The Iraqi Klondike: Oil and Regional Trade

Raad Alkadiri

(Raad Alkadiri is senior country risk analyst for the Petroleum Finance Company. The views expressed here are his own.)

Talk of a "new Middle East" was very much in vogue in the early 1990s. With a seeming Pax Americana reigning over the region after the Gulf war, and with Israel and its neighbors apparently nearing a comprehensive settlement, it looked as if economic interests, not political rivalries, would underpin ties among the states of the Middle East. Shimon Peres, one vocal proponent of the "new Middle East," envisioned that Israel would sit at the center of an integrated economic zone that would include US allies in the Arab east and the Gulf. Meanwhile, the Clinton administration devised "dual containment" to isolate Washington's foes Iran and Iraq politically and economically from the new integrated region. In Iran, the US hoped that "dual containment" would blunt the force of the Islamic revolution. In Iraq, the goal was even more ambitious: regime change.

Ironically, today it is not Israel but Iraq that is emerging as a regional trade hub, and using economic relations to normalize relations with former enemies. Cleverly taking advantage of opportunities provided by the UN Oil-for-Food program¤while always opposing the system in principle¤Baghdad has contributed to the failure of dual containment, and made itself a factor in the economic decision-making of its neighbors. The Iraqi government will not be able to achieve its ultimate goal¤lifting the eleven-year old US-led sanctions¤purely through fostering trade. But Iraq's deepening economic ties with its neighbors have cooled the Arab states considerably on US efforts to remove Saddam Hussein's regime.

Taking Advantage of Little Things

If the Iraqi government has learned anything over the past decade, it is surely to appreciate the power of economic persuasion. Despite the most onerous international sanctions in modern history, Saddam Hussein's regime has not only survived, it has used the strait-jacket to its own political advantage. Most of its trade is still carefully monitored, and most of its revenues go into a UN-controlled escrow account, but Iraq has made itself financially relevant to a host of countries in the Middle East and further afield. In doing so, Baghdad has given itself a means of influencing policy to its own advantage in nearby capitals, enhancing the prospects that the regime will survive and that, just possibly, sanctions could one day be lifted on something resembling Baghdad's terms.

Iraq's influence was demonstrated quite clearly in the debate over introducing "smart sanctions" through the UN Security Council. A host of strategic calculations were involved in Moscow's threat to veto the US-backed British proposals, many of them not at all related to Iraq. No country will risk its long-term relationship with the US simply on the basis of the promise of contracts that may not see the light of day and debts that will probably never be repaid. Nevertheless, as Russian Foreign Minister Igor Ivanov said openly in a letter to the Bush administration, commercial calculations were involved. (1)

Moscow was not alone in its thinking. In opposing smart sanctions, Jordan, Turkey and Syria all pointed to the damage their economies would suffer if Baghdad lived up to its threat and responded to a new resolution by suspending trade with them. The UN proposals designed to allay these fears¤by compensating the "front-line" states for lost trade¤merely reinforced the impression of Iraq's commercial importance in the region. Baghdad's refusal of the new mechanism was a factor that front-line states needed to consider. The reaction of Jordan, Turkey and Syria to smart sanctions seems to vindicate those officials and technocrats in Baghdad who argued in the mid-1990s that the Iraqi government could gradually breach the embargo and ultimately dismantle it, by accepting the Oil-for-Food deal. This logic was a hard sell: senior decision-makers, not least Saddam Hussein, had previously been adamantly opposed to UN proposals for limited oil sales. The regime did not believe that sanctions were sustainable, and saw no reason to accept the UN offer. In fact, they suspected¤justifiably¤that Oil-for-Food was designed by the US and Britain to blunt progress toward the eventual lifting of sanctions. Only the political backlash that followed Hussein Kamil's defection in August 1995 (which forced Baghdad to reveal the extent of its biological weapons program), combined with the fiscal crisis later that year, convinced the Iraqi regime to accept the UN offer in principle. Even then, it took almost a year of difficult negotiations between Iraq and the UN to work out the details of the new system.

Defenders of sanctions claim that Baghdad deliberately hoards humanitarian relief supplies to heighten the suffering of Iraqi civilians and raise international pressure to end sanctions. Whatever the truth of these allegations, it is dubious at best to conclude¤as the US State Department does¤that the regime is solely responsible for civilian suffering under sanctions. Many UN officials on the ground have said that delays in delivery of goods to Iraq and holds on import contracts contribute significantly to the disruptions in supply.(2) This debate aside, it is true that since finally acquiescing to Oil-for-Food, Baghdad has adroitly exploited the program to promote its political objectives.

Manipulating Oil Exports

The regime's efforts are most evident in its policies toward trade. On the export side, Iraq has from time to time cut or reduced oil supplies in order to influence UN Security Council decision-making. The first major suspension of oil exports came in November-December 1999, when the government tried but failed to block Security Council resolution 1284, which renewed sanctions.(3) Oil sales were stopped again in December 2000 as a result of a dispute with the UN over Iraq's insistence on imposing illicit surcharges on oil companies with contracts to purchase Iraqi crude. Baghdad's most recent use of the "oil weapon" took place in June and early July of this year, when the Iraqis halted supplies in protest over plans to introduce smart sanctions. The regime has also resorted to partial disruptions of oil sales as a policy tool. In early 2000, it reduced exports in protest at the delayed delivery of spare parts for the oil sector, claiming that previous levels of around 2.2 million barrels per day could not be maintained without permanently damaging its fields. The supply of goods was subsequently speeded up through the introduction of a new UN procedure, and Iraqi exports returned to their previous levels.

Whether suspending or reducing supplies, the aim has been the same: to use the threat of higher oil prices or supply uncertainty to influence UN decision-making. As experience has shown, this tactic has not always been successful. For one thing, Iraq cannot always determine the timing of political crises, and consequently has used the "oil weapon" at times when the balance of supply and demand in the market has meant that the impact on prices has not been severe. Further, markets have begun to anticipate the "Iraq risk" in advance, and are aware that Saudi Arabia and other Gulf states are willing to step in to ensure that oil supplies do not drop too far. Both these factors mean that Iraq has often had less impact on prices that it would have liked; indeed, crude prices actually fell in December 2000 despite the loss of Iraqi exports.

In addition to manipulating its exports, Iraq has awarded oil sales contracts with any eye toward politics, giving more and more contracts to companies whose governments pursue policies favorable to Baghdad. Russian, French and Chinese firms have all featured prominently on the list of recognized companies lifting Iraqi crude. Baghdad's recent announcement that Russian companies would get priority in the latest phase of Oil-for-Food comes directly after Moscow played the key role in blocking smart sanctions.(4) By contrast, the Iraqi State Oil Marketing Organization has for some time refused to sell crude directly to all but a small number of Dutch, British and US companies (although around 700,000-800,000 barrels per day of Iraqi crude still wind up on the US market).

Allure of the Iraqi Market

Baghdad has manipulated its import policy much like its oil contracts, but arguably with greater long-term success. By being selective with its official purchases under the Oil-for-Food program and its smuggling efforts, the Iraqi government has reestablished important trade relations that have served it well politically. The UN's Office of the Iraq Program (OIP) recently published revealing figures: the lion's share of import contracts over the past four years have gone to French, Russian and Chinese companies, whose governments have been the most sympathetic among the veto-wielding Security Council members to Baghdad's cause. Collectively, these firms accounted for $5.48 billion of the $18.29 billion of import contracts approved by the UN since 1997.(5)

More interesting still has been Baghdad's recent strategy of using import contracts to cement its relations with regional states. According to the UN figures, trade with four states in particular has increased significantly over the past few years: Turkey, Jordan, the United Arab Emirates (UAE) and Egypt. The value of approved contracts with Egyptian suppliers rose from $105 million in 1997 to almost $1 billion last year. The UAE saw an equally impressive jump, from $24 million in 1997 to over $500 million in 2000.(6) Part of this increase is accounted for by the UN's decision to lift financial limits on Iraqi oil exports in 1999, as well as the gradual expansion of the range of goods the UN has classified as "humanitarian" (two moves that have helped Iraq's trade-driven political strategy). Nevertheless, the trade pattern also reflects a clear Iraqi strategy: last year, companies from these states accounted for almost 30 percent of all approved contracts, compared to just over 20 percent during 1997, the first year of the Oil-for-Food program. Moreover, many of the contracts awarded to these states are on "fast track": they concern humanitarian goods that are approved semi-automatically by the UN Secretariat.

Just how much this trade policy, and Baghdad's clever use of smuggling, has contributed to rising support in Cairo, Abu Dhabi and elsewhere for a lifting of sanctions is open to debate. Clearly, other factors have been important, including Washington's failure to quell escalating Israeli-Palestinian violence and the angry reaction of the Arab "street" to Iraqi civilian suffering under the embargo. Latent fears about Iranian intentions in the Gulf have prompted calls from some Gulf states for renewed ties with Iraq. Nevertheless, the allure of the Iraqi market has undoubtedly helped to focus attention on Baghdad. As the volume of trade with Iraq has grown, states in the region have been ever more anxious to maintain the good will of the Iraqi regime.(7) This in turn has reinforced pressure for a normalization of relations with Saddam Hussein's government.

Limits of Iraqi Persuasion

The Iraqi strategy has not yet succeeded in encouraging any state to disregard completely the international sanctions regime, and resume completely normal relations with Baghdad. Even Iraq's closest trading partners do more than pay lip service to the UN embargo: they may flout certain aspects of the sanctions regime, but none has yet been willing to defy openly and absolutely the Security Council-imposed restrictions. Indeed, much of the unraveling of sanctions that has taken place over the past year, such as the resumption of civilian air flights to Iraq, has been of marginal impact. The restrictions that matter most to Baghdad, and to Washington¤namely UN control over Iraqi export revenues and prohibitions on military and dual-use imports¤remain in place. The Iraqi government is receiving some direct revenue from smuggling crude and oil products to neighboring states, but the volumes of contraband and the amount of money Baghdad receives for it are probably far lower than many commentators have suggested. Exact figures are unknown, but net revenue may total no more than $1.5 billion annually,(8) particularly as Iraq needs to sell the oil at well below market value to get buyers, and is forced to pay surcharges to ensure safe supply.(9) While significant, this revenue is a pittance compared to the Iraqi oil revenue that ends up in the escrow account (roughly $18 billion in 2000). Given the regime's need to maintain loyalty to survive, smuggling revenue probably gets spread among a much wider circle than is often suggested.

The reason that sanctions have survived so long is that, while there is clearly opposition to the embargo in certain countries and an awareness of the commercial gold mine that Iraq represents, no one quite trusts the Iraqi regime. More importantly, Baghdad cannot offer anything worth the cost of openly confronting the US over Iraq. Russia, China, France and even Syria have been willing to take some risks, but these moves are more a signal of overall discontent with US foreign policy than a sign of an imminent shift towards disregarding sanctions altogether. The sanctions-busters, even Russia, have ultimately played it safe. Moscow may have scuppered the first US attempt to introduce smart sanctions, but it has been careful to emphasize that it will not break completely with the international community on Iraq. Nor has Russia guaranteed that it will block a renewed effort to introduce the new system later this year.(10)

Floating on a Sea of Oil

Baghdad is aware of these limits on its trade strategy, and its frustration is palpable. Nowhere has this been clearer than in the oil sector. Since the end of the Gulf war, the Iraqi government has hoped that the offer of access to its vast oil wealth would induce countries to defy sanctions. The international oil industry regards Iraq as one of the ultimate prizes on offer in the world today. Iraq's 112 billion barrels of proven crude reserves are second only to Saudi Arabia's worldwide. Given that no one has done geological surveys in Iraq for decades, the actual figure could be higher¤oil-in-place is estimated to be closer to 250 billion barrels. Much of Iraq's discovered oil remains undeveloped. Of the 70-plus fields that have been discovered, only 15 have been developed to date. The remaining fields include eight with reserves over one billion barrels each. In total, there are almost 5 million barrels per day of estimated production waiting to be developed in discovered fields, most of it "easy oil" close to the surface and cheap to extract. Furthermore, Iraq has large unexplored areas in the Western Desert and the northwest that could be oil-rich. Little wonder that some in the oil industry say Iraq is floating on a sea of oil.

Recognizing how attractive its oil sector is to international oil companies, the Iraqi government shifted policy significantly in mid-1991. Henceforth Iraq would offer foreign firms direct investment and crude production opportunities in its previously closed oil industry. Baghdad thought this offer would undermine sanctions quickly. But while a stream of international oil companies have traipsed to Iraq to discuss what is on offer, wariness of the international embargo has prevented many deals from being signed. A Russian consortium led by Lukoil concluded an agreement for the giant West Qurna field (with estimated reserves of 11 billion barrels) in 1997, and the Chinese National Petroleum Company was awarded a deal for the al-Ahdab field the same year. Other than that, international firms have shied away from concluding formal contracts with Baghdad, including France's TotalFinaElf, which has engaged in long negotiations for the Majnoon and Nahr bin Omar fields (which contain combined estimated reserves of over 18 billion barrels). Iraq's Russian and Chinese partners have refused to begin significant work on their fields while sanctions remain in place, much to the dismay of Iraqi officials, who have repeatedly threatened to withdraw the awards.

Despite their reluctance, and Iraq's subsequent decision to shift its investment offer from production-sharing agreements to less lucrative "buy-back" service contracts, most foreign oil companies maintain tremendous interest in investing in the country once the UN permits it. Even the most demure oil executive is unlikely to shun dealings with the existing Iraqi government if the embargo on oil investments is removed while it remains in power. The Iraqi oil sector stands to be the great "Klondike" of the early twenty-first century.

This black gold rush, when it happens, will only reinforce Iraq's emerging position as a major trade hub in the Middle East. If Saddam Hussein's government is in place, oil development will contribute significantly to its survival¤which is precisely why Washington and London oppose unfettered foreign investment in the Iraqi oil industry at present.(11) Merely the prospect of the opening has bolstered the Iraqi regime, providing it with an important political lifeline to the outside world over the past decade. Many countries are forced to ask themselves whether a change of regime will diminish the economic benefits that dealing with the present government presents, and whether they want to pay these costs. In purely economic terms, further normalizing relations with Baghdad, and cementing bilateral economic relations, is an attractive option.

A Regime Rehabilitated?

Saddam Hussein's regime does not like the Oil-for-Food program, but this has not stopped it from using the deal to its own political advantage, assisted of course by a willing clientele of trading partners. By targeting the award of import and export contracts, the regime has positioned Iraq as an important focus for regional trade and tied its own fortunes to local and international states. This has contributed to the survival of the regime, and ultimately to its gradual rehabilitation.

Indeed, by "hard-wiring" itself to its neighbors via regional trade, the Iraqi government has made it much more difficult for the international community to impose sanctions on the country with impunity. Baghdad's opinion is important to a growing number of states. As the volume of trade has grown, so the costs of upsetting the Iraqi government have risen for these countries. The concern for many states in the Middle East is now not whether to deal with Baghdad, but rather whether Baghdad will deal with them.

The Bush administration insists that smart sanctions are not dead. This autumn will witness another UK-led campaign to get UN Security Council approval for the new system; talks are already underway behind the scenes in New York. However, in the absence of some major long-term financial aid package to countries like Syria, Jordan and Turkey, their support for the sanctions package will remain lukewarm at best, and the likelihood that they will implement the new embargo is low. Washington's other alternative¤regime change¤is even less popular with the frontline states, for reasons of both regional public opinion and trade ties.

In the longer term, unless Baghdad suspends its cooperation fully with the UN Oil-for-Food program, its economic magnetism is only likely to grow. The more the regime can turn Iraq's lucrative commercial and oil-producing potential into active trade relationships, the stronger its position will be. While the promise of the Iraqi Klondike may not lead to a full and formal lifting of sanctions, and may do little to ameliorate the humanitarian crisis in Iraq, it will certainly make efforts to contain the Iraqi regime more difficult.

Endnotes

1 Washington Post, July 26, 2001.

2 See Hans Von Sponeck, "Squeezed to Death," The Guardian, March 4, 2000. This point was stressed in personal communications between the author and numerous officials at UNICEF and the UN's Office of the Iraq Program.

3 The Iraqi pressure was, however, sufficient to ensure that the Security Council mandated a rollover of the Oil-for-Food program separately from 1284. Hence Iraq could resume oil exports without acquiescing formally to the continuation of sanctions.

4 Reuters, July 17, 2001.

5 These figures come from a document listing the full history of Iraq's contract requests that appeared briefly on the OIP website earlier this year. The list, which includes details of which contracts were approved or put on hold, can be found on the Uncoveriraq.com website at: http://home.att.net/~drew.hamre/docUNXLS.htm

6 Ibid.

7 In mid-July, Baghdad announced it would prefer Syrian firms for import contracts under the present phase of the Oil-for-Food program, because Damascus opposed the smart sanctions proposals. The Jordan Times, July 16, 2001.

8 This estimate assumes illicit exports of around 150,000 barrels per day (b/d) via Syria, 70,000-100,000 b/d via Turkey and around 50,000 b/d via Iran and the Gulf, sold at roughly half the market price for Iraqi crude. Exports to Jordan, which total approximately 90,000 b/d of oil and oil products, are part of a deal that has been approved by the UN since 1991, and are not counted here as smuggling.

9 It is not only the Iraqis and the end users that profit from these arrangements. Individuals linked to Masoud Barzani's Kurdish Democratic Party (KDP) allegedly benefit financially from a deal with Baghdad that ensures the secure movement of contraband oil products to Turkey. Companies linked to the KDP are also suspected of receiving legitimate contracts to lift Iraqi oil under the Oil-for-Food program, as a result of the leadership's smuggling relationship with Baghdad. The battle over control of oil smuggling revenue has contributed to periodic internecine fighting between the KDP and its rival Patriotic Union of Kurdistan, which has left the autonomous Kurdish regions of Iraq divided into two cantons. Meanwhile, since September 1999, Turkey has imposed a tax on oil products smuggled across its southern border with Iraq, which earned it a reported $23.5 million in the first four months of operation. Reuters, January 4, 2000.

10 Even the Russian draft proposal put forward in late June during the debate over smart sanctions did not call for an unconditional lifting of sanctions, but rather for a negotiated agreement that would allow UN weapons inspectors to return to Iraq under the formula outlined in UN Security Council resolution 1284. Russia has continued to pursue this approach since smart sanctions were postponed. See the details of a letter from President Vladimir Putin to Saddam Hussein reported by Reuters, July 18, 2001.

11 During the discussions about smart sanctions in June 2001, France proposed a draft resolution that would allow foreign investment in the Iraqi oil industry, as did the aforementioned Russian draft. The Russians proposed that controls over Baghdad's access to its oil revenue be lifted simultaneously, which would be necessary for Iraq to even consider allowing foreign investment while some form of sanctions remain in place.