The fight over Iraq's oil

Analysis By Daniel Yergin Cambridge Energy Research Associates

The threat of war in Iraq has just one reason, say many critics: Western hunger for oil. Daniel Yergin examines whether the claim stands up.

Oil figures large in the debate over the current crisis with Iraq. How could it not? Yet, when it comes to oil, there are two decidedly different points of view.

Iraq's oil infrastructure is deteriorating rapidly

According to some, the Iraq crisis has been created as a pretext and cover for an "oil grab" by the United States, Britain and the international oil industry.

According to others, Iraq, once liberated from the current regime, will flood the world market with cheap oil, boosting economies and providing a quick fix for concerns about our energy security.

Although there is a wide gulf between them, both these points of view have one thing in common - basic misapprehension about the scale of Iraq's oil industry and the timing for new production.

A second tier oil producer

No question, Iraq is a very big oil country. Its reserves are the second largest in the world - behind only those of Saudi Arabia.

Former Saudi oil minister Sheikh Zaki Yamani says oil is the major objective for the United States in seeking to occupy Iraq Click here to read Sheikh Yamani's view

But the real picture is different. Iraq represents just 3% of the world's total production capacity. Its oil exports are at about the same level as Nigeria's.

In contrast to the 1990-91 Gulf crisis, which was more about energy security, this current crisis is focused on overall security, and it requires several leaps of logic to conclude that the current Iraq crisis is "all about oil".

Physically, Iraq could double its current capacity, but that could well take a decade or more.

No US administration or any British government would launch so momentous a campaign - and take such risks - just to facilitate a handful of oil development contracts and a moderate increase in supply half a decade from now.

The 'day after' Saddam Hussein

What would be the future of Iraqi oil without a Saddam Hussein?

War could damage Iraq's output at the very moment when a new regime would desperately need oil revenues to secure its own stability.

Saddam could also torch Iraq's oil facilities in a pyrrhic defeat, although the prospect of post-war tribunals in Iraq might deter some Iraqi commanders from obeying any such orders.

There should be no assumption that Iraq will welcome foreign investors on a reasonable timetable

And there is the critical question of authority. Who would be making decisions?

If there were a temporary military government, it would be preoccupied with establishing firm control over Iraq's weaponry and laying the basis as quickly as possible for a new Iraqi authority with broad representation.

The country earns the bulk of its living - $15bn (£9.5bn) in 2001 - by exporting oil.

For that reason, any temporary military authority would be keen to see the "new" Iraq maximise its oil earnings and would be loath to get much involved in the decision making about the long-term future of the industry.

Those decision have to be made by the Iraqis themselves.

For its part, any new Iraqi government will be intent on getting its arms around its number one economic resource so that it can generate as much revenue for reconstruction and development as quickly as possible.

Following Kuwait's example?

Iraq is not Afghanistan. It has the means, through oil, to pay for rebuilding the country.

Are the Russian and US energy ministers striking a deal on Iraq's oil?

But a new government will also have another priority. It will be determined to bolster its sovereignty, legitimacy and nationalist credentials - all of which will be essential requirements for holding the country together. This ensures that when the time comes to sit down with the oil companies, Iraq will be a tough negotiator.

There should be no assumption that Iraq will welcome foreign investors on a reasonable timetable. History warns that such is not a foregone conclusion.

After the 1991 Gulf War, Kuwait said it would open its oil industry to foreign investment; 11 years later that has yet to happen - because of nationalistic opposition in Kuwait's parliament.

The limits of Iraqi oil

One of the reasons that the "It's all about oil" discussion gets off on the wrong track is that it makes the assumption, often without realising it, that Iraq would turn over its current 2.8 million barrels per day of production capacity to international companies.

Companies will be cautious when it comes to spending billions of dollars until they are pretty confident about security and stability

But that's a misleading assumption. Why would a new Iraqi government want to split revenues?

It does not need the international companies' investment for fields that are already developed, and can simply purchase technology and equipment for existing fields.

However, for its undeveloped fields, a post-Saddam government will need capital - lots of it - for exploration and new production. And that is when a new regime is likely to turn to international oil companies.

Weighing investment risks

Which ones? It will have no shortage of suitors.

Companies will be eager to get in line to sign contracts with a country that has 11% of the world's proven reserves. (Saudi Arabia, the highest, has 25%; the North Sea has just 1.7%).

It costs billions of dollars to restore destroyed oil infrastructure

But they will be cautious when it comes to spending billions of dollars until they are pretty confident about security and stability.

And, for the companies, "stability" applies both to the new regime itself and also to the contracts they sign with it.

Companies from several countries - Russia, France, Italy and China, among others - already hold contracts, but because of UN sanctions they are not operational.

Companies without contracts, including the British and American ones, will have to assess how much time and trouble they are willing to bear.

For the oil companies, the big issue is how to manage the range of risks - from the geological to the fiscal to the political. In response, they often work together in consortia and partnerships, and that's likely to be the way things work out in Iraq.

The companies with existing contracts will likely team up with other companies - American, British, European, Canadian, Australian, Japanese - to form new partnerships.

Three years to restore output

Any new Iraqi regime has to face the stark reality - the deteriorating condition of the Iraqi oil industry.

Production capacity has dropped from its peak of 3.5m barrels a day in 1980, before the Iran-Iraq War, to about 2.8m barrels per day and continues to fall.

Reservoirs have been damaged by years of mismanagement. The infrastructure - whether wells, pipelines, pumping stations or ports - is in poor shape and environmental considerations are widely ignored.

Iraq would not have the ability to 'flood' the market [with oil] - nor would it have the desire

To get back to 3.5m barrels a day could take three years or more, at an estimated cost of several billion dollars.

The next hurdle is to increase production above that. Another two million barrels per day would require a major push and would still leave Iraq several rungs below the capacity of the big three producers - Saudi Arabia, the United States and Russia.

Making that leap to 5.5m barrels a day would come some time after 2010 - at a cost of upwards of $20bn. Some say it could be as much as $30bn, because it would also require much new infrastructure in terms of pipelines, ports, and so forth.

Some assume that Iraq could turn into an Opec-buster as its output increases. But its likely growth in output would not give Iraq that kind of clout.

It would not have the ability to "flood" the market. Nor would it have the desire. Its intense need for revenues would make it much more interested in selling oil at $20 or $25 a barrel, rather than at a bargain basement rate such as $10.

Competing with the Caspian countries

World oil demand is growing, driven by countries such as China and India.

The competition is shaping up: On one side are Russia and the Caspian countries, primarily Kazakhstan and Azerbaijan. Standing on the other side is the Middle East, including Iraq.

The race to supply growing world demand has a clear and tangible prize: by 2010 the growth in world oil consumption could mean an additional $100bn or more a year in oil revenues flowing into the treasuries of nation states.

After "the day after", Iraq will be better positioned - and highly motivated - to compete for its share. It will be a strong competitor. But it will also be only one of several strong contestants.

Daniel Yergin is author of the 1992 Pulitzer prize-winning "The Prize: The Epic Quest for Oil, Money, and Power" and co-author of "Commanding Heights: The Battle for the World Economy"

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