Iraq’s oil legacy

Iraq, after Saudi Arabia and Canada, has the potential to become the third largest oil producer in the world, with an estimated 115 billion barrels of proven reserves.

It is estimated there is up to another 100 billion barrels of oil reserves in the Western Desert of Iraq. The current Iraqi administration is now making overtures to multinational companies, providing a quasi-legal framework for cooperation to explore certain areas of Iraq for untapped oil reserves.

Overview

Iraq has around 80 fields, although only 17 have current production. The most important being Kirkuk in the North and Rumailah in the South. Most of Iraq’s producing oil fields are to be found in the South. These producing fields are concentrated in the south – east of the country around the city of Basra near the Arabian Gulf.

Nevertheless, it should not be forgotten that Iraq’s oil and gas industry presently accounts for 95% to 98% of Iraq’s gross national product by some estimates which will form Iraq’s federal budget and help to fund economic regeneration and the country’s reconstruction.

I understand that at the time of writing this article, Iraq has finally ratified the federal budget for the next fiscal year of US$70 billion.

Since the imposition of UN sanctions in the 1990s, oil smuggling, particularly in the South of Iraq since the US-led occupation in 2003, has until recently become a serious problem for the Iraqi Government as a result of ineffective administrative control over the oil fields in the South.

This problem was exemplified in the form of the standoff between the central government and Sadrist militias who exert considerable influence in the South with historical ties to Iran.

However, the Maliki administration, bolstered by rising oil prices, has retaken the south’s oil fields and ports by stealth and purged senior management at the South Oil Company – which is Iraq’s largest crude producing unit.

This development has surprised and seemingly annoyed the US Government. It is claimed the US has responded to Baghdad’s manuouvreres by directing some of their military spy satellites on Iraq to anticipate any future deployments by the Iraq army.

It is interesting to note that Iraq’s administration under the Coalition Provisional Authority promulgated legislation in many areas, but such legislation did not affect the oil and gas industry.

Perhaps world opinion and the US obligations as an occupying power under the Hague conventions, in particular the remit of an occupying power’s authority to legislate in an occupied country had something to do with the former CPA’s untypical restraint in promulgating local orders.

Following the handover of sovereignty to the Iraqi Government, political battle lines were quickly drawn over the issue of Federal as opposed to regional control of the country’s oil and gas resources (including untapped oil fields) and distribution of revenue.

Constitutional shortcomings

The political schism, coupled with the need to quickly establish political consensus following the handover of authority to a new and untested Iraqi Government post Saddam, led to the ratification of an Iraqi constitution in 2005.

It can be argued that ambiguities in the drafting of the constitution, particularly the issue of ownership of oil and distribution of revenue, was deliberately intended due to increasing US pressure to establish consensus amongst the various Iraqi political parties.

This assessment gave political parties the flexibility to agree at a future date the intrinsic relationship between sovereignty and control over Iraq’s resources and the need to give the fledgling Iraqi government some semblance of credibility.

The ambiguities in the 2005 constitution inevitably led to accusations and counter accusations between the Kurdish Regional Government and the Federal Government as to what the constitution meant in relation to regional authority over oil producing assets and untapped assets in the North.

The friction culminated into a dispute over the interpretation of a draft federal oil and hydrocarbon law issued in February 2005 over these issues.

The intention behind the federal oil and hydrocarbon law is to allow, for the first time since nationalisation, foreign investment in Iraq’s upstream oil and gas development.

This divergence of views under this draft law led to the KRG introducing their own oil and gas law in August 2006.

Resisting pressure from the Federal Government as to the alleged unconstitutionality of the KRG entering into oil contracts with foreign companies, an emboldened KRG have made deals with junior IOCs such as DNO (Norwegian company) and Talisman Energy (Canadian company).

The KRG’s rush to sign contracts with IOC’s (albeit junior players) may be an viewed in some quarters as an attempt to increase their leverage with the central government over the proposed and stalled federal oil and hydrocarbon law once discussions seriously intensify between the parties.

It could also be viewed as part of the KRG’s desire to create an internationalised industry and considerably bolster the KRG’s budget which could prove very useful to the KRG in the long term when the issue of Kursdish regional autonomy may once again rear its head.

The Federal Government would appear for now to have left the issue of constitutional ambiguity for the Iraq’s Supreme Court to finally decide on. There has been a muted response from the KRG.

There have though been official reports coming from Baghdad that the Federal Government and the KRG are in private consultations to resolve their differences with a view to resolving issues such as revenue sharing mechanisms and the reconstitution of the Iraq National Oil Company to help narrow the gap between the parties differences.

It is anyone’s guess whether agreement between the parties on issues such as revenue sharing may be reached this summer. We have been here before and if last summer is anything to go by, we may see this crucial issue drag on into 2009.

Central control

Baghdad’s creeping dominance in the oil industry in Kurdish north have perhaps led the KRG’s PM Barzani to enter into shuttle diplomacy with Baghdad given that the KRG are only able to export a small amount of their upstream capacity.

Given Iraq’s tumultuous recent history, and based on my recent dealings with high level players within the Iraqi administration, I can confidently state that there would appear to be general consensus in principle among most major political factions that foreign investment in the oil and gas industry in Iraq is vital for Iraq’s future.

It remains to be seen whether the Iraq National Front (a recently established Iraqi political party comprising of Sadrists and supporters of the ex-Prime Minister Iyad Allawi) will disrupt or even undermine the consensus.

The Federal government for the first time in Iraq’s 36 year history is in the process of negotiating technical service contracts with major oil and gas companies designed to boost existing oil production in certain parts of Northern and Southern Iraq.

The anticipated TSCs will symbolically mark a radical transition in Iraq’s hydrocarbon industry as well as a concerted attempt by the central government to centralize management of its main industry.

For those not familiar with oil industry contracts, suffice to state that TSCs are a type of service contracts which are designed to provide improvements in technology and related management systems as well as training.

Given the current security situation in Iraq, TSC’s are to be performed from outside Iraq which poses serious practical limitations for all parties involved.

I am currently advising one of my clients, a top three oil and gas multinational company on two of six TSCs currently let by the Ministry of Oil. As a UK qualified projects lawyer, these transactions have raised interesting as well as challenging multijurisdictional issues without apparent legal or commercial precedent.

These issues have included the limits of sovereign power, security for payment (set off under existing UN resolutions on Iraq), site risks, limitations and exclusions of liability, the extent of the applicability of force majeure and arbitration under ICC rules and their interaction with Iraqi laws (legislated under the government of Saddam Hussein) to name but a few.

Another commercial consideration which IOC’s are trying to achieve to gain a stronger foothold in the industry is whether the TSCs will be linked to the forthcoming licensing round.

The response from Baghdad to IOC’s on the current stalled negotiations of IOC’s is that remuneration to IOCs should be based purely on a consultancy fee basis rather than a share of Iraq’s oil so as not pre-empt the more important licensing round to enter into long-term contracts to develop Iraq’s oil and gas fields.

In respect of Iraq’s general energy policy, it should be remembered that historically Iraq was one of the five founding members of OPEC. Due to its difficult history Iraq has not been able to consistently meet or benefit from its OPEC quota.

Indeed, this was one of the reasons given by the former regime in attempting to justify Iraq’s invasion of Kuwait in 1990.

Nationalisation of state-owned enterprises which are controlled and managed by the Ministry of Oil continues to this day. This position has been arguably reinforced by the 2005 constitution.

The draft federal oil and hydrocarbon law (if passed) is likely to radically overhaul the oil and gas industry by making foreign investment in the industry a central feature of both central and regional government policy for the foreseeable future.

The general legal framework regulating Iraq’s oil activities including those relating to TSCs are contained in various Federal Laws which preceded the Baath party’s rise to power and which were passed during Saddam Hussein’s tenure in office.

These Federal laws currently provide the framework for oil activities in Iraq.  It is currently envisaged this law will either be supplemented or repealed by the draft federal oil and hydrocarbon law, though whether the current draft federal oil law will be ratified in its current form is far from certain.

Legacy issues

In one of history’s ironies, the current legal framework as a legacy of Saddam Hussein for now represents an acceptable half-way house for both the KRG and the central government to develop their oil industries!

The 2005 Constitution provides the underlying framework governing the in rights and authority of the Federal Government and Regional Governments in relation to the ownership of oil producing assets.

A law issued under the Saddam Hussein admnistration confers licenses to state owned entities under the auspices of the Ministry of Oil such as the South Oil Company to conduct petroleum activities.

The main government regulatory and oversight body is the Ministry of Oil, which oversees and manages state-owned companies responsible for all upstream and downstream aspects of the oil and gas industry.

Appeals of Government decisions are dealt with under dispute resolution procedures pursuant to contracts entered into between the Government and international oil companies or service companies.

Although contracts with Government entities are typically subject to Iraqi laws, Iraqi laws allow (under certain requirements) for foreign laws to be the governing laws and permit arbitration under international rules such as the ICC.

Resource ownership

Regarding ownership over oil reservoirs, the state holds title over oil reservoirs and the vast majority of land in Iraq is state-owned.

The 2005 Constitution stipulates that oil and gas producing assets are owned by all the people of Iraq in all its regions and provinces, and obliges the federal and provincial or regional governments to fairly distribute oil and gas revenues.

Furthermore, there is no clear legal distinction under the 2005 Iraqi Constitution between surface rights and subsurface mineral rights which is the subject of a current debate between the Kurdish Regional Government and the Federal Government.

Despite currently having among the largest proven reserves of oil in the world, it is estimated that only 20% of Iraq’s reserves have been open to coordinated and intensive exploration. Iraq has around 80 fields, although only 17 have current production.

These producing fields are concentrated in the southeast of the country around the city of Basra near the Arabian Gulf.

New exploration is a priority for the Federal Government to identify resources in under-explored areas fields. The Iraqi Government has pre-qualified about 41 international oil and gas companies who shall now apply to obtain licenses from the Ministry of Oil in order to explore and assist in oil extraction production. Pending the issuing of licenses, Iraq’s oil fields are strictly off limits to exploration and production.

Regulatory framework

In terms of regulation of oil exploration and production, for the time being, the state-owned ‘Oil Exploration Company’ is responsible for coordinating oil production through three state companies, namely: The North Oil Company, South Oil Company, and Central Oil Company.

The Ministry of Oil had drawn up plans to tender concession blocks to international oil companies. However, such plans are not likely to be implemented until the adoption of the draft federal oil and hydrocarbon law.

In addition, there is the Kurdistan National Oil Company, established by the KRG which is responsible for regulating oil exploration production in the Kurdistan region.

Iraq in geographic terms remains landlocked with its neigbours save for the outlet to the Arabian Gulf, near Basra. Offshore boundary disputes with Kuwait and Iran have limited the actual potential for offshore production.

Domestic reservoirs are state-owned. At present, there are no agreements between the federal and provincial or regional governments with respect to reservoir unitization.

The Federal government of Iraq recently announced plans to develop oilfields straddling the border with Iran and to pump Iraqi oil to Iran for refining. The Federal government is likely to seek similar arrangements with Syria and Kuwait.

Historically, unitisation of cross-border oil and gas fields was handled through the law of capture (legal concept which entails ownership of petroleum on production), and was a precipitating factor in the 1990 Iraqi invasion of Kuwait.

Labour pains

As the Iraqi oil and gas industry is currently nationalised, few foreign workers are officially employed by state entities. The Iraqi labour law currently regulates all oil industry labour.

The Ministry of Oil also applies its own regulations, in particular to the state-owned enterprises in the oil and gas industry.

The Labour Law contains general provisions guaranteeing equal employment opportunities to all citizens without discrimination with regard to sex, race, language or religion, and also recognises equal wages for equal work.

It should be noted that at present, the Labour Law is currently not strictly enforced and may be even argued to be in a state of flux, subject to rapid and dramatic amendment.

Ratification

Once the TSCs are signed, the next important development in the oil industry would be the anticipated licensing round under the auspices of the Ministry of Oil following the recent prequalification of about 41 oil and gas companies which would enable foreign companies to explore undiscovered oil fields.

It is also anticipated that the Ministry of Oil are likely to invite IOCs to develop Iraq’s small oil fields in 2009 though this is not certain.

The implementation of the long-awaited Federal Oil and Hydrocarbon Law, once ratified, will entitle foreign companies for the first time to participate and invest in upstream oil and gas activities.

In terms of a mandatory price-setting regime for crude oil or crude oil products, Iraq is a member of OPEC. Accordingly Iraq should abide by OPEC price-fixing policies for crude oil.

However, domestic prices for crude oil products like gasoline are controlled by the Government and are heavily subsidised. Non compliance with a price setting regime since 2005 now comes predominantly in the form of oil smuggling, the penalty for which is dealt with under the penal code.

With respect to Iraq’s regulatory policy being affected by international treaties or other multinational agreements, Iraq has recently become a signatory of the Multilateral Investment Guarantee Agency.

Once the draft Federal oil and hydrocarbon law becomes enacted, Iraq’s membership to MIGA would (in theory) protect foreign companies against the risk of expropriation, war and civil disturbance.

Closing statements

Iraqi nationals are now in a race against time to rebuild their cities using oil revenues whilst oil dependant industrialised nations are increasingly dependant on oil as a panacea to their economic ills and to increase their stake in the emerging geopolitical landscape of the early part of the 21 century.

It remains to be seen whether foreign major players with a political/socio/economic stake in Iraq will be conducive in helping Iraqis regain control over their industry and improve the prospects of sustained long-term reconstruction and the country’s rehabilitation on the world stage or whether Iraq will remain a quasi political/religious/economic battleground as it has arguably been for the past 50 years.

Subject to an improved security situation, and the outcome of the current standoff with Iran, and against the apparent odds, I will remain in the optimists’ camp given the ancient proverb that it is “better to light a candle (of hope) than to continually curse the darkness.”