing 3.5 million barrels a day. Getting back to that volume will take months or years. Repairs to reach that threshold probably can be made with domestic resources, supplemented by the U.S. Army Corps of Engineers and its contractor, KBR, a subsidiary of Halliburton Co.

But if Iraq decides to work toward its long-standing goal of increasing production to as much as six million barrels a day, it would require substantial foreign investment, according to analysts and executives with state oil companies.

During Iraq's dozen years of isolation as an international pariah, U.N. sanctions sharply limited investment and new technologies, leaving many oil facilities jury-rigged with antiquated parts. Production at mature fields is slowing, while Iraq has lacked techniques to coax more oil out of the reservoirs. Some oil fields have been damaged by the crude and outdated practice of injecting water into reservoirs to build up pressure.

Key shipping terminals were damaged in the 1991 Gulf War, and a major export pipeline to Syria was severed during the recent conflict. Iraq also doesn't have enough storage tanks, a basic requirement of exporting. When bad weather prevents tankers from filling up, either oil must be stored or production must stop.

Oil Reserves

In a report released in December, the Council on Foreign Relations concluded that repairing Iraq's export facilities and restoring production to pre-1991 levels would require $10 billion in capital and $3 billion a year in operating costs. A recent study sponsored by the U.S. State Department concluded that bringing Iraq's output to 6 million barrels a day would require more than $30 billion.

Those sums are well beyond Iraq's ability to pay, said Sadoun, the Alshall chairman. Iraq's government is likely to take in about $15 billion a year for the next two to three years in sales of oil by state companies, he said. But the government will have to pay the salaries of 3.3 million employees and oversee its ministries, probably costing more than $10 billion a year. Interest on government debts dating to Iraq's heavy reliance on credit to fund its war with Iran -- much of it extended by Russia -- absorbs as much as $3 billion per year.

"What is left is going to be so minimal," Sadoun said. "They don't have the money, the technologies, the resources."

It is possible that the global oil market could shift in the time it takes to form a new government and make rules to allow outside investment. If, for example, Iran and Saudi Arabia decided to expand production, the SARS virus reduced demand for oil in Asia and economic growth remained sluggish in the United States -- if the world supply of oil were to grow faster than demand -- then the price would fall. And if it fell far enough, the Iraqi industry would not have the incentive to expand production.

But most analysts believe the situation in Iraq might have created a opening for which the world's oil companies have long been preparing. "Most of the companies have been thinking about Iraq for many years, and I mean many years, because of the obvious potential of the resource base," said Phillip J. Carroll, the former head of Royal Dutch/Shell in the United States, who is the chief adviser to Iraq's Oil Ministry. "There will be, I'm sure, a great deal of interest to begin discussions at as early a date as possible with the Iraqis."

For now, though, the companies have nobody to talk to: Iraq is unlikely to have a fully authorized government for at least a year. Meanwhile, the Oil Ministry, acting on an ad hoc basis, plans to soon launch a study looking at the various options that could be used to expand the industry. As part of its research, it might solicit proposals from international oil companies, Carroll said.

"Growing out of that," Carroll said, could be "that those companies that have maybe offered the best model would be the ones in a favored position to go on, in terms of expanding the oil industry."

Which companies wind up in that role is likely to be decided in a fiercely political environment. Under Hussein, oil contracts were given to companies from Russia, France and China, whose governments were more supportive of Iraq than other nations at the U.N. Security Council. Now, the ministry is under the control of an acting chief, Thamer Abbas Ghadban, who was selected by the United States. He is being advised by Carroll, the retired Texas oil executive chosen by the Pentagon.

Carroll said repeatedly that he is merely an adviser. But many in Iraq's oil industry assume that the war replaced one set of preferential beneficiaries with another: Hussein's former allies are out, while those who won the war will get most of the deals.

Adding to the potential for acrimony is the question of what to do with contracts awarded while Hussein was in power. Carroll said the ministry would examine them case by case, with an eye toward revoking those at cross-purposes with the public interests. He declined to name any deals that might meet that definition, but officials in Iraqi state companies frequently cite a $3.7 billion contract given to Russia's largest oil company, Lukoil, to expand the West Qurna field near Basra.

Hussein's regime abruptly canceled that contract this year, complaining that Lukoil failed to do any of the required work. Hussein was also angered by what he perceived to be ineffective and halfhearted Russian opposition to U.S. war planning, a South Oil Co. senior official said.

In a recent interview, the new head of South Oil, Jabbar Luaabi, said the Lukoil contract was no longer valid. But a spokesman for Lukoil in Moscow said it was. He said Lukoil did not previously do work at the field because of U.N. sanctions, but will now that the sanctions have been eliminated. "We have a legally binding contract," said the spokesman, Kirill Smolyakov. "Our contract was signed according to international law and agreed to by the Iraqi parliament."

Similar arguments could affect contracts awarded to other Russian companies as well as Chinese firms, said Nader H. Sultan, chief executive of Kuwait Petroleum Corp. "The oil lawyers will have a lot of business," he said.

At Total's headquarters in Paris, Lechevalier professed no worries about the political atmosphere as it relates to Majnoon, which was to produce 600,000 barrels a day after Total's project, up from 50,000 per day before the war. That deal was never signed, but the company could pursue it again.

Total's experience at the field, its seismic work and surveying, and its continuing contacts within the oil ministry could be significant competitive advantages, Lechevalier said. Whatever political impediments might exist could be avoided by joining consortia with other oil companies.

"There is room for everybody," Lechevalier said. "The amount of money needed is so great that no one will be able to do it alone. Nobody will be able to put $30 billion alone into Iraq."

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