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April 17, 2006

Grand Theft Babylon


by Ann Berg

Beneath the bellows over Iran and the mayhem in Iraq, the real struggle for Mideast dominance quietly unfolds. As petrostates around the globe exert increasing command over their energy assets, Iraq is on the verge of ceding theirs to the control of American and British oil companies. If all goes as planned, the oil giants will have performed the heist of the century.

A little-known analysis by Greg Muttitt in November 2005 for Global Policy Forum reveals the breathtaking earnings to be generated by the "production sharing agreements" [.pdf] ready for signing the day Iraq officially forms its new government. These agreements, which in name imply revenue-sharing and state control over the underground assets, in truth are vehicles so skewed in favor of Anglo-American petroleum companies that they have no counterpart in today's oil world.

According to Muttitt's conservative estimates, Iraq stands to lose between $74-194 billion in these agreements over the life of the contracts, which will most likely be in effect for 40 years. Instead of the average rate of return of 12 percent generated by most oil field development investments today, these arrangements will net between 42 and 162 percent. Not since Standard Oil won a 60-year concession from Saudi Arabia in 1933 for $35,000 has the oil industry been poised to make so much money.

Types of Oil Agreements

As described by Muttitt, the oil industry essentially operates under three models:

The Nationalized Industry Model: The state makes all of the decisions and takes all of the profits. Foreign participation is limited to technical service contracts. This model is used throughout the Gulf region and has been Iraq's model since the early 1970s. A variant of this model is the risk service model, in which the capital provider receives a fixed rate of return in exchange for investment, sometimes in oil or gas paybacks (the system underlying many Iranian arrangements.)

The Concession Model: The state grants a private company a license to extract oil in exchange for royalties and taxes.

The Production Sharing Agreement: The state theoretically controls the oil while a private company extracts it under contract.

According to Muttitt,

"In practice, however, the actions of the state are severely constrained by stipulations in the contract. In a PSA, the private company provides the capital investment, first in exploration, then drilling and the construction of infrastructure. The first proportion of oil extracted is then allocated to the company, which uses oil sales to recoup its costs and capital investment the oil used for this purpose is termed 'cost oil.' There is usually a limit on what proportion of oil production in any year can count as cost oil. Once costs have been recovered, the remaining 'profit oil' is divided between state and company in agreed proportions. The company is usually taxed on its profit oil. There may also be a royalty payable on all oil produced."

Only about 12 percent of the world's oil reserves operate under production sharing agreements (PSAs) according to the International Energy Agency. None of the Mideast countries use PSAs these structures being more suited for exploring marginally profitable oil fields, where cost vs. benefit is a question mark. Since the reserve levels of Iraqi oil and the investment capital needed for field development can be readily estimated by petroleum companies, PSAs are an unnatural choice for the Iraqi nation.

But they are an ideal choice for oil companies. One of the lures of PSAs in Iraq is their ability to immediately "book" new reserves. To see how critical this is one only need go back two years, when the market punished Shell Oil for overstating reserve levels by over 20 percent drubbing its credit rating and stock price. PSAs also guarantee a level of tax and regulatory predictability. Add in super-sized profits, and PSAs become irresistible.

Most interesting is the lack of discourse on the subject. In fact, handpicked Iraqi former prime minister Iyad Allawi stated that these arrangements were not open for discussion, underscoring the enormous importance of being part of the new government and signifying that most of the deals are likely already determined.

And therein lies the rub. Until the new government is truly formed, none of these deals can be signed.

U.S. Frustration

Is it any wonder that the Bush administration has told the Iraqis that it is at the end of its tether and to get on with the task of forming a government? And can we have any doubt that U.S. bases will be a permanent part of this inverted mercantilist enterprise one funded by the average American, who sinks into penury while the most profitable companies on the planet are about to rake in astronomical earnings?

According to Chris Cook, the former International Petroleum Exchange director and founder of the Iranian Oil Bourse, the recent saber-rattling toward Iran has nothing to do with its nuclear ambitions and everything to do with its interference in the formation of an Iraqi government. He believes that by foiling the new Iraqi government, "Iran and its Arab neighbors in the Gulf Cooperation Council might pool some of the proceeds of recent energy sales and use them by investing as 'capital partners' in Iraqi crude-oil production." In other words, Iran could muscle out Anglo-American PSAs an untenable prospect for the Bush administration.

Looking back on Paul Bremer's decision to exclude oil from the Coalition Provisional Authority's privatization scheme and Dick Cheney's aggressive fight to keep secret the deliberations of his energy task force, it is clear that the PSA plan was brewing before the invasion. And when George Bush says he'll accept nothing less than total victory in Iraq, we can now envision him performing the triumphal act bearing the gift of Mammon to the world's richest class while fleecing two nations at once.

 

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Ann Berg has spent a 30-year career in commodities and capital markets as a trader, consultant, and writer. While a commodity futures trader and Director of the Chicago Board of Trade, she advised foreign governments, NGOs (the United Nations, World Bank), think tanks (Catalyst Institute), and multinational and foreign corporations on a variety market-related issues. She was also a frequent conference speaker at international derivatives markets forums. In recent years, she has contributed articles to several commodities/capital markets publications, including Futures Magazine, Traders Source, Financial Exchange, and the Financial Times editorial page. Berg is also an artist. She is currently working on a body of work entitled The Unknown Unknowns – The Things You Don’t Know You Don’t Know, which explores U.S. national security policy.

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