Oil Privatization Through The Back Door

At Niqash, Greg Muttit writes:

In a survey in July 2003, Baghdad residents were asked what they thought was the main reason for America and Britain to go to war in Iraq. The most popular answer, with 47% of responses, was “to secure oil supplies”.

At first glance, it would seem that America and Britain have failed in this aim. Post-war Iraqi oil production peaked in April 2004 at 2.3 million barrels per day – still below the pre-war level of 2.5 mbpd – and has since dropped to around 2 mbpd.

But this reading would misunderstand the foreign oil interest. The aim for Iraq’s oil was not simply to obtain greater supplies – that could have been done by purchasing more oil from the former regime, and by removing sanctions. Rather, the US/UK interest was in controlling oil over the long term, through multinational companies based in their own countries.

In this respect, things now seem to be moving fast. On US President George Bush’s recent visit to Baghdad, oil was one of the key topics discussed. And last week, Bush’s Energy Secretary Sam Bodman called for an Iraqi oil law to lay out the rules of private investment.

The new Iraqi Oil Minister plans to pass an oil law through parliament by the end of the year – the timescale imposed by the International Monetary Fund – to enable the Iraqi government to sign contracts with “the largest oil companies”.

It seems the most likely type of contract being considered is the one advocated by the oil companies themselves, known as a ‘production sharing agreement’ (PSA). Four PSA contracts have already been signed by the Kurdistan Regional Government, with Norwegian, Turkish and Canadian companies.

So, what is a PSA? It is a structure which allows a foreign company to invest capital in developing an oilfield, in exchange for managing the oil production, and keeping a share of the oil.

Such contracts are often used in countries with small or difficult oilfields, or where high-risk exploration is required. They are not generally used in countries like Iraq, where there are large fields which are already known and which are cheap to extract. For example, they are not used in Iran, Kuwait or Saudi Arabia, all of which maintain state control of oil.

In fact, of the top seven countries with the largest oil reserves, only Russia – which has the World’s seventh largest – has any PSAs. Russia signed three PSAs in the early 1990s, during its own rapid political and economic transition, but has signed no more since then. Those PSAs have been so controversial, due to the poor deal they give the state, that it is unlikely any more will be signed.

Now some of the very same people who pushed PSAs in Russia and the other former Soviet states of Kazakhstan and Azerbaijan are advocating their use in Iraq.

Part of the appeal of PSAs is that they give the appearance of sovereignty over natural resources: the state is described as “owner” of the resource, and the foreign company as its “contractor”. However, in practice, most oil industry analysts acknowledge that the terms of the contract can be written so as to have exactly the same effect as a more traditional privatisation, giving the company management control, and potentially huge profits.

And with PSAs commonly lasting for 30 or 40 years, or even longer, decisions made now could sow the seeds of economic and political difficulties for decades to come.

The most obvious impact of this is that the state would obtain less revenue, as a share would go to the foreign companies. The cost to the Iraqi economy over the length of the contracts could be in the hundreds of billions of dollars. Given that oil provides more than 90% of government revenue, giving away a significant chunk of this could have a major effect on public programmes of health, education and infrastructure.

A second consequence would be the effect on the workforce. Whereas publicly-owned enterprises can include employment or the development of the national skills base among their objectives, private companies’ sole aim is to maximise profit. The international oil companies have consistently done this by reducing the size of the workforce. Similarly, they bring in many of their workers from abroad. Although the government may negotiate a percentage of local workers to be specified in a PSA contract, generally the technical and management roles go to foreigners: the Iraqis would be left with the lowest-paid and least-skilled jobs.

Furthermore, the companies would have control over the rate of oil production. For an oil-dependent country such as Iraq, the rate of depletion of its non-renewable resources – the balance between maximising production now versus saving some for later – is one of the most important economic decisions.

This may also undermine Iraq’s future relationship with OPEC. Two OPEC members with major foreign investment, Algeria and Nigeria, have repeatedly failed to control foreign companies’ production in order to comply with OPEC quotas.

If this is not worrying enough, PSAs frequently contain a ‘stabilisation clause’, making the companies effectively immune to any future legislation or regulation. As a result, future governments for the next 40 years could be constrained in their ability to pass new laws or policies.

For example, imagine that in ten years’ time a new Iraqi government wanted to pass a human rights law, or wanted to introduce a minimum wage. If this affected the company’s profits, either the law would not apply to the company’s operations, or the government would have to compensate the company for any reduction in profits.

Perhaps the government might insist that the law must be applied. In that case the company could apply to an international investment court – most likely in Geneva or Washington, DC – whichever is specified in the contract. These courts, which often sit in secret, cannot consider the body of Iraqi law, let alone the Iraqi public interest: they only consider the commercial terms of the contract. If such a court found against the Iraqi government, the government would either have to comply, or would face having its assets seized in other countries.

The human rights organisation Amnesty International has described such contracts as having a “chilling effect” on human rights, meaning that the financial disincentives are likely to discourage governments from passing any progressive human rights policies.

Production sharing agreements thus make a pretence of preserving national control, while in fact handing it over to foreign companies – in effect, privatising by the back door.

No-one doubts that the Iraqi oil sector needs investment. The advocates of PSAs argue that, because PSAs are favoured by oil companies, they are the only way to provide investment. But this ignores a range of other options: investment could be provided from public budgets, by borrowing from international banks, or by inviting foreign companies under less extreme forms of contract – for example, the buyback contract used in Iran or the risk service contracts being considered in Kuwait. Indeed, in both of those countries foreign ownership of oil is forbidden by their constitutions.

The oil companies insist that to finance oil development from public expenditure would deprive the Iraqi government of the opportunity to spend its limited funds on other public priorities. It is true that if foreign companies provide the investment now, the government would not have to.

But the Iraqi people must ask whether relinquishing future revenue and surrendering sovereignty over Iraq’s natural resources are a fair price to pay.