No Black-Gold Magic
Iraqi oil is not a panacea.


Jim Lacey

Now that sanctions have been lifted, there are a number of people who believe that all Iraq needs to do is rev up oil production and it’ll have all the cash it needs to rebuild the country, pay its debts, and propel it into the ranks of the world’s wealthiest nations. In fact, however, oil revenues will never pay for more then a fraction of Iraq’s massive needs. Iraq will never pump enough oil to pay for all the things people have already earmarked that money for — let alone to make it a rich country.

Several facts need to be kept in mind here. First of all, oil accounts for only a small proportion of global commerce. Despite their vast oil reserves, the combined GDP of all 22 Arab countries is less than that of Spain’s. In other words, for the equivalent of one-third of the cash traded on the currency markets daily, you could buy everything produced in the entire Arab world in a whole year.

It is true that oil has enriched the people of Kuwait, who have been on an oil dole for over two decades. However, Kuwait only has to split its oil revenue among about 1.5 million citizens. Iraq has close to 25 million citizens and it is growing fast. Assuming Iraq can double prewar levels of oil production — and that the price of oil remains above $25 dollars a barrel — there will still be only enough in profits to amount to about $1,000 per person, per year. And even that amount would only be available if you assume that none of the money is being used for any other purpose, which is highly unlikely.

Another alternative would be some kind of government monopoly under which all of the revenues would be used to rebuild the country. But even in this case, there would still not be enough to go around. Just paying for the upgrades to ramp up oil production would likely use up every cent of Iraq’s profit for the next half-decade or longer. Paying for repairs and improvements to basic non-oil infrastructure would cost another decade’s worth of production — even under the best-case oil-revenue scenarios.

The United States and any new Iraqi government would also have to deal with the political ramifications of any decisions they made regarding oil revenues. If the Iraqi government retains any significant control of the oil industry, every spending decision will be second-guessed and attacked. There is also the unsettling fact that with the exception of Norway, countries blessed with substantial oil reserves are corrupt and undemocratic. If the U.S stays too involved in the decision process for any length of time, we will inevitably fall prey to the charge that the entire war was only about securing the oil for ourselves.

This leaves us with two interrelated problems: how to maximize oil revenue to best help the people of Iraq, and how to keep that oil from corrupting both government and civil society. The second part of this question has a ready answer — privatization of the oil industry. But it’s how Iraq’s oil resources are privatized that will determine whether it produces enough cash to rebuild the country.

A number of privatization schemes have already been floated and some of them, particularly a well-designed voucher program, have a lot to recommend them. However, all suffer from one fatal flaw: They do not produce anywhere near the amount of cash Iraq will require to rebuild, or to create a functioning market economy that is not totally dependent on oil revenues. This last part is the key. Since there will never be enough money coming from oil to raise the bulk of Iraq’s population out of poverty, what revenues are available must be used as a base for further economic development. Oil, while not a panacea, can provide a large enough investment fund to jump-start other economic sectors that will make Iraq a future regional powerhouse.

Iraq can meet all of its immediate — and most of its future — investment needs by selling all of its oil and gas now, and placing the proceeds in an internationally administered interest-bearing trust fund. Iraq’s known and suspected oil reserves could be over 300 billion barrels, and it has another 110 trillion cubic feet of natural gas. According to a study by PricewaterhouseCoopers, oil reserves sold for an average of $5 a barrel throughout the 1990s. Thanks to its low extraction costs, Iraq’s oil would probably fetch a premium on that price. But even at $5 a barrel, Iraq can realize an immediate gain of $1.5 trillion — and that’s before any of the gas reserves are sold off.

Obviously, even a consortium of large oil companies could not scrape up such a massive sum. However, it’s not beyond the finance wizards at JP Morgan and Goldman Sachs to come up with a structure that will allow firms to pay into the fund based on revenues from Iraqi oil, and on a preset schedule. This structure would leave some flexibility for the changing cost of reserves over a prolonged period, allowing Iraq to capture most of the upside, while limiting risk. Oil firms would also be able to cease payments, in the event a future Iraqi government nationalizes the oil again.

This fund would provide instant cash that Iraq could draw down for infrastructure projects, or to help finance new industries and trade. It could also be used as collateral on low-interest loans, in much the same way nations purchase drawing rights from the IMF. However, this debt burden would not fall on Iraq. Rather, it would be assumed by the fund and paid off by the oil firms. This fund would also remove the cost of rebuilding Iraq’s oil infrastructure from the government and put it on the backs of the oil companies.

For the foreseeable future, an international body selected by the United States would administer this fund. On a set schedule, this body could make determinations as to whether Iraq has met certain goals toward achieving democracy and internal stability. When those goals were met, the fund would revert to Iraq’s control. At that point Iraq could use the collected funds as an investment vehicle (similar to what Kuwait does) or it could even distribute rights on the fund’s assets to Iraqi nationals.

Having the funds initially administered by an international body will ensure that they are not misused as Iraq begins the long process of building democratic institutions and the rule of law. It also gives foreign oil companies some recourse in the event that a future Iraqi government does not work with them in good faith. Meanwhile, Iraq gets a fair price for its natural assets, while also ensuring that it has enough cash available over the next few decades to meet its immense needs. And, most importantly, this plan will take oil decisions out of the political arena, where it tends to corrupt officials, or at the very least lead them down unsustainable economic paths.