JURIST Columnist Haider Ala Hamoudi of the University of Pittsburgh School of Law says that Iraq must reform portions of its commercial legal structure if it hopes to foster a sustainable oil industry…

Recent events seem to demonstrate that Iraq may well provide a signature lesson on the dangers of acting too aggressively vis-à-vis international oil companies if the ultimate aim is to build a sustainable oil sector. The problem, ultimately, is that successful oil production cannot be achieved without a significant investment in infrastructure and such an investment will cost a great deal of money. Investors, whether oil companies or anyone else, are extremely reluctant to invest such capital unless their returns are either larger, or their risks in operating in a difficult commercial environment such as Iraq are reduced. Neither solution is being contemplated at the moment, leading to significant limitations on the capacity of Iraq to export oil and thereby increase its national revenue.

By way of background, Iraq issued its first round of licenses to exploit oil fields in the post-Saddam era in 2009. The most lucrative of the oil fields, the vast Rumeila field, was awarded to a consortium dominated by British Petroleum (BP) and the China National Petroleum Corporation (CNPC). Not only was the contract price comparatively low, at $2 a barrel, but the award was a less-favorable “technical service contract” which is effectively a flat payment for the service of extracting the oil. This is to be contrasted with the more common “production sharing contract” where the host country and the international oil company share the reserves in the oil field at a given percentage, enabling the oil company to account for a portion of the reserves as present assets.

While the deal was certainly favorable for Iraq, it did not prevent detractors in the Iraqi legislature from castigating it as an agreement wherein Iraq cravenly capitulated to corporate interests, with one legislator going so far as to bring suit against the Iraqi Ministry of Oil for its actions. To add further complication, Iraq is currently operating without an effective petroleum law because of existing divisions within the Iraqi legislature respecting the terms of such a law. As a result, Former Minister of Oil Hossen Shahrastani was forced to claim in connection with controversies surrounding the first round of bidding that his authority to offer Iraqi oil fields for public bidding is based on the historic authority of the Ministry of Oil. The legal foundation of this claim is shaky at best, leading the Ministry perhaps not to pursue any attempt at a more controversial production sharing agreement in the absence of specific legislative authorization. (A separate legal issue exists concerning the authority of the Kurdistan region of Iraq to develop its own oil sector without input from Baghdad, but the Kurdistan Iraq oil sector, and any legal issues associated therewith, are beyond the scope of this article.)

The problem has been that the strict terms demanded by Iraq have resulted in a significant cooling of interest among companies in the development of Iraq’s oil sector. In the most recent, fourth, round of bidding held in June 2012, turnout was disappointing and only three of twelve potential blocks of oil and gas fields were awarded. In addition, there is the problem of Iraq’s dilapidated infrastructure. Iraqi oil facilities and equipment have not been significantly updated since the fall of the Saddam regime. This is due partly to past security difficulties and partly to mismanagement under both American and Iraqi administrations. While Iraq seems eager to undertake massive reconstruction in the area of oil infrastructure at this time, going so far as to commission the international oil companies operating in Iraq to provide a study on ways to improve it, the problem is ultimately one of money. The oil companies themselves regard their profit margins as razor thin and are thus unwilling to invest too heavily in Iraqi infrastructure.

In addition to thin profit margins, there are significant legal obstacles to consider. Iraq does not currently offer sovereign guarantees on its oil contracts. The oil contracts that exist are as between the international oil consortia bidding on them and a state-owned oil company in Iraq. Under Public Companies Act, No. 22 of 1997, Iraq’s state-owned companies, as with state-owned companies nearly everywhere, are clearly deemed entities with separate legal personalities whose debts are not guaranteed by their sovereign owners. Nor does Iraq have any existing relationship with an export credit agency (whether that be the Export-Import Bank of the US, the Japan Bank for International Cooperation or even the Islamic Development Bank) that might help ease the risk of sovereign default — a serious concern given Iraq’s lack of any sort of current credit rating.

A separate legal avenue could be the restructuring of Iraq’s existing commercial legal framework, which is hardly suited to the facilitation of investment of any sort. For example, while Iraq’s oil contracts generally have arbitration provisions, it is not at all clear how Iraq’s judiciary would regard such provisions. The Iraqi Civil Code has a series of provisions respecting arbitration that appear to be directed at domestic disputes and involve levels of judicial supervision unthinkable in international arbitrations. Investment Law No. 13 of 2006, does refer to the possibility of international arbitration, but it is not applicable in the oil sector. More comforting to investors would be the ratification of the New York Convention on the Enforcement of Arbitral Awards, or something like the UNCITRAL Model Law on Arbitration, but neither appear forthcoming.

The result is a rather stymied oil sector, one that brings to Iraq a significant amount of revenue but not one that is likely to enable Iraq to reach its potential, or its projections, in terms of oil production. And for the people of Iraq, that may be yet another misfortune to befall them.

Haider Ala Hamoudi is an Associate Professor of Law at the University of Pittsburgh School of Law. His scholarship focuses on Middle Eastern and Islamic Law, particularly as it pertains to matters of commerce. Hamoudi spent most of 2009 in Baghdad advising the Constitutional Review Committee of the Iraqi Parliament, responsible for developing amendments to the Iraqi Constitution aimed at national reconciliation, on behalf of the US Embassy in Baghdad. He is currently preparing a book on the drafting and subsequent evolution of the Iraqi Constitution to be published with the University of Chicago Press. He maintains a blog on Islamic Law.

Suggested citation: Haider Ala Hamoudi, Iraq’s Oil Sector Misfortunes, JURIST – Forum, Aug. 6, 2012, http://jurist.org/forum/2012/08/haider-hamoudi-iraq-oil.php.