2. Iraqi Constitution
3. Contract Conditions
4. State-owned Oil Companies
5. Restructuring of the Iraqi Oil Institutions
6. Revenue-Sharing and Equalization
7. Potential Geography
8. Present Organization and Development
9. Hydrocarbon Legislation Draft and Contracts
10. Revenue Sharing
11. Crisis Management of the Oil Industry in Iraq
12. U.S. Policy and Issues for Congress
13. China Investment in the Energy Sector
LIST OF FIGUURE
Figure 1: Iraq’s oil resources
Figure 2: Federal government function
Figure 3: Location of Iraq’s Oil Reserves and Infrastructure
Figure 4: Iraq’s Oil total target production after the second bidding round
Figure 5: Oil and gas resource in Al-Anbar governorate
Figure 6: Description of Ministry of Oil and Own-State Oil Companies abbreviated manner activities and Roles
Table 1: Target production profile
Table 2: Target production profile
Table 3: Target production profile
Table 4: Prequalified Entities
Table 5: Participation Fees
Table 6: Oil reserves in producing, partially and non producing field’s
Table 7: Oil reserves and production from developed fields according to provinces
Table 8: Oil reserves and production from the undeveloped fields according to provinces
Table 9: Total oil reserves currently known according to provinces
I would like to thank all the people who gave me their time and their views on this book. I am particularly grateful for the helpful reviews and comments received from Christine Dlugokencky.
The revenue from this book will be donated to children with cancer and organizations that help them.
Dr Muhammed Mazeel
This book covers policy proposals and interim contracts, assesses the positions of various Iraqi political actors and examines the potential significance for international foreign policy goals in Iraq. Despite a lack of progress in reaching agreements on the hydro-carbon sector and revenue sharing legislation to set new conditions for the management of the country’s significant oil and gas resources, development in Iraq’s oil and gas sector is moving forward.
The passage of the oil and gas sector framework and revenue sharing legislation will be seen as significant milestones by International governments and International Oil Companies (IOC´s). This would provide evidence of the Iraqi government’s dedication to promoting political reconciliation and providing a solid foundation for long term economic development in Iraq. Interim revenue sharing mechanisms have been introduced due to the lack of new legislation. Additionally, both the Federal Government (the Federal Oil Ministry-MoO) and the Kurdistan Regional Government (KRG) (the Regional Ministry of Natural Resources and Energy) have made oil and gas development deals with foreign firms. The MoO is working with existing regulation from the previous political and administrational regime, while the Regional Ministry of Resource and Energy Kurdistan-Iraq has designed its own laws and regulations, which the Federal Government has not yet recognized.
There is wide recognition among Iraqis of the importance of oil and gas revenue for the Iraqi economy. Most groups see the need for new legal and policy guidelines for the development of the country’s oil and natural gas resources. However, Iraq’s Council of Rrepresentatives (parliament) has not yet considered the proposed legislation due to ongoing political discord and general political instability. There are strong differences on key issues between Iraqi critics and supporters of various proposed solutions. These include the appropriate role and powers of federal and regional authorities in regulating oil and gas development; the conditions and degree of potential foreign participation in the oil and gas sectors; and proposed formulas and mechanisms for equitably sharing oil and gas revenue. Simultaneously, there are strong disagreements on related discussions about the administrative status of the city of Kirkuk and proposed amendments to articles of Iraq’s constitution that outline federal and regional oil and gas rights.
The U.S. and UK military strategy in Iraq seeks to lay the ground work for an environment in which Iraqis can resolve core political differences in order to ensure national stability and security. However, it is not yet certain whether the proposed oil and gas legislation and ongoing interim efforts to develop Iraq’s energy resources will support harmony or create deeper political tension.
The United States and its allies face difficult decisions regarding how to work with Iraqis on assorted policy proposals, related constitutional reforms and oil and gas development contracts, and at the same time encouraging their Iraqi counterparts to ensure that the content of proposed laws, amendments and contracts reflect acceptable political compromises.
In the 1920s a wide-ranging concession was granted to a consortium of oil companies known as the Turkish Petroleum company and later as the Iraq Petroleum Company. This was the beginning of oil exploration in Iraq. The nationalization of Iraq’s oil resources and production was finished by 1975. From 1975 to 2003, oil production and export operations were entirely state operated. However, from the early 1980s until the toppling of Saddam Hussein’s government in 2003, the negative effects of war, international sanctions, a shortage of investments and technology and, in many cases, mismanagement caused difficulties for Iraq’s hydrocarbon infrastructure.
According to the Oil Ministry, Iraq has the third largest proven oil reserves in the world (115 billion barrels). Other estimates of Iraq’s potential oil reserves vary. The U.S. Department of Energy’s Energy Information Administration notes that current estimates “have not been revised since 2001 and are largely based on 2-D seismic data from nearly three decades ago.” In
April 2007, oil industry consultants IHS assessed that Iraq’s proven and probable reserves tally 116 billion barrels, with a potential additional 100 billion barrels in largely unexplored western areas. The U.S. Geological Survey’s median estimate for additional oil reserves in Iraq is around 45 billion barrels. In 2004, Iraq’s then Oil Ministry claimed that Iraq had “unconfirmed or potential reserves” of 214 billion barrels. My Reservoir Engineering Estimation is that Iraq’s reserves can reach more than 320 bn bbl oil. Approximately 65 percent of Iraq’s current proven reserves are located in southern Iraq, with a concentration in the southern most province of Al Basrah. Large proven oil resources have also been found in the northern province of Al Ta´mim near the disputed city of Kirkuk. (For a map of Iraq’s oil resources, see Figure 1, below).
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Figure 1: Iraq’s oil resources /7/
At present, crude oil provides over 90% of Iraq’s domestic energy consumption and oil exports produce over 98% of Iraq’s government revenue. Due to decreases in global oil prices from their 2008 high and lower oil production, Iraqi leaders revised their 2009 revenue and budget assumptions from a projected surplus to a projected $15.9 billion deficit. According to official U.S. assessments continued fluctuations in oil prices and production could put at risk Iraq’s fiscal stability and the sustainability of its reconstruction and development plans. The expansion of oil production to the level of four million barrels per day (m/d) by 2013 and then upward to six m/d by 2017 is called for by current Iraqi plans. Iraqi officials have begun an international bid process for service contracts and renegotiated a series of Saddam era oil production agreements in order to support these goals. These include the transformation of a production sharing agreement into a service contract for Ahdab oil field with China National Petroleum Corporation (CNPC).
98% of Iraq’s government budget coming from oil revenues. As a result an agreeable intergovernmental framework for managing petroleum resources and for distributing revenues is correctly regarded as the key element of federalism. There is great potential to develop a sound fiscal framework in Iraq with consistent best practices that will distribute revenues equitably and efficiently, decentralize resource management where appropriate, and bind the country together as a stable federation.
As in most resource-rich countries, Iraq’s petroleum deposits vary from region to region and deposits differ in productive capacity, cost of extraction and processing, and quality of crude. Moreover, extensive repairs and reinvestments in Iraq’s petroleum infrastructure are necessary to amplify its production potential. Furthermore, large areas of Iraq remain unexplored, particularly Iraqi Kurdistan, Middle (Euphrates Middle), Najaf dry sea, South West and the Western Desert, and preliminary assessments point to large potential reserves.
According to Iraq’s constitution ownership of petroleum resources is by “the people of Iraq in all its regions and provinces.” Although the constitution establishes federal management of present fields, it also recognizes resource development ambitions in the historically deprived regions, for example, Kurdistan and Basra. The document does not define the jurisdiction over future fields.
The constitutional ambiguity on this assignment defers authorities and responsibilities around resource management, revenue-raising and revenue sharing to subsequent negotiations and legislation. Furthermore, the federalism established by the constitution is asymmetrical, wherein regions have greater autonomy than governorates, providing malleability for intergovernmental affairs.
Few resource-rich federations can avoid granting a preferential share of resource revenues to originating regions either through regions’ own taxation powers or through sharing of federally collected revenues. Such preferential treatment has implications for the efficiency of the economic union: The allocation of other resources is distorted by “net fiscal benefits” across regions. Greater public services funded by oil-revenues at lower levels of taxation in resource rich regions attract labour. A federally coordinated equalization program is necessary to alleviate these fiscal inequities.
However, in Iraq as in any resource-endowed country, the division of federal and subnational powers around natural resources is not simply a matter of revenue-sharing; rather, it is a question of how the resource is to be managed. Arrangements then involve the interrelated issues of the oil industry’s structure, regional authority over exploration and development, environmental management, revenue-raising mechanisms, the administration of revenues, and the terms for a prospective oil revenue fund.
More specifically in Iraq’s case:
- Will control of current petroleum resources monopolized by a central Iraqi National Oil Company (INOC) on what terms?
- How will governorates and regions be represented in the INOC and a federal oil and gas commission?
- What will be the tendering and approval authorities of regions and governorates within their territories? In particular, will regions have the authority to tender independent and distinct arrangements with foreign exploration and development firms?
- How will petroleum revenues be distributed to regions and governorates? In particular, where will funds be deposited and what are the regions’ assurances for the prompt and accurate distribution of their entitlements?
- Will stabilization or savings funds be done nationally or regionally? How much of the revenues will be allocated? Who will manage the fund what objectives will guide its investments? What will be the terms for withdrawals? How will a federal fund be accountable to regions and governorates?
Competent management of exploration and development is essential for the future of Iraq's petroleum industry. The first step is the discovery of resource deposits. Following this, upfront investments are necessary for development. In order to ensure efficient production technology must be upgraded and capital renewed. Maximizing resource rents means attracting and retaining investment, technical expertise and high-calibre management. The correct incentives must be offered to governments, national entities and private enterprise in order to revitalize the Iraqi oil industry. This means arrangements between the federal government and regions must encourage efficiency within the oil industry.
To give an appropriate framework for Iraq, I first review relevant features of Iraq’s federal structure and oil industry, with an special focus on geography. Then I propose principles relevant to Iraq to aid the design of policies for: a) the efficient assignment of ownership, management and revenue-raising around natural resources; b) revenue-sharing and equalization programs; and c) saving oil revenues and stabilizing public finances.
2. Iraqi Constitution
Iraq is presently comprised of 18 governorates (muhafadhah). Notably, the divisions are based on territory and not ethnicity. The Kurdistan Region is formally recognized by the constitution and allows governorates to assemble into regions.
The law establishing the process for regionalization was passed in October 2006. Under the Iraqi Constitution, regions have the right to legislate an independent constitution, assuming it does not conflict with the federal constitution. Regional governments have the option of amending any other federal legislation as it applies within the region’s borders. Furthermore, regions have the right to residual powers not specifically assigned to the federal government by the Constitution.
Governorates do not participate in a discussion of federalism in Iraq, and argue that an Iraqi national identity is an enduring concept that will ultimately resist sectarian divisions and support a balanced federation. The law organizes the autonomy of such unattached governorates. In this way, the constitution creates an asymmetrical and flexible form of federalism, creating core federal institutions but with the intention that the inter-governmental relationship should evolve gradually. Due to Iraq’s geographically-dispersed and ethnically-diverse character, the ultimate balance between federal shared rule and self rule will be critical to the success of the arrangement.
A deadline was of December 2007 has been set by the Constitution for a referendum to be held to allow Kirkuk to decide whether or not to join the Kurdistan Region. With the assent of the Kurdistan Regional Government (KRG), the deadline was subsequently extended to June 2007. In spite of the fact that this deadline has passed, no referendum has been held. The KRG sees a resolution of Kirkuk’s status as deeply linked to federal arrangements on petroleum management and sharing of oil revenue. A look at the history shows that north Iraq was not originally Kurdish. It became Kurdish due to the immigration of the Kurds from other regions to this part of Iraq during Islamic religious missions. Indeed, it is indisputable that the north of Iraq is now Kurdish, but in fact Kirkuk never was a Kurdish city. Christians, Jews, Turks and Arabs inhabit the city. The geographical placement of Kirkuk to north has had a strong influence. Kurds immigrated to Kirkuk for economic reasons.
The Kurd's main political divisions are into Talibanis and Barazanis main groups. Both desire Kirkuk for the oil potential. They are also looking for other regions and territory to include to Kurdistan. In my opinion Arabs (Sunni and Shiaa), Christians, Turks will have strong negative reactions to this and it will continue to be a point of conflict in the future.
Chapter 5 of the Constitution explicitly provides for the authority of provinces in powers not specifically granted to the federal government. Foreign affairs, defense, customs, currency, immigration, telecommunications, statistics and management of water resources are included in the federal powers established in Chapter 4. Environmental protection is included as a power shared between the federal and subnational governments. The Constitution makes no mention of provisions of social services, education and municipal infrastructure. Furthermore, provinces are not given specific powers under Chapter 5; they are only granted authority to legislate in areas that do not conflict with explicit federal powers. A law of provincial powers was passed in March 2008, more clearly laying out provincial authorities and setting October 2008 as the deadline for holding provincial elections. This law mainly clarified federal-subnational relations and did not clear up the ambiguity of precise subnational legislative authorities. Figure 2 shows the federal government function.
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Figure 2: Federal government function /9/
The definition of ownership of oil and gas is intentionally vague: “Oil and gas is the property of all the Iraqi people in all the regions and governorates” (Section 4, Article 111). Nevertheless, the following article defines the management of present resources. It assigns existing fields to the federal government and authorizes per capita payments to regions and governorates as well as compensation for the “damaged regions”:
Section 4, Article 4 (1): The federal government, with the producing governorates and regional governments, shall undertake the management of oil and gas extracted from present fields, provided that it distributes its revenues in a fair manner in proportion to the population distribution in all parts of the country, specifying an allotment for a specified period for the envisions three scenarios of partial federalism, radical decentralization and a balanced federation.
The question is how regional representation at the federal level and inter-governmental relations might evolve, arguing for regional capacity damaged regions which were unjustly deprived of them by the former regime, and the regions that were damaged afterwards in a way that ensures balanced development in different areas of the country, and this shall be regulated by a law.
This article allows for future legislation for future fields based on agreements between the federal and subnational governments:
Section 4, Article 4 (2): The federal government, with the producing regional and governorate governments, shall together formulate the necessary strategic policies to develop the oil and
gas wealth in a way that achieves the highest benefit to the Iraqi people using the most advanced techniques of the market principles and encouraging investment.
Iraq Constitution and Oil Resources
As mentioned above, oil revenues are most significant aspect of public finance in Iraq. While it is beyond question that the present collapse of the broader, diversified economy has caused this, Iraq’s resources will continue to be the major source of government revenues for the foreseeable future. As a result the federal and subnational governments in resource management should cooperate on the following mutual goals:
- secure economic rents from petroleum exports for the owning peoples of Iraq;
- ascertain knowledge of Iraq's full resource potential by optimizing exploration activities;
- promote the efficient exploitation of resources over the long-term;
- stabilize public finances in the short- and medium-terms with potentially volatile resource revenues;
- use the resource base for reconstruction and economic diversification;
- decrease distortions in fiscal capacity across the economic union and aid efficiency of the internal common market;
- ensure that the oil industry is appropriately regulated –with particular reference to its environmental performance;
- provide Iraqi citizens in all regions with equitable levels of public services; and
- appease potential macroeconomic destabilization from resource revenues.
Each issue must be dealt with in a principled intergovernmental arrangement which engages both federal and subnational powers. This arrangement requires an understanding of the common entitlements of Iraqi „social citizenship“ in different residential jurisdictions due to the political dimensions. Nevertheless, economic principles should guide this arrangement. The federation’s stability will be dependent on the efficiency and equity of the economic union. Additionally, productive efficiency must be ensured by the assignment of powers and the structure of the oil industry.
There are several stages in the production of natural resources. In general, these are: exploration; development; extraction; transport from extraction site; processing; transport to market; recycling; and closure/site remediation. The government affects this process at many points. Additionally, activities occur in different locations. Specifically, oil must be transported from the site of extraction to a refinery. Transport of extracted crude is typically by pipeline.
As follows, we apply such principles to each dimension of such an arrangement for Iraq. In general, we argue that the ideal arrangement is one in which:
- contracts for exploration and development are administered in a two-stage process with a competitive auction for initial exploration rights and a profit-based royalty or resource rent tax imposed during production.
- the authority to negotiate contracts and to assign exploration and development rights according to a flexible but consistent set of national standards is given to regions and governorates, who have requisite technical and administrative competence.
- The National Oil Company commits private firms for certain oil field services. In addition, it should compete with private firms for future exploration and development prospects and provide pipeline transport to all producers without price discrimination.
- Oil revenues should be collected in a clear and transparent manner by the federal government.
- Petroleum revenues are shared on a per capita basis – possibly with some limited preferential share for originating regions and governorates.
- Regions and governorates are given sufficient fiscal independence to deal with their expenditure responsibilities, providing reasonably equal levels of public services at equivalent taxation rates.
- As statistical capability allows, a federal equalization program provides transfers to mitigate disparities in fiscal capacity between regions, including those created by sharing of derived petroleum revenues but excluding benefit taxes.
- Oil revenues are managed by federal and subnational governments based on competent short- to medium-term budget plans for capital expenditures.
- In the immediate future, infrastructural investment and reconstruction programs are given priority when investing petroleum revenues.
- In the longer term, following adequate recovery and reconstruction, the federal government directs an acceptable portion of revenues, as part of federal budgeting and consistent with the federation’s medium-term expenditure plan, to a federally-administered oil revenue fund.
- Maintenance of future generation's level of wealth should be such a fund's long term objective.
- The principal means of securing the stability of government finances should be publicly accountable budgeting with a medium-term expenditure plan – rather than reliance an oil revenue fund’s rules.
- Such an oil revenue fund should operate with clear objectives, flexible but firm rules, a standard asset-management strategy and direct accountability to government as well as to the regions and governorates.
According to Iraq’s draft Oil Law and draft Law of Financial Resources, the country’s legislators generally appear to envision such a system.
Ownership and Management
Ideal assignment of ownership is impossible to separate from the owner's capacity to manage the resource efficiently. This means that should be assigned to an agent whose management will maximize the social surplus from its extraction. The maximization of resource rents and the promotion of economic development are included. From a government's perspective, the important features for “ownership” of resources are the powers to:
- Assign exploration and development rights for the subsurface;
- Regulate exploration and development; and
- Exact payment for the extraction of resources and for complementary activities.
Government ownership of the subsurface is preferable to initial ownership by the surface owner. First of all, a “split bestatte” that detaches ownership of the subsurface from ownership of the surface is most efficient and enables the optimal use of each. Secondly, due to the “hidden” character of resources, the problems of collective management, efficiencies from pooling exploration risks, and the broad goal to maximize social surplus government ownership of the subsurface is advisable.
In a federation, ownership of resources should then be assigned to the government with the capabilities to capture resource rents and administer resources most efficiently.
Decentralization of management is beneficial in cases where subnational governments are competent as decisions are brought closer to those they most impact. The owning government must have sufficient administrative and technical capacity to:
- maximize public capture of resource rents;
- promote exploration and to organize the competitive assignment of subsurface exploration rights;
- competently and predictably regulate the development of a discovered deposit; and
- assess compensation for surface users predictably and consistently.
There are two general possibilities for the administration of subsurface rights: i) a competitive regime for granting exploration and development rights; or ii) resource production by a state owned monopoly. State participation through contracts that entitle the government to a share of the proceeds is not ruled out by the first option. Similarly, the second alternative does not preclude private-sector participation since firms may competitively bid for service contracts.
Furthermore, a regime in which a state-owned national oil company (NOC) has the option of taking part in competitive bidding for exploration and development rights alongside private
firms. Moreover, another structure might involve government monopolies limited to related infrastructure or particular components of the production process – for instance, refineries and pipelines. If this is the case, private firms would require credible commitments that government control would not be used to force additional rents from producers.
3. Contract Conditions
The process for assigning rights will incorporate the capture of rents under reliable contract conditions of exploration and development rights. That is, in order for exploration to smoothly lead to development the taxation structure for resource production must be clear.
In general, rights are assigned according to two approaches: a) a fixed, legislated framework for exploration permission and royalties/taxes on production, or b) project-specific contracts that set out the schedule of contingent payments and are decided by auction and negotiation. In both cases, a two or more stage process is created by legislation or contracts in which exploration rights may be altered into rights for development and production. Payments may accompany these rights at each stage; for example, a rental fee for land use or an initial payment for the purchase of exploration rights. The legislation or contract will also determine the methods by which the government will acquire rents.
The information set, risk aversion, liquidity constraints and time-value of funds of the particular government will influence the methods. There are risks at each stage of the production process, ranging from exploration risks for discovering a resource to technical risks around production to commodity price risks.
Generally, many years are needed to explore and develop a particular field well. A decade may pass between the discovery of a resource and its production. It is possible that several years will pass before any profit is made.
A highly risk-averse government will want to transfer risk to a less risk-averse party. Governments have the opportunity to reduce exploration risk, by acquiring greater information about their subsurface through state geosciences or contracted surveys, government. If a government has a high discount rate, it will find payments in the short term preferable to larger cash flows in the long term.
Considering these features, it is advisable to provide for resource management by the least risk-averse, most knowledgeable and most patient level of government. In this case the government will be able to maximize the expected value of resource rents. If there greater risk aversion, less information or higher time-discounting in another tier of government, it will not be capable of efficiently managing the resource. Ideally, under competitive assignment, exploration rights are assigned in a competitive auction or tender process and a resource rent tax is levied on realized profits. An auction of exploration rights secures that these rights are assigned to the user with the highest utility. The awarding of rights might be connected with an initial payment and land use fees during exploration. Minimum activity deadlines should be implemented for exploration and development activities. These rights should not endure forever, rather they should be granted for a fixed period. Idle or purely speculative investment can be prevented by such provisions.
It would not be wise to hold a single auction, granting all rights based on a single up front payment and imposing no production-based royalties or taxes. The number of auction participants will likely be limited by the size of the ex ante payment and bidding will not be competitive. Uncompetitive auctions allow bidders with private information about an area's potential to keep their information secret and to strategically underbid. Furthermore, even in a competitive auction, the winning bid will only show the expected value of the resource and the government will abandon the title to any realized rents.
A risk-averse government may welcome the short term auction returns, instead of the long term realized rents. Nevertheless, part of the logic of granting all subsurface rights to the government is to allow for the optimization of pool exploration risks. Moreover, if the bidding firms have a lower discount rate and lower risk aversion than the government, the net present value of the ex post capture of rents will exceed the ex ante payment. The maximization of public returns from subsurface resources will ensure when the government receives all realized rents ex post rather than expected rents ex ante. However, in cases where ex post instruments are used to capture realized rents, an auction may be an effective tool to most efficiently assign exploration rights or tender a project or specific contract.
A competitive auction has the feature of assigning the rights to the bidder with the highest expected utility. Notwithstanding, it would be unwise to implement ex post instruments, ad valorem or per-unit royalties. Companies will increase the minimum grade they are prepared to extract from a known reserve when faced with a per unit royalty. Lower grades will not be extracted, although they would be under a pure rent tax. The challenge of „high-grading“ will be bypassed by ad valorem royalties but nonetheless change the time-path of production and put deposits with higher costs of extraction at a disadvantage.
An ad valorem royalty urges a high-cost project to maximize the extraction rate to offset diminished future cash-flows. An ad valorem royalty would discourage investment in marginal projects with high capital costs, despite the economic profits the project could provide.
A resource rent tax is the better option. It must provide the producer with a sufficient rate of return but appropriate additional rents. That this tax is efficient can be seen in that it does not change the influence the extraction decision for marginal deposits. The tax then captures the economic profits represented by the value of production less the producer’s opportunity costs.
This tax is akin to a cash-flow tax with unlimited carry-forward, in which capital costs are immediately deducted from revenues. During any period, losses are advanced to the future, inflated at an appropriate discount rate and applied to future positive cash-flows.
On the other hand, the government is made vulnerable to “lumpy” cash flows by such a tax. Administrative and technical sophistication are necessary to carry it out. Tax authorities must effectively assess various capital costs and expenses. In order to measure the risks of production, the government must possess adequate technical expertise. Furthermore, uncertainty and risk are present during exploration. Exploration firms must hold the rights to some portion of the resource rents; otherwise they will not take the risk of prospecting. Without this condition, prospecting carries a negative expected value. To gauge the required compensation for prospectors, the government must have the appropriate technical expertise.
Designing comprehensive legislation for a resource rent tax is a challenging task. In spite of this, oil profit taxes are levied in both developed and developing oil-exporting. However, there are differences in the character of deposits and in the level of pre-exploration information. In addition, exploration and development firms are unwilling to deal with the political risks of legislative amendments or even expropriation.
A production sharing agreement (PSA) makes these risks somewhat more palatable and provides flexibility because agreements are customized for the given project. A certain share of production is allocated to the government by simple PSAs. This mirrors ad valorem or per unit royalties. On the other hand, profit-based resource rent taxes can be inserted in the terms of more sophisticated PSAs. Additional transactions costs arise due to the fact that PSAs must be negotiated. Various contingencies must be embedded in the contract terms. Furthermore, a contracting government must retain legal and technical expertise. Production sharing contracts also potentially want for clarity. While flexibility is desirable, consistency and predictability are essential in the contracts’ core provisions. In the end, the contract approval process must be liable to the government and conducted according to a published model agreement.
Another possible instrument for capturing resource rents is equity participation. This was the government receives an equity share of the project in return for development rights. When this equity is without charge for the government, there is an effective a resource rent tax. A contract for the government equity participation also might include in-kind contributions by the government. The government might establish that any project include a minimum government share. The terms of equity participation might also be negotiated as part of a PSA. For such an agreement, it is integral that regulatory and contract approvals are administratively separate. If a department acts as the owner it should not act as the regulator. The following shows key information for bidders:
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Table 1: Target production profile /8/
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Table 2: Target production profile /8/
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Table 3: Target production profile /8/
Tables: Information on Contract Areas 1
The Annexes to the Contract contain the specific details for each Contact Area (coordinates, map, definition of reservoirs and Minimum Work Obligation). Plateau Production Target bids below this level will not be accepted. Note that only Crude Oil (as defined in the Contract) will count towards meeting the Plateau Production Target.
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Table 4: Prequalified Entities /8/
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Table 5: Participation Fees /8/
After paying a Participation Fee on a Contract Area, entities designated as Operators will be given a individual Bid Envelope and Bid Form for that area. This envelope and form are the only way for an Operator to submit a bid.
As indicated above, Contract Areas will be offered in a fixed order. The Chairman will define a deadline and entities/consortia have until then to enter a bid for the relevant Contract Area. The bid must be handed over in a sealed Bid Envelope. It is not necessary for Consortia to disclose in advance of submitting the Bid Envelope the composition of their consortium for a bid.
Details of the entities making the bid (including the Operator), the percentage of interests of each, information concerning the Bid Bond, the authority of a duly Authorized Representative of each entity (alone or in a consortium) presenting the bid, and acceptance of all bidding conditions will be detailed on the front of the envelope.
Upon receipt, an examination of the Bid Envelope will commence, to confirm that all entities identified on the front are eligible to bid and that all requirements have been observed in the completion. The PCLD may ask, at its sole discretion, for any required corrections.
The Chairman will then request that a sealed enveloped containing the Ministry’s maximum acceptable Remuneration Fee be placed in the bid box. At this point the names of the bidding entity or entities will be disclosed. A representative from each entity will be invited to place its sealed Bid Envelope in the bid box.
If a Bid Form or Bid Envelope is accidentally ruined by an Operator, a replacement may be requested from the PCLD. Replacement will only be issued if the ruined Bid Form and Bid Envelopes are turned in. The Operator should not discard the ruined Bid Forms or Bid Envelopes, as an exchange will otherwise not be possible.
After all the Bid Envelopes have been approved and placed in the bid box, the envelopes will be removed one at a time. The Chairman of the Bid Committee will open and examine the bid. Provided the bid conforms with the instructions on the Bid Form, the bidding consortium and content of the bid will be disclosed.
This process will be repeated until all Bid Envelopes have been opened.
Once the last bid has been disclosed, the points allocated to each bidder according to the formula in Section 7.2 (see the attachment) will be made public and the bidder with the highest points will be indicated. The winner will be announced based on the Remuneration Fee per barrel in the highest scoring bid being equal to or below the pre-defined maximum,.
The Chairman of the Bid Committee will then announce the timing of bids for the next Contract Area to be offered.
Bidding Parameters and Evaluation Criteria
There are two bidding parameters for the DPSC:
The Remuneration Fee Bid (RFB), expressed in US$ per barrel of oil equivalent (as defined in the Contract) delivered to the designated Transfer Point(s). Bids may be placed in one cent increments.
The Plateau Production Target (PPT) is expressed in barrels of oil per day to be delivered.
For the evaluation of bids, each of the bids will be scored as follows:
Bid Score = RFB bid score + PPT bid score
RFB bid score = 80 * (Lowest RFB / Bidder RFB)
PPT bid score = 20 * (Bidder PPT / Highest PPT bid)
Minimum Acceptable Bids
Assuming the RFB does not top the Maximum Remuneration Fee (“MRF”) pre-defined by the Ministry of Oil, the highest scoring bidder for each Contract Area will be accepted.
Once all bids for a Contract Area have been opened and scored, the Chairman of the Bidding Committee will check that the RFB(s) of the highest scoring bidder(s) is/are equal to or below the MRF. If there is:
a. single highest scorer whose RFB does not exceed the MRF, that bidder will win the bid.
b. single highest scorer whose RFB exceeds the MRF, the Chairman disclose the MRF and the highest scorer will have the opportunity to accept the MRF. The deadline for the decision will be defined by the Chairman (expected to be about 30 minutes later). If accepted, the highest scorer will be confirmed as the winner for the Contract Area in question.
If this option is declined and the second place RFB does not exceed the MRF, it will be declared winner. If the RFB of the second place scorer is above the MRF and the option to match is declined by the highest scorer, the option to match the MRF will be offered immediately to the second place scorer. In this case, it must be accepted or declined immediately. If accepted, the second place scorer will be confirmed as the winner.
If declined, the option to match will move immediately to the third place scorer, or directly awarded to that bidder if its RFB does not exceed the MRF.
The offer to the third place scorer will be the final offer. If the third-placed scorer declines, no award will be made a tie between two or more bidders; all tied bidders proceed to the tie-breaker.
In the event of a tied bid score the tied, bidders will be provided with additional Bid Forms to submit a modified bid. The Chairman of the Bidding Committee will set a deadline. In preparing revised bids: The Plateau Production Target may not be revised from the original bid; and the RFB may not be raised. If one or more of the tied Bidders has exceeded the MRF, the MRF will be disclosed to all tied Bidders before the tiebreaker. A tiebreaker RFB in excess of the MRF will not be accepted.
In the event of a tie between a consortium and a single entity bidder, the consortium bidder will be declared the winner. If the tie is between consortia or between single entities, the award will be settled by a random allotment.
A Bid Bond in favor of the Ministry of Oil for each Contract Area should be presented by each entity or consortium for each area on which it plans to bid. This guarantees the winning Bidder’s obligation to sign the Contract for the relevant Field(s). Each Bid Bond will be in the amount of five million United States Dollars (US$5,000,000).
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Figure 3: Location of Iraq’s Oil Reserves and Infrastructure /10/
4. State-owned Oil Companies
State-owned national oil companies (NOC’s) have increased in popularity, particularly amongst OPEC members, as a method for capturing resource rents while pursuing national objectives for the oil industry. Indeed, numerous NOC’s have expanded their operations outside of their own borders. However, the dual objectives of national development and profit-maximization are potentially at odds.
As NOC’s are isolated from competitive pressures, they have been accused of numerous inefficiencies. These include under-performing management, capture of rents by special interests and suboptimal levels of exploration. In order to expand reserves and maintain capacity, constant reinvestment in the oil industry is necessary.
A government may be tempted to drain an SOC of its cash-flows. Furthermore, associated labour groups and corruption might beset the NOC’s with rent seeking behavior. To avoid these problems, procurement processes must be clear and transparent. Cash flows must be well audited and the NOC must have appropriate internal controls. Management must also be motivated to minimize costs. The status of monopoly is counterproductive for these processes. The security of this position provides disincentives for efficiency. Top technical talent may not find this environment attractive in the long term.
On the other hand, NOC’s may give the state an opportunity to learn by doing and coordinate the rate of resource development and extraction with better social welfare.
Developers might extract at higher-than-optimal rates. Slower development may also correspond better with regional development objectives. A gradual pace of extraction also provides opportunities to develop forward linkages, providing value-added processing, and backward linkages, supplying services and machinery to the petroleum industry.
Despite the prevalence of efficiency concerns, these should not be an a prima facie case against NOC’s. The efficiency of an NOC depends on surrounding institutional arrangements. In particular, the optimal situation for an NOC is as an arms-length corporation with rigorous internal controls and public transparency of its balance sheet. In this case, government acts as a share-holder, approving long term investment plans but delegating operations to competent managers. Moreover, there should be a strict line between regulation and shareholding. Different agencies or governments should act as shareholders and regulators.
Ownership and Management of Oil and Gas Resources
Significant unexplored areas in Iraq have strong oil and gas potential. According to the recent IHS study, there are abundant deposits underlying the sparsely-populated western desert and the largely autonomous Iraqi Kurdistan. The promotion of efficient exploration to discover and delineate deposits should be given special priority. In order to achieve this, Iraq must engage high-calibre talent and investment in petroleum exploration.
A PSA regime with competitive auctions for exploration blocks and resource rent taxes embedded in the agreement is an appropriate approach. If this approach is to work, the negotiating government must have adequate expertise and the final PSA approval must be accountable and acceptably transparent.
The Draft Oil Law allows the federal government to retain ownership of presently producing oil fields. Management is assigned to the Iraq National Oil Company (INOC). At present, the INOC has a monopoly on refineries and pipelines. This arrangement should continue in the short-term, because the INOC has established capacity on which to build.
Privatizing this strategic, network industry is risky and vulnerable to rent-seeking. Iraq is certainly not in a position to organize the competitive privatization of its oil industry. Due to the importance of the oil sector for Iraq's economy, it is unavoidable that the state plays a role. Moreover, the INOC likely has a comparative advantage in exploration and development of new fields proximal to or associated with existent fields.
Nonetheless, by all accounts, the INOC’s existent above-ground infrastructure is gravely in need of renewal. In addition, a two-day strike by Basra oil workers in July 2005 showed that its operations are subject to pressure by special interests. INOC's capacity should benefit the reconstruction of infrastructure and revitalization of the industry. However, state-of-the-art technology and guidance from experienced petroleum professionals are also necessary for the Iraqi oil industry. Internal competition will be encouraged by contracting private oil service firms and IOC´s for these purposes. Technology transfer will also be facilitated. Subjecting the INOC to competitive bidding for future fields will encourage efficiencies, as well.
The draft law provides for an open, competitive regime for contracting in existent fields and for exploration and development contracts. It would establish a framework in which the Federal Oil and Gas Commission (FOGC) establishes model contracts and creates the general framework for administering rights. Federal ministers and representatives of producing regions and governorates would make up the FOGC. The administration of contracts would be done by qualified regional authorities, with sufficient technical and administrative capacity. Furthermore, the KRG'S previously signed agreements would be explicitly recognized by the draft law. The responsibility for reviewing these agreements would rest with the KRG.
This framework corresponds with the previously listed principles for ownership. Assuming subnational governments can competently administer contracts in their own territories, they should be responsible for this activity. Because subnational governments have knowledge specific to their region, they are able to take local externalities into consideration more successfully. In addition, they are specifically accountable to the region’s citizens. Government management of natural resources is not simply about public finance. It involves supporting sustainable regional development through forward and backward linkages. A federal framework provides uniform and consistent, nation-wide standards while allowing administrative flexibility for competent subnational governments. This arrangement is fitting to Iraq's version of asymmetrical federalism and the differing administrative capacities between the KRG and other governorates.
Preliminary exploration rights would be granted for extendable 4 year periods. These contracts would be modified to 15- to 20-year development rights in the case of a successful discovery. A 12.5% ad valorem royalty would be paid to the Ministry of Oil at the entry flange to the Main Pipeline, either in kind or in cash, based on the prevailing market price. In contrast, the KRG’s model Production Sharing Contract provides for both a 10% ad valorem royalty and sharing of petroleum profits according to an R-factor (calculated as the ratio between a producer’s cumulative revenues and costs). Iraq’s Draft Law’s chapter on the Fiscal Regime does not specifically mention a profit-based royalty or resource rent tax, but it would be possible to include this kind of payment in a model Exploration and Development contract, as determined by the FOGC.
A superior option is the federal collection of revenues. Firstly, the federal government has better administrative and technical facilities than the governorates at present. The federal government is also better able to negotiate contracts and administer profit-based royalties or resource rent taxes on oil production. Secondly, due to the national scale of the oil industry and the export of oil for sale, infrastructure across multiple governorates is needed for transport and processing. Exploration blocks and deposits will also likely extend across multiple governorates. Lastly, volatile resource revenues can better be managed by the federal government, as federal collection eliminates inter-regional discrepancies that subnational collection would create.
The national pipeline would continue to be operated by the INOC. There would be specific regulations prohibiting price discrimination and transport would be on reasonable commercial terms. In a dispute, firms could appeal to the Minister of Oil who would collaborate with the involved region and governorate to achieve a resolution. However, the relationship of the Oil Ministry with the INOC remains somewhat unclear. The Oil Minister would be appointed to the FOGC. The Oil Ministry would be a regulatory authority. Although the descriptions of the INOC board are not precise, it seems that the Oil Ministry would also be responsible for oversight assuming the Oil Minister is to serve on its board. Producing regions and governorates would also be represented on the INOC board. This final feature is proper because it ensures accountability to subnational governments as foreseen by a federal structure.
In addition, there is a possible conflict of interest due to the presence of the INOC president on the FOGC. According to the Draft Law, the INOC is a state-owned competitor within the national oil market. The INOC is to be financially and administratively independent, and run on a commercial basis. If the INOC is given voting rights on the FOGC, the company will have influence on federal decisions on oil and gas policy and on the terms of Exploration and Development contracts.
5. Restructuring of the Iraqi Oil Institutions
Any meaningful reform in the sector should include the reworking of existing policies, restructuring and reorganization of oil companies and the Ministry as well as the legal framework and commercialization.
The development of the Iraqi oil and gas policies should be approved by the intended federal executive council under the chairmanship of the Minister President. The main objective of the policies is to make far reaching changes and ensure the fundamental transformation of Iraqi Oil and Gas industry in order to optimize the development of the Oil and Gas industry; this in turn will hopefully maximize economic growth and overall country development.
The first steps toward restructuring and reorganizing the institutions and the legislation include taking ownership of oil and gas resources, allocating acreages to Kurdistan/Iraq and neighbors states, Government participation, fiscal principles, and improving of transparency and good governance.
It is important to provide the institutional framework that governs the operations of the industry, including the functions, powers, structures and funding of these institutions.
The operations in the upstream of the industry include Licenses, leases and contracts. Other considerations covered are award processes, right of participation by the government, marginal fields, indigenous companies, termination and revocation of licenses and leases, matters on fees, rents and royalties and finally provisions on Associated Natural Gas.
The legislation in the downstream sector focuses especially on matters of licensing, refining and marketing of oil products, the transport logistics company, facility management companies, pipelines and depots and issues relating to pricing of products. The operating stocks and Iraqi strategic stocks are also necessary.
The needs of the downstream natural gas include both technical and commercial licensing regulations and conditions, the network, gas supply licenses, transportation pipelines licenses and the whole sale market in addition to the possibility of third party access, customer protection, the pricing regime, issues of public service obligations, competition and market regulation.
The legislation is essentially an amendment to the existing Technical Service Contracts (TSC) in Iraq and Production Sharing Contracts Agreements (PSC) in Iraqi Kurdistan based on the need to create a new fiscal framework that takes into consideration various compelling issues. The issues include the need to capture the full gas value chain for taxation purposes, developing a fiscal regime for gas that is removed from oil thereby creating a level playing field for all investors in gas, and promoting the effective management of costs across the industry –which in turn will maximize the government’s take. Other considerations revolve around the requirement to develop a fiscal system that is responsive to the significant changes in prices; the need to clarify inconsistencies and/or conflicts in the application of fiscal terms for oil and gas; and finally, to develop a fiscal rule of general application based on a body of expected fiscal laws.
Quality, health, safety and environment are missing elements in Iraq. During the restructuring and reorganization of the institutions, the QHSE should take on a big role in working with the aforementioned departments in the Oil Ministry and the operating companies. The obligations of the state and international oil companies toward the state environmental regulations and public rules, must be upheld according to the licensees, lessees and contractors with consideration for the matters of abandonment, decommissioning and disposal and their funding.
The various actors in the oil and gas production processes have obligations toward the various communities in the oil-producing region of the country. Supporting community development, providing employment opportunities, compensation, Infrastructure, protection and management of the environment are all essential components.
The Ministry of Oil remains essentially a civil service outfit that is ill-equipped to conceive and enact the required policies for such a complex and sophisticated industry. Therefore, there is a strong need for the principal and basic interaction between the following institutions:
- The Federal Oil Ministry
- Existing directorial and state oil companies
- Kurdistan Ministry of Energy
- Private sector operatives
As well as the restructuring of the following institutions:
- Directorial of Petroleum Regulation
- Iraqi National Oil Company and Iraqi National Gas Company