IRAQ: Oil revenues insufficient for reconstruction

Analysis

With US military action against Iraq looking increasingly likely (see UNITED STATES: Bush firm on Iraq, 'centrist' on reform - OADB, January 29, 2003, I. ), US government officials, the UN and various commentators have begun to address the issue of post-war Iraq. However, neither a clear administration policy on the kind of post-Saddam government it is seeking (see UNITED STATES: Bush firm on Iraq, 'centrist' on reform - OADB, September 18, 2002, I. ), nor a clear blueprint for the administration of the country while conditions stabilise (see UNITED STATES: Bush firm on Iraq, 'centrist' on reform - OADB, December 10, 2002, IV. ) has yet emerged.

US costs . At issue are the costs to the United States of both war and whatever US civilian and military presence might be needed in the country thereafter in order to guarantee stability while new political structures are created. Estimates of these costs vary enormously, even where there is a common basis of calculation. Variables include the outcome and therefore length of the war, and the time and effort required to put a devastated country back on its feet politically and economically after 22 years of almost continuous wartime or sanctions.

Bush's former chief economic advisor Lawrence Lindsey and the House Budget Committee both estimated last autumn that the war itself could cost the United States 100-200 billion dollars. However, last month, the director of the Office of Budget and Management, Mitchell Daniels, came up with a figure of 50-60 billion. As to post-war costs, the respected US economist, William Nordhaus, has estimated that occupation of Iraq lasting 5-20 years would cost 75-200 billion dollars and that reconstruction and nation-building would last at least six years and cost anything between 25 and 100 billion dollars, depending on the scale of the project.

Allies reimbursement . While other members of the international community, notably the EU and UN, would no doubt make contributions to nation-building and reconstruction, they are most unlikely to pay any of the costs of war or military occupation. Nor are they likely to pay 'collateral' war costs, including aid to front-line states such as Turkey and Jordan to compensate them for war-related losses and to ensure their military cooperation. Figures for this aid of 4-15 billion dollars (Turkey) and "hundreds of millions of dollars" annually (Jordan) have recently been mentioned. Most of the costs of the 1991 Gulf war were covered by Gulf states (mainly Saudi Arabia and Kuwait). However, they are distinctly unenthusiastic about current US plans for war or regime change.

Oil revenues . In theory, Iraqi oil reserves -- the second largest in the world -- could be used to reimburse US war costs and finance Iraq's post-war reconstruction. However, in practice there are two major obstacles:

1. Output constraints . Iraq's oilfields and export facilities are in poor condition after years of war and sanctions (see Iraq readies oil production for further sanction lift - OADB, October 28, 1999, III. ). Current capacity is 2.8 million barrels per day (mbd) compared to 3.5 mbd before the Gulf war, and is declining at a rate of about 100,000 each year due to inadequate maintenance. A return to this level will require months, and possibly years, of work costing several billion dollars. A respected US thinktank last month came up with a figure of 20 billion dollars to rehabilitate existing wells and a further 10-20 billion to develop new fields. War damage, including torching of oil facilities by Saddam, could increase the costs, while post-war Sunni/Shia/Kurdish tensions could, if post-war politics prove chaotic, lead to major delays in all timetables. It would take years to achieve Iraq's target of 6 mbd. Recent estimates have suggested (perhaps optimistically) that Iraq could add 1-2 mbd in 1-3 years after the end of war, and that achieving 5 mbd would take at least three years. The same thinktank has estimated initial post-war oil revenues at 10-12 billion dollars a year, assuming no war damage.

It may be difficult to secure the required investment from international oil companies (IOCs) to restore and then boost output in immediate post-war conditions, despite the allure of the Iraqi upstream. Iraq's oil industry technocrats are undoubtedly competent and could remain in place after the political appointees to whom they report are removed. However, in order to conclude the long-term agreements necessary to attract the required levels of IOC investment, they will need political masters representing a legitimate government with the confidence and popular mandate to give political authorisation.

If the present regime was replaced by a similar one without outside involvement then attracting such investment might not be problem. However, a US or UN administration would not meet these criteria, while the emergence of a 'legitimate' Iraqi administration could take some time. Arguments over the legality of oil contracts entered into during sanctions, which cover the five largest fields, could also delay progress. The good offices of the UN may be needed in both cases.

Another possible constraint on Iraq's oil revenues arises from the international oil market itself. Either Iraq will once again submit to an OPEC quota -- itself a fraught process due to the competing interests involved -- which will limit output or, as often in the past, it will ignore OPEC quotas and produce as much as it can. In this case, the effect will be to reduce prices, and thus its revenues.

2. Other calls . Whether or not Nordhaus's estimates are accurate, they do capture the scale and cost of nation-building and reconstruction. Following so many years of war and sanctions, Iraq has sunk to the level of a pre-emerging economy with a per capita GDP 15-20% of its 1979 level:

The immediate humanitarian problems created by war involve both refugees fleeing into other countries and internally displaced persons (IDPs). The UN estimates that as many as 7.4 million people in Iraq will require food aid, 2 million of them IDPs. This will presumably last for months.

Restoration of basic infrastructure, already in a desperate state and likely to be further damaged by war, will be the next priority.

Another early call on resources will be the costs of nation-building, in order to secure peace and stability and prevent Iraq from becoming a 'failed state'

Other major calls on oil revenues include outstanding debt and Gulf war compensation claims. Iraq's total foreign debt is estimated at 65-83 billion dollars, with Russia, France and Japan the biggest creditors, and is owed to a mixture of bilateral and commercial lenders. Post-war debt service could absorb 5-12 billion dollars per year depending on repayment schedules. The UN Compensation Commission has so far made compensation awards against Iraq totalling 43.75 billion dollars of which about 16 billion has been paid. Currently, 25% of oil revenues go to meet these claims, implying a post-war outlay of some 3 billon dollars per annum. Aid donors will probably insist on a formal rescheduling before committing funds.

US dilemmas . The Bush administration would also face political problems in seeking reimbursement from oil revenues:

Although in reality the increased availability of Iraqi oil is not in the interests of the US domestic oil lobby (one of the most powerful influences on the administration), Washington would need to tread carefully, in view of the widespread perception -- particularly strongly held in the Middle East -- that its motive for war was to 'control' Iraqi oil.

The freeing-up of oil revenues for development will inevitably involve some element of debt forgiveness. In such a climate, Washington will be under great pressure to waive its own claims.

The new Iraqi government, whatever its composition, is unlikely to be other than highly nationalistic, and will be particularly sensitive to what it might see as US attempts to 'control' Iraqi oil. Any negotiations will be protracted and difficult. Only a well-established and legitimate government would feel confident enough to make concessions. All this makes it unlikely that any compensation would be agreed before Bush seeks re-election in November 2004.