Thursday, September 14, 2006

Kurdistan's Oil Under The Control Of Foreign Companies?

The publication last month of the draft of the Kurdistan Regional Government’s oil law was intended to mark the region’s assertion of control over the development of natural resources. However, it seems that as quickly as it wins its economic autonomy from Baghdad, the KRG wants to surrender it to foreign companies.

Niqash reports:
International oil companies were certainly pleased. "Congratulations and our compliments, this is a modern petroleum law that covers all relevant points," said an e-mail from one company to the KRG’s Natural Resources Minister, Dr Ashti Hawrami.

Dr Hawrami is no doubt keen to attract investment quickly to the region. Having been starved of investment for decades, the Kurdish political parties see greater economic independence - particularly in the oil sector - as a necessary element of federalism. The question is: At what cost does this investment come?

In the consultation on the draft law, some respondents criticised the proposed role for foreign companies, and the type of contract to be signed with them, for giving too much away. Bizarrely, Dr Hawrami characterises such criticisms as “anti-Kurdish” or “anti-federalism”.

The centrepiece of the draft Act is the decision to sign production sharing contracts of up to 32 years with international oil companies. These would give the companies effective control over oil production, as well as a significant share of the revenue from it.

Alarmingly, the draft Act makes no provision for parliamentary approval of such contracts. It is normal practice around the world for parliaments to be given the ultimate right of approval of production sharing contracts, given their profound effect on a country’s economy, politics and even sovereignty.

On the other hand, one positive feature of the Act is that it requires that such contracts be made available for public scrutiny (albeit only after they have been signed) – something the KRG pointedly refused to do with the four production sharing contracts it has already signed since 2003.

The KRG has made at least some efforts to limit the extent of foreign companies’ power, although in practice, it is not clear how effective these would be. For example, any oilfield development would be overseen by a management committee containing equal representatives of both companies and government.

However, both sides would be given an effective right of veto over the most important decisions – which would make it difficult to regulate the rate of production, in particular in relation to future OPEC quotas. This problem has been consistently experienced by Algeria and Nigeria, two OPEC countries with major foreign involvement in their oil industries.

Meanwhile, any disagreements between the KRG and the foreign companies would be arbitrated not in the courts of Kurdistan or Iraq, but in secretive investment courts in London or Washington, DC – courts that consider only the enforcement of the commercial terms of the contract. In a ‘model’ contract published alongside the draft Act, and intended to form the basis for any actual contract negotiations, it further specifies that any such arbitration would take place in the English language, and under the law of England.

But it is when combined with the decentralisation of authority for signing contracts that the cost of the policy starts to escalate. And while the KRG really insists on such decentralisation, the Oil Ministry in Baghdad is totally opposed. Deputy Prime Minister Barham Salih recently told Reuters that the drafting of the federal oil law has been delayed because of disagreements on this issue.

Part of the goal of the publication of the draft KRG petroleum act is to influence policy Iraq-wide. Indeed, the KRG also drafted an act for the whole of the country, which it has presented to the Ministry of Oil, although not made public.

One of the most striking elements of the KRG’s draft law, and presumably of its proposed federal law, is that it assigns control over oil in disputed territories such as Kirkuk to the KRG, with immediate effect, only offering to return such control to the federal government if the planned December 2007 referendum does not choose Kirkuk to be part of Kurdistan. Such an approach would seem to put the cart before the horses.

It is difficult to see any chance of this being accepted – most likely it is included as a negotiating position, which can be dropped in exchange for keeping the other contentious aspects of the KRG’s policy, with the Kirkuk issues to be resolved after the referendum.

But the dispute over decentralisation of responsibility for contracts is not simply a power struggle – it will have a bearing on the economics of oil production as a whole.

The precise terms of any contract – and in particular how the revenues are shared between state and private company – are determined by negotiation. They thus depend on the relative bargaining power of the two sides.

If the decentralisation arguments are taken to their logical conclusion, each region and province would be encouraged to pursue its own policies and strategies, and carry out its own negotiations, to attract investment. Unrestricted competition for investment could hamper coordination in Iraq’s economy and infrastructure, and could sow the seeds of fracturing the country.

Furthermore, it could create a race to the bottom, where each region or province tries to offer more generous terms to attract companies. Multinational companies would conversely have an opportunity to play different regions off against each other, forcing ever greater concessions – at the expense of the Iraqi people.

The KRG has opted for a major role for foreign companies precisely because the KRG itself does not have sufficient expertise to run its own industry, in contrast to the Oil Ministry and the state-owned operating companies.

But this may be a mistake. It seems to be commonly assumed that if there is a lack of technical capacity, the solution is simply to allow foreign companies to make the investment. What this assumption misses is that the investment must be managed – from negotiation, to regulation, to monitoring. And given the scale – hundreds of millions of dollars or more – this too requires institutional capacity.

It is helpful here to recall the early history of Iraq’s oil industry. In the 1920s, Iraq did not have the capacity to develop its own oil; it had to rely on foreign companies. But by signing very long-term contracts with them, the government remained powerless to adapt to the new circumstances as Iraq built up its indigenous skills.

Now, for Kurdistan, there are two other options: work with Iraq’s experts, or take time to build up expertise in Kurdistan. It seems both options have been rejected.

In fact, the KRG seems even more impatient to sign away its resource wealth than some figures in the Iraqi Oil Ministry. In comments last week, Dr Hawrami announced that the KRG was already negotiating with more companies, aiming to sign contracts soon after the draft Petroleum Act is approved by the Kurdish Parliament in September.

This timing can be expected to get the worst possible deal for Kurdistan.

The issue of whether contract-signing authority should be decentralised to the regions is highly contentious, and federal Oil Minister Husayn al-Shahristani has clearly stated that only Baghdad should have that authority.

For a company to sign with the KRG before a federal oil law has been passed, and before the constitutional review is complete, carries enormous risks that the KRG’s Act will later be found legally invalid. As such, any company will expect very high profits to justify that risk. The two possible outcomes are either chaos if the contract is over-ruled, or the giveaway of a large share of revenue if it survives. These terms, despite reflecting the risk at the time of signing, will persist for 32 years.

The citizens of the Kurdish region have a right to see investment in their economy – something which has been denied them through decades of repression. But to seek economic independence from Baghdad, through complete reliance on foreign capital, may constitute a leap from the frying pan into the fire.