Political and Legal Obstacles in Iraq

Since June 2009, the Government of Iraq (GoI) has secured nearly a dozen major oil field technical service agreements with international oil companies (IOCs) after two highly publicized bidding rounds. The deals are seen as the cornerstone of Iraq’s economic development in the coming years. While future oil production has been rather optimistically projected as high as 12 million barrels per day (bpd) by 2020, significant obstacles to the development of the oil and gas industry remain. The country’s infrastructure and skilled labor supply are insufficient, the security situation remains tenuous although much improved, and billions of dollars of investment are needed to facilitate oil field development and exports.

In addition, legal challenges from within Iraq’s fractious political system also threaten to derail development of the oil and gas industry. Central to this issue is the ambiguous legal framework that undergirds Iraq’s oil industry. The absence of any national hydrocarbon law leaves lawmakers and regional governments at odds over procedural issues. A draft law to govern investment and production has been in limbo since 2007 amid disputes between Baghdad and the Kurdistan Regional Government (KRG) over the proper mechanisms for revenue sharing.

The Iraqi National Constitution as written (particularly Article 112(2) and Article 115) would seem to grant significant power to regional governments to manage hydrocarbon resources, as well as negotiate their extraction. However, the GoI has insisted on the primacy of the central government in negotiating and signing any deals with IOCs. Furthermore, the process by which the GoI negotiated contracts following the two rounds of oil auctions in 2009 was so centralized around the Ministry of Oil (MoO) that it has drawn wide and vocal accusations of unconstitutionality.

One internal row that has drawn significant publicity, both within Iraq and abroad, is the recent lawsuit filed by outgoing MP Shadha al-Musawi against the GoI, which challenges the constitutionality of the November 2009 BP-CNPC Rumaila deal, and aims to settle the question of whether Iraq’s prime minister, parliament, or provincial governments have the legal authority to finalize oil contracts with foreign firms. Musawi and her allies point to a pre-invasion law (Law 97 of 1967) that required federal oil contracts to be ratified by parliament, and argue that the same requirement should hold for the Rumaila development. The GoI, and the MoO in particular, have argued that the Rumaila and other IOC deals are merely technical service agreements, and thus do not warrant the same scrutiny as the production licenses envisioned by the 1967 law.

Even if Iraqi courts accept the government’s defense, there are serious questions about how the MoO developed the model contracts upon which the IOC deals were based. It is unclear whether government lawyers and ministers outside the MoO were given the opportunity to scrutinize the contracts before they were signed and declared legally binding.

Beyond these specific legal challenges there are quiet rumblings among Iraq’s political factions about the possibility of revisiting the oil contracts once a new government is formed. ‘Iyad Allawi, the leader of the Iraqiyya coalition, has promised a review of the IOC contracts if he becomes Iraq’s next prime minister. Among the most vocal critics are the followers of Shi‘ite cleric Muqtada al-Sadr (the Sadrist Trend), the Fadhila Party, and some other Iraqi nationalists, who have accused the GoI of surrendering the nation’s oil wealth to foreigners, and insist that Iraq can develop its oil resources relying solely on national efforts. Hazim al-Araji, a senior member of the Sadrist Trend, said his party might challenge the legality of the IOC contracts, claiming that there had been “great mistakes” in the negotiations.

It is unclear to what extent the promises to revisit IOC contracts are anything other than political rhetoric. The GoI has quietly assured IOCs that the legality of the existing contracts will not be challenged, but their confidence seems based on the assumption that, given the importance of oil revenues to Iraq’s economic future, no one would jeopardize the development of the oil industry by suspending field operations or demanding lengthy renegotiations.

Another consequence of failing to pass a national hydrocarbon law has been the lingering dispute between Baghdad and the KRG over oil production and exports in Iraq’s northern provinces. Frustrated by stalled negotiations over a national oil law, the KRG passed its own hydrocarbon investment law in 2007 based on a contentious interpretation of the Iraqi constitution, and began independently issuing production sharing agreements (PSAs) to several dozen smaller IOCs. Baghdad has condemned these PSAs, which have drawn international scrutiny over allegations of impropriety (if not outright corruption). In addition, the central government blacklisted any IOCs operating in partnership with the KRG, barring them from its 2009 oil auctions.

Despite the strong stance taken by the MoO against the Kurdish PSAs, the promise of $2 billion in annual oil revenues eventually compelled Baghdad in June 2009 to allow Kurdish oil exports, but only after negotiating that all revenues would be channeled into the federally managed Development Fund for Iraq, rather than directly to Irbil. At the same time, Baghdad refused to spend oil revenue on contracts it did not have a hand in negotiating, which left the KRG unable to pay its IOCs. After months of squabbling between the governments, which saw Kurdish oil exports halted in October 2009 and restarted in February 2010, the GoI reportedly agreed to cover the costs of foreign firms operating in the Kurdish region, including paying exploration and extraction costs, but not their profits. On February 14, the KRG agreed to publish the details of its PSAs online. The saga of the Kurdish oil industry reinforces the importance of a national hydrocarbon law in allowing for the full development of Iraq’s oil industry. Without such legislation there is no clear mechanism for dispute resolution and arbitration between the central and provincial governments on issues related to oil investments.

Additionally, at the nexus of the oil law and the KRG dispute rests the central legal and political issue of Iraq’s political future: the long-running dispute over the administration of the ethnically mixed and oil-rich area around Kirkuk. Iraqi Kurds have repeatedly called for the area’s energy resources to be placed under KRG administration. At a minimum, the Kurds insist that they be included in potential deals on oilfields near Kirkuk, and otherwise have threatened to withhold security for any IOCs working the field. The local Arab population, along with local Turkmen and other ethnic minority groups, are equally insistent that Kirkuk and its oil remain outside the KRG domain. The failure to resolve the issue of the eventual status of Kirkuk and its oil threatens the prospects for permanent political stability in Iraq.

While the Kurds had hoped to use their seats in the new parliament to win concessions on Kirkuk, an unexpected strong showing by the Iraqiyya coalition may have cut their leverage. Whichever coalitions succeed in forming the country’s next government, oil and gas will dominate Iraq’s political landscape for the foreseeable future. IOCs and international investors are all eagerly waiting to see how events unfold. The GoI must adopt a new national hydrocarbon law, reduce tensions among Sunni and Shi‘ite Arabs, as well as Arabs and Kurds, and reach a political consensus on the future of Kirkuk and its oil. None of these tasks is easy. Nor will they be achieved in the near-term. While Iraq has made significant progress during the years since the US-led invasion, this progress has been punctuated by periods of intense political and security crises. There is little doubt that conditions in Iraq will continue to improve, but for now we must expect the same staccato march into the future.