Key Principles For An Effective Iraqi Petroleum Policy And Regulatory Framework

By Hamid Dhiya Jafar

Hamid Jafar is an Iraqi-born private-sector oil and gas professional with 38 years of direct international petroleum industry experience across the world’s five major continents. He is Chairman & CEO of the Crescent Petroleum Group in the UAE, the Middle East’s oldest private-sector oil and gas company and Executive Chairman of Dana Gas (PJSC), the first regional private-sector integrated gas company in the Middle East. He is also a son of Dr Dhiya Jafar who, as the cabinet Minister in charge, was instrumental in radically renegotiating Iraq’s petroleum fiscal regime and maximizing the country’s petroleum economic rent in the 1950s.

The optimal development of Iraq’s enormous oil and gas reserves is the most critical economic element for the future of the country. After decades of mismanagement, underinvestment, and political manipulation, Iraq has a golden opportunity to set the right policy and regulatory framework to achieve this vital goal. But it is perhaps a one-off opportunity: pushing through a flawed or politically motivated law under external pressure would at least hold Iraq back from achieving its full potential to the detriment of its people, and would also likely engender the conditions for wider and prolonged internal conflict while threatening its fledgling democracy. The stakes are high – Iraq will surely only have this one chance to get it right for generations to come.

What does “optimal development” mean in practice? Simply put, Iraq’s primary objective must clearly and simply be to maximize production in the shortest time possible, while maximizing returns to the State. There is no other way to maximize returns to the State for the benefit of the Iraqi people. This can only be achieved by having INOC focus on currently producing fields only, to rehabilitate them and maximize production to 4mn b/d (a huge task in itself), while inviting private-sector companies (both Iraqi and international) to make the hundreds of billions of dollars of investments necessary to develop the remaining fields and carry out exploration, all under risk-reward (not service) contracts which achieve maximum investment and while ensuring highest returns to the State.

A critical element of a successful legislative framework will be the clear and unequivocal separation of powers and roles between the ‘Regulator’ (ie the Government, as may be represented by the concerned Ministry), and the ‘Regulated’ (all the investing companies, including INOC and the private-sector oil and gas companies that are contractually charged with exploration and development). The current federal draft law is surely a good start, but it embodies critical ambiguities that must be ironed out. Also, the published Annexes to the draft law, as proposed by some, purport to grant nine-tenths of Iraq’s proven reserves to a yet-to-be-established, and unaccountable, national oil company. In practical terms, and bearing in mind current realities and lack of resources, that would deal a death blow to any hope for rapid progress and development in this sector; indeed, it would run counter to the Iraq Constitution, which in Article 110 covering oil policies and legislation, requires “relying on the most modern techniques of market principles and encouraging investment.”

With this in mind, there are eight key principles that could make or break the success of Iraq’s petroleum policy and regulatory framework:

1) The Central Objective

A great deal of political rhetoric and noise has been made in recent weeks and months over the proposed oil and gas law. Insofar as petroleum policy and regulatory framework is concerned, the objective for Iraq is actually straightforward: it must simply be to maximize the economic return to the Iraqi people. This is essentially a function of three elements: maximizing optimal production, as rapidly as possible, and under the best commercial terms for the State. Just that, without embellishment or confusing complication.

Frankly, all other claimed objectives and flowery statements about “achieving national unity” and “protecting the national interest against foreign ownership” are smoke-screen relics of the past and a total red herring which Iraqis have become tired of hearing for the last two decades. Article (109) of the Iraqi Constitution clearly states that “Oil and gas are the property of all the Iraqi people in all the regions and provinces.” There is no dispute as to who owns Iraq’s oil. The issue of sharing the revenues is to be dealt with under separate legislation, and is really about how to divide up the pie, which is to be on a pro-rata basis to population as laid down in the Iraqi Constitution. What we are therefore concerned with, when it comes to an effective petroleum policy, is how best to maximize the size of this pie for all Iraqis: a legal framework that encourages maximum optimal development of the country’s petroleum resources. Period.

2) Role Of The State

The role of the State, as performed by the Government of Iraq, is clearly important and required as a powerful and effective policy-maker and regulator, overseeing the entire sector and all the companies operating within it, while setting the necessary policies and standards, and focusing on maximizing the economic rent to the State from these operations.

If the Government engages in operating and commercially managing the sector, it compromises its own role as an effective regulator. It cannot be on both sides of the fence. Experience worldwide has demonstrated that public sector management of commercial enterprise is inefficient and open to political abuse, with Iraq’s own history providing an all-too-illustrative example of this. Though there is inevitably a nostalgic vocal minority who wish to see its return, the days of a centrally-planned and state-run socialist economic model are over.

3) Need For The Private Sector

Iraq’s current oil production of around 2mn b/d is in fact today at the same level as it was in 1975, at the time of nationalization, and a fraction of where it ought to be, given Iraq’s hydrocarbon reserves and potential. One only has to look at Russia, with oil reserves significantly less than Iraq’s, producing six times as much! It is also telling that 60% of Iraq’s current proven reserves were in fact discovered by private-sector companies, with a further 20% from structures originally identified by the private sector.

There ought to be no doubt whatsoever that petroleum exploration, and the development of undeveloped oil and gas fields going forward, needs to be undertaken through the private sector in the interests of the country. That said, clearly all such work must be strictly regulated by the Government to ensure proper adherence to contractual commitments. Experience worldwide has shown that governments are inefficient at managing commercial enterprise, and Iraq is certainly no exception. In addition, in Iraq’s case the need for investment by the private sector is even more clear in order to address the Iraqi State’s severe shortage of financial, technical, and adequate qualified human resources. Awarding proper ‘risk’ contracts, frankly in whatever form, is the only way to engage the private sector, including IOCs, into aligning their interests with those of the State and putting their full resources – financial, technical, and managerial – behind the effort. Again, it does not matter what form of contract is adopted for the investment, so long as it is risk-based and provides the appropriate incentive to the investor, while optimizing economic rent for Iraq. Speed and efficiency are paramount, as is the imperative for maximizing competition.

Leaving aside the smaller Gulf States such as Qatar or the UAE which have both achieved rapid progress through the benefits of private sector investments, even the larger ‘socialist’ Arab republics of Egypt, Syria and Libya are now welcoming a large number of private sector companies investing under production-sharing agreements. Egypt, for example, has 64 such companies operating in its oil and gas sector, ranging from the large international majors to smaller regional independents, and through the resulting activity and competition has achieved rapid progress in increasing its reserves and production while maximizing returns to the State in a manner that would not have been possible through state company monopoly.

Indeed production-sharing agreements are not some tool of foreign domination as has been falsely claimed and irresponsibly maligned by some. This model contract was, in fact, invented by Indonesia, a prominent OPEC member, and is simply a way of ensuring the minimum required reward for the investing company to maximize benefits to the State. Any description to the contrary is pure fiction. On the other hand, non-risk service contracts, which have been suggested by some, are primarily being used in Iran in the form of ‘buy-back’ contracts, and that with limited success, and only because of constitutional constraints peculiar to that country. Indeed, as mentioned, Article 110 of Iraq’s Constitution actually requires “relying on the most modern techniques of market principles and encouraging investment” for managing the oil sector.

4) Rationale For INOC

The establishment of the Iraqi National Oil Company (INOC) is required for managing and rehabilitating currently producing oil fields and assets, and taking their production levels up to their potential of 3.5-4mn b/d. This is a huge challenge by any international standards, especially given the current unhappy state of Iraq’s oil facilities and an Iraqi national petroleum cadre that has been dismembered by war, sanctions and an unprecedented brain drain, as well as a lack of funds and technology. The task earmarked for a yet-to-be-established INOC will require enormous management and financial resources, but if properly channeled and carried out, would result in one of the largest oil companies in the world, and operating well over half of Iraq’s possible production capacity.  

INOC should not, however, divert its attention and resources from this crucial task, and therefore should not be permitted to engage in other work such as development of Iraq’s undeveloped fields, or in exploration, or in foreign investment, or in petroleum services. It must also remain free from political interference and operate as a commercial enterprise under the regulatory oversight of the Ministry, as with other operating companies. As such, it must be “benchmarked” and accountable like any other commercial enterprise, to ensure efficiency and no wastage of national resources.

Indeed, a new INOC must very quickly, like any other commercial enterprise, become self-reliant on funding, and not expected to be funded by the State’s treasury. Conversely, it should be allowed to make profits like other industry operators. In that manner, INOC will be accountable to its shareholder (the State, not the Ministry of Oil) for its efficient operations and results. Accordingly, INOC must be free to manage its business efficiently without party political interference, and its delegation of authority and structure must be designed accordingly. The Chairman must not be the Minister of Oil or any other politician, and Board Members should be appointed for non-renewable fixed terms, and so on.

Above all, INOC must not in any way take on the role of a regulator, which must remain the exclusive and separate function of the regulatory bodies of the State such as the Federal Oil and Gas Council, and the concerned Ministries at Federal and State level. Eventually, in years to come, INOC may be partially privatized through wide distribution of ownership among Iraqis in a transparent public subscription progress.

Finally and critically, attempts by some politically-motivated parties to grant between 80% and 90% of Iraq’s reserves to INOC through proposed Annexes to the law, including virtually all of Iraq’s undeveloped fields, would kill any hope for rapid economic progress for Iraq and ensure the permanent retardation of the development of Iraq’s vital energy sector. To take Iraq back to a centralist and state-controlled model of the past (even the Ba΄thist socialist regime began to turn away from this model in the 1980s) would be a crime against the Iraqi people, and in clear violation of the Iraqi Constitution in any case. Iraq would lose years of progress, and Iraqis would forego billions in urgently needed state funds for the return of their prosperity as rapidly as possible. We must shrug off this outdated mind-set of centrally-planned and managed economies. As a famous Nobel laureate once said, “We can’t solve the problems of yesterday with the same mentality that it took to create them!”

           

5) Use Of State Funds

The estimated required investments to fully and properly develop the Iraqi oil sector range from the tens to hundreds of billions of dollars. Without debating the figures, it is clear that the needs are huge and Iraq today has large debts already of the same order, and competing higher priorities for state funds such as basic infrastructure, security, health and education.

In any case, and as a basic principle, state funds or credit lines should not be used up for commercial enterprise investments when private sector investment is available, and this is a policy now widely followed both in the region as well as internationally, even in countries where state funds and personnel are actually available. Why? Because it is simply good economic sense and best for ensuring efficiency of delivering results and achieving optimal use of state funds. This is another reason to define and restrict the role of government in investing and operations in the petroleum sector: there is simply no point wasting Iraq’s precious state funds making investments that could be done by the private sector, more efficiently and with greater economic returns to Iraq.  

6) Commercial Terms

Some responses to the proposed oil and gas law have accused the drafters of ‘selling out to foreign interests’ or ‘giving away 70% of Iraq’s oil wealth’. This is complete nonsense of course. The days of colonialist governments dictating terms are long gone, and empty nationalist rhetoric must not cloud the reality of practical economic logic. Confident oil-producing governments have no need to think in this way, and if socialist Arab Republics like Egypt, Syria and Libya can achieve progress with these kinds of risk contracts, it is insulting to imply that Iraqis are incapable of doing so as well in their national interest.

As the world’s last major undeveloped oil basin, Iraq can and should extract excellent commercial terms from companies, given its relatively low cost of production, large reserves, and today’s high oil prices. As an example, for a major field development, the profit oil percentage granted to the private company making the investment under a production-sharing agreement could be 5% or even lower. This means the State keeps 95% or more of the production revenues from the field after costs, and without having to risk or make any investment of its own. By contrast, each year of delay in developing such a field is a permanent economic loss to the Iraqi people of at least 10% (Iraq’s Central Bank rates today are in fact approaching 20% per annum).

7) Ambiguities In The Current Draft Law

The current draft oil and gas law addresses many of the issues in a forward modern manner, though it still embodies ambiguities that need addressing. On the positive side, the law makes a clear distinction between the regulated and the regulator, thereby eliminating the conflict and ambiguity of government oversight; it seeks to enlist private sector investment in all aspects of upstream operations, including (importantly) encouragement of the Iraqi private sector; it sets up INOC and gives it the mandate to rehabilitate Iraq’s currently-producing fields, which in itself is an enormous task as mentioned above. Unfortunately however, the draft also appears to grant INOC the right to develop undeveloped fields, and even undertake exploration, yet without accountability or forethought as to the cost to the State’s treasury. Here, “the devil is in the detail”, which if not sorted out clearly and unambiguously, could easily regress us back into the discredited old system of state control: if INOC is given the right to take over everything, then we will in practice have not advanced one bit and an oil and gas law to regulate investment in this sector will be unnecessary.

8) Iraqi Private Sector

A final but important element of a successful policy must be the development and encouragement of an active indigenous Iraqi private sector in all aspects of Iraq’s petroleum industry, as is the case in successful oil industries around the world. This not only gives the best chance of maximizing Iraqi employment, positive economic multiplier effects, technology transfer, and a globally competitive management and workforce, but it is also the best answer to the xenophobic critics of ‘foreign domination’. Although there is reference to the encouragement of the Iraqi private sector in the current draft law, the absence of a mechanism to effect this provision places doubt on the seriousness of policy-makers in practical implementation of this initiative.

Training or retraining the Iraqi oil and gas workforce must of course be a condition incumbent on all enterprises and ventures operating in Iraq’s petroleum industry; but beyond this priority must be given to real, effective participation of the Iraqi private sector, which needs to be nurtured and encouraged to develop professionally. While Iraq's private sector is in its infancy, a formal program, under for example World Bank/IFC guidance, should be put in place to encourage the development of Iraqi private sector capabilities in all aspects of the petroleum industry, including the upstream, and not just the service or downstream industries. Furthermore, to give real force to this positive intention, the law should oblige or at least encourage IOCs to partner with qualified Iraqi private-sector companies and to develop their capabilities.

To conclude and in summary: there cannot be an effective regulatory framework for Iraq’s oil sector without a clear separation of roles between the regulator and the regulated, and there cannot be a successful modern petroleum policy for development of the sector without a large number of companies competing to achieve maximum production for Iraq, and under the watchful eye and oversight of an impartial and strong governmental regulatory authority, focused on maximizing the economic returns to the State for the benefit of the people of Iraq.