The Magazine

Oil's Not Well in Iraq

But it's not too late to fix the problem.

Feb 19, 2007, Vol. 12, No. 22 • By MICHAEL MAKOVSKY
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On March 27, 2003, Paul Wolfowitz, then deputy secretary of defense, predicted that Iraq's oil revenue would "finance" its reconstruction and do so "relatively soon." With wise investment and management, Wolfowitz might have been right. Even though its oil sector accounts for 95 percent of the Iraqi state's revenue and is essential to the country's ability to one day pay its own way, the United States has yet to make a serious effort to boost the Iraqi oil industry, which controls the second or third largest reserves (mostly undeveloped) in the world. President George W. Bush's recent Iraq plan is no better in this regard.

Despite Iraq's violence and political difficulties, its oil revenue has grown about 30 percent each year since 2004, topping $30 billion in 2006. This achievement, however, was due mostly to high oil prices, which, as the recent broad price drop indicates, cannot be counted on in the future. According to State Department figures, production has been stagnant at 2.1 million barrels per day, or 400,000 barrels per day below the immediate prewar peak (which was matched for a few months in 2004). The shortfall from even this modest target represents a loss of over $7 billion annually (based on $50 per barrel of Iraqi oil) and about 15 percent of unused, or spare, global oil production capacity (a significant amount in a still tight market).

Many in and out of government accept the conventional wisdom that security problems are to blame. Indeed, security problems have contributed to smuggling and irregular oil exporting through the north to Turkey, as well as limited refining and uneven distribution of gasoline and other petroleum products. And certainly if violence were to spread to the southern oil facilities, Iraq could suffer a longstanding loss of significant oil production and exports.

But putting all the blame on security is mistaken. To illustrate this error simply, there have been few attacks in the south, where over 80 percent of Iraqi oil is produced, and yet oil production and exports there have been generally stagnant for over three years.

Blaming the lack of security masks the serious problem of poor Iraqi and U.S. management of vital oil projects. Most notably, Iraq's overwhelmed and centralized bureaucracy, increasingly fearful of accusations of corruption, has managed to spend only a fraction of the Iraqi funds available for oil projects in the past couple of years. Through underinvestment, the United States also hobbled initial efforts to improve Iraq's oil revenue, despite the potential for even small upgrades in Iraq's oil sector to result in spectacular financial returns for the Iraqis. Fears that a more assertive policy would fuel conspiracy theories and upset Iraq's oil-exporting neighbors (who are supposedly worried that a resurgence of Iraqi oil production would oversupply the market and reduce their market share) has led Washington to seek only to restore facilities to their prewar condition. In contrast, after many years of watching their country's oil capacity decline because of war, sanctions, and looting, several senior Iraqi oil officials sought to boost oil production and exports. Too bad this point of view was not more widely shared. Some U.S. and Coalition Provisional Authority officials have seemed to believe the oil industry does not need much funding at all. And what little funding has been allocated has been interrupted by delays and contracting procedures, when not mismanaged or spent to import fuel. The result has been a practice of underinvestment in a sector that should be yielding enormous financial returns.

The past notwithstanding, the Bush administration should bring greater focus to this issue. The White House views oil primarily as a political vehicle to unite Iraqis instead of as a means to advance Iraq's economy and self-sufficiency. In his January 10 address, Bush limited discussion of oil to the question of equitable revenue-sharing and Iraq's need for a good law to bring that about. Perhaps such a law will contribute to national political reconciliation, but the issues involved are very complex, and agreement and implementation could take far longer than the media and perhaps even the White House imagine.

There needs to be, however, not one oil law but a multilaw hydrocarbon regime to address not only revenue-sharing but also foreign investment, taxation, contracting, the establishment of a decision-making federal petroleum committee, and the reestablishment of Iraqi national oil companies, among other vital matters. Revenue-sharing might be part of the horse-trading, but its resolution should not be a precondition for addressing every other issue. For any such agreements to become law under Iraq's constitution, a draft law must pass through the Council of Ministers and then Parliament. If any constitutional amendments are required to accommodate any new oil laws, the process will go on even longer.

While this whole process plays out, the Iraqi oil sector will continue to deteriorate, to the short- and long-term detriment of Iraq's ability to become self-sufficient. Iraqi oil stagnation or decline will also contribute a bullish element to the global oil market, which is certainly not constructive to U.S. economic or strategic interests.

Thus, the U.S. government should be looking beyond the politics of Iraqi oil to help Iraq pursue the economic advantages of developing its oil sector. Here are some practical ways the United States can help.

* First, Washington should work to bolster necessary Iraqi and U.S. technical expertise in Baghdad. The number of excellent Iraqi oil officials, many of whom trained abroad, is quickly dwindling because of age, security, and ministry politicization. The United States needs to encourage the Ministry of Oil to hire outside experts in contracting, project management, security, and other important areas, and integrate them into its bureaucracy just as Russian, Saudi, and other national oil companies have hired foreign experts. Likewise, the U.S. State Department must rely less on diplomats and more on private sector experts to run and reform its reconstruction operations. Broadly, State should withdraw generalist civilian ministerial advisers in favor of targeted industry experts, to whom the Iraqis will be more likely to listen.

* Second, Washington should hike its funding for training Iraqi oil officials beyond the current $2.5 million managed by the Trade and Development Agency, and conduct extensive training in the United States as some senior Iraqi oil officials have requested. Most training is conducted elsewhere in the Mideast because of cost and U.S. visa difficulties. But it would better serve U.S. interests to train future Iraqi oil leaders here, where they can improve their English, study our ways, and develop relationships with a range of U.S. oil executives and government officials. Russia, Britain, China, and others have hosted hundreds of Iraqi oil officials for extended training in their home countries.

* Third, the United States should facilitate the expenditure of additional funds to increase Iraqi oil production, export, and storage capacity, particularly in the south. Some projects, such as oil well refurbishments, can quickly bring superb returns. Of course, the Iraqis must spend some of their own money, but the United States must not wait for that to happen. Whatever the Iraqis do not spend now, they will certainly need later anyway.

* Fourth, the United States ought to dedicate more resources to infrastructure security in the south, which suffers fewer attacks than the center or north but is far more important to the oil industry. While the United States can help with money and personnel, Iraq must take overall responsibility for infrastructure security and bring in private contractors to help with training and guarding key facilities--the cost of which will be offset by the extra oil revenue generated.

The Iraqis must take the lead in developing and securing their highly promising oil industry. But the United States should provide targeted guidance and assistance, so that Iraq can generate greater revenue in the near and long term. That remains an essential condition for reviving and stabilizing Iraq and finally reducing its dependency on the U.S. military and taxpayer.

Michael Makovsky was a special assistant for Iraqi oil policy in the office of the secretary of defense, 2002-2006.