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Copyright © 2010 Diplomica Verlag GmbH ISBN: 9783836649414

http://www.diplom.de/e-book/227896/iraq-constitution-petroleum-resources- legislation-and-international-policy Muhammed Abed Mazeel

Iraq Constitution - Petroleum Resources Legislation and International Policy

Diplom.de

Fachstudie

Muhammed Abed Mazeel

Iraq Constitution

Petroleum Resources Legislation and International Policy

Diplom.de

Muhammed Abed Mazeel Iraq Constitution - Petroleum Resources Legislation and International Policy

ISBN: 978-3-8366-4941-4 Herstellung: Diplomica® Verlag GmbH, Hamburg, 2010 Diplomica Verlag GmbH, Hamburg, Deutschland, Fachstudie, 2010

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1. Introduction ...... 1 2. Iraqi Constitution ...... 7 3. Contract Conditions...... 15 4. State-owned Oil Companies ...... 27 5. Restructuring of the Iraqi Oil Institutions ...... 33 6. Revenue-Sharing and Equalization...... 36 7. Potential Geography ...... 50 8. Present Organization and Development ...... 56 9. Hydrocarbon Legislation Draft and Contracts ...... 59 10. Revenue Sharing ...... 65 11. Crisis Management of the Oil Industry in Iraq ...... 88 12. U.S. Policy and Issues for Congress...... 99 13. China Investment in the Energy Sector...... 112 14. Conclusion ...... 119 15. References...... 127 16. Attachments ...... 129

Figure 1: Iraq’s oil resources /7/...... 3 Figure 2: Federal government function /9/ ...... 9 Figure 3: Location of Iraq’s and Infrastructure /10/27 Figure 4: Iraq’s Oil total target production after the second bidding round /4/...... 65 Figure 5: Oil and gas resource in Al-Anbar governorate /7/...... 76 Figure 6: Description of Ministry of Oil and Own-State Oil Companies abbreviated manner activities and Roles /4/...... 96

Table 1: Target production profile /8/ ...... 20 Table 2: Target production profile /8/ ...... 21 Table 3: Target production profile /8/ ...... 21 Table 4: Prequalified Entities /8/ ...... 22 Table 5: Participation Fees /8/ ...... 22 Table 6: Oil reserves in producing, partially and non producing field’s /6/...... 52 Table 7: Oil reserves and production from developed fields according to provinces /6/ ...... 53 Table 8: Oil reserves and production from the undeveloped fields according to provinces /6/ ...... 54 Table 9: Total oil reserves currently known according to provinces /6/ ...... 55

ACKNOWLEDGEMENTS

I would like to thank all the people who gave me their time and their views on this book. I am particularly grateful for the helpful reviews and comments received from Christine Dlugokencky.

The revenue from this book will be donated to children with cancer and organizations that help them.

Dr Muhammed Mazeel

1. Introduction

This book covers policy proposals and interim contracts, assesses the positions of various Iraqi political actors and examines the potential significance for international foreign policy goals in Iraq. Despite a lack of progress in reaching agreements on the hydro-carbon sector and revenue sharing legislation to set new conditions for the management of the country’s significant oil and gas resources, development in Iraq’s oil and gas sector is moving forward.

The passage of the oil and gas sector framework and revenue sharing legislation will be seen as significant milestones by International governments and International Oil Companies (IOC´s). This would provide evidence of the Iraqi government’s dedication to promoting political reconciliation and providing a solid foundation for long term economic development in Iraq. Interim revenue sharing mechanisms have been introduced due to the lack of new legislation. Additionally, both the Federal Government (the Federal Oil Ministry-MoO) and the Kurdistan Regional Government (KRG) (the Regional Ministry of Natural Resources and Energy) have made oil and gas development deals with foreign firms. The MoO is working with existing regulation from the previous political and administrational regime, while the Regional Ministry of Resource and Energy Kurdistan- Iraq has designed its own laws and regulations, which the Federal Government has not yet recognized.

There is wide recognition among of the importance of oil and gas revenue for the Iraqi economy. Most groups see the need for new legal and policy guidelines for the development of the country’s oil and natural gas resources. However, Iraq’s Council of Rrepresentatives (parliament) has not yet considered the proposed legislation due to ongoing political discord and general political instability. There are strong differences on key issues between Iraqi critics and supporters of various proposed solutions. These include the appropriate role and powers of federal and regional authorities in regulating oil and gas development; the conditions and degree of potential foreign

1 participation in the oil and gas sectors; and proposed formulas and mechanisms for equitably sharing oil and gas revenue. Simultaneously, there are strong disagreements on related discussions about the administrative status of the city of Kirkuk and proposed amendments to articles of Iraq’s constitution that outline federal and regional oil and gas rights.

The U.S. and UK military strategy in Iraq seeks to lay the ground work for an environment in which Iraqis can resolve core political differences in order to ensure national stability and security. However, it is not yet certain whether the proposed oil and gas legislation and ongoing interim efforts to develop Iraq’s energy resources will support harmony or create deeper political tension.

The United States and its allies face difficult decisions regarding how to work with Iraqis on assorted policy proposals, related constitutional reforms and oil and gas development contracts, and at the same time encouraging their Iraqi counterparts to ensure that the content of proposed laws, amendments and contracts reflect acceptable political compromises.

In the 1920s a wide-ranging concession was granted to a consortium of oil companies known as the Turkish Petroleum company and later as the . This was the beginning of oil exploration in Iraq. The nationalization of Iraq’s oil resources and production was finished by 1975. From 1975 to 2003, oil production and export operations were entirely state operated. However, from the early 1980s until the toppling of ’s government in 2003, the negative effects of war, international sanctions, a shortage of investments and technology and, in many cases, mismanagement caused difficulties for Iraq’s hydrocarbon infrastructure.

According to the Oil Ministry, Iraq has the third largest proven oil reserves in the world (115 billion barrels). Other estimates of Iraq’s potential oil reserves vary. The U.S. Department of Energy’s Energy Information Administration notes that current estimates “have not been revised since 2001 and are largely based on 2-D seismic data from nearly three decades ago.” In

2 April 2007, oil industry consultants IHS assessed that Iraq’s proven and probable reserves tally 116 billion barrels, with a potential additional 100 billion barrels in largely unexplored western areas. The U.S. Geological Survey’s median estimate for additional oil reserves in Iraq is around 45 billion barrels. In 2004, Iraq’s then Oil Ministry claimed that Iraq had “unconfirmed or potential reserves” of 214 billion barrels. My Reservoir Engineering Estimation is that Iraq’s reserves can reach more than 320 bn bbl oil. Approximately 65 percent of Iraq’s current proven reserves are located in southern Iraq, with a concentration in the southern most province of Al Basrah. Large proven oil resources have also been found in the northern province of Al Ta´mim near the disputed city of Kirkuk. (For a map of Iraq’s oil resources, see Figure 1, below).

Figure 1: Iraq’s oil resources /7/

3 At present, crude oil provides over 90% of Iraq’s domestic energy consumption and oil exports produce over 98% of Iraq’s government revenue. Due to decreases in global oil prices from their 2008 high and lower oil production, Iraqi leaders revised their 2009 revenue and budget assumptions from a projected surplus to a projected $15.9 billion deficit. According to official U.S. assessments continued fluctuations in oil prices and production could put at risk Iraq’s fiscal stability and the sustainability of its reconstruction and development plans. The expansion of oil production to the level of four million barrels per day (m/d) by 2013 and then upward to six m/d by 2017 is called for by current Iraqi plans. Iraqi officials have begun an international bid process for service contracts and renegotiated a series of Saddam era oil production agreements in order to support these goals. These include the transformation of a production sharing agreement into a service contract for Ahdab oil field with China National Petroleum Corporation (CNPC).

Petroleum Background

98% of Iraq’s government budget coming from oil revenues. As a result an agreeable intergovernmental framework for managing petroleum resources and for distributing revenues is correctly regarded as the key element of federalism. There is great potential to develop a sound fiscal framework in Iraq with consistent best practices that will distribute revenues equitably and efficiently, decentralize resource management where appropriate, and bind the country together as a stable federation.

As in most resource-rich countries, Iraq’s petroleum deposits vary from region to region and deposits differ in productive capacity, cost of extraction and processing, and quality of crude. Moreover, extensive repairs and reinvestments in Iraq’s petroleum infrastructure are necessary to amplify its production potential. Furthermore, large areas of Iraq remain unexplored, particularly , Middle ( Middle), Najaf dry sea, South West and the Western Desert, and preliminary assessments point to large potential reserves.

4 According to Iraq’s constitution ownership of petroleum resources is by “the people of Iraq in all its regions and provinces.” Although the constitution establishes federal management of present fields, it also recognizes resource development ambitions in the historically deprived regions, for example, Kurdistan and Basra. The document does not define the jurisdiction over future fields.

The constitutional ambiguity on this assignment defers authorities and responsibilities around resource management, revenue- raising and revenue sharing to subsequent negotiations and legislation. Furthermore, the federalism established by the constitution is asymmetrical, wherein regions have greater autonomy than governorates, providing malleability for intergovernmental affairs.

Few resource-rich federations can avoid granting a preferential share of resource revenues to originating regions either through regions’ own taxation powers or through sharing of federally collected revenues. Such preferential treatment has implications for the efficiency of the economic union: The allocation of other resources is distorted by “net fiscal benefits” across regions. Greater public services funded by oil-revenues at lower levels of taxation in resource rich regions attract labour. A federally coordinated equalization program is necessary to alleviate these fiscal inequities.

However, in Iraq as in any resource-endowed country, the division of federal and subnational powers around natural resources is not simply a matter of revenue-sharing; rather, it is a question of how the resource is to be managed. Arrangements then involve the interrelated issues of the oil industry’s structure, regional authority over exploration and development, environmental management, revenue-raising mechanisms, the administration of revenues, and the terms for a prospective oil revenue fund.

More specifically in Iraq’s case:

5 • Will control of current petroleum resources monopolized by a central Iraqi National Oil Company (INOC) on what terms?

• How will governorates and regions be represented in the INOC and a federal oil and gas commission?

• What will be the tendering and approval authorities of regions and governorates within their territories? In particular, will regions have the authority to tender independent and distinct arrangements with foreign exploration and development firms?

• How will petroleum revenues be distributed to regions and governorates? In particular, where will funds be deposited and what are the regions’ assurances for the prompt and accurate distribution of their entitlements?

• Will stabilization or savings funds be done nationally or regionally? How much of the revenues will be allocated? Who will manage the fund what objectives will guide its investments? What will be the terms for withdrawals? How will a federal fund be accountable to regions and governorates?

Competent management of exploration and development is essential for the future of Iraq's petroleum industry. The first step is the discovery of resource deposits. Following this, upfront investments are necessary for development. In order to ensure efficient production technology must be upgraded and capital renewed. Maximizing resource rents means attracting and retaining investment, technical expertise and high-calibre management. The correct incentives must be offered to governments, national entities and private enterprise in order to revitalize the Iraqi oil industry. This means arrangements between the federal government and regions must encourage efficiency within the oil industry.

To give an appropriate framework for Iraq, I first review relevant features of Iraq’s federal structure and oil industry, with an special focus on geography. Then I propose principles relevant to Iraq to aid the design of policies for: a) the efficient assignment of

6 ownership, management and revenue-raising around natural resources; b) revenue-sharing and equalization programs; and c) saving oil revenues and stabilizing public finances.

2. Iraqi Constitution

Iraq is presently comprised of 18 governorates (muhafadhah). Notably, the divisions are based on territory and not ethnicity. The Kurdistan Region is formally recognized by the constitution and allows governorates to assemble into regions.

The law establishing the process for regionalization was passed in October 2006. Under the Iraqi Constitution, regions have the right to legislate an independent constitution, assuming it does not conflict with the federal constitution. Regional governments have the option of amending any other federal legislation as it applies within the region’s borders. Furthermore, regions have the right to residual powers not specifically assigned to the federal government by the Constitution.

Governorates do not participate in a discussion of federalism in Iraq, and argue that an Iraqi national identity is an enduring concept that will ultimately resist sectarian divisions and support a balanced federation. The law organizes the autonomy of such unattached governorates. In this way, the constitution creates an asymmetrical and flexible form of federalism, creating core federal institutions but with the intention that the inter- governmental relationship should evolve gradually. Due to Iraq’s geographically-dispersed and ethnically-diverse character, the ultimate balance between federal shared rule and self rule will be critical to the success of the arrangement.

A deadline was of December 2007 has been set by the Constitution for a referendum to be held to allow Kirkuk to decide whether or not to join the Kurdistan Region. With the assent of the Kurdistan Regional Government (KRG), the deadline was subsequently extended to June 2007. In spite of the fact that this deadline has passed, no referendum has been held. The KRG

7 sees a resolution of Kirkuk’s status as deeply linked to federal arrangements on petroleum management and sharing of oil revenue. A look at the history shows that north Iraq was not originally Kurdish. It became Kurdish due to the immigration of the from other regions to this part of Iraq during Islamic religious missions. Indeed, it is indisputable that the north of Iraq is now Kurdish, but in fact Kirkuk never was a Kurdish city. Christians, Jews, Turks and Arabs inhabit the city. The geographical placement of Kirkuk to north has had a strong influence. Kurds immigrated to Kirkuk for economic reasons.

The Kurd's main political divisions are into Talibanis and Barazanis main groups. Both desire Kirkuk for the oil potential. They are also looking for other regions and territory to include to Kurdistan. In my opinion Arabs (Sunni and Shiaa), Christians, Turks will have strong negative reactions to this and it will continue to be a point of conflict in the future.

Chapter 5 of the Constitution explicitly provides for the authority of provinces in powers not specifically granted to the federal government. Foreign affairs, defense, customs, currency, immigration, telecommunications, statistics and management of water resources are included in the federal powers established in Chapter 4. Environmental protection is included as a power shared between the federal and subnational governments. The Constitution makes no mention of provisions of social services, education and municipal infrastructure. Furthermore, provinces are not given specific powers under Chapter 5; they are only granted authority to legislate in areas that do not conflict with explicit federal powers. A law of provincial powers was passed in March 2008, more clearly laying out provincial authorities and setting October 2008 as the deadline for holding provincial elections. This law mainly clarified federal-subnational relations and did not clear up the ambiguity of precise subnational legislative authorities. Figure 2 shows the federal government function.

8

Figure 2: Federal government function /9/

9 The definition of ownership of oil and gas is intentionally vague: “Oil and gas is the property of all the Iraqi people in all the regions and governorates” (Section 4, Article 111). Nevertheless, the following article defines the management of present resources. It assigns existing fields to the federal government and authorizes per capita payments to regions and governorates as well as compensation for the “damaged regions”:

Section 4, Article 4 (1): The federal government, with the producing governorates and regional governments, shall undertake the management of oil and gas extracted from present fields, provided that it distributes its revenues in a fair manner in proportion to the population distribution in all parts of the country, specifying an allotment for a specified period for the envisions three scenarios of partial federalism, radical decentralization and a balanced federation.

The question is how regional representation at the federal level and inter-governmental relations might evolve, arguing for regional capacity damaged regions which were unjustly deprived of them by the former regime, and the regions that were damaged afterwards in a way that ensures balanced development in different areas of the country, and this shall be regulated by a law.

This article allows for future legislation for future fields based on agreements between the federal and subnational governments: Section 4, Article 4 (2): The federal government, with the producing regional and governorate governments, shall together formulate the necessary strategic policies to develop the oil and gas wealth in a way that achieves the highest benefit to the Iraqi people using the most advanced techniques of the market principles and encouraging investment.

Iraq Constitution and Oil Resources

As mentioned above, oil revenues are most significant aspect of public finance in Iraq. While it is beyond question that the present

10 collapse of the broader, diversified economy has caused this, Iraq’s resources will continue to be the major source of government revenues for the foreseeable future. As a result the federal and subnational governments in resource management should cooperate on the following mutual goals:

• secure economic rents from petroleum exports for the owning peoples of Iraq;

• ascertain knowledge of Iraq's full resource potential by optimizing exploration activities;

• promote the efficient exploitation of resources over the long- term;

• stabilize public finances in the short- and medium-terms with potentially volatile resource revenues;

• use the resource base for reconstruction and economic diversification;

• decrease distortions in fiscal capacity across the economic union and aid efficiency of the internal common market;

• ensure that the oil industry is appropriately regulated –with particular reference to its environmental performance;

• provide Iraqi citizens in all regions with equitable levels of public services; and

• appease potential macroeconomic destabilization from resource revenues.

Each issue must be dealt with in a principled intergovernmental arrangement which engages both federal and subnational powers. This arrangement requires an understanding of the common entitlements of Iraqi „social citizenship“ in different residential jurisdictions due to the political dimensions. Nevertheless, economic principles should guide this

11 arrangement. The federation’s stability will be dependent on the efficiency and equity of the economic union. Additionally, productive efficiency must be ensured by the assignment of powers and the structure of the oil industry.

There are several stages in the production of natural resources. In general, these are: exploration; development; extraction; transport from extraction site; processing; transport to market; recycling; and closure/site remediation. The government affects this process at many points. Additionally, activities occur in different locations. Specifically, oil must be transported from the site of extraction to a refinery. Transport of extracted crude is typically by pipeline.

As follows, we apply such principles to each dimension of such an arrangement for Iraq. In general, we argue that the ideal arrangement is one in which:

• contracts for exploration and development are administered in a two-stage process with a competitive auction for initial exploration rights and a profit-based royalty or resource rent tax imposed during production.

• the authority to negotiate contracts and to assign exploration and development rights according to a flexible but consistent set of national standards is given to regions and governorates, who have requisite technical and administrative competence.

• The National Oil Company commits private firms for certain oil field services. In addition, it should compete with private firms for future exploration and development prospects and provide pipeline transport to all producers without price discrimination.

• Oil revenues should be collected in a clear and transparent manner by the federal government.

• Petroleum revenues are shared on a per capita basis – possibly with some limited preferential share for originating regions and governorates.

12

• Regions and governorates are given sufficient fiscal independence to deal with their expenditure responsibilities, providing reasonably equal levels of public services at equivalent taxation rates.

• As statistical capability allows, a federal equalization program provides transfers to mitigate disparities in fiscal capacity between regions, including those created by sharing of derived petroleum revenues but excluding benefit taxes.

• Oil revenues are managed by federal and subnational governments based on competent short- to medium-term budget plans for capital expenditures.

• In the immediate future, infrastructural investment and reconstruction programs are given priority when investing petroleum revenues.

• In the longer term, following adequate recovery and reconstruction, the federal government directs an acceptable portion of revenues, as part of federal budgeting and consistent with the federation’s medium-term expenditure plan, to a federally-administered oil revenue fund.

• Maintenance of future generation's level of wealth should be such a fund's long term objective.

• The principal means of securing the stability of government finances should be publicly accountable budgeting with a medium-term expenditure plan – rather than reliance an oil revenue fund’s rules.

• Such an oil revenue fund should operate with clear objectives, flexible but firm rules, a standard asset-management strategy and direct accountability to government as well as to the regions and governorates.

13 According to Iraq’s draft Oil Law and draft Law of Financial Resources, the country’s legislators generally appear to envision such a system.

Ownership and Management

Ideal assignment of ownership is impossible to separate from the owner's capacity to manage the resource efficiently. This means that should be assigned to an agent whose management will maximize the social surplus from its extraction. The maximization of resource rents and the promotion of economic development are included. From a government's perspective, the important features for “ownership” of resources are the powers to:

• Assign exploration and development rights for the subsurface;

• Regulate exploration and development; and

• Exact payment for the extraction of resources and for complementary activities.

Government ownership of the subsurface is preferable to initial ownership by the surface owner. First of all, a “split bestatte” that detaches ownership of the subsurface from ownership of the surface is most efficient and enables the optimal use of each. Secondly, due to the “hidden” character of resources, the problems of collective management, efficiencies from pooling exploration risks, and the broad goal to maximize social surplus government ownership of the subsurface is advisable.

In a federation, ownership of resources should then be assigned to the government with the capabilities to capture resource rents and administer resources most efficiently.

Decentralization of management is beneficial in cases where subnational governments are competent as decisions are brought closer to those they most impact. The owning government must have sufficient administrative and technical capacity to:

14