Oil and Energy Trends, 18 April 2003

Contents

• Focus: War in Iraq: it is about oil

Focus: War in Iraq: it is about oil

• Invading Iraq
• Destroying Iraq
• Restructuring Iraq
• Reviving the oil fields

The US-led invasion of Iraq has several causes that have little to do with oil; but considerations about oil are beginning to dominate the discussion about what happens in Iraq when the war is over.  American plans for the reconstruction of Iraq will rely heavily on revenues from the export of oil.  The opening-up of Iraq to foreign oil investment will offer some of the most tempting upstream opportunities in over a decade.  A sharp rise in Iraq’s oil production, however, threatens the pricing strategy—and, ultimately, the existence—of OPEC.  How far any of this will happen depends not so much on how rapidly the coalition wins the war but on how quickly it can win the peace.

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Invading Iraq

The war progressed quickly at the start, notwithstanding some delays to the US attack on Baghdad, which became bogged down for a time at Nasiriyah.  By the second week of April, the British were substantially in control of Basrah, the southern oil fields, and ports, while US forces were in central Baghdad.  Oil markets reacted to military events, rising or falling respectively on bad or good news about the coalition’s progress through Iraq.  US defence secretary Donald Rumsfeld created alarm and despondency by accusing Syria of providing ‘military supplies’ to Iraq and threatening unspecified reprisals.  Oil markets looked for reassurance to secretary of state Colin Powell, who tried to repair relations with countries frightened or offended by Mr Rumsfeld and his fellow hawks.

An early objective of the coalition forces was to prevent the destruction of oil production facilities by Iraqi forces.  Fears were expressed that large numbers of wells would be set on fire, as happened in 1991 when the Iraqis retreated from Kuwait.  In the event, there was little damage reported, though an estimated seven wells were set on fire in the Rumailah oil field, which lies close to Basrah.  The northern fields of Kirkuk escaped major damage at the start of the war.

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Destroying Iraq

There is nevertheless some damage to both Iraqi oil fields and the upstream infrastructure of pipelines, storage, and terminals.  All exports via the Persian Gulf terminal of Mina al-Bakr ceased at the start of the war.  Oil continued to flow from Kirkuk to the Turkish Mediterranean port of Ceyhan, but tankers were unable to load following the suspension of the United Nations’ oil-for-food programme at the start of the war.  All crude loaded at Ceyhan is governed by the provisions of the programme.  The UN and US authorities were unable to agree who should be in charge of Iraqi oil sales following the invasion.  About 8 mn bbl of Iraqi crude therefore ended up in storage in Ceyhan.

The loss of Iraqi exports has had little effect on world markets since the start of the war coincided with the seasonal fall in demand.  World oil demand in the second quarter is likely to be 1.6 mn bpd below first quarter levels.

Two countries, however, have been affected.  Jordan, which relied on Iraq for all its oil imports, has had to arrange for supplies from Saudi Arabia, Kuwait, and the UAE.  Iraq supplied 82,000 bpd of crude to the Zarqa refinery, near Amman, along with a further 20,000 bpd of refined products (see Table A).  Jordan’s deliveries were made outside the oil-for-food programme.

The other country affected is Syria.  Iraq supplied some 200,000 bpd of crude, also outside the UN programme, via a pipeline from Kirkuk to Banias.  The Iraqi imports allowed Syria to maintain its crude exports at a high level despite falling domestic production (see Table 4.4d).  Syria’s March 2003 exports were a record 450,000 bpd.  April’s exports look like being in the region of 330,000 bpd, and May’s will probably be even lower.  The US will be anxious to restart oil exports as soon as possible.  How quickly such exports can be restored depends in part on the state of Iraq’s oil fields and their associated infrastructure.

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Restructuring Iraq

Once the oil fields have been secured by the military and installations cleared of mines and booby traps, the US Army Corps of Engineering (USACE), assisted by civilians from US engineers Kellogg Brown & Root, will examine the fields and draw up plans for their return to production.  It may, however, be some months before exports resume.

Although the wells appear to be more or less undamaged in the south of the country, pipelines, gas–oil separation plants, and other infrastructure are reported to be in poor condition, though in many cases this is likely to be as a result of UN sanctions since 1990 rather than because of recent war damage.  There is also a shortage of Iraqi personnel to operate the fields and infrastructure since many of these have fled the area.  Some parts of the infrastructure are still damaged from the last Gulf War, such as the Faw export terminal, and the offshore terminal at Khor al-Amaya.

USACE will be in immediate charge of rebuilding Iraq’s oil production and oil infrastructure, including the extinguishing of any oil well fires.  Other aspects of the post-war reconstruction will be supervised by the US Agency for International Development (USAID).  Many countries have called for the UN to be involved as well, but the US is against the UN’s having a major role, since most of its members were opposed the war.  There is widespread belief that most post-war reconstruction contracts will go to US companies.  The UN will nevertheless have to be involved on some level.  In the first place, it will require a UN vote to end the sanctions that have been in operation since 1990.  It will also require agreement between the US and the Security Council before oil exports can be resumed.  Following the suspension of the oil-for-food programme on 17 March, the UN has agreed to take charge of the humanitarian aid programme that formed part of the oil-for-food deal.  It is still not resolved, however, who should have authority over the export of oil.  Oil companies will be reluctant to take Iraqi oil until the legal and administrative issues connected with exports are settled, for fear of subsequent legal claims over the ownership of the oil.  These issues not only affect future exports but also existing contracts to buy Iraqi oil.  An estimated 210 mn bbl remain to be lifted under contracts signed with the government of Saddam Hussain.

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Reviving the oil fields

Oil exports will not simply have to be restored: they will have to be increased, probably substantially, to pay for Iraq’s post-war reconstruction.  Iraq may also receive some foreign aid, though this may not amount to much.  Most countries are unlikely to offer aid unless the UN is directly involved in the post-war settlement.  Moreover, economic conditions in the main industrialized countries suggest there will not be much largesse to distribute to Iraq in the near future.

If Iraq is to be rebuilt substantially with the aid of its oil revenues, a large amount of reconstruction will be required in the upstream sector.  Before the war, Iraq was capable of producing about 2.7 mn bpd, of which 1.0 mn bpd came from the northern fields centred on Kirkuk, and the remainder from central and southern Iraq, principally from the southern fields of North Rumailah (0.5 mn bpd) and South Rumailah (0.7 mn bpd).

During the 1990s, the Ministry of Oil announced plans to raise production to 3.4 mn bpd by 2000, subject to an easing of UN restrictions on imports of equipment.  These plans were never realized and USACE inspections of some southern fields suggest that the fields are in a poor state as a result of years of sanctions and neglect.

Iraqi opposition groups vying to take over the government have indicated their desire to raise production to 6.0 mn bpd (which was also the old regime’s medium-term target).  The Iraqis may nevertheless have to settle for a much more modest target over the next few years.  As a first step, they will need to rehabilitate the main producing fields at Kirkuk and Rumailah.  Both field complexes are mature and face decline without urgent attention.  Kirkuk is probably the more vulnerable of the two, but both require the drilling of new production wells and work to remedy problems with secondary and tertiary recovery.  Their problems are similar to those in some Iranian fields that were neglected during the years following the 1978 revolution (see ‘Looking Ahead’).  Iran’s upstream industry has still not fully recovered from that period.

The infrastructure also needs to be rebuilt: not just the production facilities but the export pipelines and terminals as well, parts of which have remained damaged or inoperative since the Gulf War of 1990–1.  The two pipelines from Kirkuk to Ceyhan, for example, can only operate at 56% of their combined 1.6 mn bpd capacity owing to the lack of pumps.  In the south, most of the 1.2 mn bpd Khor al-Amaya marine terminal is out of action.  The pipeline connecting the northern and southern fields also requires upgrading.

Once Kirkuk and Rumailah have been stabilized, the new government can consider increasing production at some of the newer fields and, ultimately, bringing on fields that are not yet in production.  This will involve similar technical considerations to those outlined above; but there are several legal and political issues to be resolved as well.  The old Iraqi government signed a series of agreements with foreign companies to expand existing fields or open new ones (see Table B).  Under UN rules governing sanctions, no work was permitted until sanctions were formally ended.  US and Iraqi opposition sources, however, have hinted that such agreements may be renegotiated.  Iraq excluded US firms from these upstream deals and Washington is keen to see its own firms readmitted to Iraq.  Iraqi opposition members claim that the agreements themselves are overgenerous to the oil companies and need to be modified.

France’s TotalFinaElf has held talks with the US government in an attempt to ensure it is not excluded from any post war settlement.  Russian companies are also lobbying hard to remain in Iraq.  Both France and Russia opposed the US-led war with Iraq.  Russian companies are seen by Moscow as a means of preserving Russia’s long-standing political and economic involvement in Iraq dating primarily from the 1970s.  Russia, like the USSR, is anxious to retain a foothold in the Middle East.  It also has a strong economic motive to do business in Iraq, since it is owed some $8 bn by Iraq in debts dating from the Soviet era.

Companies wanting to fulfil their Iraqi contracts claim legal backing for their agreements.  In some cases, however, the Iraqis have muddied the waters by trying to alter certain of the deals.  Last December, for example, the Iraqi government cancelled Lukoil’s contract for the West Qurnah field on the grounds that the Russian company had failed to carry out the work specified in the agreement.  Lukoil countered that it was prevented from doing so by UN sanctions.  Baghdad tried to pressurize other companies into carrying out development work in defiance of UN rules, breaking off negotiations with TotalFinaElf over the Nahr Bin Umar field in favour of a proposed deal with Russia’s Zarubezhneft.

In all discussions of post-war reconstruction, it appears to be assumed that the new government will favour foreign (especially Western) companies.  The same assumptions were made about Kuwait in 1991 following the emirate’s liberation by a US-led coalition.  Since then, though, strong political opposition inside Kuwait has kept foreign companies out.  There is no reason to suppose that there will not be powerful opposition amongst certain sections in post-war Iraq to foreign involvement in oil production.

It may take many months to sort out the legal issues connected with Iraq’s upstream sector.  Carrying out the work will take longer still.  Many oil companies will be nervous about Iraq’s stability after the war and may delay their involvement until the political risks have subsided.  Financing the reconstruction of the oil sector could prove a further problem.  The projects announced already (see Table B) amount to more than $40 bn in investment costs.  On top of this, Iraq has foreign debts of nearly $100 bn, as well as owing Kuwait $23 bn for war reparations.

Projects announced by the government of Saddam Hussain amount to more than 4 mn bpd of new oil production.  They are unlikely to be realized in full before 2010.  On the other hand, once output has been stabilized in Kirkuk and Rumailah, it should not be difficult to bring another 1.5 bn bpd on-stream within a few years, giving Iraq a production capacity of 4.0 mn bpd by 2007–8.  This could pose considerable problems for OPEC.  Given its revenue needs, Iraq would be most unlikely to want to shut in any of its capacity.  Other OPEC countries, such as Iran and Kuwait would themselves be unwilling to accommodate Iraq without a rise in their own quotas.  Higher quotas would mean lower prices, which would put OPEC under further strain.  Some US policy-makers would see the end of OPEC as no bad thing, especially if this were to be brought about by a democratic pro-Western Iraq.  The rest of the Middle East is unlikely to let this happen without a reaction of its own which could, in some cases, be as hostile as Iraq’s once was to the outside world.  Peace could be a long way off in the Persian Gulf.