In November 2005, PLATFORM published Crude Designs, an unprecedentedly detailed study of Big Oil's plan for exploiting Iraq's oil wealth. -- As the press release announcing the study says, this is the first study to attempt to calculate the cost to the Iraqi people of the oil contracts being forced upon them. -- "Control of Iraq's future oil wealth is being handed to multinational oil companies through long-term contracts that will cost Iraq hundreds of billions of dollars." -- No wonder the resistance to American plans is considerable. -- The Bush administration's plans for Iraq, of course, are predicated on the notion that most Americans and Iraqis are too thick to be able to see the arrangements described here for what they are: a design to rip off Iraq's oil wealth. -- Primarily the work of researcher Greg Mottiett, the study is called Crude Designs: The Rip-Off of Iraq's Oil Wealth. -- While a clever pun, this title is not really accurate, since the U.S. plan is anything but a crude one. -- Perhaps Refined Design would have been a better title. -- The second part of the PLATFORM study, presented below, explains how Big Oil plans to use PSAs (production sharing agreements) to get hundreds of billions of dollars in profits from Iraq. -- While the oil industry would have us believe PSAs are normal, in fact none of the justifications for them are present in Iraq. -- Moreover, they are not found in any country comparable to Iraq. -- Countries with reserves the size of Iraq's do not use PSAs because they are able to invest in their oil industries on far more beneficial terms. -- PLATFORM is a 20-year-old London-based group of activists, environmentalists, artists, and social scientists working on issues of social and environmental justice; in recent years, the group has concentrated on the role of British companies in the global hydrocarbon economy....
Unraveling the Carbon Web
CRUDE DESIGNS -- THE RIP-OFF OF IRAQ'S OIL WEALTH
Control of Iraq's future oil wealth is being handed to multinational oil companies through long-term contracts that will cost Iraq hundreds of billions of dollars.
Crude Designs: The Rip-Off of Iraq's Oil Wealth reveals that current Iraqi oil policy will allocate the development of at least 64% of Iraqs reserves to foreign oil companies. Iraq has the worlds third largest oil reserves.
Figures published in the report for the first time show:
--the estimated cost to Iraq over the life of the new oil contracts is $74 to $194 billion, compared with leaving oil development in public hands. These sums represent between two and seven times the current Iraqi state budget.
--the contracts would guarantee massive profits to foreign companies, with rates of return of 42% to 162%.
The kinds of contracts that will provide these returns are known as production sharing agreements (PSAs). PSAs have been heavily promoted by the U.S. government and oil majors and have the backing of senior figures in the Iraqi Oil Ministry. Britain has also encouraged Iraq to open its oilfields to foreign investment.
However, PSAs last for 25-40 years, are usually secret, and prevent governments from later altering the terms of the contract.
Crude Designs: The Rip-Off of Iraq's Oil Wealth
By Greg Mottiett
2. RE-THINKING PRIVATIZATION: PRODUCTION SHARING AGREEMENTS
THE NATURE OF PRIVATIZATION
Given the Wests fundamental strategic interest in the oil reserves of Iraq and the Gulf as outlined in the previous section, some observers were surprised when the oil sector was excluded from the sweeping privatizations of Iraqs economy by U.S. Administrator Paul Bremer in 2003 and 2004. Decisions on the future structure of the oil industry were deferred, to be addressed by an elected Iraqi government.
The Coalition Provisional Authority only awarded short-term repair and restoration contracts -- for service companies such as Halliburton and Parsons to restore the countrys existing oil infrastructure, which had been damaged by war and sanctions -- rather than long-term extraction concessions. In February 2005, Interim Oil Minister Thamer al-Ghadban stated that "As for the extraction sector, that is, dealing with the oil and gas reserves, which are 'assets', privatization is completely out of the question at the moment." [Note 20: Eric Watkins, 'Iraq seeks E&D investment, nixes reserves privatization', Oil & Gas Journal, 16 February 2005]
But if the non-privatization of oil was a surprise, this was largely based on a misconception of what privatization means in the Iraqi context. In the minds of some neo-conservatives, writing on Iraqi oil before the war, privatization meant the transfer of legal ownership of Iraq's oil reserves into private hands. However, in all countries of the world except the U.S.A. [Note a: In the USA, onshore reserves belong to the landowner, which may be a public or private body or individual], reserves (prior to their extraction) are legally the property of the state. This is the case in Iraq, and remains so under the new Constitution. There has never been a realistic prospect of U.S.-style privatization of Iraqs oil reserves. But this does not mean that private companies would not develop Iraqs oil. In some ways, the debate on privatization has obscured the important practical issues of who gets the revenue from the oil, and who controls the way in which oil is developed. On this matter, Iraq has a relevant history.
The development of Iraqs oil industry began in the aftermath of the First World War, while the country was occupied by Britain under a League of Nations Mandate. In 1925, Iraqs British-installed monarch, King Faisal, signed a concession contract with the Iraq Petroleum Company (IPC) [Note 21: Then the Turkish Petroleum Company -- renamed in 1928], a consortium of British, French, and (later) American oil companies. The contract followed a model widely applied in the British colonies. It was for a period of 75 years, during which terms were frozen. Combined with two further concessions granted in the 1930s, the IPC obtained rights to all of the oil in the entire country. Even the Iraqi call for a 20% stake in the concession was denied, despite having been specified in earlier agreements. As Iraqi frustration at the unfair terms of the deal grew, in the 1950s and 1960s the contract came under pressure.
Underpinning this were the issues of whether the split of revenues between company and state was a fair one, and the degree of control the foreign companies had over the development: they restricted production to boost their producing areas elsewhere in the world, and used their monopoly on information to fix prices, depriving Iraq of income. These same arguments were echoed in all of the major oilproducing countries at the time, most of which had similar deals with multinational companies. The ultimate conclusion to these disputes was the nationalization of many oil industries -- in Iraqs case in two stages in 1961 and 1972. [Note [b]: The last remnants of concessions were nationalized in 1975.]
INTRODUCING PRODUCTION SHARING AGREEMENTS
While these disputes were raging in the Middle East, a different model was emerging in Indonesia. There, a new form of contract was introduced in the late 1960s: the production sharing agreement (PSA).
An ingenious arrangement, PSAs shift the ownership of oil from companies to state, and invert the flow of payments between state and company. Whereas in a concession system, foreign companies have rights to the oil in the ground, and compensate host states for taking their resources (via royalties and taxes), a PSA leaves the oil legally in the hands of the state, while the foreign companies are compensated for their investment in oil production infrastructure and for the risks they have taken in doing so. Although many in the oil industry were initially suspicious of Indonesias move, they soon realized that by setting the terms the right way, a PSA could deliver the same practical outcomes as a concession, with the advantage of relieving nationalist pressures within the country. In one of the standard textbooks on petroleum fiscal systems, industry consultant Daniel Johnston comments: At first [PSAs] and concessionary systems appear to be quite different. They have major symbolic and philosophical differences, but these serve more of a political function than anything else. The terminology is certainly distinct, but these systems are really not that different from a financial point of view. [Note 22: Daniel Johnston, International Petroleum Fiscal Systems and Production Sharing Contracts (Pennwell, 1994), p.39]
So, the financial and economic implications of PSAs may be the same as concessions, but they have clear political advantages -- especially when contrasted with the 1970s nationalizations in the Middle East. Professor Thomas Wälde, an expert in oil law and policy at the University of Dundee, describes them as: A convenient marriage between the politically useful symbolism of the production-sharing contract (appearance of a service contract to the state company acting as master) and the material equivalence of this contract model with concession/license regimes in all significant aspects . . . The government can be seen to be running the show -- and the company can run it behind the camouflage of legal title symbolizing the assertion of national sovereignty. [Note 23: Thomas W. Wälde, "The Current Status of International Petroleum Investment: Regulating, Licensing, Taxing and Contracting," in CEPMLP Journal, Vol. 1, no. 5, July 1995 (pub. University of Dundee)] As we will see, these advantages now appear to make PSAs the Western method of choice for future development of the Iraqi oil industry.
[Inset: OPTIONS FOR OIL POLICY
There are essentially three models a country may choose from for the structure of its oil industry, plus a number of variations on these themes.
1. The system currently in place in Iraq, which has been the case since the early 1970s, is a NATIONALISED INDUSTRY. In this model, the state makes all of the decisions, and takes all of the revenue. The extent of involvement of foreign private companies is that they might be hired to carry out certain services under contract (a technical service contract) -- a well-defined piece of work, for a limited period of time, and for which they receive a fixed fee. This is the model used throughout most of the Gulf region.
One variant on the technical service contract is the risk service contract. In this system, a private company provides capital to invest in a project, but is paid a fixed rate of return, agreed in the contracts (thus preventing excessive profits). A similar mechanism is the buyback contract, which has been used on some fields in Iran, in which companies also have a right to buy the oil or gas.
2. In the CONCESSION model, sometimes known as the tax and royalty system, the government grants a private company (or more often, a consortium of private companies) a license to extract oil, which becomes the companys property (to sell, transport or refine) once extracted. The company pays the government taxes and royalties for the oil.
3. The PRODUCTION SHARING AGREEMENT (PSA) is a more complex system. In theory, the state has ultimate control over the oil, while a private company or consortium of companies extracts it under contract. In practice, however, the actions of the state are severely constrained by stipulations in the contract. In a PSA, the private company provides the capital investment, first in exploration, then drilling and the construction of infrastructure. The first proportion of oil extracted is then allocated to the company, which uses oil sales to recoup its costs and capital investment -- the oil used for this purpose is termed cost oil. There is usually a limit on what proportion of oil production in any year can count as cost oil. Once costs have been recovered, the remaining profit oil is divided between state and company in agreed proportions. The company is usually taxed on its profit oil. There may also be a royalty payable on all oil produced. Sometimes the state also participates as a commercial partner in the contract, operating in joint venture with foreign oil companies as part of the consortium -- with either a concession or a PSA model. In this case, the state generally provides its percentage share of development investment and directly receives the same percentage share of profits.]
3. PUMPING PROFITS: BIG OIL AND THE PUSH FOR PSAs
As with many issues of foreign policy, the interests of the worlds largest oil corporations mesh closely with those of their national governments -- as we saw in section 1. While the governments seek secure and adequate supplies of oil to feed their economies, the corporations need control over reserves to ensure their future profitability, to deliver returns to their shareholders. For governments, secure oil supplies often means that they are in fact part-controlled by major oil corporations based in their own countries.
For their part, major multinational oil companies have made no secret of their desire to gain access to Iraqs reserves. Shortly before the invasion Archie Dunham, chairman of U.S. oil major ConocoPhillips, explained that We know where the best [Iraqi] reserves are [and] we covet the opportunity to get those some day. [Note 24: Carola Hoyos, "Big Players Anticipate Iraq's Return to Fold," Financial Times, 20 February, 2003] Shell has stated that it aims to establish a material and enduring presence in the country. [Note 25: Shell in the Middle East magazine, April 2005, available online at http://www.shell-me.com/english/apr05/news-me2.htm]
[PHOTO of oil derrick; CAPTION: Oil companies covet Iraq's oil wealth, and are pushing for access to it through production sharing agreements]
Since the overthrow of Saddam Hussein, foreign oil companies have worked hard to build relationships with Iraqs Oil Ministry. They have appointed lobbyists to develop relationships with influential officials, provided training (often for free) for Iraqi officials and technicians, sponsored Oil Ministry participation in international conferences, and entered contracts (again, often for free) to analyze oilfield geological data.
In 2004, Shell recruited an Iraqi external affairs officer to help the company gain access to Iraqi government decision-makers, specifying in their advertisement: A person of Iraqi extraction with strong family connections and an insight into the network of families of significance within Iraq. [Note 26: Glenn Irvine International, recruitment advertisement, August 2004, http://www.irvine-int.com/irqext.html#irqext. Luay Jawad was appointed to the post] Through these means, the companies aim to be well-positioned when it comes to the signing of contracts.
WHAT OIL COMPANIES WANT
It is helpful at this point to look at the companies agenda for Iraq. Oil corporations are looking for three things when they invest in a country, all of which are delivered by production sharing agreements:
1. A right to oil reserves. Companies want a deal that guarantees their right to extract the reserves for many years, thus ensuring their future growth and profits. Furthermore, they want a contract that allows them to book these reserves -- including them in their accounts -- which increases their company value. Production sharing agreements, like concession contracts, permit companies to book reserves in their accounts. The importance of this should not be underestimated for the oil majors. In 2004, when British/Dutch oil company Shell was found to have overstated the size of its booked reserves by over 20%, it lost the faith of the financial markets: this impacted heavily on its share price and credit rating.
Shell is now desperate to acquire new reserves -- which is a key reason why Shell has made more effort than most to make friends in Iraq.
2. An opportunity to make large profits. Generally, oil companies make their profits from investing and risking their capital. In some cases, they lose their capital, for example when they drill a dry well. But in some cases they will find large and hugely profitable fields. Oil companies are therefore very different from service companies like Halliburton, which make money from fixed fees on predictable contracts. Oil companies aim for deals which may be more speculative, but which give them a chance of making super-profits. Production sharing agreements are designed to allow companies to achieve very large profits if successful.
3. Predictability of tax and regulation. While companies can accept exploration risk (that they wont find oil) or price risk (that the oil price falls), both being beyond their control, they try to manage political risk (that tax or regulatory demands will increase) by locking in governments. They thus seek to bind governments into long-term contracts that fix the terms of their investment. Production sharing agreements generally last for 25 to 40 years with terms protected from potential change by incoming governments. Shells head of Exploration & Production, speaking at a conference in 2003, made the case for PSAs: . . . international oil companies can make an ongoing contribution to the region [the Persian/Arabian Gulf] . . . However, in order to secure that investment, we will need some assurance of future income and, in particular, a supportive contractual framework. There are a number of models which can achieve these ends. One option is the greater use of production sharing agreements, which have proved very effective in achieving an appropriate balance of incentives between Governments and oil companies. And they ensure a fair distribution of the value of a resource while providing the long term assurance which is necessary to secure the capital investment needed for energy projects. [Note 27: Walter van der Vijver, speech to ECSSR conference, "A New Era for International Oil Companies in the Gulf: Opportunities and Challenges," Abu Dhabi, 19 October 2003]
THE VOICE OF BIG OIL
The most detailed expression of what the oil companies are seeking in Iraq has been made by the International Tax & Investment Center (ITIC), a corporate lobby group pushing for pro-business investment and tax reform. Almost all of ITIC's 110 listed sponsors are large corporations, with roughly a quarter of these in the oil sector. ITICs Board of Directors contains representatives from Shell, BP, ConocoPhillips, ExxonMobil and ChevronTexaco. Since its launch in 1993, ITIC has primarily focused on the former Soviet Union, but more recently, it has expanded its work to include Iraq. Its 2004 strategy review concluded that this project should be continued and considered as a 'beachhead' for possible further expansion in the Middle East. [Note 28: International Tax & Investment Center (ITIC), Strategic Questions For Our Future, undated  http://www.iticnet.org/publications/StrategicQuestions.pdf]
In autumn 2004 ITIC issued a major report entitled Petroleum and Iraq's Future: Fiscal Options and Challenges, which includes the following key recommendations:
--"The most appropriate legal and fiscal form for the facilitation of [Foreign Direct Investment] longer-term development of Iraq's petroleum industry will be a production sharing agreement (PSA). [Note 29: International Tax & Investment Center (ITIC), "Petroleum and Iraq's Future: Fiscal Options and Challenges," Fall 2004, p. 3]
--Foreign Direct Investment, by ITIC members and other multinational oil companies, would effectively 'kick start' the [Iraqi] economy and avoid the government diverting spending to oil development that is sorely needed for other programs. [Note 30: Ibid., p. 3] PSAs are lauded as providing the simplest and most attractive regulatory . . . framework which the ITIC claims are now the norm in most countries outside the OECD. [Note 31: Ibid, p.10] Having reviewed the various options, with due consideration to international experience and regional preferences, the ITIC concludes that the alternative models are far inferior to PSAs.
INAPPROPRIATE FOR IRAQ
PSAs are indeed quite common in countries with small oil reserves and/or high extraction costs (especially from offshore fields) and/or high exploration or technical risks. However, none of these conditions apply to Iraq; in fact, Iraq is quite the opposite. PSAs are not found in any other country comparable to Iraq.
[PHOTO of oil refinery; CAPTION: Countries with reserves the size of Iraq's do not use PSAs because they are able to invest in their oil industries on far more beneficial terms]
It is difficult to overstate how radical a departure PSAs would be from normal practice, both in Iraq and in other comparable countries of the region. Iraqs oil industry has been in public hands since 1972; prior to that the rights to develop oil in 99.5% of the country had also been publicly held since 1961. [Note [a]: During the final years of Saddam Hussein's regime, Iraq tried to re-open its oil industry to foreign capital. This process was highly political, and contracts were negotiated with and awarded primarily to companies from U.N. Security Council member countries Russia, China, and France, in an attempt to win support for the dropping of U.N. sanctions. A PSA deal was actually signed in 1997 -- with Russian company Lukoil for the West Qurna field -- but never implemented, due to the sanctions. Ultimately, Saddam cancelled the contract. Disputes still continue with the new Iraqi authorities as to whether this contract has any validity. Saddam also signed a development and production contract (DPC) with China National Petroleum Corporation for the al-Ahdab field (also never implemented, and ultimately frozen), and came very close to signing a PSA deal with French company Total, on the Majnoon field. Negotiations also took place on various other fields for PSAs, buybacks or DPCs (see section 6).]
In Iraqs neighbours Kuwait, Iran, and Saudi Arabia, foreign control over oil development is ruled out by constitution or by national law. These countries together with Iraq are the worlds top four countries in terms of oil reserves, with 51% of the world total between them. [Note 32: BP, op. cit., p. 4] Together with the United Arab Emirates, Venezuela, and Russia, seven countries hold 72% of the worlds oil reserves. These latter three all have some foreign involvement through concession agreements, although both Venezuela and Russia are currently drawing back from it, following unsuccessful expansions in foreign investment in the 1990s. Of these seven countries with major oil reserves, only Russia has any production sharing agreements. Russia signed three PSAs in the mid 1990s; however, PSAs have been the subject of extreme controversy ever since, due to the poor deal the state has obtained from them, and it now looks unlikely that any more will be signed.
Countries with reserves the size of Iraqs do not use PSAs because they do not need to and are able to run their oil industries on far more beneficial terms.
4. FROM WASHINGTON TO BAGHDAD: PLANNING IRAQ'S OIL FUTURE
Prior to the 2003 invasion, the principal vehicle for planning the new post-war Iraq was the U.S. State Departments Future of Iraq project. This initiative, commencing as early as April 2002, involved meetings in Washington and London of 17 working groups, each comprised of 10-20 Iraqi exiles and international experts selected by the State Department. [Note 33: Marc Grossman, Under Secretary for Political Affairs, Testimony before the Senate Foreign Relations Committee, 11 February 2003; Eli J. Lake, "U.S. Plans for Post-Saddam Iraqi Government," Washington Times, 5 June 2002]
The Oil and Energy working group met four times between December 2002 and April 2003. Although the full membership of the group has never been revealed, it is known that Ibrahim Bahr al-Uloum, the current Iraqi Oil Minister, was a member. [Note 34: Nicolas Pelham, "Oil to Be Privatized but Not Just Yet, Says Iraqi Minister," Financial Times, 5 September 2003] The 15-strong oil working group concluded that Iraq should be opened to international oil companies as quickly as possible after the war and that the country should establish a conducive business environment to attract investment of oil and gas resources. [Note 35: 35 Carola Hoyos, "Exiles Call for Iraq to Let in Oil Companies," Financial Times, 7 April 2003] The subgroup went on to recommend production sharing agreements (PSAs) as their favored model for attracting foreign investment. Comments by the handpicked participants revealed that many in the group favoured production-sharing agreements with oil companies. Another representative commented, Everybody keeps coming back to PSAs. [Note 36: Ibid.]
The reasons for this choice were explained in the formal policy recommendations of the working group, published in April 2003: Key attractions of production sharing agreements to private oil companies are that although the reserves are owned by the state, accounting procedures permit the companies to book the reserves in their accounts, but, other things being equal, the most important feature from the perspective of private oil companies is that the government take is defined in the terms of the [PSA] and the oil companies are therefore protected under a PSA from future adverse legislation. [Note 37: U.S. State Department, Future of Iraq Project, Oil and Energy Working Group (Oil Policy Subgroup), April 2003, published in Middle East Economic Survey, "Iraqi Oil Policy Recommendations after Regime Change," 5 May 2003, pp. D1-D11]
The group also made it clear that in order to maximize investments, the specific terms of the PSAs should be favorable to foreign investors: PSAs can induce many billions of dollars of foreign direct investment into Iraq, but only with the right terms, conditions, regulatory framework, laws, oil industry structure, and perceived attitude to foreign participation. [Note 38: Ibid.]
Recognizing the importance of this announcement, the Financial Times noted: Production-sharing deals allow oil companies a favourable profit margin and, unlike royalty schemes, insulate them from losses incurred when the oil price drops. For years, big oil companies have been fighting for such agreements without success in countries such as Kuwait and Saudi Arabia. [Note 39: 39 Carola Hoyos, op cit] The article concluded that: The move could spell a windfall for big oil companies such as ExxonMobil, Royal Dutch/Shell, BP and TotalFinaElf...
SHAPING THE NEW IRAQ
The U.S. and U.K. have worked hard to ensure that the future path for oil development chosen by the first elected Iraqi government will closely match their interests. So far it appears they have been highly successful: production sharing agreements, which were first proposed by the U.S. State Department group, have emerged as the model of oil development favored by all the post-invasion phases of Iraqi government.
PHASE 1: COALITION PROVISIONAL AUTHORITY AND IRAQI GOVERNING COUNCIL
During the first fourteen months following the invasion, occupation forces had direct control of Iraq through the Coalition Provisional Authority. Stopping short of privatizing oil itself, the CPA began setting up the framework for a longer-term oil policy.
The CPA appointed former senior executives from oil companies to begin this process. The first advisers were appointed in January 2003, before the invasion even started, and were stationed in Kuwait ready to move in. First, there were Phillip Carroll, formerly of Shell, and Gary Vogler, of ExxonMobil, backed up by three employees of the U.S. Department of Energy and one of the Australian government. Carroll described his role as not only to address short-term fuel needs and the initial repair of production facilities, but also to:
--Begin planning for the restructuring of the Ministry of Oil to improve its efficiency and effectiveness; [and]
--Begin thinking through Iraqs strategy options for significantly increasing its production capacity. [Note 40: Philip J. Carroll, "Personal Commentary," in Oxford Energy Forum (pub. Oxford Institute for Energy Studies) November 2004]
In October 2003, Carroll and Vogler were replaced by Bob McKee of ConocoPhillips, and Terry Adams of BP, and finally in March 2004, by Mike Stinson of ConocoPhillips and Bob Morgan of BP. [Note [a] Bob Morgan died as a result of a rocket attack on his car in Baghdad, in May 2004.] The £147,700 cost of the two British advisers, Adams and Morgan, was met by the UK government. [Note 41: Dr. Kim Howells MP, answer to Parliamentary Question by Harry Cohen MP, 13 July 2005, Hansard column 1123W] Following the handover to the Iraq Interim Government in June 2004, Stinson became an adviser to the U.S. Embassy in Baghdad. On 13 July 2003, in the first move towards Iraqi self-government, the CPA Administrator Paul Bremer appointed the quasi-autonomous, but virtually powerless, Iraqi Governing Council. On the same day Bremer appointed Ibrahim Bahr al-Uloum, who had been a member of the U.S. State Department oil working group, as Minister for Oil. Within months of his appointment Bahr al-Uloum announced that he was preparing plans for the privatization of Iraq's oil sector, but that no decision would be taken until after elections scheduled for 2005. [Note 42: Nicolas Pelham, op. cit.]
Speaking to the Financial Times, Bahr al-Uloum, a U.S.-trained petroleum engineer, said: "The Iraqi oil sector needs privatization, but it's a cultural issue, noting the difficulty of persuading the Iraqi people of such a policy. He then proceeded to announce that he personally supported:
--Production sharing agreements for upstream (i.e. extraction of crude oil) development;
--giving priority to U.S. oil companies, and European companies, probably. [Note 43: Ibid.]
PHASE 2: IRAQ INTERIM GOVERNMENT
In June 2004, the CPA formally handed over Iraqi sovereignty to an interim government, headed by Prime Minister Iyad Allawi. The position of Minister of Oil was handed to Thamir al-Ghadban, a U.K.-trained petroleum engineer and former senior adviser to Bahr al- Uloum. In an interview in Shells in-house magazine, al-Ghadban announced that 2005 would be the year of dialogue with multinational oil companies. [Note 44: Thamer al-Ghadban, interviewed by Bobby Schuck in Shell in the Middle East magazine, October 2004]
About three months after taking power, Allawi issued a set of guidelines to the Supreme Council for Oil Policy, from which the Council was to develop a full petroleum policy. Pre-empting both the Iraqi elections and the drafting of a new constitution, Allawis guidelines specified that while Iraqs currently producing fields should be developed by the Iraq National Oil Company (INOC), all other fields should be developed by private companies, through the contractual mechanism of production sharing agreements (PSAs). [Note 45: Energy Compass, "Iraq: Puzzling over the Futurem," 1 October 2004] Iraq has about 80 known oilfields, only 17 of which are currently in production. Thus the Allawi guidelines would grant the other 63 to private companies.
Allawi also added that:
--New fields would be developed exclusively by private companies, with the policy ruling out any participation of INOC; [Note 46: "For new development of undeveloped oil and gas fields, and for exploration, all of which must start as soon as possible and in tandem with INOC's efforts, these should be accomplished through private sector investment via competent international . . . oil companies . . . However, these new ventures should specifically not be allowed to partner with any state-owned enterprises, including INOC, in order to ensure state impartiality and avoid the pitfall of state interference in corporate enterprise management." [Cited in Middle East Economic Survey, "Allawi Outlines New Iraqi Petroleum Policy: INOC for Currently Producing Fields/IOCs for New Areas," 13 September 2004, pp. A1-A4]]
--The national oil company INOC, which manages existing oil fields, should be part privatized; [Note 47: "Eventually, in years to come, INOC may be partially privatized through wide distribution of ownership among Iraqis through public subscription" [ibid]]
--The Iraqi authorities should not spend time negotiating the best possible deals with the oil companies; instead they should proceed quickly, agreeing whatever terms the companies will accept, with a possibility of renegotiation [Note [b]: In this, Allawi was being highly unrealistic. Although contracts can allow a certain degree of renegotiation, companies will not sign them if the potential for renegotiation is substantive or meaningful.] later. [Note 48: "Should we spend months and years trying to exact the last penny in negotiating the commercial terms? I would suggest that there is no need to waste time. Time is of the essence." [ibid.]]
PHASE 3: TRANSITIONAL GOVERNMENT AND WRITING THE CONSTITUTION
The interim government was replaced in early 2005 by the election of Iraq's new National Assembly, which led to the formation of the new government with Ibrahim al-Jaafari as Prime Minister. In a move which no doubt assisted policy continuity from the period of U.S. control, Ibrahim Bahr al-Uloum was reappointed to the position of Minister for Oil. Meanwhile, Ahmad Chalabi, the Pentagons former favorite to run Iraq, was appointed chair of the Energy Council, which replaced the Supreme Council for Oil Policy as the key overseer of energy and oil policy. Back in 2002 Chalabi had famously promised that U.S. Companies Will Have a Big Shot at Iraqi Oil. [Note 49: 49 Dan Morgan and David B. Ottaway, "In Iraqi War Scenario, Oil Is Key Issue," Washington Post, 15 September 2002, Page A01]
By June 2005, government sources reported that a Petroleum Law [Note [c]: Following the agreement on a Constitution, a Petroleum Law is the next step in defining how the oil industry is to be run] had been drafted, ready to be enacted after the December elections. According to the sources -- although some details are still being debated -- the draft of the Law specifies that while Iraqs currently producing fields should be developed by INOC, new fields should be developed by private companies. In October 2005, a new Constitution was accepted in a referendum of the Iraqi population. Like much of the Constitution, the oil policy section is open to some interpretation. Apparently referring to fields not currently in production, it states:
The federal government and the governments of the producing regions and provinces together will draw up the necessary strategic policies to develop oil and gas wealth to bring the greatest benefit for the Iraqi people, relying on the most modern techniques of market principles and encouraging investment. [Note 50: Text of the draft Iraq Constitution, translated by Associated Press, 28 August 2005, article 110]
There are two issues here. The reference to market principles and encouraging investment indicates a clear direction of travel, in terms of opening to private companies. Meanwhile the first part of this clause, somewhat vaguely, tries to deal with the issue of jurisdiction. However, while this states that the federal and regional governments will work together, a subsequent clause states that: "All that is not written in the exclusive powers of the federal authorities is in the authority of the regions. In other powers shared between the federal government and the regions, the priority will be given to the region's law in case of dispute. [Note 51: Ibid., article 111]
Signing of contracts for extraction of oil and other natural resources is not listed [Note 52: Ibid., article 108] as one of the exclusive powers of the federal authorities -- the implication is thus that on new fields, it is the authority of the regional governments. This situation is quite unclear, and is further muddied by a last-minute deal, arranged just before the constitutional referendum, that the Constitution could be amended in the first half of 2006, and by comments by Zalmay Khalilzad, U.S. Ambassador to Iraq, that after that, as Iraq evolves, so, too, will this charter evolve. [Note 53: Embassy of the United States, Baghdad, Ambassador Khalilzad statement on the referendum results, October 26, 2005] In so far as the decision rests with Baghdad, the Oil Ministry is keen to sign contracts as quickly as possible. According to officials in the Ministry, their aim is to begin signing long-term contracts with foreign oil companies during the first nine months of 2006. [Note 54: Christian Schmollinger, "Iraqi Officials Hopeful Foreign Oil Firms Will Return in 2006," International Oil Daily, 15 June 2005] In order to achieve this goal, officials wanted to start negotiations with oil companies during the second half of 2005, before a legitimate Iraqi government is elected and in parallel with the writing of a Petroleum Law. [Note 55: Glen Carey & Faleh al-Khayat, "Iraq Looks to Woo Majors for Field Revivals," Platts Oilgram News, 22 June 2005] This time frame means that contracts will be negotiated without public participation or debate, or proper legal framework.
Meanwhile, the Kurdish authorities are even more impatient to sign deals. In June 2004, the Kurdistan Regional Government (KRG) signed an exploration and development deal with Norwegian company DNO. In a clear sign of the tensions between Baghdad and the regions, the Oil Ministry reacted by warning companies that if they signed deals with regional governments, they would be excluded from contracts at a national level.
Then in October 2005, the KRG signed a memorandum of understanding (MOU) with K Petroleum Company, which is jointly owned by the Canada-based Heritage Oil and the Kurdish company Eagle, to carry out oilfield studies adjacent to the Taq Taq field in Kurdistan. Announcing the deal, Heritage stated that Negotiations to formalize the MOU into a Production Sharing Agreement(PSA) are scheduled to commence while the work program is being carried out. KPC is confident these studies will translate into a PSA, although there is no guarantee that a license will be awarded to the Company. [Note 56: Heritage Oil Corporation press release, 'Heritage Oil signs agreement for Kurdistan, Iraq field study', 28 September 2005] For the southern oilfields, the outlook is less clear. In any case, regional governments of both Kurdistan and southern Iraq would have far weaker bargaining power in negotiating with foreign oil companies than the Iraqi Oil Ministry (or Iraq National Oil Company), as they lack both the institutional experience and the consolidated weight of handling the entire countrys resources. The likely result would be more negative terms than could be achieved at a national level. As noted above, only 17 of Iraqs 80 known fields are currently in production. [Note 57: U.S. Department of Energy (US DOE), Energy Information Administration, Iraq -- Country Analysis Brief, June 2005, http://www.eia.doe.gov/emeu/cabs/iraq.html]
As these 17 fields represent only 40 billion of Iraq's 115 billion barrels of known oil reserves, the policy to allocate undeveloped fields to foreign companies would give those companies control of 64% of known reserves. [Note 58: Ibid] If a further 100 billion barrels are found, as is widely predicted, the foreign companies could control as much as 81% of Iraq's oil; if 200 billion are found, as the Oil Ministry predicts, the foreign company share would be 87%.
Given that oil accounts for over 95% of Iraqs government revenues [Note 59: Adil Abd Al-Mahdi, Finance Minister, remarks at the National Press Club, Washington DC, December 21, 2004], the impact of this policy on Iraqs economy would be enormous.
[MAP: Map of Iraqi oil fields and pipelines (University of Texas Libraries)]
5. CONTRACTUAL RIP-OFF: THE COST OF PSAs TO IRAQ
While the advantages of production sharing agreements for multinational oil companies are clear, there is a severe shortage of independent analysis of whether PSAs are in the short, medium, and long-term interests of the Iraqi people. Unfortunately the Iraqi people have not been informed of the pro-PSA oil development plans, let alone their implications, which have transformed so seamlessly from U.S. State Department recommendations into Iraqi government policy. This report hopes to go some way towards redressing this balance. Our analysis shows that production sharing agreements have two major disadvantages for the Iraqi people:
1. The loss of hundreds of billions of dollars in potential revenue;
2. The loss of democratic control of Iraq's oil industry to international companies; PSAs may also undermine an important opportunity to establish effective public oversight and end the current corruption and financial mismanagement in the Iraqi oil sector (see Section 6). PSAs generally last (with fixed terms) for between 25 and 40 years: thus once signed the Iraqi people would have to live with the consequences for decades.
LOSING REVENUE: HOW MUCH WOULD PSAS COST THE IRAQI PEOPLE?
In order to understand why foreign oil companies are so keen to invest in Iraq, one needs to look at the economic outcomes that would result from applying PSA contracts to the Iraqi oil sector.
We have produced economic models of 12 of Iraqs oilfields that have been listed as priorities for investment under production sharing agreements. We do not know yet what terms Iraqi contracts might contain (that will not be known until they are signed -- and possibly not at all, if they are not disclosed to the public). Therefore we have taken contractual terms used in other comparable countries, and applied them to the physical characteristics of Iraqs oilfields (based on data from the Iraqi Oil Ministry, the U.S. Government and respected industry analysts such as Deutsche Bank see Appendix 3). This process allows us to project the cashflows to the Iraqi state and to foreign oil companies, under a range of assumptions (such as oil price).
Specifically, we look at terms used in Oman and Libya (both having comparable physical conditions to Iraq) and Russia (the only country with any PSAs which has reserves at all comparable in scale to Iraqs). The terms recently applied in Libya are widely viewed to be among the most stringent in the world. We have then compared the results with expected revenues of a nationalized system, administered by state-owned oil companies. [Note [a] We also ran the models with the terms used in PSAs in Syria and in Equatorial Guinea, and those signed by Saddam Hussein with Lukoil for the West Qurna field in 1997 (which was never implemented, and was subsequently cancelled). All of them produced results within the same range as the three outlined here.]
Using an average oil price of $40 per barrel, our projections reveal that the use of PSAs would cost Iraq between $74 billion and $194 billion in lost revenue, compared to keeping oil development in public hands. This massive loss is the equivalent of $2,800 to $7,400 per Iraqi adult over the thirty-year lifetime of a PSA contract. By way of comparison Iraqi GDP currently stands at only $2,100 per person, despite the very high oil price. [Note 60: Population and economic data taken from U.S. Central Intelligence Agency, The World Factbook 2005]
It should be noted that these figures relate to only 12 of Iraqs more than 60 undeveloped fields. Iraq has identified 23 priority fields on which to potentially sign contracts in 2006. [Note [b] Of these, we were unable to obtain full data on 11 of the smaller ones; however the 12 we have analyzed still account for more than 90% of the 23 fields projected production (and hence revenue).] Thus when the other 11 fields are added, along with a further 35 or more later, and especially other fields yet to be discovered (recall that Iraqs undiscovered reserves may be as large or even double the known reserves), the full cost of the PSA policy could be considerably greater.
[Inset: TABLE 5.1: IMPACT OF PSAs ON IRAQI STATE REVENUES : Total undiscounted revenue (US$ billion)/State take/Total revenue loss under PSA scenario (US$ billion): Nationalized: 971/100%/-; Russia PSA terms: 779/80%/192; Oman PSA terms: 777/80%/194; Libya PSA terms 897/92%/74. Figures in real terms (2006 prices), at constant $40/bbl oil price, for the period 2006-35. See appendices 3-5 for details of full results, data sources, methodology and modelling assumptions.]
We have been deliberately conservative with our assumptions. Our assumptions and methodology are outlined in Appendix 4.
Both the corporate lobby group ITIC (see section 3) and the British Foreign Office have argued that foreign investment can free up Iraqi government budgets for other priority areas of spending, to the tune of around $2.5 billion a year. [Note 61: ITIC, Petroleum and Iraq's Future, op cit, p.17; FCO, Code of Practice for the Iraq Oil Industry, op cit p.5] Although technically true, this is deeply misleading -- as the investment now would be offset by the loss of revenues later.
Amazingly, in ITICs report advocating the use of PSAs, the economic impact is only examined up to 2010 [Note 62: ITIC, Petroleum and Iraq's Future, op cit, Annex 3, pp. 64-70] -- ignoring the fact that any foreign investment must be repaid. [Note [a] This omission compounds the inaccuracy of ITICs assumption that without foreign direct investment, oil production will not grow beyond 3.5 million barrels per day on this point, see the section 6.] It is as if one took out a bank loan but only considered the economic impact prior to paying it back!
[PHOTO of oilfield workers CAPTION: The use of PSAs could deprive Iraq of $190 billion of revenue]
In contrast, in this report, we look at the impact of PSAs over the whole length of the contract. Economists and indeed oil companies compare investments using the process of discounting, and the concept of net present value (NPV). NPV is a measure of what the later income or expenditure would be worth if they were received or incurred now (See Appendix 2).
When looked at in these terms, far from saving the government $8.5 billion of investment (the whole investment over several years, in 2006 NPV), these contracts will cost Iraq a (2006) NPV of $16-$43 billion, at a 12% discount rate. [Note [b]: We have used a 12% discount rate, as the rate most commonly used in the oil industry. However, it should be noted there is some debate among development economists as to what discount rate should be used for public sector investments. It is commonly argued that, since states can borrow capital at lower interest rates than private companies, and since states do not invest in the same way as companies (and so do not experience the same extent of opportunity costs), the discount rate should be lower than for private sector investments. For example, U.S. public institutions use a discount rate of 7%. Some economists even argue that states should apply a zero discount rate, as the process of discounting undervalues expenditure for future generations. A lower discount rate would mean a higher NPV loss to the Iraqi state]
Our assumed oil price for these calculations is $40 per barrel. The oil price is currently fluctuating around $60 per barrel, and there is an argument that structural factors, such as increasing demand in China and India, mean that oil prices are likely to stay at this level which would make our $40 assumption conservative. However, the oil price is notoriously difficult to predict. We therefore also look at the models at a higher price of $50 and a lower price of $30 per barrel. Here the models show that Iraq would lose $55 to $143 billion at $30 per barrel, while if the oil price averaged a higher $50 per barrel, Iraq would lose far greater revenues of $94-$250 billion, compared to the nationalized model.
[Inset: TABLE 5.2: IMPACT OF PSAs ON DISCOUNTED IRAQI STATE REVENUES: State revenue - 2006 net present value (US$ billion)/State take/Revenue loss under PSA scenario -- 2006 NPV (US$ billion): Nationalised 183/100%/-; Russia PSA terms: 140/77%/43; Oman PSA terms: 147/80%/36; Libya PSA terms: 167/91%/16. Figures in real terms (2006 prices) , at constant $40/bbl oil price, using a discount rate of 12%, for the period 2006-35. See appendices 3-5 for details of full results, data sources, methodology and modelling assumptions.]
[Inset: TABLE 5.3: IMPACT OF ALTERNATIVE OIL PRICE SCENARIOS ON IRAQI STATE REVENUES: Loss relative to nationalised scenario shown in brackets [Note [c] May differ slightly from difference between figures in table, due to rounding.] [1st 2 figures] US$30/barrel scenario/[2nd 2 figures] US$50/barrel scenario; Total undiscounted revenue (US$ billion)/Total NPV revenue at 12% (US$ billion)/Total undiscounted revenue (US$ billion)/Total NPV revenue at 12% (US$ billion): Nationalized: 716/133/1,227/232; Russia PSA terms: 580 (136)/104 (30)/977 (250)/175 (57); Oman PSA terms: 573 (143)/107 (26)/982 (245)/186 (46); Libya PSA terms: 661 (55)/122 (12)/1,133 (94)/212 (20).]
MASSIVE PROFITS: HOW MUCH DO THE OIL COMPANIES STAND TO GAIN?
Our economic model has also been used to calculate the key measure of oil project profitability -- the Internal Rate of Return (IRR) (see Appendix 2) -- which the oil companies are expected to make. This provides another measure of whether PSAs represent a fair deal for Iraq. Profitability varies according to the size of the oil field, so we have based our projections on three different fields which (in Iraqi terms) are typical small, medium, and large oil fields. Our figures show that under any of the three sets of PSA terms, oil company profits from investing in Iraq would be quite staggering, with annual rates of return ranging from 42% to 62% for a small field, or 98% to 162% for a large field. This shows that under PSAs, Iraq's loss in terms of government revenue will be the oil companies gain.
By way of comparison, oil companies generally consider any project that generates an IRR of more than a 12% to be a profitable venture. For Iraqi oil fields, even under the most stringent PSA terms, it is clear that the oil companies can expect to achieve stellar returns. Even at prices of $30/barrel, profits are excessive on all fields, with any terms, ranging from 33% on a small field with stringent terms to 140% on a large field with lucrative terms. At $50/barrel, the profits are even greater, ranging from 48% to 178%.
LOSING CONTROL: THE DEMOCRATIC COST OF PSAS
Iraq's democracy is new and weak. Having suffered decades of oppression by Saddam Hussein, Iraq's institutions and civil society need time to develop and mature. In this situation many Iraqis may feel that they do not wish to immediately lock their country into any single model of oil development over the long term. Unfortunately this is exactly what Iraqi politicians,
[Inset: TABLE 5.4: IMPACT OF PSAS ON OIL COMPANY PROFITABILITY: [All 3 figures] Projected oil company Internal Rate of Return (%). Amara field (small)/Nasiriya field (medium)/Majnoon field (Large): Russia PSA terms: 62/105/162; Oman PSA terms: 51/83/120; Libya PSA terms 42/67/98. For $40 per barrel average oil price, in real terms (2006 prices). See appendices 3-5 for details of full results, data sources, methodology and modeling assumptions.]
[Inset: TABLE 5.5: OIL COMPANY PROFITABILITY AT DIFFERENT OIL PRICES: [1st 3 figures] US$30/barrel scenario/[2nd 3 figures] US$50/barrel scenario: Amara/Nasiriya/Majnoon/Amara/Nasiriya/Majnoon: Russia PSA terms: 46%/82%/140%/74%/122%/178%; Oman PSA terms: 41%/67%/107%/60%/95%/131%; Libya PSA terms: 33%/53%/91%/48%/79%/109%.]
[PHOTO of oilfield workers CAPTION: Under PSAs, Iraq would hand sovereignty over oil resources, to foreign companies and international investment courts]
under US and UK pressure, appear to want to do. As we saw in section 2, in theory PSAs would allow the Iraqi state to retain ownership and control over their oil resources. However, in practice they will impose severe restrictions on current and future Iraqi governments for the full lifetime (25-40 years) of the contract. PSAs have four key features that will in practice limit and remove democratic control from the Iraqi people:
--They fix terms for 25-40 years, preventing future elected governments from changing the contract. Once a deal is signed, its terms are fixed. The contractual terms for the following decades will be based on the bargaining position and political balance that exists at the time of signing a time when Iraq is still under military occupation and its governmental institutions are weak. In Iraqs case, this could mean that arguments about political and security risks in 2006 could land its people with a poor deal that long outlasts those risks and is completely unsuited to a potentially more stable and independent Iraq of the future.
--Secondly, they deprive governments of control over the development of their oil industry. PSA contracts generally rule out government influence over oil production rates. [Note 63: Like many of the other details of the contracts, the extent to which this is a problem will depend on the outcome of negotiations. However, experience elsewhere suggests it will be difficult. For example, OPEC members Algeria and Nigeria have consistently struggled, and largely failed, to rein in foreign companies' production rates. Of the 11 members of OPEC, these two (along with Indonesia, which has recently under-produced its quota anyway, due to declining capacity) are the ones with the greatest level of foreign oil company involvement. Similarly, when Iraq under Saddam Hussein attempted to attract foreign investment in 1995, the Oil Minister admitted in an interview with Middle East Economic Survey that guarantees would have to be given to oil companies that they would be able to produce at their desired level. [Dr. Safa Hadi Jawad al-Habubi, interview with MEES, 38:25, 20 March 1995, p.A5]] As a result, Iraq would not be able to control the depletion rate of its oil resources as an oil-dependent country, the depletion rate is absolutely key to Iraqs development strategy, but would be largely out of the governments control. Unable to hold back foreign companies production rates, Iraq would also be likely to have difficulty complying with OPEC quotas which would harm Iraqs position within OPEC, and potentially the effectiveness of OPEC itself. The only way to avoid either of these two problems would be for Iraq to cut back production on the fields controlled by stateowned oil companies, reducing revenues to the state.
--Thirdly, they generally override any future legislation that compromises company profitability, effectively limiting the government's ability to regulate. One of the most worrying aspects of PSAs is that they often contain so-called stabilization clauses, which would immunize the 60-80% of the oil sector covered by PSAs from all future laws, regulations and government policies. Put simply, under PSAs future Iraqi governments would be prevented from changing tax rates or introducing stricter laws or regulations relating to labour standards, workplace safety, community relations, environment, or other issues. One common way of doing this is for contracts to include clauses that allocate the 'risks' for such tax or legislative change to the state. [Note 64: E.g. in Azerbaijan's ACG PSA [Article XXIII, clause 23.2]: "In the event that the Government or other Azerbaijan authority invokes any present or future law, treaty, intergovernmental agreement, decree or administrative order which contravenes the provisions of this Contract or adversely or positively affects the rights or interests of Contractor hereunder, including, but not limited to, any changes in tax legislation, regulations, administrative practice, or jurisdictional changes pertaining to the Contract Area, the terms of this Contract shall be adjusted to re-establish the economic equilibrium of the Parties, and if the rights or interests of Contractor have been adversely affected, then SOCAR shall indemnify the Contractor (and its assignees) for any disbenefit, deterioration in economic circumstances, loss or damages that ensue therefrom." In the PSA for Shell's Sakhalin II oil developments in Russia, Appendix E exempts the project from, amongst other laws, the Russia Water Code which forbids discharge of flows and drainage waters in spawning and wintering areas for valuable and protected fish species and in habitat for Red Book protected wildlife and plant species. Destruction of salmon spawning sites as a result of oil spillage is a major concern in the project. Article 24 (f) also provides blanket compensation for damage caused to Shell's profits: The Russian Party shall compensate the Company for any damage caused to the consortium's "commercial position" by "adverse changes in Russian laws, subordinate laws and other acts taken by Government bodies after December 31, 1993 (including changes in their interpretation or their application procedure by government bodies and by the courts in the Russian Federation)."]
In other words, if the Iraqis decided to change their legislation, they would have to pick up the bill themselves. The foreign oil company's profits are effectively guaranteed.
--Fourthly, PSAs commonly specify that any disputes between the government and foreign companies are resolved not in national courts, but in international arbitration tribunals which will not consider the Iraqi public interest. Within these tribunals, such as those administered by ICSIDd in Washington DC, or by the International Chamber of Commerce in Paris, disputes are generally heard by corporate lawyers and trade negotiators who will only consider the narrow commercial issues and who will disregard the wider body of Iraqi law. As the researcher Susan Leubuscher comments, That system assigns the State the role of just another commercial partner, ensures that non-commercial issues will not be aired, and excludes representation and redress for populations affected by the wideranging powers granted [multinationals] under international contracts. [Note 65: Susan Leubuscher, 'The privatisation of justice: international commercial arbitration and the redefinition of the state'. MRes thesis, Birkbeck College, 2 June 2003 http://www.fern.org/pubs/reports/dispute%20resolution%20essay.pdf] They may also -- especially if connected to bilateral investment treaties -- make a foreign companys home state a party to any dispute, thus enabling that country to weigh in on the companys behalf. This loss of democratic control is illustrated by the case of BPs Baku-Tbilisi-Ceyhan (BTC) oil pipeline, which is being built from the Caspian Sea to the Mediterranean. This project is governed by a Host Government Agreement, some of whose legal provisions are comparable to those in PSAs.
In November 2002, the Georgian Environment Minister said she could not approve the pipeline routing through an important National Park, as to do so would violate Georgias environmental laws. Both BP and the US government put pressure on the Minister, through then President Shevardnadze. The Minister was forced first to concede the routing with environmental conditions, and then to water down her conditions. Part of the reason for her weak bargaining position was that two years earlier Georgia had signed the Host Government Agreement for the project, which set a deadline for environmental approval within 30 days of the application and stipulated that the contract had a higher status than other Georgian laws. The environment laws the Minister referred to were irrelevant. Ultimately, on the day of the deadline, the President called the Minister into his office, and kept her there until she signed, in the early hours of the morning. [Note 66: Nino Chkhobadze (Georgian Minister for the Environment), letter to BP CEO John Browne, 26 November 2002; AFP, 'Georgia Approves $2.9bn Oil Pipeline', 2 December 2002] Shortly after Shevardnadze was overthrown in a rose revolution in November 2003, new President Mikhail Sakashvili commented, We got a horrible contract from BP, horrible [Note 67: We Wont Be Bullied, Transitions Online, 9 August 2004] but he could not change it.
MULTINATIONAL COMPANIES FAVOR COMPLEXITY
Another feature of production sharing agreements is that they are the most contractually complex form of oil contract. PSAs generally consist of several hundred pages of technical legal and financial language (often treated as commercially confidential). It is their complexity, not their simplicity, which is advantageous to oil companies.
The simplest form of oil fiscal system is the royalty (defined as a percentage of the total value of the oil), which can be seen as a company paying the state for its oil -- effectively buying it. This is used in most concession agreements, and sometimes in PSAs. In comparison with production sharing formulae, it is very clear what the state should receive from royalties -- a fixed percentage of the value of oil. As long as the number of barrels extracted is known, and the oil price, it is easy to work out what royalty is due from the oil companies.
However oil companies dislike royalties and prefer systems based on an assessment of profits, such as PSAs. The reason is that they want what they call upside (i.e. opportunities for greater profits) -- ways they can reduce their payments, rather than being subject to a fixed level of payment for oil extracted.
Under profit-based systems, revenue is based on the profit remaining when the oil companies production costs have been deducted from the total revenue. As such, they depend on complex rules for which costs can be deducted, how capital costs are to be treated, and so on. The more complicated the system, the more opportunities there are for a company to maximize their share of the revenue by sophisticated use of accountancy techniques. Not only do multinational companies have access to the worlds largest and most experienced accountancy companies, they also know their business in more detail than the state they are working with. Consequently a more complicated system tends to give multinationals the upper hand.
For example, in the Sakhalin II project in Russia, the complex terms of the PSA resulted in all cost overruns being effectively deducted from state revenue instead of from the Shell-led consortiums profits. During the planning and early construction of the project, costs inflated dramatically. In February 2005, the Audit Chamber of the Russian Federation published a review of the economics of the project, finding that cost overruns, due to the terms of the PSA, had already cost the Russian state $2.5 billion. Although three PSAs were signed in the mid 1990s in Russia, they have been the subject of extreme controversy ever since. The changing view of PSAs in Russia in general also illustrates the loss of democratic control inherent in PSAs if the government or political climate changes, the terms of a PSA cannot change to reflect new priorities. PSAs generally last for between 25 and 40 years. In Russias case, the rush to privatize in the early 1990s is now being questioned but with the PSAs already in force it is impossible to rectify mistakes.
The Sakhalin II PSA is an example of a special type of PSA, which is growing in prominence. In such PSAs, the sharing of profit oil is based not on a fixed proportion, but on a sliding scale, based on the foreign companys profitability. The state receives only a low proportion of profit oil (or in the Sakhalin case, none) until the company has achieved a specified level of profit. Thus, states are deprived of revenue, while corporate profits are guaranteed. (See Appendix 1).
IRAQ WOULD FARE NO BETTER
In theory, Iraq may be able to negotiate PSAs with much more stringent terms than those used elsewhere in the world. As noted above, we do not know what exact terms Iraq might adopt if it uses PSAs. Iraq could also, in theory, avoid some of the more draconian legal clauses outlined above.
However, we have also seen that there are a number of structural features of PSAs which are likely to act against Iraqs interests, whatever the terms. Helmut Merklein, a former senior official of the US Department of Energy, explains this based on the concept of economic rents -- the excess profits of oil production (after deducting production costs and a reasonable return on capital):
For all the sophistication and the bells and whistles these contracts have, . . . they all have two basic flaws, which make them less than perfect in terms of capturing rent. They are subject to distortions through petroleum price fluctuations in world markets, and they generally fail to provide the host country with its proper rent if the field turns out to be greater than expected. Various triggers in those agreements reduce the host countrys exposure, but they never really eliminate it. [Note 68: Helmut Merklein, "Who Needs Big Oil in Iraq: The Case for Going It Alone', Middle East Economic Survey, 12 January 2004]
The generation of rents is a feature of oil production. Because of oils sheer value, its extraction generates profits beyond what is normally expected on an investment. These rents should belong to the country that possesses the oil resource. However, Merkleins point is that PSAs cannot -- in unpredictable economic circumstances -- deliver the country its fair share of the rents, and inevitably tend to give foreign oil companies excessive profits at the countrys expense.
To the flaws identified by Merklein, we would add the long-term and restrictive nature of PSAs, that their terms are fixed as negotiated in a situation which -- one hopes -- will not persist in Iraq; and that they also place legal constraints beyond the issue of revenue-sharing, as we have seen. In some countries, circumstances in the oil sector may favor investment through a mechanism such as PSAs, in spite of these disadvantages -- such as where fields are offshore, risk capital for exploration is required, or the country lacks technical competence. In Iraq, however, these conditions do not apply, and given the countrys huge oil wealth, it does not need to accept the negative consequences of PSAs. On top of these structural flaws in PSAs, there are grounds to doubt whether the specific terms Iraq might achieve would be any better than in other countries, despite Iraqs enormous oil reserves. The key issue here is bargaining power: the Iraqi state is new and weak, and damaged by the ongoing violence and by corruption, and the country is still under military occupation. In fact, rather than negotiating a more stringent PSA deal than elsewhere, the oil companies will inevitably wish to focus on the current security situation to push for a deal comparable to -- or better than -- that in other countries in the world, while downplaying the huge reserves and low production costs which make Iraq an irresistible investment. Indeed, precisely this point is being pushed by the oil companies and their governments. The corporate lobby group ITIC attempts to invert conventional economic logic, by implying that there is greater competition among oil-producing countries than among private companies: Although Iraqs potential petroleum wealth is enormous, the government still faces competition from other countries offering petroleum rights to investors. . . . Investors, too, are competing for access to attractive petroleum deposits but competition among them may be limited if the project in question requires scarce expertise or depth of financial resources. [Note 69: ITIC, Petroleum and Iraq's Future, op cit, p.33]
Thus one of ITICs key recommendations is that Iraq offer to companies profit potential consistent with the risk they bear. [Note 70: Ibid., p. 8] Their argument that countries, not companies, must compete is especially perverse given the high oil price, and the wide recognition of supply constraint: that there is a shortage of access to reserves, not of access to capital.
Similarly, the U.S. governments development agency USAID has advised the Iraqi authorities that Countries with less attractive geology and governance, such as Azerbaijan, have been able to partially overcome their risk profile and attract billions of dollars of investment by offering a contractual balance of commercial interests within the risk contract, one that is enforceable under U.K. and Azeri law with the option of international arbitration. [Note 71: Bearing Point, op. ci.t, p. 5] If Iraq follows that advice, it could not only concede a contractual form which is not in its interests, but specific terms which radically understate the countrys attractiveness to the international oil industry. Along with much of its future income, Iraq could be surrendering its democracy as soon as it achieves it.
--PLATFORM is an interdisciplinary organisation working on issues of environmental and social justice. Founded in 1984, it specializes in addressing the impacts of British oil corporations on development, environment and human rights. http://www.carbonweb.org
--Global Policy Forum monitors policy making at the United Nations, promotes accountability of global decisions, educates and mobilizes for global citizen participation, and advocates on vital issues of international peace and justice. http://www.globalpolicy.org
--The Institute for Policy Studies strengthens social movements with independent research, visionary thinking, and links to the grassroots, scholars and elected officials. With an emphasis on the U.N. and the Middle East, IPS's New Internationalism Project works to strengthen the U.S. and global peace movements. http://www.ips-dc.org
--Oil Change International campaigns to expose the true costs of oil and facilitate the coming transition towards clean energy. We are dedicated to identifying and overcoming political barriers to that transition. http://www.priceofoil.org
--The New Economics Foundation (NEF) works to construct a new economy centred on people and the environment. Founded in 1986, it is now one of Britains most creative and effective independent think tanks, combining research, policy, training, and practical action. http://www.neweconomics.org
--War on Want is a U.K.-based campaigning charity. Founded in 1951 it has links to the labor movement and supports progressive, people-centred development projects around the world. War on Want campaigns in the U.K. against the causes of world poverty. http://www.waronwant.org