Iraq’s legal framework for the oil industry remains as unfinished as the country’s transport, electrical and bureaucratic systems
Six years after control of Iraq was handed to Iraqis, the country still has an odd kind of legal problem: it doesn’t have enough law.
The country remains without an oil law that would create a legal structure for the contracts the government signs with foreign oil companies, a proper state ownership structure to manage Iraq’s stake in its oil, or an equitable division of oil revenues among the country’s competing factions.
In political terms the three are closely intertwined. That they are not resolved is thought to hold back the foreign direct investment needed for Iraq to develop to its potential.
Disputes also continue over the legality of moves by the Kurdistan Regional Government (KRG) to unilaterally award oil blocs located within its jurisdiction to foreign companies, and on the constitutionality of the production sharing agreements under which these companies are operating.
The most dangerous unresolved legal issue is the status of Kirkuk, with Baghdad and Erbil at loggerheads over whether and when to hold a constitutionally mandated referendum on the fate of the ethnically divided and oil-rich city.
There are also other shortcomings, not least of which is an absence of employment law that leaves companies without a codification of what Iraqis expect from oil companies that hire and train them.
Companies may be distracted from a proper reckoning with the legal risks of operating in Iraq by the more immediate security and operational issues. This would be a mistake, particularly for firms that will look to raise finance or merge as the market matures.
To help make sense of the current situation, Oil & Gas Middle East spoke to George Booth, Partner at Clyde & Co.
Booth is acting for Russian Oil giant Lukoil, which operates the supergiant West Qurna II concession and is currently awarding service contracts, and for another international oil company operating in the South.
In Kurdistan, he acts for Mass Global, a company developing improved electricity supply for the region, and is working on joint venture agreements for oilfield services sector clients across Iraq.
“Notwithstanding the lack of a legal framework for the upstream oil and gas industry, IOCs been persuaded that this is a country they want to be in,” says Booth. “We deal with sophisticated clients who are aware of the risks.”
They key is for companies to know what their legal risks are can mitigate them as much as possible. The first step is to ensure due diligence is done on the license that underpins field development all the way down the contractual chain. This has to be done whether an oil field is covered by Baghdad or Erbil.
“You are looking at a unique environment in Iraq which does require a complete due diligence exercise,” says Booth. “You also need to have a deep understanding of how things work in Iraq, and a sensitivity to where Iraq has come from over the last eight years.”
Broadly speaking, at present, says Booth, “the contract is king. Companies have to rely almost exclusively on the terms of the technical services contract or production sharing contract. There is not a great deal outside the contract, which is of a great of assistance in interpreting your rights.”
Draft oil laws
The need for oil companies – and therefore for the firms servicing them – to understand their legal position has been thrown into relief by the clash of draft Oil Laws issued by the Iraqi Cabinet and Parliament respectively, both of which were released this year.
The Cabinet’s draft predictably affords greater power to the Iraqi executive than the Parliament’s draft. It would effectively put the Oil Ministry in charge of almost all of the aspects of the upstream sectors’ development, and would guarantee a seat for the Deputy Prime Minister on the federal oil and gas council while removing a previous provision that guaranteed representation for Kurds, Shi-ites and Sunnis.
The Cabinet draft also aims to reduce the KRG’s powers in particular, drafted to give the Oil Ministry the exclusive authority to conduct the bidding for most oil and gas fields, including those currently administered by the KRG.
The Kurds – whose parliamentary party in Baghdad holds the balance of power in Parliament, currently keeping Prime Minister Nuri al Maliki in government, say such centralisation breaches the government’s constitutional responsibility under Article 112 to jointly manage oil fields, and have threatened to rescind support for the government if the issue is not resolved.
Both draft laws provide for a contract review process of all current oil exploration and production contracts – including ones made with the KRG – with the power to amend contracts that do not (1) accord with the constitution or Oil & Gas Law or (2) do not, in the words of the Cabinet’s draft, “achieve the highest economic benefit for the Iraqi people.”
The first is more straightforward, but the later clearly raises considerable commercial uncertainty, as the appropriation of the interests of ‘the Iraqi people’ by politicians to date attests.
In a shifting legal landscape, Booth advises oil firms to ensure they understand the legal situation at the time a contract is executed and prepare to defend existing contracts.
The fourth oil field auction (see page 8) could bring Iraq’s legal limbo to an end. “The Energy Committee is recommending that no new oil deals are signed until an oil law in place, and yet at the same time you have the fourth round underway with pre-qualification complete and quite
an aggressive timetable set,” says Booth. The need to pass an oil law may delay the bidding – slated for March – but bidders can’t bet that the legal framework being resolved before bidding on exploration blocks.
Kurdistan
The issue is not an abstract one for the KRG, which has signed production and sharing contracts (PSCs) with dozens of independent oil explorers under its own regional oil laws, starting with DNO’s deal for the Tawke Field in 2004. Baghdad’s failure to recognize their contracts has cost the KRG – and independents like DNO that are now producing – millions of dollars a day in revenue.
The KRG shut down exports from October 2009 to February 2011 over the issue. In 2008 the Kurdish Regional Government obtained a legal opinion from Professor James Crawford, a senior UK barrister and academic, via international law firm Clifford Chance.
Crawford’s opinion was clear: that the KRG’s own Oil & Gas Law is constitutional and is effective to govern the development of oil & gas in the Kurdistan region for currently producing fields, and that “the authority of the KRG to authorize the conclusion and implantation of new contracts is unqualified.”
Crawford’s opinion is based on the reasoning that, because there were no producing fields before the constitution was enacted, the joint management of fields between the KRG and Baghdad “appears to be limited to oil and gas after it has been extracted, on which basis the management of the extraction and production process itself falls outside the federal joint management power.”
Crawford’s opinion also tackles the 2007 draft Oil Law, which was prepared for the Bush administration to hand to the Iraqi government by BearingPoint, a US consultancy, and on which the various political factions in Iraq agreed in 2008, only to fall out.
Crawford states that the draft 2007 law would be unconstitutional, as it removes the responsibility to manage fields from the KRG, relegating it to a tax-collecting body. On this basis, Crawford says “it is difficult to see how and investor could rely on the proposed Law to protect investments.”
Crawford’s opinion on the 2007 draft is significant because it applies even more strongly to the Cabinet draft of 2011, giving the KRG confidence in its position. Independents in Kurdistan cite Crawford’s opinion to investors as evidence that their rights to profit oil under Kurdish PSCs will, ultimately, be safe.
Nor for turning
The Iraqi government is equally confident of its opposition position, namely that all PSCs are illegal because they divest interests in Iraq’s oil from the Iraqi people, and so must be converted to technical services contracts of a type signed in the south’s previous bidding rounds.
Hussain Al-Sharistani, Iraq’s Deputy Prime Minister with responsibility for energy, recently emphasised Baghdad’s hard line on the issue. On 10 October he said: “the contracts as they stand will have to be presented to the government and brought into line with our other contracts.”
Asked if he thought the Kurdish contracts were unlawful, Sharistani replied “Yes, as far as the Iraqi government is concerned those contracts are not binding with Iraq.”
This position is anathema to Erbil, which could not attract the independents it has without the lure of profit oil and the ability for those companies to book reserves in order to raise capital for field development.
Meanwhile, Baghdad continues to effectively blacklist oil firms which do business with the KRG. In September, US firm Hess was booted out of the fourth bidding round on the basis of operating the Dinarta and Shakrok fields.
Ultimately a solution is more likely to struck in political negotiations than handed down by an constitutional judge, and in the meantime, oil companies are happy to press into Kurdistan, confident that one day a slice of the region’s profit oil will be theirs.
More than Kurdistan’s quasi-independence, the impending fourth round of bidding for oil concessions is likely to bring the vexed issue of the Oil Laws to a head.
