When it comes to the political economy of Iraqi oil, some questions need to be answered. Should Iraq stay in OPEC? Should state-owned oil assets be privatized? Should rapid and massive foreign investment be encouraged? Should Iraq have a development fund similar to those created in Alaska, Alberta and Norway? In answering these questions, I offer my personal views.
Should Iraq stay in OPEC?
Staying in OPEC would probably limit Iraq’s production quota and would therefore deprive it of badly needed revenues to fund its infrastructure, including oil fields and pipelines. I estimate that Iraq would be able to generate between $15 to $20 billion from oil export at the prewar level. This amount of money would not be sufficient to meet Iraq’s financial obligations to its sovereign creditors and its financial needs to fund domestic education, health, security, and the rehabilitation of the oil industry.
It is true that increased Iraqi exports would lower oil prices, but Iraq has a competitive advantage when it comes to oil production. It can afford to keep selling oil at a low price of $10/bbl. If Iraq decides to stay in OPEC, it may consider pushing for liberalization or even abolition of both production quotas and the pricing band ($22 - $25). It would find some OPEC members who would emulate it, including Nigeria and Venezuela.
Politically speaking, leaving OPEC would in the short run hurt Iraq’s image as a founding member of the organization, which historically symbolized the solidarity of developing countries vis-a-vis the more powerful industrial consuming countries. Other members of the Group of 77 may see it as a betrayal of that solidarity. But some Iraqi officials would weigh this negative element against the potential benefits that could be generated from badly needed increased cash flows that would be realized from selling more oil.
Should state-owned oil assets be privatized?
I believe that privatization of Iraqi oil industry should be seriously considered, taking into account the financial as well as sovereign rights of Iraq. Since the country is in tatters, Iraq now is not in a position to run its oil industry. Moreover, there are huge acreages that are not yet explored, there is a need for foreign technology for oil recovery enhancement, and there is a need for foreign companies to help Iraq to curb environmental breaches.
However, the questions that remain to be answered are: How much should Iraq privatize? 50 percent or 100 percent? The next question, what model to use? Should the 2002 model, which was envisaged by the Iraqi Oil Ministry, be used? The Oil Ministry had suggested the utilization of development and production contracts (DPCs). Alternatively, should Iraq adopt the traditional production-sharing agreements (PSAs) or the Alaska model? Would a combination of other fiscal regimes be better? Regardless of what model will be used, multinational oil companies, whether major or independent, could still find new lucrative deals in the future Iraqi oil industry. Why? One of the reasons is that recent reports indicate that Iraq has high proven reserves, especially when other regions in Iraq are explored. Another reason is that oil companies have found recently that many oil-producing countries (Russia and the Caspian Sea area) have substantially overestimated their own reserves.
Should rapid and massive foreign investment be encouraged?
After solving the pending issues related to the exploration and production rights obtained by the Russian, French and Chinese oil companies, other companies should position themselves to benefit from the situation in the Iraqi oil industry, taking advantage of the competitive cost structure of oil production. Oil companies, though, should pressure the US and British governments to set up a national government and improve the security and social situation of the Iraqi people. The World Bank and export-import banks in the US, Japan, and Australia should come up with creative methods to fund infrastructure and oil industry and to provide guarantees to foreign investments in Iraq. The Multilateral Investment Guarantee Agency (MIGA) of the World Bank could be tapped in this regard.
Should Iraq have a development fund similar to those created in Alaska, Alberta, Kuwait, Norway, and elsewhere?
I recognize the benefits of rainy-day funds for oil producing countries. But given the current fragile Iraqi economy and infrastructure, I believe that establishing an oil trust fund in Iraq should be planned now but implemented later, say, after seven to 10 years, when an increased oil production capacity is in place, and when the country is able to generate some cash surplus. Oil trust funds can serve as an indirect hedge against the decline in oil revenues. Since it is not financially feasible to set it up now in Iraq, Iraq should consider hedging its oil revenues by considering adopting some risk management tools, such as options, futures, and swaps.
— Musa Essayyad is the Saudi-British Bank Professor of Finance at King Fahd University of Petroleum and Minerals.
