Middle East Economic Survey

VOL. XLIX

No 18

30-Apr-2007

Iraq’s Petroleum Law: Politicized Management Vis-à-Vis Optimal Resource Management

The following article was written for MEES by Tariq Shafiq, Founding Executive Director, Iraq National Oil Company (INOC), Director, Petrolog & Associates, and Chair, Fertile Crescent Oil Development Co (based in Baghdad).

The first draft petroleum law which I and my two colleagues Thamir Ghadhban and Faruq al-Kasim had the honor of preparing attracted unfounded politicized criticism in the media based mostly on speculative unpublished material. With the appearance of the leaked versions, followed finally the publication of the government Draft Petroleum Law of 15 March 2007, as well as the declaration by Iraqi oil professionals, the criticism become more realistic and has built up a momentum which remains with us to this date.

We all know that the 15 March draft was the result of months of discussions which took place among members of a ministerial committee. The discussions were long mainly because of the divergent stands between the Federal Government and the Kurdistan Regional Government (KRG) over the constitutional interpretation of the articles governing the oil and gas assets in the Constitution. KRG interprets Article 111 of the Constitution as meaning that the oil and gas assets in Kurdistan are owned by the Kurds, while the article states the oil and gas are the property of the whole nation, and adds, for emphasis, in all the regions and governorates.

To resolve the dispute, a number of concessionary changes to the first draft were made under external pressure and to meet the KRG ive to secure as wide as possible authority consistent with its de facto confederal state. The changes, in the main, have radically modified the decision-making process concerning the granting of exploration and development rights, the tasks of the Ministry of Oil (MoO), and the make-up and tasks of the Federal Petroleum Commission (FPC) and the Think Tank (Petroleum Advisory Council). The responsibilities and tasks of the MoO were reduced and passed mainly to a Federal Oil and Gas Council (FOGC) and some to a newly established Regional Units, while the Petroleum Advisory Council was renamed the Independent Consulting Bureau (ICB) and downgraded.

It is regrettable that:

1. The process of negotiation took the nature of the familiar politicized Muhasasah [accommodation by compromise] over a period of over eight months. By the nature of this political accommodation, and as past experience has repeatedly demonstrated, the concessions that were made served primarily the interest of the parties concerned.

2. These political accommodations have fragmented and weakened the central ive of the first petroleum draft: that of a unified and balanced oil resource management policy run from the center by the federal authorities, not only in cooperation with (required by Article 112 of the constitution) but also, in many instances, through the participation of the regions and governorates.

3. These concessions have produced a petroleum law that contains imprecise provisions, and has created several new management entities with authority for many critical issues at the expense of the first draft ive of balanced and unified plans, policies and decision-making processes.

4.  What has been given to the KRG today is bound to snowball vertically and horizontally, with damaging consequences to the effective management of resources and the unity of the country.

5. This latest draft law has some points on the credit side, such as the fact that all revenues and exports are placed under federal control, and INOC manages the pipeline network and has a reasonable share of, though not all, the discovered fields to operate. But, there are quite a few points on the debit side. The law has too many ambiguous procedures, with numerous parties and processes involved in decision-making that could easily create more problems than they solve. The decision-making path is long, tortuous, and ineffective. It is open to malpractices and short on effective checks and balances, and transparency. For example:

5.1     Final decisions regarding such matters as the choice of operator and approval of development plans subsequent to a discovery, both of which are vital to successful and efficient development and operation, are left to the regions, even though at this stage they lack the necessary institutions, while the development of the required expertise is at the embryonic stage.

5.2     The prequalification of companies to bid, and the negotiation of contracts, are in the hand of the regions (of which there is only KRG for the time being) and the MoO or INOC. Their finalized and initialed contracts are then examined by the FOGC and finally (this may or may not be the case) sent to the ICB for advice. The initialed contracts may even be rejected if the FOGC judges that the company, at this late stage, is not qualified to bid. The authority and responsibility of each unit in the process could overlap with the next. And, above all, the process lacks the necessary checks and balances, accountability and transparency. What happens if agreement can not be reached between the federal authorities and the regional ones is left entirely to speculation. Oil companies, including INOC, will have difficulty performing under such ambiguity.

5.3     The potential “immediate” implementation of the 65 exploration blocks is unnecessary, untimely, divisive and not in the national interest. After all, Iraq’s present oil reserves can build a production plateau of 10mn b/d and maintain it for well over a decade without the need for one additional barrel of oil. Considering that Russia produces around 9.5mn b/d, while its reserves are around 74bn barrels, one wonders why Iraq, with 115bn barrels of reserves and a production of only 2mn b/d, needs to urgently supplement its reserves by exploring all its potential reserves of some 215bn barrels through 65 oil and gas exploration contracts destined for international oil companies (IOCs).

5.4     While all revenue is earmarked to the whole nation, this may not necessarily be the maximum revenue as long as the management of the resources is not optimal. For example, the allocation of exploration and development projects on a geographical/regional basis could not be equated to an optimized exploration and development plan for the whole nation. An optimum management plan can only be based on unbiased allocation after assessing the whole resource and infrastructural base of the country. Besides, fragmentation of the government’s regulatory functions will inevitably lead to sub-optimal and divergent practices that will prove harmful to overall efficiency in managing the resources.

5.5     Unconstitutionally, some 26 discovered oil and gas fields have not been allocated to INOC and have thus been passed on to the regions and provinces at a time when these lack the institutions and expertise to negotiate or take complex managerial and technological decision. It is indeed questionable whether the regions and provinces could manage efficiently to develop, let alone manage well, Iraq’s potential reserves of some 215bn barrels.

By way of conclusion, the latest draft of 15 March has introduced some concessionary changes which are cumbersome, damaging and unworkable. The draft law could invite corruption on account of the expected lack of accountability and transparency, and the embryonic state of institutions in regions and governorates.

The first petroleum draft was crafted with full realization that:

1.    The constitutional articles governing the management of oil and gas resources lack clarity and consistency. This required that a neutral and ive interpretation be sought to provide the basis for the petroleum law. A competent legal authority was sought to provide such interpretation.

2.    Article 111 dictates that the oil and gas assets are the property of the nation. And, Article 112 made the oil and gas strategic policy contingent on achieving the maximum benefit to the nation. This made it mandatory that the most efficient exploration and development policy, and management plans be sought; and that any policy that did not lead to achieving the highest benefit, revenue and fringe benefits to the nation was not acceptable.

3.    But Article 112 requires that the strategic policy and management of the discovered fields be carried out by the federal government in cooperation or consultation with the regions and governorates. 

4.    The oil and gas geological reality is such that the proven oil reserves of 115bn barrels are housed in some 80 oil fields spread out unevenly and across provincial boundaries throughout the country. Basra, for example, holds over 50% of the country’s oil reserves and there are scores of fields crossing provincial boundaries. It becomes ever clearer in the interest of unity of the nation, that a unified and balanced policy run from the center is vital to avoid potential conflicts across borders and between those who have and those who have not.

5.    In the meantime, Article 112 continues with a complimentary statement which implies that the exploration and development for potential oil reserves of 215bn barrels are carried out by the regions and governorates.

6.    While it is imperative that the state continues to manage the discovered fields, future oil and gas exploration with subsequent development, if left entirely to management by the provinces, would cause undesirable and damaging consequences. Lack of institutions and uncontrolled total reliance on IOCs leads to, among other things, undesirable competition with the state’s own oil plans as well as among the provinces themselves. Worse still, as the proven reserves are exhausted, reliance on the IOCs will grow, leading to greater dependence on the foreign companies with all the undesirable consequence this entails, including the loss of the state’s economic sovereignty.

7.    In the absence of a radical corrective measure to the above mentioned constitutional condition, then and at the present time, the first petroleum draft sought cooperation and participation with the regions and governorates in many areas as a means of forging a unified policy and resource management from the centre.

8.    Optimum management of petroleum resources to produce the maximum benefit can only be achieved through unified plans, policy, regulatory practices and decision-making process. Efficient management of the resources and maximum benefit to the nation can be realized only when the plans and policy are designed to encompass the country as a whole and not any localized region or province in isolation from the rest.

9.    A radical solution to truly satisfy the ive of the overriding Article 111, where oil and gas is the property of the whole nation, was to insist that exploration and development of potential new resources should be managed in the same way as the discovered and proven oil and gas reserves. Amendment of the constitution would therefore be required to modify Article 112 to include the management of the exploration and development of new resources in the same way under the umbrella of the Federal Government.

10. But a compromise had to be adopted in order to balance the ambitions of the regions and governorates on the one hand and the stated and implied overall responsibility of the Federal Government – as the executive custodian of the whole nation – on the other hand. The compromise had to manage the petroleum resources at a high level of efficiency to ensure the maximum benefits to the nation.

11. Therefore a governance scheme for the petroleum upstream sector had to be devised. A central council (Federal Petroleum Commission, later renamed the Federal Oil and Gas Council) was created to act on behalf of the Council of Ministers, the ultimate executive authority, under the chairmanship of the Prime Minister. The Minister of Oil would assume the secretariat function, with other members at ministerial level, having the necessarily managerial qualities. To carry out their task, two administrative units were created: a Think Tank (named the Petroleum Advisory Council) of nine long-experienced members, including three nominated by the regions and governorates; and a specialized Negotiating Unit tasked with the vital process of organizing the process leading to the granting of exploration and production rights.

12. The MoO remained tasked with all its traditional duties of supervisory and regulatory roles in consultation and cooperation with the regions and governorates, while the fields’ supervision was tasked to the regional or provincial authority concerned, in coordination with the MoO.

13. The commercial roles were taken away from the MoO and charged to a national oil company (INOC) with the entire discovered fields ear-marked thereto. INOC was designed as a holding company. It was granted the rights to explore and develop the discovered fields, hold the state participation shares and enter into competitive bidding for new exploration and development projects. It would operate through affiliated companies in which the regions and the governorates could hold up to 50% participation. Directors of these operating companies would become directors of INOC and thus form the linkage with the regions and governorates through shared decision making at the holding company level. This was designed in order to permit the regions and governorates unreserved participation in the management of the discovered oil resource.

Thus the above simple and effective administrative changes were made to the existing upstream petroleum administration with clarity, efficiency, accountability transparency and consistency. The overriding ive has always been to achieve the maximum benefit to the nation.

The first draft petroleum law was built with the above principles in mind leaving no margin for subsequent political bargaining. The concessionary changes introduced into the latest petroleum draft of 15 March 2007 are definitely outside the context in which the first draft was written. In our opinion the compromises produced a draft with numerous drawbacks, falling sadly short of achieving the maximum benefit to the nation which is emphasized in the constitution.

The burden now falls on the shoulders of the members of Iraq’s Council of Representatives to set the record right by acting to amend the latest draft Petroleum Law for the sake of the nation, in all the regions and governorates, regardless of sect or ethnicity, to bring about the highest return in accordance with optimum resource management and the constitution.