Pipe dreams of Iraqi oil

Millions of barrels must flow soon to pay for reconstruction contracts, write Faisal Islam and Oliver Morgan

The industry

The oil has started to flow at last. For the first time since the beginning of the war in Iraq, supplies from the world's second largest reserve are being pumped into a sluggish global economy in need of an injection of cheap black gold.

Today, a BP tanker is scheduled to load 2 million barrels of Basra Light crude oil at the Gulf port of Mina Bakr. US oil giant ChevronTexaco will lift a further 2m barrels next Sunday, and Shell will take its own tranche the following week. These are the first direct purchases of freshly pumped Iraqi crude since the fall of Saddam. Other exports have been taken from stocks, or last week's cargo to a Swiss-based trading house. At least three-quarters of the new oil will be heading for the US.

It is a landmark for Iraq. The occupying authorities say that it will be the first time that proceeds from the country's oil wealth will directly benefit its people. Most of the $200m proceeds from the sale will go into the coalition-controlled Development Fund for Iraq, though some will be diverted to Kuwait to pay reparations for Saddam's invasion of the country in 1991.

British and American tankers making off with the first few million barrels of Iraqi oil are only likely to confirm long-held suspicions of war-sceptics. But the sales, though more than $5 per barrel below standard US crude prices, will be the lifeblood of Iraq's reconstruction. The problem for the Iraqi and world economies is that the country is not exporting enough of its oil.

The budget announced by Paul Bremer, head of the US Coalition Provisional Authority (CPA), assumes that oil exports will fund just over the half of the coalition's spending until the end of the year.

'Your budget allocates over 9 trillion dinars ($6 billion) to key [reconstruction] projects and the key challenges ahead. A little over half of the money will come from oil revenues. It is the coalition's policy that Iraq's oil will finally be used for the benefit of the Iraqi people. The officials who used to steal Iraq's resources have gone,' Bremer said in an address to the Iraqi people last week.

This would require exports of around 800,000 barrels per day. But oil flows out of the unsettled country remain a trickle - just 363,000 barrels per day compared with daily pre-war capacity of some 2m barrels. Exports are even below last month's figures, and well below the 1m target of Iraq's oil officials.

This is partly due to sabotage of the pipeline from the northern fields near Kirkuk to the Turkish port of Ceyhan. No fresh oil has been pumped through this key pipeline since the US-led invasion of Iraq. So the first challenge after stabilisation is repair.

Last week the US Army Corps of Engineers (ACE), Iraqi oil officials, and contractor Kellogg, Brown & Root, a subsidiary of Vice President Dick Cheney's former company Halliburton, held a four-day conference in Baghdad aimed at pushing oil production to 3m barrels per day.

Tomorrow the US ACE will hold a conference in Dallas to issue two further contracts, worth $1 billion in total, for upgrading the oil industry infrastructure in the north and south of Iraq.

On CPA estimates, total oil production should reach 1m barrels per day by the end of summer and 1.5m by the end of the year.

The Centre for Global Energy Studies (CGES) had predicted that existing fields could be back to full capacity of more than 3 million barrels per day within three years, depending on foreign investments and the restoration of security, the rule of law and the country's infrastructure.

'Now with the lack of security, pillaging and so on, things aren't so promising the authorities cannot start serious work, everything will be pushed back by at least a year,' says Manouchehr Takin of the CGES.

Exploitation of new finds, such as the huge West Qurna field in southern Iraq and the untapped Western Desert could see production as high as 8m barrels per day by 2011. Even under a pessimistic case the CGES sees Iraqi oil production at this rate by 2020.

The implications of such production would be huge. Opec's grip on world oil prices would be weakened fatally. The budgets of Saudi Arabia, Russia and Venezuela could be thrown into turmoil by a low oil price. Saudi Arabia would have to share its control over the oil price with Iraq and Russia. But by that time, demand for oil from industrialising behemoths such as China and India, may also have surged. Saudi Arabia too, could ramp up production from 10.2m bpd to as much as 14m.

But Iraq, when it gets a new government, may choose to keep its foot off the gas pedal. The cost of redeveloping fields may exceed $30bn, says the CGES, a huge amount in a country with more fundamental reconstruction priorities. It is also unlikely that a low oil price would be in Iraq's interest. Opec is likely to argue for the resumption of Iraq's pre-1990 quota of 3.5m barrels per day. Iraq will not be allowed to participate in the organisation until an Iraqi government is established.

'My personal view is that Iraq will remain a member of Opec, but in the first two or three years production won't even approach a theoretical quota level,' says Takin. But the mere threat of Iraqi oil coming back onstream has prompted remarkable discipline within Opec. At the start of the year the cartel was beset with quota-busting of more than 3m barrels per day. The latest Reuter survey shows that total Opec production is within half a million barrels per day of its quotas, keeping prices at the high end of its $22-$28 target price range.

The 'Iraq effect' on global oil prices is likely to be a long time coming.

Finance: Free market forces take hold of reins

Iraq will soon have its very own Alan Greenspan. The Coalition Provisional Authority will introduce an independent central bank to control monetary policy. An Iraqi will take the helm at the Iraqi Central Bank, charged with the task of rebuilding the country's banking sector, issuing new currency and eventually controlling inflation.

British firm De La Rue, which recently bought the Bank of England's note printing business, will soon be churning out Saddam-free dinars. The land that centuries ago invented the cheque and the limited liability company is reacquainting itself with the free market.

Fiscal policy has already been set by US administrator Paul Bremer, who signed off a 9 trillion dinar ($6 billion) budget last week.

At $2.2bn, the budget deficit for the last half of this year is a huge proportion of GDP, anything between 7 per cent and 75 per cent, depending on whether Saddam-era economists' estimates of GDP are to be believed.

With oil revenues likely to come in below the costs of reconstruction (Bremer is pencilling in about $13bn in revenues next year), voices within the US administration have come up with a novel solution. The US Export-Import Bank, a government trade promotion agency, has launched a campaign for a securitisation of future Iraqi oil receipts to pay for the reconstruction work of foreign contractors.

The controversial scheme will essentially sell a proportion of Iraq's oil receipts over the next few years. The move will simultaneously solve Iraq's funding gap, take the funding pressure off an overstretched US budget, and provide the security of payment that can attract the finest US contractors to work in the unstable country. No coincidence then, that a trade lobby featuring the likes of Pentagon favourites Halliburton and Bechtel is also pushing the plan.

'Commonsense says get Iraq running. How do you get the country running? By using its own oil revenue 100 per cent for the benefit of the Iraqi people. If you want to wait three or four years, be my guest. But that means the country is going to be running on the dole [hand-outs] of the United States,' said Philip Merrill of the Exim Bank.

The plan is deeply controversial. It is not at all clear that military occupation confers any right to sell off future oil production.

'There has to be a legitimate government to do that. The Security Council resolution does not grant the US the power to commit the Iraqi people to such loans,' says Manouchehr Takin of the Centre for Global Energy Studies.

It is also difficult to imagine tens of billions of dollars more debt being added to Iraq's backlog, when the US is haranguing European nations to cancel their own historic debts.

Iraq already owes as much as $120bn in sovereign and commercial debt. On Friday the Paris club of rich country creditors announced that its members were owed $21bn in loans from contracts that pre-date Saddam's invasion of Kuwait in 1990, and probably the same again in interest arrears.

Infrastructure: A whole year just to turn the taps back on

When he appeared before the Commons liaison committee last Tuesday Tony Blair swatted aside suggestions that the UK and US went to war without an adequate plan for the peace.

Things on the ground don't bode well. A senior source with the US Agency for International Development (USAID) in the region last week told The Observer he believed it could take a year just to get the water treatment system in Baghdad functioning again.

And, while he did not say there was 'no planning', he indicated bad planning. Jay Garner, the retired general chosen by the Pentagon to run and start rebuilding Iraq, along with his Office for Reconstruction and Humanitarian Assistance (ORHA) and most of its senior personnel, faced heavy criticism for mishandling the post-war situation, and were replaced in May by diplomat Paul Bremer and his Coalition Provisional Authority (CPA).

As the USAID official says: 'They [ORHA] underestimated the amount of effort, money and time it would take to turn Iraq around. Many of them thought they were going to be gone by the end of June and there would be an Iraqi interim administration by then.'

While there appeared to be poor planning for civil administration, minds in Washington appeared to be focused on commercial arrangements.

Contract awards have been accomplished efficiently, and Washington is now effectively running big business in Iraq. As the US Department of Commerce says in its guide to the country: 'Business opportunities in Iraq are presently limited primarily to the US government reconstruction contracts outlined in this guide, issued mainly by the USAID and Department of Defense.'

Latest information is that 15 contracts, ranging from seaport administration to 'economic recovery, reform and sustained growth in Iraq' have either been let or are out to tender.

The eight so far signed off by USAID - including the controversial $680 million capital construction deal that went to Bechtel, the construction giant with close links to Bush - total close to $1 billion. There are two ways to look at that figure. Either it is very large, a huge subsidy by US tax payers to US companies; or it is very small, a tiny fraction of reconstruction estimates of up to $180bn.

But the early signs are that this US-led public-private partnership is facing real difficulties. The problem for companies is still security. Chris St George, commercial director of London-based Olive Security, which is contracted to supply armed security to Bechtel and its subcontractors in Iraq, says: 'There are two types of threat - first from armed local Iraqis, and second from forces loyal to Saddam or terrorists such as al-Qaeda.'

US contractor SSA pulled its staff out of the southern port of Umm Qasr on 21 June when Iraqis went on a 48-hour looting spree with guns and hand grenades. St George says this is not an isolated case: 'The events at Umm Qasr, with armed gangs looting, are typical of what companies operating around Iraq are facing.'

A USAID spokesman says: 'Along with the sanitation problem, armed gangs have been sabotaging electricity towers and substations. Bechtel has been trying to be strategic, but it is being knocked off course day to day by these kinds of events.'

Some companies are more irritated than nervous. One UK company currently bidding for work on Iraq's oil infrastructure says: 'The organisation has been appalling. First there was the Garner thing, and more recently there has been another major change of personnel in Baghdad. The whole thing has been a shambles.'

The process of setting up the post-war administration, along with the award of contracts, is to be examined by the US General Accounting Office - the equivalent of our National Audit Office. A separate contract has been awarded by USAID to the US Army Corps of Engineers to monitor the execution of other reconstruction contracts by USAID.

'We are aware that whatever we do on this we are likely to be criticised,' said a USAID official in Washington. 'We would like to have had a private sector operator, but there are none.'

In the meantime, departments in Washington are continuing to promote Iraq as a business opportunity. The Department of Commerce lists 'the prime sectors that should provide a firm foundation for trade and investment in Iraq'. Among these are listed oil, ports, railways, roads, power, water and telecoms. It records that in all of these sectors bar oil, preliminary work is being carried out by Bechtel under its capital construction programme. Preliminary oil work - more contracts have just been put up for grabs - is being carried out by a subsidiary of Vice President Dick Cheney's old company, Halliburton.

There are plenty of US firms, such as Mack Trucks and American Express, and some UK ones who want to be in Iraq in future. But there are huge risks, including security threats to individuals, problems with getting insurance, inadequacies in currency and banking systems, legal bars to investment and gaps in civil law to enforce commercial claims.

While they are sensitive to criticism, US officials believe the situation will improve. One said: 'There has been a lot of criticism about how long it is taking to get things moving. It is true there are security issues. But if you compare it with Kosovo, for example, we are actually doing well. We are sanguine.' Tony Blair can only hope American sanguinity is justified.

Who will foot the bill for human tragedy?

The final cost of the war on Iraq to British taxpayers is likely to exceed the £3 billion put aside by the Chancellor of the Exchequer.

The Treasury will soon publish its public finance out-turn report, which will detail exactly how much of the special contingency funds established for the war have been drawn on by the Ministry of Defence.

Despite the war's comparatively short duration, the likelihood of a long stay in southern Iraq is likely to stretch the MoD budget.

A raft of legal claims from the families of killed civilians may cost the coalition millions more. The Survey of Civilian Deaths in Iraq says that there were a minimum of 4,000 and a maximum of 7,000 deaths. But the chances of the relatives of victims being able to make successful claims against UK or US forces through the courts is open to doubt.

Martyn Day, of human rights law firm Leigh Day, investigated the likelihood of such actions succeeding after the Kosovo conflict. 'We were asked to look at some of the Kosovo civilian deaths which had occurred as the result of dropping cluster bombs. It never really got very far. My feeling about this is that it is not impossible for people to make a claim, but it is very difficult.'

Day says claims would have to be judged in the national courts of the forces being sued. In the UK, this would mean the High Court.

Relatives would have to prove that forces acted in a way which they knew would cause civilian casualties, rather than in a way which mistakenly caused them. 'It would have to be something like a cluster bomb where a decision was made to use cluster bombs that would bring numbers of civilians into peril.'

In the case of a missile hitting a house or civilian facility such as a hospital, Day says: 'The difficulty is that you would have to show that it was not a mistake. I would be amazed if our courts said they expect the military to be so exact as not to avoid mistakes in war.'

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