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Iraq: Oil Production Strengthens But Remains Problematic

International oil companies are signing new contracts to buy Iraqi oil in what some analysts say is a vote of confidence in Iraq's re-emerging oil-export sector. But doubts remain as to whether Iraq can increase its export levels in the months ahead dramatically enough to offset the mounting costs of the country's reconstruction.

Prague, 31 July 2003 (RFE/RL) -- The U.S. administration for Iraq is expected to finish signing this week contracts to sell an average of as much as 750,000 barrels per day of oil for the rest of the year.

The U.S. daily "The Wall Street Journal" notes that the contracts represent the first time since the war that the U.S.-led Coalition Provisional Authority (CPA) in Iraq has committed itself to deals based on future production of crude oil, an arrangement the oil industry calls "term sales."

Previously, the CPA had only struck deals with companies to buy oil that had already been pumped and stored.

Oil analysts say the new commitments are a sign of confidence on the parts of both oil purchasers and the Iraqi oil sector that Baghdad can now guarantee limited oil production despite ongoing security problems.

Gerald Butt, an oil industry expert with the Cyprus-based Middle East Economic Survey (MEES) says the new contracts mark a cautious return of oil companies to the Iraqi oil market. He calls it "cautious" because the contracts commit companies only to buy crude oil through the end of the year.

Still, he says, the deals are a sign that oil companies think the Iraqi oil industry is gradually regaining strength.

"Certainly, it is a sign that things are getting better and [the fact] that Iraq is in a position to offer even limited term sales like these is a sign that things are better now than they were a month ago or three months ago. But everyone, including those in the industry, including those who are signing up for term agreements now, is cautious because nobody quite knows what the future holds," Butt says.

The first term sales come as Iraq's oil production continues to vary but recently has reached peaks of 1.2 million barrels per day. Iraq itself consumes about 500,000 barrels a day domestically, leaving the remainder available for export.

But even as production has jumped since Iraq stopped producing during the March-April war, it remains far from the pre-war level of some 2.5 million barrels per day. The main reason is that the oil sector -- which escaped the combat with little damage -- was hard-hit by looting and continues to be plagued by theft and sabotage.

Those security problems make it almost impossible to predict how much the oil sector can raise production in the coming months. Iraqi oil officials have said they hope to export 2 million barrels per day by the end of the year, but that goal is seen by many as highly optimistic. Butt calls 1 million to 1.5 million barrels a day of exports more realistic.

"Somewhere in the region of 1 to 1.5 [million barrels per day] by the end of the year, that is probably achievable assuming there is no major disruption, no major attack on the southern oil pipelines, those leading to the terminals at the northern end of the Gulf," Butt says.

He continues: "But it is a huge 'if' because by all accounts the looting is going on and even some of the facilities that have been repaired have subsequently been looted again, and also there is daily theft of oil by people simply tapping holes in oil pipes and then smuggling the oil out of the country, mainly down into the Gulf and into Iran as well."

The analyst notes that because of the security problems, Iraq currently is only able to export production from its southern fields. The pipeline from the northern oil fields around Kirkuk to Turkey's Mediterranean port of Ceyhan is still not able to resume transporting crude and, to date, any Iraqi oil being sold at Ceyhan still comes from supplies previously stored there. Two explosions damaged the pipeline earlier this month in what Turkey's foreign minister called sabotage.

Washington has made reviving Iraq's oil industry a priority because it counts on export revenues to help offset the mounting costs of reconstructing the country. But the oil sector's continuing problems make it uncertain how significant its contributions will be.

Early this month, U.S. civilian administrator for Iraq L. Paul Bremer approved a budget for the second half of 2003 that assumed oil production would rise to 1.5 million barrels per day by the end of the year. Bremer's aides told reporters at the time that oil exports would generate $3.5 billion in revenues, assuming an oil price of $20 per barrel.

But the director of the U.S. government's Office of Management and Budget, Joshua Bolten, told the Senate Foreign Relations Committee on 29 July that the cost of reconstruction work in Iraq this year alone will be some $7.3 billion. That is in addition to the cost of stationing some 150,000 American troops in Iraq -- about $4 billion per month.

Bolten, who testified to the Senate along with Deputy Defense Secretary Paul Wolfowitz, declined to estimate what Washington's involvement in Iraq might cost during fiscal year 2004, which begins 1 October. Wolfowitz said, "it is impossible to estimate what recovery in Iraq actually will cost."

Meanwhile, the U.S.-led authority in Iraq must spend additional large sums to repair Iraq's oil fields if it wants to boost production. Iraq is aiming to produce 2.5 to 3 million barrels per day by the end of next year -- something comparable to its output before the 1991 Gulf War. As part of that effort, Washington and the Iraqi Oil Ministry recently signed a $1.6 billion plan to rehabilitate oil fields and infrastructure.

Oil analyst Butt says that in the short term the cost of reviving Iraq's oil sector will be borne by the U.S. and others interested in reconstructing Iraq, and not by international oil companies.

"In the short term there can be investment in the sense that foreign companies can be brought in [at the expense of the U.S.-led authority in Iraq] on a contract-by-contract basis to [repair] damage that has been caused by the war or damage over the years and those sort of short-term engineering, oil field equipment contracts and so on, can be agreed and signed and carried out," Butt said.

But he says oil companies will not invest their own money until there is a fully sovereign government in Baghdad.

"What there cannot be is any kind of long-term investment that would see the expansion of exploration and production. One would need a legitimate government in order to sign those kinds of long-term exploration and development contracts," he says.

Butt says major oil companies require a sovereign government that is internationally recognized as the legal representative of the Iraqi people before they will invest the thousands of millions of dollars needed to explore and develop new fields. That requirement is to assure -- as far as possible -- that future Iraqi governments will not overturn their contracts later.

So far, the UN has stopped short of recognizing Iraq's U.S.-appointed Governing Council -- which took office 13 July -- as the country's sovereign government. The Council, which the coalition authority in Iraq has empowered to sign contracts, appoint a president and cabinet, and review laws, is tasked with preparing the way for future general elections.

Bremer, who retains the power to veto Governing Council decisions, said recently that he considers general elections to be possible within a year. But he said the date depends on the efficiency of the council in preparing the ground, including writing a new Iraqi constitution.

So far, the 25-member council has been hampered by power-sharing problems. After two weeks of deliberation over naming a president, the council decided this week to adopt a rotating presidency of nine members.