Iraqi oil: black gold or curse?

The world’s most advanced economy and largest oil consumer, the United States, is likely to spearhead efforts to develop alternative energy sources on a global scale. When this happens, producers are likely to respond to a diminishing oil market by trying to diversify their economies to reduce dependence on oil exports. Until such a process begins to materialize, high dependence on oil is a short-term reality for consumers and producers.

According to the US Department of Energy, 2001 world oil demand is forecast to rise by an average of 1.2 percent per year. In a low economic growth scenario this takes demand from a 2001 average of 403.9 million barrels per day (mbpd) to 477.5 mbpd in 2010. In a high growth scenario, demand is forecast to increase by 2.4 percent per year, from 403.9 mpbd to 491.1 mpbd in 2010.

As long as oil remains the world’s dominant energy source, net consumers and producers have to improve the management of this strategic resource.

On the consumer side, the US yet again finds itself in a position where the management of its global oil interests must be improved to mitigate persistent price and market shocks.

The problem of management, however, especially affects producers. They stand to lose the most in the event of a global shift to viable energy alternatives. On the supply side, the Iraqi oil industry provides a good example of how producers need to focus the management of strategic oil interests toward improving domestic stability and allowing for economic growth, diversification and less dependence on oil exports.

For Iraq, oil is potentially the engine of growth. How it is managed will shape Iraq’s future. Historically, Iraq has seen more problems than benefits from its oil industry, which has been characterized by negligent mismanagement, mainly in terms of revenue accounting, legal frameworks, production sharing, training and institutional development.

Iraq’s oil industry has persistently experienced patterns of poor accounting and administrative corruption. Most recently, a minimum of $5 billion of oil revenue (during 2003-2004) is still unaccounted for. This amount was under the administration of the Coalition Provisional Authority (CPA), under the auspices of the Development Fund for Iraq (DFI). Only by launching formal investigative processes can the new Iraqi government set the required legal precedent for the more efficient and transparent management of Iraq’s oil revenue. Without such efficiency and transparency, oil is unlikely to act as an engine of growth, facilitating sustained economic development and the diversification of Iraq’s economy. In this case, Iraq’s economy will continue to depend on an inefficient and antiquated oil industry.

In addition to better revenue management, Iraq’s oil industry also requires appropriate legal frameworks and effective legislative authorities to regulate the Iraqi government’s interaction with the international market, particularly in the areas of exploration and production. Iraq’s oil industry also suffers from outdated skills, as well as a lack of specialized technical and training institutions needed to maintain global technical standards. In reality, transnational oil companies are best placed to facilitate the resources, skills and technology required for the rehabilitation of Iraq’s oil industry and the sustainable expansion of Iraqi production.

This is best achieved through a comprehensive field development program, with production sharing agreements (PSA) as the most effective mechanism with which to pursue strategic production targets. Iraq’s Supreme Petroleum Council (SPC), established by the previous interim government, was a step in the right direction in terms of establishing the appropriate legal frameworks to allow foreign companies to successfully operate in Iraq’s industry, although the SPC’s authority still needs to be formally ratified as an integral part of Iraq’s constitution.

Reforming Iraq’s oil industry is certain to have a positive impact on improving Iraq’s security situation, especially if such reform expands job opportunities for ordinary Iraqis who have historically seen little benefit from the country’s considerable reserves. The situation in Iraq has gone from the need for ambitious long-term projects, to realistic short-term targets. Only by focusing on the fundamentals of revenue management, production sharing and institutional development can Iraq transform its oil industry from its current state as a volatile and inefficient asset into an engine of growth and stability. This in turn can only be achieved by an Iraqi government genuinely committed to promoting the stability and territorial integrity of Iraq. To a large extent, the ability to reform Iraq’s oil industry also depends on the political will of the US government as arguably the most significant external influence on Iraq’s oil industry.

For net consumers and producers, the search for alternative energy sources remains a long-term challenge, although this prospect is more realistic for technically and economically advanced consumers like the US. Most producers, as in the case of Iraq, must drastically reform the management of their oil industries in order to diversify their economies, reduce dependence on oil exports and avoid the long-term adverse impacts implicit in the shift to sustainable alternatives.