SF Gate: Which way to go?/Iraq must choose a course for expanding its oil production - national or multinational

From: Rakesh Bhandari (rakeshb@STANFORD.EDU)
Date: Sun May 25 2003 - 14:35:29 EDT

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Sunday, May 25, 2003 (SF Chronicle)
Which way to go?/Iraq must choose a course for expanding its oil
production - national or multinational
Verne Kopytoff, Chronicle Staff Writer

    After repairing its looted and decrepit oil fields, Iraq's leaders will
confront the pivotal decision that many other petroleum-rich nations have
had to make: how to expand their oil industry.
    Should they allow multinational oil companies to drill and take a share of
the crude, as do Nigeria, Kazakhstan and Azerbaijan? Should they maintain
a nationalized industry and prohibit foreign companies from coming in, as
Mexico does? Or should they implement some sort of hybrid?
    The answer could have a huge impact on how quickly Iraq gets back on its
feet financially. It also promises to raise politically divisive issues
ranging from national sovereignty to concerns that U.S. firms will be
unduly favored for drilling contracts.
    History shows that there are benefits and stumbling blocks to whichever
path a nation takes to build an oil industry. And several countries have
even changed course midstream.
    What is clear is that allowing multinationals to own a stake in oil fields
is gaining popularity across the globe. Yet major producers, such as Saudi
Arabia and Kuwait, now prohibit foreign ownership of crude, after
nationalizing their industries in the early 1970s.
    "Most Middle Eastern oil producers started off in a very colonial fashion
and got sick of all the oil companies taking the money," said Crispin
Hawes, a oil analyst for the Eurasia Group, a research firm in New York.
"For second- and third-generation producers such as Angola and Nigeria,
there never was a colonial hangover, so they offered contracts to
    The multinationals are companies like San Francisco's ChevronTexaco, as
well as ExxonMobil, Royal Dutch/Shell, TotalElfFina and BP, formerly
British Petroleum. They pump oil from dozens of countries on every
continent but Antarctica.
    Iraq, which has the world's second-largest known oil reserves, at 112
billion barrels, would clearly be a prize for any firm installed there.
Only Saudi Arabia, with 264 billion barrels in reserve, has more oil.
    The door for Iraq to begin exporting oil again was opened Thursday when
the United Nations Security Council voted to lift sanctions against the
country. Exports, which ground to a halt just before the war, had been
overseen by the United Nations to make sure the proceeds from oil sales
were used for humanitarian needs, not weapons.
    Pumping in Iraq is considered to be highly profitable because its crude is
relatively close to the surface. Extracting it can cost just over $1 a
barrel by some estimates, a fraction of the $10 to $15 it costs in some
other countries, particularly where offshore drilling is required.
    Iraq's oil industry is in shambles. Years of neglect and damage from
combat and looting have ground production virtually to a standstill.
    Just getting the nation's oil exports back to prewar levels of 2 million
barrels per day could take a year and cost an estimated $1 billion,
according to U.S. and British officials. Boosting exports to 6 million
barrels a day, as several members of an Iraqi oil advisory group created
by the State Department envision, could take several years and cost up to
$40 billion more.
    That's money Iraq doesn't have.
    Therefore, the country's leaders -- with prodding by the United States --
will probably turn to the multinationals, analysts said. It would give
Iraq access to the deep pockets and technical expertise it lacks in
developing new fields.
    "In the longer term, clearly the U.S. government would like the super-
majors to be working in Iraq," Hawes said. "One would assume that the
Iraqi oil ministry as it is constituted now would be favorable to that."
    Contracts known as production-sharing agreements are considered to be
among the most lucrative in the oil industry. They give the multinationals
or their subsidiaries at least part ownership of the fields in which they
    Such deals are the norm in nations including Kazakhstan, Oman, Angola,
Indonesia and Algeria. Companies often take home 30 percent of the oil
    In Angola, ChevronTexaco produced an average of 164,000 barrels of crude
per day for 2002. That translates into about $4.8 million per day in
revenue for the company at today's price of $29 per barrel.
    In addition, the multinationals often get big financial breaks, to the
point of paying no taxes and reduced royalties. They are also sometimes
absolved of responsibility for environmental damage.
    However, there can be a downside to production-sharing agreements in Iraq,
as elsewhere. The multinationals could lose the billions they invest if
civil unrest or an unfriendly government chases them out of the country,
analysts said.
    Furthermore, foreign ownership of oil rights is a sensitive subject in the
Middle East. Many countries, including Iraq, kicked out multinational
petroleum companies in the early 1970s after complaining for decades that
they were being shortchanged of profits.
    "Allowing equity investment is tricky because of nationalism in Iraq,"
said Simon Henderson, founder of Saudi Strategies, an oil industry
consulting firm, in London. "There are various halfway houses which I
suspect that the American companies would rather seek to develop."
    One model is the system used in Saudi Arabia, where multinationals cannot
produce oil in the nation proper. But the Saudi national oil company hired
a ChevronTexaco subsidiary in 1949 to pump oil for it in a neutral zone
along Saudi Arabia's border with Kuwait. ChevronTexaco does all the work,
from building the oil infrastructure to overseeing production and
providing technical expertise. In return, the company gets the oil
produced and pays royalties and taxes to the kingdom of Saudi Arabia.
    Another model is Iran, which also prohibits foreign ownership of oil
    It uses a rare kind of contract known as buybacks.
    Under this system, multinationals finance development of oil fields.
However, Iran's oil company controls production.
    Multinationals are paid a certain fee based on what Iran receives from
crude sales. The rate is usually about 15 percent to 17 percent of the
value of the oil, according to the Energy Information Administration.
    But analysts said that there are serious drawbacks to this scenario. The
shortcomings center on the multinationals taking a lot of risk for limited
    For one thing, the contracts tend to be short by oil-industry standards --
seven to 10 years instead of the standard terms of up to 40 years. That
increases the risk that the multinationals will be unable to recoup their
initial investment.
    Furthermore, the multinationals have to shoulder the extra costs to boost
production if the field fails to live up to expectations. The Iranian
government, on the other hand, gets most of the rewards if the field
exceeds expectations.
    Which way is Iraq leaning regarding its own oil future? Analysts said it's
difficult to know.
    They expect a lot of pushing and shoving between Iraq internal political
factions, competing Middle East oil producers and countries where the
multinationals are based. A decision could be several years away.
    "Nobody knows what's going to happen," said Michael Economides, an
economics professor at the University of Houston, and co-author of the
book "The Color of Oil." "What if Iraq ends up being under the influence
of Shiite fundamentalists? This is not as simple as people think."
    Saddam Hussein was eager to open up Iraq's oil fields to multinationals
during the 1990s. His government even negotiated and signed contracts with
an array of firms.
    However, exploration couldn't begin, because of U.N. sanctions. Those
    with firms from such nations as China and India, are now in serious
jeopardy, because they are perceived as being based on Hussein's attempts
to curry political favor rather than financial return, according to
    Conceivably, Iraq could continue to produce oil under its current
nationalized model. But analysts point out that even Mexico, one of the
few other nations without ties to multinationals in its oil industry, is
considering allowing private investment.
    No matter what model a country uses, the financial benefits have proven to
be limited. Profits aren't guaranteed to reach beyond the elite to the
average citizen.
    Many nations that allow production-sharing agreements, such as Nigeria and
Angola, are still bedeviled by shantytowns and squalor. Mexico's
nationalized oil has succeeded in erasing some of that nation's poverty,
but not all of it. Iran also has a long way to go.
    Saudi Arabia's system, in which multinationals are allowed in under
limited circumstances, has produced billionaires. But some analysts say
the Saudis actually need foreign investment if they are going to expand
production in the future.
    Saudi Arabia's wealth, they said, has diminished since the 1970s, partly
through mismanagement and partly because of relatively low oil prices.
    James Paul, executive director for Global Policy Forum, a New York
organization that monitors the United Nations and is critical of U.S.
policy in Iraq, is concerned that Iraq may make a mistake in choosing
which course to take. He said that U.S. companies may receive preferential
treatment in winning contracts in Iraq because of the U.S. military
    Additionally, Paul said, the presence of multinationals in a nation -- no
matter where -- tends to foster dictatorships that squander much of the
"oil rent." The companies have an interest in keeping authoritarian
governments in place to protect their investments, he said.
    "It's not to say that there shouldn't be companies operating in Iraq, or
that Iraq should have a state command economy," Paul said. "But I think
it's important to realize how deeply problematic the role of the companies
    Paul recommended that if multinationals are allowed into Iraq, the pool of
those considered should be as big as possible. It would create a better
deal for Iraq if smaller firms from nations such as Malaysia, Canada and
Italy were also in the mix, he said.
    "China's national oil company isn't necessarily nicer than ExxonMobil,"
Paul said. "It's more about competition."

    Only the national oil company can explore and produce oil.
    Example: Mexico .
    National oil companies allow multinationals to produce crude for a limited
term in exchange for royalties and taxes. Multinationals get no equity
stake in the venture.
    Examples: Saudi Arabia's neutral zone along border with Kuwait .
    Buy back:
    Multinationals are allowed to invest their own money to explore and pump
oil. In return, they receive an allotment of crude. But the national oil
company retains control of production.
    Examples: Iran .
    Production sharing:
    Multinationals are allowed partial ownership of oil fields and a portion
of the crude they pump.
    Examples: Kazakhstan, Nigeria, Angola, Azerbaijan .
    Tax and royalty:
    Companies pay normal tax and royalties to government based on the value of
the oil they produce.
    Examples: Norway, United Kingdom, Canada, United States
    E-mail Verne Kopytoff at vkopytoff@sfchronicle.com.
Copyright 2003 SF Chronicle

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