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| Iraqi Oil After Saddam April 22, 2003 The Short-Term Return of Iraqi Oil The US military has now taken contol of all of Iraq’s oil infrastructure: wells, gas-oil separation plants, pipelines, loading terminals, etc. (plus the refineries that make oil products for domestic Iraqi consumption). None or very little of this is currently in operation, but it is being assessed by the US Army Corps of Engineers and American firms contracted for the job of seeing what is needed to get things restarted. Getting everything back working again, however, should not be difficult from a technical perspective. The wells were not systematically blown up—there are over 1600 wells in Iraq, so the 10 or so wells that were blown were only a drop in the bucket and appear to have been local moves by a couple guys with some poorly-laid explosives and not any systematic attempt to blow all the wells. So the infrastructure is pretty much intact as it was before the war. That said, even before the war, the Iraqi industry was in very poor shape due to the decade of sanctions (lack of investment, spare parts, well workovers, etc.). Iraqi engineers and technocrats have proven highly competent at running the industry under extremely difficult circumstances, but the whole thing now runs on the equivalent of chewing gum and matchsticks. There have been conflicting reports of what standard the Army Corps of Engineers plans to set as acceptable before saying the fields should restart, although my suspicion is that getting oil flowing is paramount, the only issue being whether it goes at reduced flow rates or at the same levels it was pumping prior to the war. The real issue is political: Iraqi oil under sanctions can only be sold legally via the Oil-for-Food program controlled by the United Nations. The sanctions are of course still in place, and were the US or an interim Iraqi administration to try and sell the oil outside the UN program, it could be seized by creditors. The risk is not trivial, and in fact basically all the major purchasers of Iraqi oil in the US and abroad have indicated that they would not even consider purchasing it without a clear legal framework that ensured cargoes could not come under threat of seizure or litigation. At present, there is also no sovereign Iraqi government that can approve oil sales under the Oil-for-Food program. The UN will have to recognize a government, be it an American occupation government or an interim Iraqi government, in order for there to be a legal seller of the oil. But of course, the US has not exactly made a lot of friends at the UN these days, so either getting the UN to recognize a government or getting the sanctions lifted with a specific clause protecting Iraqi oil from legal action is not an easy path. These political problems are what are likely to be the greatest obstacle to the return of Iraqi oil. Market Implications of the Return of Iraqi Oil As for what this means for the global oil market: this is incredibly oversimplified, but in a nutshell we currently have a situation of low demand growth and relatively high Non-OPEC supply growth. Do the economics—low demand and high supply equals downward pressure on prices. However, there are two sources of supply, Non-OPEC countries and OPEC countries. It is the OPEC countries (who produce roughly a third of global oil) that determine at the margin whether supply is greater than demand, so if they restrain themselves enough, they can keep prices high. Problem is, if Iraq were producing full-out right now, the remaining OPEC countries’ financial needs would make it very hard to pull back production enough to keep the price up. So, for now it is the fact that Iraq is not on the market that is giving OPEC a break and letting them produce enough to keep the price at an acceptable level for them. Assuming Iraq takes a few months to come back on the market, that has probably bought OPEC about another nine months to one year of relatively high prices (though they have come down from the very high prices seen during the run-up to the war and I expect will continue to slowly slide throughout this year). Around the first quarter of next year, OPEC is going to be
stuck in a dilemma of either pulling back production so far that they can not
earn enough money to feed many of their governments' budgets, or else just
increasing production and letting the price crash. Allowing a price crash
makes some sense because high-cost wells outside of OPEC (like in the United
States) will find it uneconomic to produce and probably go out of business, in
many cases forever. Demand for oil will also be boosted in developing economies
like China or Southeast Asia. So for OPEC in the longer-term a low price is
actually good: higher demand and less competition from other sources of supply.
Of course, the downside is that they lose a lot of money in the meanwhile from
very low prices. Several OPEC countries have sufficient money in the bank to
weather such a period (Saudi Arabia, Kuwait, the UAE, Iran, Libya), but several
others do not (Nigeria, Venezuela) and could face serious domestic troubles as a
result. Indeed, with politics in Nigeria and Venezuela being as fragile as they
are right now, it's not a stretch to say Long-Term Control of Iraqi Oil On the issue of how Iraq's oil wealth will be handled: this is a very sensitive issue in Iraq where oil is viewed very much as a national resource. The technocrats who run the industry are some of the most nationalistic people in the country as well. An Iraqi friend who knows people in the oil ministry says that the technocrats are already getting back to work at the ministry in Baghdad (the only government ministry building that US forces protected and prevented from destruction—a fact bitterly noted by many Iraqis) and that they are working on their own and refusing to take any American advice. The industry was nationalized in 1972 in a very popular move by the then relatively young Ba'athist regime. Completely privatizing the industry in a blatantly American-guided manner would provoke serious anger inside Iraq. That said, the technocrats realize that they lack the investment capital, technology, and training for the younger generation of engineers needed to develop the industry as they like. In the last 10 years or so they have therefore negotiated for the entry of several foreign oil companies to develop fields in the country (though none of the deals reached fruition due to sanctions). This is not a takeover, but allowing companies to develop new wells (the old ones staying in the hands of the state North Oil Company and South Oil Company) while still keeping ultimate ownership in the Iraqi state’s hands and while paying the Iraqi government a significant portion of the oil profits from the new wells. So, Iraqis seem willing to allow foreign investment on their own terms, but not the wholesale privatization of the industry which would, I believe, be seen as robbing the nation's wealth. This is in a very real sense going to be a test of what the US' intentions inside Iraq actually are: if Americans are seen as making the big decisions or trying to arm twist Iraqis into making certain decisions, it will go down very badly. If, on the other hand, Iraqis are placed in charge and allowed to freely make their own decisions even if the US doesn't like the decisions taken, then the worries inside Iraq may fade. Unfortunately, the appointment of former Shell executive Philip Carroll to be in charge of the oil sector and the talk from neoconservative circles of forcing privatization of the Iraqi industry, do not inspire the confidence of many in the Middle East about US intentions. Ultimately though, only time will tell.
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