Iraqi Oil Exports Resume Though Challenges Remain

Abstract: This week's resumption of Iraqi oil exports indicates legal hurdles covering 10 million barrels of stranded oil have been overcome. However, future Iragi oil exports present significant physical and political challenges.

Analysis: This week, the nation of Iraq shipped its first oil since the coalition invasion in March.

But as with most things concerning Iraq, the news is more symbolic than substantive.

A multitude of questions remain about how much oil Iraq can produce for export, and in what timeframe. Longer-term issues are still in flux concerning the extent of rehabilitation necessary for the oilfields to produce at anywhere near potential capacity. And when production approaches capacity, how will OPEC accommodate Iraqi exports? Other questions include the eventual structure for Iraq's post-war oil industry. Will it be a state-dominated enterprise, or privatized?

Time will tell. What is known currently is that one million barrels of oil were loaded onto a Turkish tanker at the Mediterranean port of Ceyhan on Sunday. The cargo was earmarked for a Turkish refinery along the Aegean Sea. A second million barrels of cargo destined for a Spanish refinery were loaded at Ceyhan on Monday.

News reports of the first Iraqi oil shipment since the war also noted exports are expected to begin later this week at Mina Al-Bakr, Iraq's Persian Gulf oil terminal.

But don't hold off filling your tank in anticipation of lower gasoline prices just yet. The exports simply indicate legal entanglements have been resolved following the collapse of Saddam Hussein's regime. Essentially, this week's shipments are the first to occur since the UN Security Council agreed in May to lift sanctions on Iraq under Resolution 1483 and legally recognize U.S. authority over Iraq as the Coalition Provisional Authority.

The legal clarification enables international business contractual transactions to move forward, which is where the symbolism comes into play. The oil shipments this week were from terminals in Turkey where more than eight million barrels had been stored since before the start of hostilities in March. Two million more barrels in prewar storage are also located at Mina Al-Bakr.

In other words, this is the last oil of the old regime.

Talk of fresh oil for export suggests the process of rehabilitation in the Iraqi oil sector still has a lot further to go. Early expectations were that Iraq would be producing 1.5 million barrels per day at the end of June. Currently, the nation is pumping about 800,000 bbls/d, about two-thirds of which is generated in the oilfields north of Baghdad.

Looting and sabotage have hampered efforts to generate new oil for export. Looting alone has cut as much as 500,000 bbls/d from Iraqi productive capacity.

Meanwhile, officials are ratcheting down earlier predictions for year-end production levels. Last weekend, interim Iraqi oil minister, Thamir al Ghadhban, dropped the target 20 percent to two mmbbls/d as problems in the nation's electrical grid affected the country's petrochemical infrastructure.

Lower than expected Iraqi output is one reason OPEC agreed this month to leave its production quotas unchanged. OPEC has expressed interest in keeping Iraq as a member of the 11-nation cartel. Should that transpire, the quota system will need to evolve in order to accommodate Iraqi production. Iraq's original quota was 3.5 mmbbls/d, on par with Iran. However until a formal government is established, Iraqi participation as a full member of OPEC cannot take place.

Before the invasion, Iraq was exporting 1.7 mmbbls/d on production of 2.5 mmbbls/d. The country's 112 billion barrels in oil reserves are considered second only to Saudi Arabia's in size, and those reserves are likely understated since during the last 50 years little has been done to explore the full nature of their extent.

To return Iraqi oil production to its pre-1990 state of 3.5 mmbbls/d will take at least two years--likely longer--and an estimated $5 billion in investment. To ratchet production up to the nation's six mmbbls/d potential will require billions more in investment between now and 2010.

The most immediate problems facing Iraqi oil production include sabotage and looting. At least two explosions over the last week have hit Iraqi export pipelines. The 600-mile pipeline connecting Kirkuk, Iraq, and Turkey was targeted last week. Elsewhere, a gasoline pipeline was set afire west of Baghdad while a second explosion on an oil pipeline connecting Iraq and Syria occurred Sunday. Internally, a vital pipeline connecting the northern and southern oilfields was also damaged through possible sabotage.

While sabotage is politically motivated, looting also plays a role. Looting has decimated plants that produce water used in refineries at Rumailah and the satellite-operated systems that control pressure and direct flow volumes on export pipelines.

When exports resume, questions over how to apportion the proceeds will come to the fore. Currently, the protocol calls for revenues to be deposited into the U.S.-controlled Iraq Development Fund where they will be allocated to rebuilding the nation's battered infrastructure. Iraqi oil sales are expected to net $3.3 billion by yearend.

The U.S. will assume full responsibility for the Iraq Development Fund when the UN's oil for food program is phased out by November. The program was created in 1996 to overcome the debilitating impact of sanctions on the Iraqi population after Iraq's 1990 invasion of Kuwait. Essentially, under the program the Iraqi regime could sell oil as long as the money was allocated to the purchase of food, medicine, or other humanitarian goods. Iraq exported 3.4 billion barrels under the program, earning $64 billion. About $27 billion in humanitarian supplies were acquired with the rest directed to war reparations, weapons inspections, and administrative costs.

The U.S., meanwhile, is considering several policy options. These include creating a social safety net financed by oil revenues, establishing a national trust fund to underwrite public pensions, or providing dividend payments directly to Iraqi citizens similar to the program in Alaska.

The U.S. is aggressively pushing for privatization of the Iraqi oilpatch, though the move is politically unpopular in both Iraq and the Arab world. Handled poorly, this phase of the recovery could have long-lasting negative repercussions.

An issue of more immediate concern for U.S. taxpayers centers on the cost of the transition. Either U.S. officials don't know or are reluctant to share the information with the public. Halliburton, which has an open-ended contract to restart Iraqi oil production, has charged $185 million to date, up from $77 million in May, according to the U.S. Army Corps of Engineers, which is overseeing the contract. The Corps of Engineers talked about opening the contract to competitive bidding by August but has since back-pedaled from any timetable.

That seems to be par for the course. While the war may have run according to plan, the aftermath is presenting complex and unforeseeable hurdles.