Finance

With favorable political and financial conditions, post-Saddam Iraq could become a supergiant oil producer, according to Fadhil Chalabi, Executive Director of London’s Centre for Global Energy Studies (CGES).

Speaking at the CGES seminar A New World Oil Market Structure: Developments in Iraq, Venezuela and US Oil Policies in London in March, Dr Chalabi, the former OPEC Deputy Secretary-General and Under-Secretary of the Iraqi Ministry of Oil, said that Iraq’s officially quoted oil reserves base of 112bn barrels would enable the country’s production capacity to be built up over six to eight years to a total 8mn b/d.

“However,” he added, “there is lots of oil still to be discovered in Iraq. A recent CGES/Petrolog study says that yet-to-be-discovered reserves could amount to 200bn barrels, which would be in addition to the 112bn barrels of discovered oil. If we believe what the IEA, EIA and OPEC forecast for worldwide oil demand, this additional oil will be badly needed. According to these forecasts, the world will need by 2020 an additional 44mn b/d in the EIA’s opinion, an extra 31mn b/d in the view of OPEC, and about 28mn b/d more in the IEA’s reference case. This would be no problem for OPEC, so long as there was enough demand to absorb all the increases in supply that are possible from Iraq, Saudi Arabia, Nigeria, Russia and others.” Proving up of the undiscovered resources would enable Iraqi production to be raised as high as 10mn b/d, he added.

Assessing the potential impact of growing Iraqi production capacity on world oil markets typically requires a study of supply/demand forecasts. Dr Chalabi warned that these have generally been over-optimistic in the past: “What is better is to examine trends in the world oil industry and in politics. Over the last 10 years the rate of growth of oil demand has been 1.3% a year, but over the last five years this has fallen to 0.8% a year.” He noted that IEA, EIA and OPEC long-term forecasts put anticipated oil demand growth at about 2.8% a year: “But these forecast growth rates cannot be sustained. The best that can be expected in the future is 0.8% a year.”

Among reasons for declining demand growth rates, Dr Chalabi listed environmental programs calling for energy conservation and reduced carbon dioxide emissions as well as investment in alternative energies, technological progress reducing consumption in transport and industry, increased taxation of oil products, the prospect for lower growth rates in the world economy and an increasing trend for industrialized countries to invest in less energy-intensive sectors such as services and hi-tech industry. “All these indicators,” he said, “suggest that the world economy will grow at a lower rate than before, with the result that less oil is needed.”

Dr Chalabi warned that there were grounds for fears that conditions of weak demand and increasing supplies would make Iraq’s potentially huge incremental capacity a negative factor for the oil market. Rapid development of Iraqi capacity could lead to lower oil prices and even an over-supply of oil, in which case OPEC would find itself unable to stabilize the market or control price movements: “To maintain the $25/B OPEC Basket target price in such conditions, either Iraq would not have to increase capacity or Saudi Arabia should not expand production, which it cannot do because of its financial constraints.”

OPEC’s oil price policy has helped to shift investment from traditional low cost exploration and production areas such as the Middle East into high cost areas, he noted: “The amount of production outside OPEC and the FSU grew from 16mn b/d in 1974 to 31.7mn b/d in 2002, whereas OPEC production fell from a peak of 31.4mn b/d in 1974 to 25.2mn b/d in 2002.” Dr Chalabi continued: “Lower prices resulting from additional Iraqi oil could help to create a shift in emphasis from high cost areas to low cost areas. But this would depend not only on prices but also on a restructuring of the Middle East industry. State ownership is also behind the shrinking of development in traditional areas to areas outside OPEC.”

One spur to Iraqi capacity growth could be increasing emphasis in government policies on oil supply security: “Since 11 September there have been growing concerns about supplies from the Middle East. Now Saudi Arabian oil is the pillar of the world market: 20% of total oil trades comprise Saudi Arabian exports, and production is more than 9mn b/d. If anything happened to Saudi oil, there would be great oil market disruption.” Dr Chalabi said that Iraqi oil was important as the only alternative source of oil reserves of sufficient magnitude to compare with Saudi Arabia’s, and that increased Iraqi production capacity could be seen as establishing a more stabilized and secure system of supplies.

“The isolation of the Iraqi oil industry has led to shrinkage,” Dr Chalabi said, “but allowing equity participation to international oil companies would help the reintegration. Without this, the numbers I have mentioned cannot be realized and the economic problems cannot be solved.” He estimated that before capacity could be expanded, an investment of $5-6bn would be required to rehabilitate Iraq’s war-damaged oil industry, with a lead time of at least two years. This would not be possible through the use of the government’s already sparse finances. At the same time, the production sharing agreements negotiated with international oil companies during the mid-90s would not be conducive to expanding capacity, since the investors would not be entitled to equity oil and there would be a cap on returns.

Dr Chalabi concluded that an ambitious program of capacity expansion would not be achieved easily in Iraq: “It would require political stability and the existence of a credible government, along with reforms to the oil industry with a view to higher rates of growth and contributing to solving the economic problems of Iraq. This can only be done if a new structure for the oil industry in Iraq is created. Iraq has politically always been against the presence of international oil companies, but in order to secure capital, good management and good market outlets, Iraq would have to allow the participation of foreign oil companies. Iraq would have to be realistic, and allow at least partial privatization.” He recommended the creation of an independent Iraqi oil company, supervised by government but self-managed. Importantly, a 25-40% privatization through the sale of shares in stock markets would enable the Iraqi industry to be managed jointly by international companies and Iraqi nationals, some representing the government, giving Iraq a majority share in decision-making.

This radical reform in the structure of the oil industry in Iraq would need a thorough study by experts in legal and financial affairs, and it could take time before clear-cut measures are taken, Dr Chalabi noted. He drew a parallel to the case of Statoil of Norway, which was first 100 percent owned by the Norwegian Government and is now 20 percent privatized, a share which could be increased in the future. He added: “It is also worth studying the case of the Russian oil industry after the collapse of communism and the conversion of the oil industry into the private sector. In fact, the present privatized Russian industry has achieved progress for expansion in the industry. However, this kind of radical reform may face particular resistance in Iraq, especially by the older generation, which may still be attracted by outdated concepts of oil nationalization.”

Middle East Economic Survey provides a weekly review of regional energy, finance and politics from the Middle East.
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