Local Partners
Desperately short on capital and lacking a credit rating, Iraq has no choice but to seek foreign direct investment to recharge its economy. Under the laws of the Coalition Provisional Authority, the temporary ruling body run by the United States, Iraq allows 100 percent foreign ownership of a business, but the multinational companies that seek to develop the nation’s blighted oil fields, not to mention its midsized manufacturers, will enhance their long-term chances of stability by setting up joint ventures with local partners. There are several dozen local merchant clans who survived the Ba’th regime’s nationalization of private land, and have kept control over their private stretches of paradise along the Tigris and Euphrates rivers. These clans could be essential partners to foreign investors. They are likely to have an important, although indirect, role in the oil industry, establishing companies to provide peripheral services such as construction, trucking and food processing.

Investors also need to understand that one of the greatest threats to stability in postwar Iraq is unemployment. Some believe the unemployment level may currently be as high as 50 percent. Nothing in the law mandates local hiring, but clearly foreign companies will have to consider the payoffs in terms of good will and local support.

Much needs to be done. The economy has been in shambles since well before the April 2003 war and the U.S. occupation. It has to overcome 11 years of tight sanctions, which followed the invasion of Kuwait and Desert Storm. The bloody eight-year war with Iran in the 1980s took a huge toll. Iraq’s planned economy struggled under the pressure of these events, but even if they had not occurred, its flaws—centralized production, nationalized farms and industry—discouraged private enterprise. The Soviet-style factories that made shoes, television sets and all manner of appliances with no appeal outside the domestic market, will now most likely close, adding to the dire unemployment picture.

Black Gold
Despite this hazardous political and economic terrain, foreign companies will find a country with a great deal of economic potential, largely from oil, the only reliable source of wealth and certainly Iraq’s only natural advantage. If it can attract $3 billion to $5 billion in capital, Iraq will be able to increase its oil production from the current output of about 2.3 million barrels a day to its 1980 production level of 3.5 million barrels a day. Only 15 of a total of 73 oilfields in the country are actively exploited, and with an additional $10 billion to $20 billion in capital, Iraq could develop the untapped fields and boost production to 6 million barrels a day. This would allow it to export about 5.5 million barrels a day, making it the world’s second-largest source of oil, after Saudi Arabia.

Desperately short on capital and lacking a credit rating, Iraq has no choice but to seek foreign direct investment to recharge its economy.

Before the occupation, Iraq’s Ministry of Oil had signed memorandums of understanding (MOUs) with a number of foreign companies to develop more of its oil fields. France’s TotalFinaElf had agreed to develop the Majnoon field, one of the largest and most underused in the world. Lukoil of Russia was allocated the West Qurna field, and other smaller deals were signed with Chinese and Malaysian companies. The work never started because of the sanctions by the United Nations.

All these agreements were based on a production sharing arrangement whereby the international oil companies (IOCs) agreed to invest and develop the fields in return for 90 percent of the production for six years. They agreed to transfer ownership back to Iraq in the two or three years that followed. The IOCs also received a guaranteed return on the initial investment, all their expenses paid out of the Iraqi share of production, and favorable terms in business arrangements after the full handover of the production.

With capital needs being what they are, the Ministry of Oil  (run by technocrats from the Hussein regime who have been kept in place because no one else knows how to do their job) will probably reopen the negotiations with the IOCs as soon as the new government is installed. There are unofficial discussions going on already. The Coalition Provisional Authority has a number of so-called advisors in the Ministry, including a former president of Shell Oil. U.S. and U.K. firms are likely to be the main beneficiaries of new production sharing arrangements, and French and Russian companies, in particular, will find their preexisting MOUs worthless.

Cheap feedstock could help Iraq become a major world producer of fertilizer and petrochemicals.

The civil servants at the ministry might prefer to work with national oil companies from Gulf states, such as Saudi Arabia’s Aramco, which has experience in oilfields similar to those of Iraq. But Aramco has never invested in exploration outside of its home country, and the general perception among the Gulf companies is that the United States is going to keep them out.

A Perilous Divide
Investment capital for the oil industry will most likely flow into the Shi’ite dominated south, rather than into the north. The fields of the south have enough production potential to reach 6 million barrels a day within five to six years, so oil producers have no incentive to venture into the perilous north. The export routes from the southern fields to the Persian Gulf are short, and go through territory inhabited by Shi’a Arabs, who, at this time, are less likely than the Sunnis in the north to sabotage oil installations.

The northern fields have a capacity of 1.1 million barrels a day, but actual production has been hampered by sabotage and attacks on the pipeline to Turkey and to the refineries. As a consequence, actual production has been well below 800,000 barrels a day, and much of this is reinjected into the fields, at great expense and danger to the integrity of the fields, for lack of export routes. Kurdish groups are claiming the city of Kirkuk, which sits on the oil fields, as their own. Should they get their way, Turkey, Syria and Iran are likely to refuse any oil exports that could finance a Kurdish independence movement that might spill over their borders. The IOCs have nothing to gain from investing in the northern fields.

Before the war with Iran, Iraq was an important regional manufacturer of petrochemicals and fertilizers, and there is no reason it could not reappear as a major supplier of these and other energy-intensive products, including direct reduction steel and aluminum. Iraq could also use its energy resources to become an important producer of aluminum, emulating Bahrain, which has the largest single aluminum plant in the world, producing 550,000 tons a year. Both plants would be a boon to the south, but once again would leave out the north. Aluminum would require access to cheap ore from Australia; direct reduction steel, of which there is currently some production already in the south, requires proximity to water.

Iraq still has four large fertilizer plants and two petrochemical complexes, but the sanctions most likely left these plants in disrepair. A major redevelopment of the petrochemicals industry will require very substantial investments after oil production is fully reestablished. Once oil products and natural gas are fully available, Iraq will have one of the cheapest costs of raw material feedstock in the world. Cheap feedstock could help Iraq become a major world producer of fertilizer and petrochemicals. Saudi Arabia, which is part owner of one of the Iraqi petrochemical complexes, can be a model and a source of capital. The Saudis have spent more than $30 billion on their own petrochemical infrastructure, which has made Saudi Arabian Basic Industries the 11th largest petrochemical company in the world, producing 42 million tons of products per annum. Western and Japanese companies are likely to invest in plants that take advantage of the cheap Iraqi feedstocks for the manufacture of ethylene, propylene and their by-products. These ventures will all have to be set up in the south simply to be close to the source of cheap energy and the export markets.

One of the lesser-known tragedies of Iraq’s economy is the decline of a viable food processing industry that, before the socialist Ba’th party took over, grew up under the command of local merchant clans with vast agricultural holdings. Although foreign capital is sorely needed for this and other consumer products sectors, neither the south nor the north offers much incentive. Iraq will never be able to catch up with Asia as a globally competitive manufacturing center, so whatever production occurs will be limited mostly to the domestic market and will probably be of little interest to anyone but the merchant clans that are now coming out of hiding.

With the tenuous political balance among Iraq’s factions, the ongoing attacks on U.S. and British forces and the country’s enormous infrastructure investment needs, Iraq may not seem to be “open for business” for some time. When money begins to flow, the north-south divide could further complicate the country’s fragile political structure. With these factors all up in the air, it is difficult to determine who will benefit from Iraq’s economic revival. 

Jean-Francois Seznec teaches Gulf politics and finance at Columbia University and Georgetown University and is a managing director of the Lafayette Group in Annapolis, Md., a privately held investment company.