Decline in Oil Output Dims Iraq's Recovery

http://www.latimes.com/news/nationworld/world/la-fg-oil25jan25,0,7362139.story?track=tottext,0,7428446.story?track=tothtml
From the Los Angeles Times
Decline in Oil Output Dims Iraq's Recovery
As U.S. financial aid winds down, concerns grow, with no quick turnaround in sight.
By Chris Kraul
Times Staff Writer

January 25, 2006

BAGHDAD — Iraqi oil production fell by 8% last year, calling into question the nation's ability to support itself and fund reconstruction efforts as U.S. assistance is scaled back.

A sharp decline near year's end left average daily production at half the 3 million barrels envisaged by U.S. officials at the outset of the war in 2003. Prospects for improvement this year are slim, many experts say.

Reasons for the shortfall include the poor state of the nation's oil fields, a creaky infrastructure, poor management and ongoing insurgent attacks, particularly on pipelines in the north-central region that are meant to export oil through Turkey.

"There is no instant turnaround," said Paul Horsnell, energy analyst with Barclays Capital in London. "It could take five years, six years or seven years."

As of last month, Iraq was pumping a million barrels a day less than in early 2003, shortly before the U.S.-led invasion that toppled Saddam Hussein from power.

In advocating the war, Bush administration officials had predicted that a strong Iraqi oil industry could help pay for the nation's postwar recovery. To prime the effort, Congress approved a three-year, $20.9-billion reconstruction package, of which about $2 billion was dedicated to restoring Iraq's oil production.



Instead of production steadily increasing, average output fell last year to 1.83 million barrels a day, including a sharp decline during the final quarter resulting in a December dip to 1.57 million barrels daily.

The latest production figures from the International Energy Agency compare with the 2.5 million barrels a day Iraq was pumping just before the war, a level it nearly equaled in March and April 2004. Officials said last month's output was affected by bad weather and a scarcity of tugboats at Persian Gulf marine terminals, in addition to the violence and poor facilities and management.

Oil revenue contributes 94% of the fledgling Iraqi government's budget, and a drop in global oil prices from their current high levels could wreak havoc if the nation's output remains depressed.

Financial stress was evident last week when Turkey suspended shipments of gasoline and other fuels to Iraq, saying its refiners were owed $1 billion. Although Iraqi officials said the nonpayment was the result of a short-term budget shortfall, the incident served as an example of how stretched this country's finances are.

The most serious and pressing problem is the lack of adequate security, said Gal Luft, executive director of the Institute for the Analysis of Global Security in Washington.

Insurgent attacks on pipelines — more than 300 since the March 2003 invasion — have not only cost the country billions of dollars in export sales but have diverted U.S. funds and manpower that otherwise would have gone toward oil field recovery and expansion.

Because of the pipeline attacks, exports to the Turkish port of Ceyhan on the Mediterranean Sea via Iraq's northern pipeline averaged only 40,000 barrels a day in 2005, compared with an 800,000-barrel-a-day average reached during some months before the war.

In July, Iraqi officials said attacks had cost the nation $11 billion in revenue. Kidnappings and killings of oil officials — the oil minister barely escaped an assassination attempt in October — and of oil field workers has cooled the pace of repairs. Two German engineers were reported kidnapped Tuesday from the Bayji refining complex 125 miles north of Baghdad.

"We don't see any foreseeable improvement in security this year," said Neil Partrick, senior analyst at Economist Intelligence Unit in London.

At the same time, authorities acknowledge, the security situation has been calm around Iraq's southern oil fields near Basra, which generally accounts for more than two-thirds of the nation's oil output.

"Even though the southern oil fields are benign, the overall security affects the perception of the government and institutions," a U.S. official said. "If the capital is under siege, as this one appears to be, then it's difficult because you have to come here and talk to people to make those investments."

Compounding the problems, experts say, are years of neglect and damage to Iraq's oil infrastructure.

"It's taken a lot longer than we thought [because] the problems were greater than what we thought coming in," the U.S. official said. "I didn't realize the underlying infrastructure was as weak as it is."

The weaknesses include a lack of crude oil storage facilities, many of which were destroyed in the Iran-Iraq war in the 1980s and never rebuilt, and refineries that decayed during a decade-long period of economic sanctions against Iraq. The former problem forces Iraq to pump oil back into the ground when pipelines are blown up or tankers are delayed, damaging the long-term viability of the reservoir. The latter means that the nation must import nearly half its gasoline and kerosene from Turkey, Iran and Kuwait.

Mismanagement of oil fields by Iraqi and U.S. officials since the war began may have made a bad situation worse. To maximize oil revenue, analysts say, U.S. and Iraqi operators "stressed" the reservoirs by continuing poor practices from the Hussein era such as injecting unused crude and refinery wastes back into the fields.

"I don't think the Americans deliberately mismanaged it, but they were in a difficult position of wanting to get the oil economy going after the war, to get all the revenues coming in that they could," said former IEA economist Antoine Halff, now of New York-based Eurasia Group. "So in practice, they continued to operate under conditions not that different than Saddam did under sanctions."

Efforts have lagged to repair the Qarmat Ali water pumping complex, needed to inject water into Iraq's southern fields, after more than $225 million in U.S. funds has been spent. Injecting water into wells to fill the void created by the extraction of gas and oil is crucial to maintaining an oil reservoir's life.

Although the plant near Basra is 75% operational, the pipeline grid that takes water to the wellheads is leaky and unreliable. As a result, some of the nation's largest fields are in the grip of a deteriorating trend that U.S. officials say is probably irreversible in the near term.

"Just about everything that could have gone wrong has," said Jamal Qureshi, an oil analyst with PFC Energy in Washington.

Improvements in performance of Iraq's three major oil refineries have been outstripped by continued attacks on pipelines that feed them, as well as on the pipelines and truck convoys that deliver the refined fuels to the consumer, said a U.S. official who asked not to be identified.

By the end of this year, the United States will have spent $2 billion in its three-year effort to get the Iraqi oil industry back on its feet. Navy Capt. Michael Sherbak, who is attached to the Iraq Project and Contracting Office, the agency leading the oil sector reconstruction effort, said the 3-million-barrel-a-day goal was to leave Iraq at "a self-sustaining level that is adequate to help them invest in equipment and help them make their oil production more efficient."

But reaching that level will require much more money and several more years, experts agree. The World Bank estimated it would take $8 billion in funding, public or private, to restore Iraq to 3 million barrels a day, which it last exceeded in 1979, and as much as $35 billion to reach 5 million barrels of daily output.

Those goals appear out of reach now not just because of security issues but because of an unsettled political and legal landscape that is also worrisome to private investors. Companies are put off by the vague and at times confusing laws governing oil investments emerging from Iraq's new democratic government.

The nation's new constitution, ratified in October, seems to favor provincial governments over the national oil company, giving the governments in largely Kurdish and Shiite Muslim regions more power. That leaves the few companies that are interested in investing in Iraq wondering whether they should deal with the national government or the regional entities, said Michelle Billig, political risk director at PIRA Energy Group in New York.

The Kurdish region's signing of drilling deals with two Turkish and one Norwegian firm last year — without the participation of the central government — added to the confusion.

"Who has the authority to sign a deal? Even if you get the security situation under control and the companies start feeling comfortable, which they don't right now, you have to clarify this legal ambiguity," Billig said.

She said regionalizing jurisdiction over Iraq's oil assets could add "bureaucratic obstacles" to oil development and to ethnic tensions that the emerging government must address if the insurgent violence is to recede. The Shiite and Kurdish factions want regional jurisdiction, because the biggest fields are in areas they dominate, whereas the Sunni Muslim Arabs want more federal authority, Billig noted.

Issam Chalabi, an oil minister under Hussein who is now a consultant in Amman, Jordan, said the constitution must be amended to strengthen the state oil company's hand or the situation will exacerbate divisions between the have and have-not regions.

"Iraqi oil law as it stands is a recipe for national disintegration," Chalabi said.