Iraq's return to market could cause shake-up

news.ft.com By Carola Hoyos, Energy Correspondent Published: February 20 2003 20:59 | Last Updated: February 20 2003 20:59

As President George W. Bush presses ahead with his plans to topple Saddam Hussein, the oil world is preparing for what many foresee as the dramatic effects of any return by Iraq to the international market. "The re-emergence of Iraq will be of historic significance, because of the scale of the resources and because of the realignment it may portend among the major oil exporters," says Daniel Yergin, chairman of Cambridge Energy Research Associates (Cera), an industry consulting group.

Fadhil Chalabi, a former Iraqi oil minister and a second cousin of the Iraqi opposition leader Ahmed Chalabi, goes further. He predicts that Iraq could within five years rival the dominant position of Saudi Arabia, which controls 260bn barrels of crude oil reserves, more than 20 per cent of the world's total and the majority of its spare capacity.

Iraqi oil officials suspect the country's 112.5bn barrels of proven crude oil reserves - the world's second largest after Saudi Arabia - would top 300bn barrels once Iraq's entire acreage was mapped.

And unlike the Caspian region - the "great new frontier" of the 1990s - Iraq's crude oil is easier to access and to export. Iraq has the added advantage of having the ability to transport much of its output through the Mediterranean via pipeline to Turkey in case of turmoil in the Gulf - a flexibility many other Middle East producers lack.

The need for more reliable sources of oil has become acutely apparent, to Washington in particular, in the past two months as political turmoil in Venezuela halted 15 per cent of the US's usual import stream.

Neo-conservatives have lobbied for the US to reduce its dependence on Saudi Arabia, since it emerged that 15 of the 19 hijackers involved in the September 11 terrorist attacks in 2001 hailed from the kingdom.

The US relies on the kingdom for one sixth of its oil imports and depends on it as the only producer that, with a usual spare capacity of up to 3m b/d, could boost its exports significantly in the event of a world crude oil shortage.

That dependence could change drastically if Iraq were finally able - after decades of wars and sanctions have left many oilfields undiscovered and much of its infrastructure destroyed - to fulfil its true potential.

"Iraq needs to be seen as a part of the larger emerging contest between Russia and the Caspian on one side and the Middle East on the other side as to who will add more capacity to meet the growing world's demand," says Mr Yergin, author of The Prize: The Epic Quest for Oil, Money and Power.

After the collapse of the Soviet Union, international oil companies flocked to the Caspian region, tempted by possible total reserves of more than 200bn barrels and potential exports of more than 3m b/d by 2010.

Meanwhile, Russia began to resurrect the production it lost throughout the 1980s and 1990s, pushing it to more than 7m b/d within eight years and steadily eating away at Saudi Arabia's share of the world market. More recently, presidents Putin and Bush announced a strategic partnership between the two countries and BP this month signed a $6.8bn (€6.3bn, £4.3bn) deal to create Russia's third-largest energy company.

Nevertheless, bottlenecks from Russia's pipelines to its ports and an inhospitable business environment make the country a long-term bet rather than a short-term possibility in terms of investment and strategic oil supply, in the eyes of many oil executives.

Whether the same must be said for Iraq depends on many "unknowable factors", as one oil company director put it. Would the country's transition be a smooth one, or would Iraq disintegrate into political turmoil? Would Saddam Hussein, who last month appointed Sameer Aziz al-Naji, a ruthless Ba'athist commander, as his new oil minister, destroy Iraq's oilfields as he retreated?

Vera De Ladoucette, of Cera, warns it could take Iraq two to three years to restart production after a damaging war.

But Mr Chalabi takes an optimistic view, dividing Iraq's investment needs into two phases: recovery and development. The first phase, which would probably last one to two years, would see Halliburton, Schlumberger and other service companies helping Iraq restore its production from the current 2.5m b/d average to 3.5m b/d, a volume it last saw in July 1990, just before it invaded Kuwait.

The second, the development phase, would include the world's biggest oil companies, among them BP, Total, ChevronTexaco, Exxon/Mobil, Shell, Lukoil and Eni, vying for lucrative production sharing contracts with the new government.

Mr Chalabi estimates Iraq's production capacity could increase by another 4.5m barrels per day by 2008, eventually reaching 10m bpd and possibly surpassing Saudi Arabia and Russia to 12m. Others are far more pessimistic.

"This isn't going to happen overnight. It can't. We are going to have to be patient," says James Simpson, managing director for the Middle East and North Africa for ChevronTexaco.

Adam Sieminksi, analyst at Deutsche Bank, says a large increase would be theoretically possible, but he believes Iraq, unwilling to risk severely depressing world oil prices, would choose to move much more slowly. In a recent report he concluded: "In theory, new investment could add a mind-bending 4.7m b/d to Iraq's capacity. In reality, this looks more like a 20-year investment trend and extremely unlikely to come on stream over a short period of time."

Still, Iraq's desperate need for money to reconstruct an economy ravaged by sanctions would probably encourage deals, analysts say. Adding to the burden is the country's $140bn debt and the possibility that the US could demand that a new regime help pay for the cost of the war.

What type of oil policy Iraq would then follow is as unclear as who would run the country. Even if Iraq did not maintain a similar policy of voluntarily shutting in some of its production to act as a swing producer, an aggressive production growth policy could have huge ramifications for the future of Opec.

Since 1999 the cartel has managed to maintain high oil prices by reining in production - a delicate balancing act that could be destroyed if the group's members felt their market share was in jeopardy. That would undercut prices and ultimately also reduce Iraq's returns, but it would benefit consumers, as did the discoveries in the North Sea and Alaska that helped bring down prices from the lofty heights they reached after the Iranian revolution in 1979, when Americans queued for gasoline for the first time.

Rilwanu Lukman, who recently stepped down as Opec's president and is Nigeria's presidential energy adviser, says Opec must face the reality of Iraq's return: "Sooner or later they will come back." He adds: "You have to be reasonable. If we allow Iraq in, someone is going to have to give up."

That sacrifice will probably have to be made by Saudi Arabia, which has gained the most in extra market share from Iraq's absence. How much the kingdom will be willing to rein in production will ultimately decide the future of the oil market and perhaps of Opec itself.