Before the war in Iraq began, many policymakers and oil industry experts believed that Iraq's oil industry, with the second-largest proven reserves of light crude in the world, would recover and provide most of the funds needed for Iraq's reconstruction. On March 27, 2003, for example, Deputy Secretary of Defense Paul Wolfowitz said that Iraq's oil revenues could bring between US$50 and $100 billion within two or three years following the country's liberation. "We're dealing with a country that can really finance its own reconstruction, and relatively soon," he said. Iraqi National Congress leader Ahmad Chalabi promised that American oil companies would have a "big shot at Iraqi oil."
Such optimism was unwarranted. More than two years after Saddam Hussein's statue fell, the performance of Iraq's oil industry is far below prewar expectations. Looting, sabotage, neglected infrastructure, and mismanagement have all curbed production and kept major oil companies away from Iraq. But the Iraqi leadership could reverse this trend should it learn to manage its vast oil resource in a productive way, ensuring it becomes an engine of growth and prosperity rather than a curse.
In 2004, Iraq's oil production averaged 2.4 million barrels per day (bpd), well below the coalition's stated goals of 2.8 to 3 million bpd and even lower than the 3.5 million bpd Iraq produced prior to 1990. After deducting Iraq's own domestic needs, an average of only 1.5 million bpd is left for exports, a level lower than that of the prewar period. As a result, total oil revenues are just over $25 billion. This figure would have been far smaller if not for last year's sharp jump in oil prices.
To many policymakers, the underperformance of Iraq's oil industry seems mundane. But it could be not only the most critical element determining success or failure in reconstructing Iraq but also an important issue to the global economy. With demand for oil soaring due to the Asian economic boom, the need for Iraq's oil is more pressing than ever. As the consumer of a quarter of the world's oil and leader of the coalition in Iraq, the United States has the highest stake in having Iraq's oil industry operate at full throttle.
What makes the disappointment with the Iraqi oil industry's failure so deep is the scope of potential oil resources that rest beneath its sands. There are many estimates about Iraq's oil reserves. The Energy Information Administration of the Department of Energy suggests Iraq has over 112 billion barrels of proven reserves, roughly a tenth of the world's total. Other petroleum analysts believe the country's reserves may be twice as high. They may well be right. Of all the oil producing countries, Iraq is perhaps the least explored. There are only 2,300 wells in Iraq, compared with one million in Texas alone. Only ten percent of Iraq has been explored. Only 17 of 80 fields discovered and evaluated in Iraq are operating, most of them clustered around Kirkuk in the north and Rumaila in the south. Two decades of isolation have taken their toll. Virtually no exploration has occurred in recent years, and what little has was without the benefit of sophisticated exploration techniques.
Such potential wealth might catapult Iraq to a high place in the list of major oil producing countries. But the industry is burdened with structural and regulatory problems. The Baathist government nationalized Iraq's oil industry in 1972, slamming the door on foreign ownership or investment. Under sanctions (1990-2003), the industry suffered from neglect and lack of investment, which precipitated a steady decline in production. Under the Oil-for-Food program (1996-2003), Iraq could only export two million bpd in exchange for food and medicine. While the Iraqi government produced oil in contravention to sanctions, the industry had neither the capability nor the incentive to modernize. With political stability and sufficient investment, Iraq may be able to bolster production to as much as six million bpd by 2010 and eight million bpd by 2020. To ramp up production to such levels, Iraq will have to attract billions of dollars in foreign investment, a level contingent on achieving better security.
The Sabotage Campaign
Various spoilers have waged an all-out war against Iraq's vital economic infrastructure, first and foremost among which is the country's web of pipelines, pumping stations, wells, refineries, and terminals. Since the April 2003 end of major hostilities, insurgents have targeted oil more than 220 times. They spared no part of the 4,000-mile pipeline network. Attacks on the pipeline running from Kirkuk to the Turkish port of Ceyhan have severely curtailed Iraq's exports. Every day that this pipeline is not operational, Iraq's tottering economy loses $7 million. In March 2004, terrorists began targeting oil installations in the south near Basra where more than two-thirds of Iraq's oil is produced. There has also been a shift in insurgent focus from export lines to the complex network of pipelines feeding the refineries in and around Baghdad and the Bayji refinery complex 125 miles north of the capital. The insurgents' intention is to prevent Iraq's nascent government from providing basic services. In November and December 2004 and in January 2005, for example, insurgents simultaneously struck all three crude oil pipelines connecting the northern fields to the Dawra refinery in Baghdad, the nation's largest producer of gasoline, kerosene, and other products, and the main source of fuel to Baghdad's main power plant. The campaign of oil terrorism is directed not only against infrastructure but also against those who operate it. Jordanian terrorist Abu Musab al-Zarqawi masterminded a campaign against truck drivers who import fuel from Turkey. Terrorists have murdered senior members of the country's oil industry. On March 29, 2005, the head of Iraq South Oil Company, Iraq's largest state-owned oil company, narrowly escaped assassination. Many firefighters, security guards, oil engineers, and workers have quit their positions because of terrorist intimidation.
Altogether, the sabotage campaign has reduced Iraq's oil production by approximately one million bpd. Iraq's oil minister, Thamir Ghadban, estimated lost export revenue from sabotage at about $7 billion in 2004. As oil prices continue to climb, the loss of potential revenue grows. At current oil prices of roughly $55 per barrel, this constitutes a loss to the economy of $15-$18 billion per year.
Not all of Iraq's failure to rebound is of its own making. Too many interests in and outside of Iraq have a stake in preventing it from becoming a major oil producing country. Sunni insurgents target oil in order to undermine the efforts by the coalition and Iraq's interim government to rebuild the Iraqi economy. The precision and sophistication of the attacks raises suspicion that former members of Saddam's oil ministry aid the sabotage campaign. Shi'ites attacked oil facilities in response to coalition operations in Najaf last summer. Jihadists from across the Muslim world attack oil as part of their holy war against the West. They hope their attacks will cause oil prices to soar, damaging the American economy. In mid-December 2004, Arab satellite channels aired an audiotape message by Osama bin Laden in which he called on his cohorts to attack the oil industry in order to disrupt supplies to the United States from the Persian Gulf. Two days later, a follow up statement by the Saudi branch of Al-Qaeda was published, calling on "all mujahideen ... in the Arabian Peninsula" to target "oil resources that do not serve the nation of Islam." These statements reflect the post-9-11 reality in which terrorists see the world's energy system as "the provision line … to the artery of the life of the crusader nation." "The killing of ten American soldiers is nothing compared to the impact of the rise in oil prices on America and the disruption that it causes in the international economy," one jihadist website declared. The sabotage campaign could affect the U.S. economy. The financial burden of reconstruction rests upon the United States. If Iraq cannot pay for its own reconstruction, U.S. taxpayers will foot the bill. This coupled with high oil prices could worsen the U.S. trade deficit and unemployment. Many jihadists are even willing to sacrifice their lives in order to hurt the U.S. economy and deny Iraqis oil revenues. On April 24, 2004, three suicide boats attempted to destroy the Basra terminal zone, Iraq's only offshore export outlet in the Persian Gulf. Had the attack succeeded, it would have cut Iraq's oil revenues to almost zero.
The countries surrounding Iraq are not enthusiastic about the prospects of its economic revival. Their financial interests may allow some countries passively if not actively to support insurgents. The House of Saud is concerned about the prospects of democratic Iraq and even more so by the empowerment of Iraqi Shi'ites. Such a development could bring about destabilization of Saudi Arabia by its own Shi'ite minority, which is concentrated in Saudi Arabia's oil-rich eastern province. Any unrest in this region could significantly weaken the Saudi government and devastate global oil markets. Neither is Iran, for its part, eager to see a prosperous Iraq on its border. Should Iraq rejoin the small club of giant oil producers, the gradual increase in Iraq's OPEC quota would come at their expense. A conservative estimate is that between 1990 and 2003, Saudi Arabia raked in at least an extra $80 billion and Iran an extra $24 billion from having absorbed Iraq's quota.
Neither Saudi Arabia nor Iran has done much to prevent insurgents from crossing their borders into Iraq. Terrorism specialist Reuven Paz compiled the names of jihadists identified by Islamist websites and newspapers as killed in Iraq between September 2004 and March 2005. Sixty-one percent of these were Saudis. Syrians accounted for little more than 10 percent, and Iraqis just 8 percent. More than two-thirds of those carrying out suicide attacks were also Saudis. With an active military manpower of 150,000 men and with no immediate enemy threatening its territory since Saddam's ouster, Riyadh would have been better equipped to seal the border than the nascent Iraqi army or the otherwise engaged multinational forces in Iraq. Instead, the Saudi government told U.S. officials that if terrorists crossed the Saudi-Iraqi border, then it was the U.S. responsibility to stop them. Syria, for its part, might have also been the source of some of the saboteurs who blow up pipelines in the north.
Though it is difficult to determine exactly who stands behind the attacks, one thing is clear: the insurgents are well organized and technologically savvy. In order to prolong disruption, they go after critical junctures in the pipeline system and focus on equipment that is difficult to repair or remanufacture. "They know what they are doing," Aiham Alsammarae, the Iraqi electricity minister, said. "I keep telling our government, 'Their intelligence is much better than the government's.'"
The Impact of the Oil War
The insurgents' sabotage campaign has hurt the morale of the Iraqi people and affected their attitude toward occupation. Despite its huge reserves, Iraq suffers from an endemic shortage of refined petroleum products, forcing it to import half its gasoline and thousands of tons of other refined products such as heating fuel and cooking gas. Angry Iraqi drivers spend hours in line for gasoline at Baghdad's gas stations. Exacerbating the problem is the more than 50 percent rise in domestic oil consumption. The number of private cars has tripled. Gasoline is widely used to power home generators that are much needed due to the low reliability of the power system. While the coalition and Iraqi government struggle to restore electricity to prewar levels, domestic demand has increased because of the postwar, custom-free import of freezers, air conditioners, and other power-hungry appliances. Unlike in the United States where only about 3 percent of electricity is produced from oil, most of Iraq's power plants operate on petroleum. Any disruption in oil delivery immediately creates power outages that add to Iraqis' vexation with their government and the coalition. The cycle creates a Catch-22: without power, the Iraqi oil industry cannot function. Electricity is needed to inject water to the oil wells to maintain reservoir pressure and to operate refineries and pumping stations.
The sabotage campaign also has an impact on Iraqi economic development. To meet its growing needs for foreign exchange, Iraq must begin to develop its untapped reserves, especially those in the western desert. Under normal circumstances it takes between five and ten years to translate reserves into production. This means that investment in new capacity should begin as soon as possible so that sufficient revenues can be generated toward the end of the decade. But Iraq is, today, considered the riskiest destination for foreign investment of any of the world's emerging markets. Some of the world's largest international oil companies, such as Exxon Mobil, Royal Dutch/Shell, and ChevronTexaco, have indicated an interest in developing Iraq's oil resources but without security and a hospitable investment climate, they are unlikely to send skilled workers and expensive equipment to Iraq or make the multi-billion dollar investment required. "There has to be proper security, legitimate authority, and a legitimate process ... by which we will be able to negotiate agreements that would be longstanding for decades," Sir Philip Watts, chairman of Royal Dutch/Shell, said. "When the legitimate authority is there on behalf of the people of Iraq, we will know and recognize it." While many potential Iraqi fields sit idle, foreign oil companies are scrambling to find entry into Libya where the lifting of sanctions allows a safer outlet for investment.
Making Iraq Competitive
Iraq's ability to become a top oil producing country depends on three factors: a secure environment, infrastructure investment, and good governance. The most urgent priority for stability is defeat of the insurgency. Beyond this, the government will have to bolster efforts to protect critical energy infrastructure. In the months following Saddam's fall, the Coalition Provisional Authority entrusted oil security to private contractors. These contractors, in turn, hired tribal interests to guard oil installations at a monthly rate of over $1,000 per mile secured. This approach failed largely because the tribes began to compete amongst each other. Losers would blow up pipelines and oil wells in the territory of the tribe that won the contract in order to prove the successful bidders' incompetence.
Toward the end of 2004, responsibility began to shift from foreign contractors to the indigenous security forces. The Iraqi Oil Ministry today employs about 14,000 guards to protect oil facilities all across the country. Some 2,000 guards have been posted in the area north of Baghdad and along the pipelines running from Kirkuk. The remaining 12,000 are in the south, whose oil terminal accounts for more than 80 percent of Iraqi exports. That sabotage is concentrated in the Baghdad and Bayji regions indicates that the Iraqi government should deploy more guards to this vulnerable region.
Technology might also play an important role in the effort to secure Iraq's oil infrastructure. As a result of progress in high-resolution remote sensing and image processing technology, it is now possible to deploy sophisticated surveillance systems, including small and medium-sized unmanned aerial vehicles and unmanned helicopters to survey critical areas. Some defense contractors are even developing unmanned aerial vehicles mounted with lethal weapons for use against saboteurs. New technologies for seismic sensing of underground vibrations can provide early warning when saboteurs approach the protected area. Naturally, such systems are expensive and would add to the production cost of Iraq's oil. But over the long run, better security is likely to pay off since it will attract foreign investors and reduce the number of costly disruptions. Furthermore, these technologies rely on small numbers of rapid-response teams and eliminate the need for large numbers of security guards.
Should the country be unable to afford such technologies, it should invest in mechanisms to minimize the damage attacks can cause. The cheapest and most effective way to protect a pipeline is to bury it or prevent easy access by surrounding it by walls and fences. Pipes can also be fortified with external carbon fiber wrap that can mitigate the affects of explosive devices. Equally important is shortening the lead-time between the attack and the repair. Saboteurs often target pipelines at critical junctions or hit custom made parts that take a long time to replace. As a result, ruptured pipelines are often out of operation for weeks. To reduce the lead-time, pipeline operators should be equipped with sufficient repair teams as well as inventories of spare parts.
Even if security forces quelled the sabotage, the Iraqi government would still need to invest considerable funds to replace aging equipment and leaky pipes, train its oil workers, and overcome wasteful and environmentally damaging practices. In most oil producing countries, for example, gases separated from oil prior to the refining process are captured and turned into usable products. In Iraq, due to lack of relevant infrastructure, they are simply burned. The first step needed in order to generate sufficient income to meet reconstruction needs is for Iraqi export facilities to be repaired and upgraded. Absorptive capacity is also a problem. The Iraqi government has nearly $8 billion in bank accounts it cannot use. Throwing money at problems is not enough if there is a lack of skilled labor and security. Iraq's most important export facility is Mina al-Bar on the Persian Gulf. The facility, which was heavily damaged during the 1991 Kuwait war, can handle just half of its original capacity. Another exit to the Persian Gulf is located at Khor al-Amaya, which has not been in operation since 1991. Substantial repairs need to be made in both terminals in order for Iraq to be able to ramp up its Persian Gulf exports. Similar effort is needed in the other outlets in the north. The government is planning to invest $3 billion in its oil infrastructure in 2005 and increasing sums thereafter.
In addition to physical security, foreign investors also need political stability and financial security. Dealing with an interim government is risky because there is no guarantee that subsequent governments will honor contracts. This is why it is so critical that elected government officials project in their private and public statements a sense of stability and continuity. It is also important that the elected government handle Iraq's oil wealth with care, providing transparency and accountability to the people of Iraq and the international community at large. Iraqi officials have already indicated that the new government will open its oil business to foreign investment and allow foreign energy companies to bid for oil and gas concessions. Former Iraqi prime minister Iyad Allawi promised in January 2005 that "economic policy will move away from government intervention and allow private investment. The state will no longer monopolize everything, including the oil sector, except for the upstream, which will be under the jurisdiction of the elected Iraqi government." Experience with privatization efforts in other countries shows that privately held energy infrastructure generates greater efficiency and higher profits than projects run by centrally-planned and state-owned entities. But privatization will not be an easy process. After decades of tight government control over the oil market, the Iraqi oil industry is unaccustomed to a strong private sector and open market practices. Additionally, Iraqis see oil as part of their national identity; many still believe that the United States invaded Iraq to seize its oil. They are, therefore, averse to the idea that part of the country's oil reserves be controlled by foreigners.
Privatization will also require the introduction of a new pricing system to the heavily subsidized market of refined petroleum products. In Iraq, government subsidies keep gasoline prices so low that it can be purchased for about five cents a gallon. Such low prices encourage not only inefficiency and over-consumption but also sustain a black market and an industry of fuel smuggling to neighboring countries. Privatization is likely to entail a painful rise in fuel prices that many Iraqis cannot afford. To persuade the public that privatization of the oil industry is for the good of the people, the government should guarantee that the process takes place gradually and in a fully transparent manner. The public aversion to high fuel prices could be overcome by providing low income Iraqis with ration stamps for fuel. Ordinary Iraqis should realize that despite the problems, a privatized oil industry is the best way to ensure high revenues for the Iraqi economy, better living standards for the Iraqi people, and the return of Iraq to a leadership role in the world community. Successful privatization could also serve as a model for other state-owned oil industries in OPEC countries, hence weakening the cartel's domination of the energy markets.
Most important, as Iraqis lay the foundations for a democratic future, their leaders should think how to ramp up oil production and become a major oil producing country while avoiding many of the pitfalls and social illnesses associated with over reliance on natural resources. With the exception of countries such as Canada and Norway, most oil economies have failed to utilize their oil wealth for the benefit of the people. Democracy in these countries is either flawed or nonexistent. There are, however, positive examples of oil producers that introduced potentially useful models to address the problem economists call "natural resource curse." Norway set up a trust fund in which oil revenues are kept for the benefit of future generations. In Alaska, oil revenues are distributed directly to all citizens, and in Chad, the World Bank mandates that nearly three-quarters of the royalties are spent on health, education, and poverty reduction. Such models can only succeed in countries with honest or, in the case of Chad, independent monitoring.
As a new democracy, Iraq might explore similar models. With very little other than oil to offer the world, Iraq will continue to rely on oil revenues as a key element of its economy in the years to come. But it is the country's ability to develop its human resources and diversify its economy that will guarantee future economic and social stability. If every dollar invested in oil production is matched by at least a dollar invested in education and the creation of a private sector and manufacturing economy, Iraq could become the first functional market economy among the major oil exporting countries. Failure to diversify the economy will invite corruption, uneven distribution of wealth, a disgruntled population, authoritarianism, human rights abuses, and growing radicalization—all of the scourges from which Iraq had to be liberated in the spring of 2003.
Gal Luft is executive director of the Institute for the Analysis of Global Security.
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