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The following text is a summary of the proceedings of a special Middle East Institute conference on "Iraqi Oil after Sanctions." The event took place on February 29, 2000 at the National Press Club. MEI President Roscoe Suddarth delivered welcoming remarks, and the panel was moderated by MEI Vice President David Mack. v The participants in the panel included Fadhil Chalabi, Executive Director of the Center for Global Energy Studies in London and a former Iraqi oil official; Issam Al-Chalabi, a Jordan-based consultant who served as president of the Iraq National Oil Company and as Iraq's Minister of Oil until October, 1990; Walid Khadduri, Executive Editor of the Cyprus-based Middle East Economic Survey and a specialist on the Iraqi oil industry; and Vahan Zanoyan, President and Chief Executive Officer of Petroleum Finance Company in Washington.

Fadhil Chalabi: Iraq Oil in the Future Global Energy Balance

Chalabi discussed the future of Iraqi oil in the context of the future global oil market. First, he discussed the size of Iraq's potential oil production and its likely effect on the world market for oil. He noted that, due mainly to political factors, Iraq's oil is greatly underexplored and underdeveloped, especially relative to that of other Middle Eastern countries. Chalabi estimated that Iraqi production after sanctions could increase by more than three million barrels per day, through partnerships with foreign companies. In only five to ten years, he predicted, Iraqi oil capacity could reach eight, ten, or even twelve million barrels per day if new oilfields are discovered and exploited.

The key question, Chalabi argued, is whether world demand will be sufficient to absorb this large increase in production. He took issue with a number of analyses that forecast a "robust growth" in the call for OPEC oil in the next ten years. If demand indeed expands in line with these forecasts, the market will not become unbalanced. However, Chalabi doubted that this would be the case, for several reasons. First, a number of trends are creating downward pressure on world demand for oil. These trends include slowing global economic growth, the shift in growth to non-energy-intensive industries such as services and information technology, drastic reductions in fossil fuel consumption due to the Kyoto Protocol on climate change, increased fuel efficiency in transportation, higher taxation on gasoline in Europe, and increased substitution of natural gas and nuclear power for oil-consumptive power sources. Chalabi thus expected that world oil demand will not grow at a rate higher than 1.5% per year, adding less than one million barrels per day (per year) to the world demand. In addition, he noted that OPEC's share of the world oil market is declining, especially because of increased production of oil by countries outside OPEC through offshore drilling made possible by newer technologies.

As a result of these trends, Chalabi argued, "the world is living in a situation of oversupply," and this will only increase with the lifting of sanctions. He added that the sluggish demand for OPEC oil is exaggerated by OPEC's policy of acting as a producer of last resort in the world market. Chalabi concluded that OPEC will continue to find itself in a difficult position, as its capacity will increase by 6-7 million barrels per day (including Iraq) at a time when OPEC already has 6 1/2 million barrels per day of unused capacity. The present situation of oversupply means that "OPEC is reducing its production artificially to keep prices up." This policy, he suggested, will continue in the future.

Assuming, then, that demand will not increase to accommodate Iraq's increased production, Chalabi asked, "What will be Iraq's position vis-a-vis OPEC? Will it continue to be an OPEC member and restrict supply in order to keep prices up?" Chalabi said that, once sanctions are lifted, decision makers in Iraq will face a "difficult choice." On the one hand, Iraq could choose to stay within the OPEC framework (with some adjustments in production by other OPEC countries to accommodate Iraq's increased capacity) and seek to maximize its gains through a careful balancing of volume and price. Iraq would thus restrict production to keep oil prices relatively high. On the other hand, Chalabi suggested, "Iraq will need to produce every single barrel [possible] to reconstruct the country and repay the debts." Thus, he proposed, Iraq might choose to maximize production and rely on volume to produce income despite the drop in prices that would result. Iraq could win with this strategy, Chalabi said, because its production costs are so much lower than those of many other oil exporters.

In any case, Chalabi concluded, the end result of these global trends combining with Iraq's post-sanctions production increase may be a more competitive market in which Iraq will fare better than others because its production costs are so much lower.

Issam al-Chalabi: The Likely State of Iraqi Oil Industry After Sanctions

Al-Chalabi discussed the current grave state of the oil industry in Iraq and suggested some important priorities for post-sanctions policy.

He began by noting that, in the history of the Iraqi oil industry since the discovery of oil at Kirkuk in 1927, the industry only enjoyed about six years, from 1974 to 1980, with sufficient resources and freedom to develop. Using graphs to illustrate the changes in oil production over the past 42 years, he pointed out that Iraqi production has never since surpassed 1979's figure of 3.5 million barrels per day, representing the peak of the industry's development. The next highest figure, after the end of the Iran-Iraq War in 1989, was 2.968 million barrels per day. Al-Chalabi's conclusion was that the two Gulf Wars and the nearly 10 years of sanctions have prevented Iraq from developing its oil industry above the standards of the late 1970s. Thus, the oil industry in Iraq relies on technology developed in the 1960s and early 1970s, and has merely duplicated that technology in its subsequent development.

Al-Chalabi gave a brief account of the oil industry in Iraq at the time he left office in October 1990: production capacity was 3.5 million barrels per day, with projects under development to reach 4.2 million barrels per day by the end of 1990. The crude oil export capacity was 5 million barrels per day, with plans to expand capacity to 6 million barrels per day. Refining capacity was 700,000 barrels per day.

Since the sanctions were put into place, Al-Chalabi argued, the industry has deteriorated severely. The deterioration of equipment and fields is accelerated and heightened by the unavailability of necessary spare parts and by overproduction that threatens proper stewardship of Iraq's oil reserves. The speaker displayed charts showing a dramatic increase in Iraqi oil production since the 2nd Quarter of 1998 and another increase beginning in the 2nd Quarter of 1999, such that current production levels rest at about 2.81 million barrels per day.

At the same time, Al-Chalabi noted, the oil-for-food program enabled purchase of spare parts for the industry only beginning in Phase 4 of the program. He pointed out the great discrepancy between the number and value of contracts made for spare parts and the number and value of those contracts that were approved and actually delivered. Citing the increased production figures and Iraq's lack of spare parts the speaker surmised that Iraq has decided to maximize production with "complete disregard for proper well management... It was evident that the mode of operation would eventually cause damage to the reservoir, proportional to the size of overproduction and the periods of overproduction."

Al-Chalabi cited the Saybolt report to the United Nations Secretariat in Spring 1998 in describing the Iraqi oil industry as in a "lamentable state." Over the past several months the speaker said, production capacity has continued to decline at a rate of 4-8% of total production, while Iraq has continued to increase its total production. These facts, combined with the delay in arrival of spare parts for oil operations, has meant that well pressures have not been maintained at proper levels, which means that some known reserves may be irrecoverable. Al-Chalabi cited UN reports to the effect that 20% of the reserves in the north of Iraq have been irreparably damaged by this problem. Even Iraqi officials, he pointed out, now admit the damage occurring at Iraqi oil facilities. He argued that even if the losses are only of 1% of Iraq's reserves, that would translate to 11 billion barrels (conservatively speaking, perhaps $110 billion), far outweighing the $22 billion Iraq has generated through overproduction in the oil-for-food program.

Al-Chalabi said that the situation he described demanded immediate attention. He made a strong argument for the immediate delivery of spare parts, and insisted that better methods than the current one be found for overseeing and approving spare parts contracts in order to streamline delivery. "Every part is potentially dual-use," he noted, but a means must be found of controlling use without denying Iraq access to badly needed equipment.

The speaker also argued that Iraq must end overproduction and, when sanctions end, focus first on thorough field studies to assess and repair infrastructural damage. The next priority should be efforts to upgrade facilities for proper production, storage, and export. He estimated that the studies would require about two years to complete. Based on this assessment, Al-Chalabi opposed the notion that Iraq should focus immediately on the discovery of new fields to produce new income streams before the current damage is understood and rectified. Although the potential is clearly there for greater production, the speaker suggested that Iraq should wait at least a decade after the lifting of sanctions to rebuild the industry before it considers going down that path.

Later in the morning, Al-Chalabi again took the podium to discuss the means by which Iraq could take advantage of its potential reserves after the lifting of sanctions. He argued that increasing production and discovering and exploiting new fields would demand foreign participation, but that the country's electrical, water, and other societal infrastructures could not absorb a large number of foreign companies working at many different sites at once. A lack of skilled labor was a further barrier to aggressive foreign participation, he noted, since many of the oil industry's Iraqi experts and skilled workers have left the country and are unlikely to return immediately even if the regime were to change. He thus suggested that Iraq concentrate on achieving enough reliable foreign partnerships to develop the 4-5 major oil fields.

Finally, Al-Chalabi discussed the US position on sanctions. He pointed out that the Iraqi oil industry belongs to the people of Iraq, "not to a person or a regime." He argued that something must be done to alleviate the suffering in Iraq and the damage done by the years of sanctions. Over ten years, he stated, the sanctions have failed to achieve their goals. "Lift them please," he concluded.

Vahan Zanoyan: Potential External Capital and Technology Sources for the Iraqi Oil Industry

Zanoyan discussed what oil companies are looking for in Iraq and what kinds of capital flows the oil sector in Iraq can expect to receive after sanctions are lifted.

Ten years ago, Zanoyan said, foreign oil companies had a single goal in pursuing contracts: access to reserves. Today, by contrast, they seek good investments; reserves are necessary, but not sufficient, to attract their money. Zanoyan cited several changes in the world economy that has led to this altered attitude. First, many countries previously closed have opened their oil industries to "upstream" foreign investment. These states, he noted, represent about 460 billion barrels of oil reserves, "a huge amount." Thus, Zanoyan argued, the resources are available to investors, and the competition for access is much lower than before. Second, Zanoyan noted that companies today are judged by their financial health, not by their growth in production. Thus, they are increasingly concerned about getting a good return on their investments and less concerned about making a "blind rush" for access to oil resources.

Zanoyan described the factors companies consider today in making foreign investments in oil. He argued that companies are "very comfortable" with risk, both the below-ground (reservoir, exploration and technical) risks and the above-ground (commercial and political) variety. But, he cautioned, they are not insensitive to risk; they judge it relative to their likely return. Since low-risk, high-return projects are rare, he explained, companies are willing to invest in risky projects, but only if the potential rates of return increase in line with the risks. By contrast, companies generally refuse to invest in high-risk, low-return projects such as those available in Russia, despite its large oil and gas reserves. There are, however, countries that offer oil companies high risk and potentially high returns, especially in North Africa and West Africa, Zanoyan said. These countries are attracting large amounts of capital, even Algeria during its civil war.

In addition, Zanoyan noted, companies judge their risk-return ratio in light of the competition among countries for foreign capital. Companies today, he argued, consider a wide range of investment opportunities and select the best risk-return ratio. Zanoyan asserted that Iraq must understand these factors influencing corporate decisions, and particularly must understand the competition it faces from other countries, in order to attract direct foreign investment. Iraq, he argued, cannot rely on its location in the Middle East and its large reserves to attract foreign capital.

More particularly, Zanoyan considered whether Iraq would do better at attracting foreign interest by working to discover and develop new fields or by engaging in "oil recovery projects" such as those suggested by Issam al-Chalabi. He argued that reconstruction and realizing the potential of existing fields will provide Iraq with short-term (3-5 years) capital flows from foreign investors, but that short-term investment is not in Iraq's best interest. To ensure long-term waves of investment and a commitment to the development of Iraqi industry by foreign oil companies with "technological inputs and contributions," Zanoyan suggested, Iraq must "design a proper, performance-based project return package for the industry to look at," including specific new commercial and fiscal terms for foreign participation that will attract foreign firms and keep them reinvesting in the country every few years.

Walid Khadduri: What UN Sanctions under Resolution 1284 Permit and What They Prevent

Khadduri began by noting that a year ago no one seemed to want Resolution 1284. The resolution was approved on 17 December, 1999 by the full UN Security Council, despite great differences in opinion among the five permanent members of the Council over what should replace Resolution 986, and only after many delays and compromises.

Khadduri noted three enlightening aspects of the situation under the new resolution: First, the resolution left many subjects to be decided later, including the head, composition, and mandate of the new weapons inspections team. The open questions regarding the weapons team and control over the oil industry and oil revenues, Khadduri suggested, create many possibilities for compromise, but also for conflict, among Security Council members.

Second, Khadduri noted, Iraq had condemned the resolution but had not formally rejected it. He asserted that this indicated Iraq's willingness to cooperate with the resolution's terms if it would in fact lead to the lifting of sanctions.

Finally, Khadduri argued, the abstention of France, Russia, and China from the vote on the final resolution was a clear statement of their intentions to seek major changes in the sanctions regime despite "adamant US opposition." He suggested that the tripartite abstention would also serve to deter any US-UK actions against Iraq should it refuse to cooperate with the resolution's terms.

Khadduri pointed out that the steps required to implement Resolution 1284 engender much disagreement among the Security Council members, and so tension has been evident from the moment the resolution was passed. Subjects that have raised these tensions include the appointment of the head of UNMOVIC, the new weapons inspection team. An early test of the resolution, Khadduri pointed out, will be whether Iraq accepts the new weapons team. If it refuses to cooperate, Iraq may find itself isolated from France, China, and Russia in the light of the new crisis.

Khadduri also discussed the economic and financial provisions of Resolution 1284, which rely less on cooperation from Baghdad and whose implementation can therefore be expected shortly. These provisions include the lifting of the ceiling on oil exports (currently set at $5.26 billion over six months), and an increase of funds to purchase spare parts for the oil industry (the Secretary General's report on the industry's needs is due to be published on March 10th). In addition, Khadduri predicted that the Sanctions Committee would take several actions to ease approval of contracts and goods delivery.

However, Khadduri emphasized that several economic matters demand Iraq's cooperation with the new resolution. These issues include foreign participation in the development of Iraq's oil industry in line with recommendations made by the Secretary General; but the recommendations will only be implemented as long as Iraq cooperates with the new weapons inspections regime. Khadduri suggested that international oil companies are not likely to invest capital nor manpower in Iraq if the situation there is to be reevaluated every four months, as called for in the resolution.

According to Khadduri, the resolution is quite ambiguous with respect to future policies, stating that "the Council will act within 12 months of the resolution, provided Iraq cooperates with UNMOVIC and the IAEA," without specifying the nature of the action. Thus, the end result of Iraqi cooperation is unclear.

Khadduri predicted an early confrontation with Iraq in the next "2-6 weeks," as Iraq has tightened oil production while it cannot use the $5.5 billion of revenues held in escrow under the current regime for oil equipment. The potential confrontation will coincide, he noted, with renewed OPEC discussions about production quotas in light of high world prices for oil, and with the presentation of new UNMOVIC head Hans Blix's first report to the Security Council.Khadduri concluded that, if Resolution 1284 does not succeed in breaking the current deadlock between Iraq and the UN, the sanctions regime will face the challenge of increased leaks of goods and equipment into Iraq. This situation, he argued, is the worst possible, since the high price of smuggled goods is "the most expensive and least efficient for the welfare of the country." Illicit oil exports could also increase, he said, with more countries and oil companies involved in the effort and an increased waste of Iraq's oil resources resulting from the smuggling.

The resolution, Khadduri argued, faces a number of early tests in the upcoming months at the same time as international opposition to sanctions mounts. In this situation, he suggested, either the Security Council and Iraq will come to an accommodation to implement the resolution, or Iraq will formally reject the resolution and provoke a new crisis within a "deeply divided" Security Council. The outcome of such a crisis, Khadduri proposed, might be negotiations that would de-link the issues of humanitarian trade and development from that of disarmament.

The views expressed in this document do not necessarily reflect those of the Middle East Institute, which does not take a position on Middle East issues. As a summary of the speakers' remarks, they may not be definitive expressions of their views.

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