Iraqi story needs strong direction for happy ending

With the rush of recent contract awards, Iraq could soon be the world's largest oil producer. Its 12 million barrels per day (bpd) by 2015 would be only slightly less than Saudi Arabia's capacity, and the kingdom is unlikely to be producing its maximum. In reality, the build-up is likely to be delayed by logistics. These projects are almost all concentrated in a small area around Basra, with decrepit infrastructure after years of wars and sanctions.

Export facilities are constrained and necessities as diverse as water, skilled labour, drilling rigs and a functioning banking system are in short supply. Corruption is rampant, security still shaky and substantial sections of Iraqi politics remain hostile to foreign investment. With the draft national oil law still not passed, a future government may annul the contracts. Against this backdrop, the foreign companies have to deliver the fastest increase of oil production in history.

The first system in peril is OPEC's quotas. The group has been remarkably successful so far in steering its way through the economic crisis, reviving the oil price to about US$70 a barrel. But quota discipline is already eroding. In the next few years, OPEC has to deal with subdued global demand and new oil from Brazil, Kazakhstan and elsewhere. Saudi Arabia is a status quo power in the oil world, while the new Iraq is not. It is not in the Iraqis' interest to cause an oil price crash or destroy OPEC, but the country's current output is so far short of its potential that it might be prepared to pump a lot more at somewhat lower prices, pouring the money into desperately needed rebuilding.

Iraq will surely want at least medium-term parity with Iran, about 4 million bpd, and will feel that its reserves justify higher levels in the long term. The other OPEC members are used to following the Saudis' lead. But this time, even if a resurgent Iraq's huge projects deliver only half of their potential, everyone else will have to cut back. Significant market space is likely to open up for Iraqi oil only after 2020.

This implies a challenging decade ahead for OPEC. The second system challenged by the new contracts is the pattern of foreign investment in Gulf oil. International oil companies have revealed they are willing to accept remarkably low rewards for participation in giant fields. This goes not only for Chinese companies, long thought to be hungry for oil, but also to the US, UK, France, Japan, Russia and even Angola, which is also a member of OPEC.

Despite facing so many security, logistical and political risks, the investors in Iraq will be taking home as little as 68 cents a barrel, less than 1 per cent of the sales price. With such terms, it is hardly possible to argue they are "stealing Iraqi oil". This should trigger a rethink in Iraq's next-door neighbours, Kuwait and Iran. Both desperately need outside investment in their hydrocarbon industries but bankrupt policies cannot deliver it.

Endless time-wasting discussions have exhausted the patience of the international oil companies and industry watchers. The opportunities in Iraq will further cause investors to lose interest in Kuwait and Iran. Kuwait has had to turn to buying costly liquefied natural gas and its plans to increase oil output have been repeatedly delayed. Similarly, Iran has the world's second-largest gas reserves but is a net importer. It is threatened with conceding its second place in OPEC to the Iraqis, but the political situation is deeply unpromising for any decisive action. Yet of all OPEC states, Iran (with Venezuela), is the most vulnerable to a period of low oil prices.

Thirdly, Iraq's oil threatens to disrupt the fragile country. The remarkable series of deals engineered by Dr Hussein al Shahristani, the oil minister, has overshadowed the autonomous Kurdistan region, the scene of several giant discoveries. The status of the city of Kirkuk and its underlying supergiant oil field is still disputed. The Kurds cannot export oil without using central government pipelines, while Baghdad refuses to pay the companies active in Kurdistan, arguing they are operating under illegal contracts, and even barring the Chinese giant Sinopec from the bidding rounds.

If output from the Basra fields increases as anticipated, the central government will have no need of revenues from Kurdistan, and would prefer not to have another internal competitor for its OPEC quota. Yet some kind of accommodation on all these issues will have to be reached if Iraq is to survive in something like its current shape. Perhaps a grand bargain can be reached, encompassing shared government of Kirkuk and fair distribution of oil revenues.

In a previous oil boom, Venezuela sought to "sow the petroleum" to grow a sustainable economy. That can happen in Iraq, too. But the country's fabulous oil wealth can also sow the seeds of destruction. It poses threats to OPEC, to the international oil companies, to its neighbours and to itself. All need wise leadership and luck to guide them through the next decade. Robin Mills is a Dubai-based energy economist and author of The Myth of the Oil Crisis

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