Legal Update on the State of the Iraqi Draft Oil and Gas Law (Revised)

Legal Update on the State of the Iraqi Draft Oil and Gas Law (February 2007 Draft)

B. Salman Banaei[1]

SUMMARY:

The Draft Law recently passed by the Iraqi Council of Ministers provides for a flexible legal structure and expert oversight that promises to stimulate the nation’s oil and gas sector.  Nonetheless, it also presents several problems and ambiguities that reflect the fractured state of the Iraqi political system. 

Introduction[2]

Article 109(2) of the Constitution of Iraq provides that Iraq’s oil and gas policy shall be “developed in a manner that provides the maximum benefit to the Iraqi people” by applying sound principles of economics with an eye towards encouraging foreign investment. The Draft Law constitutes the Iraqi government’s ambitious first effort in this direction. Iraq's Council of Ministers[3] approved it on February 26, 2007. [4] The Council of Representatives[5] is expected to pass it within the next few months. 

I. Overview

This section presents three elements of the Draft Law that collectively provide an overview of the legal regime imposed by the Draft Law. First, the Appendix to the Draft Law divides the nation’s oil and gas blocks into four categories, each with its own legal regime and bidding process. Second,Iraq has created a Federal Oil and Gas Council (FOGC) that plans and implements Iraqi petroleum policy. Finally, the Draft Law provides an outline of the terms of controversial “exploration and production” contracts that, presumably, forms absolute minimum terms the Iraqi government may grant in a contract.   The content of the Appendix is still being negotiated and constitutes the most critical issue remaining before the Draft Law may be passed. 

1. Field Categories

The Iraqi Draft Law divides the nation’s oil blocks into four legal categories. The first and second categories are administered by the re-created Iraqi National Oil Company (INOC). The first category contains “discovered and developed fields controlled by INOC.” The second category contains “discovered but not developed yet fields controlled by INOC” – these are fields located close to fields currently in production and are thus close to distribution networks which are owned by the federal government.[6]

The third and fourth categories are open for competitive bidding. As discussed later in this paper, there is no standard model contract associated with developing these blocks. Thus, these blocks offer the greatest opportunity for the international oil company (IOC). The third category contains “discovered” fields that are “not developed.” These fallow fields will be up for competitive bidding on terms determined by the FOGC. INOC may bid for these contracts with IOCs on a competitive basis. The last category contains “discovery areas.” These are areas of the country where there has not yet been a discovery of an oil or gas field.[7] In the fallow field and prospecting blocks, there is a competitive bidding process. Specific fields within each of the above-mentioned categories and their associated blocks are listed in the appendices to the Draft Law.

2. The Federal Oil and Gas Council

Among the more innovative aspects of the Draft Law is the creation of the FOGC. The FOGC operates outside of the Oil Ministry and determines Iraq’s oil and gas laws and policy. The FOGC is composed of representatives from various federal entities, regional governments, and “experts” in “petroleum, finance, or economics.”[8] The FOGC is given broad petroleum policymaking power. For example, all companies seeking contracts in any part of Iraq must be pre-qualified. The criteria for pre-qualification are determined by the FOGC. Additionally, the FOGC may use a flexible range of contract forms and terms for the optimal development of Iraq’s oil and gas wealth.

Perhaps the most important specific function given to the FOGC involves its authority over what contracts and under what specific terms the nation’s oil and gas resources will be developed. Specifically, the FOGC may utilize the “service contract, exploration risk contract, or exploration and production contract” forms. It is important to stress that this is not an exclusive list. The use of any of these or any model contract forms is based on “the nature of the field or the exploration area or offers.” Moreover, the FOGC has final say over any contract signed in Iraq, even if the signing party to the contract is a regional government.[9] It should also be noted that the Draft Law allows the FOGC to retain outside consultants to assist in formulating policy.  It is unclear to what extent FOGC deliberations and the contents of contracts will be made publicly available. 

3. Exploration and Production Contract Terms

The “exploration and production” model contract form is the only form discussed in any detail in the Draft Law. It is a possible contract form for fallow and prospective blocks.  On one end, one may assume are production share agreements (PSAs) with favorable terms for IOC.  On the opposite end are the “current fields” where INOC is to be the sole operator. One may thus infer that these terms amount to the absolute minimum standard a private company must meet in order to contract and operate in Iraq.

Chapter III of the draft oil and gas law sets limits on the term of the exploration and production periods. The exploration term has a first period with a maximum of four years that may be renewed for two additional periods of two years each. The production term may not exceed 20 years. Additionally, Chapter VII of the draft oil and gas law presents the general fiscal regime governing “exploration and production contracts.” This legal regime imposes royalties, property taxes, municipal and local taxes, as well as income taxes on the IOC. Royalties are to be exacted at 12.5% of gross production measured at the pipeline. IOCs may freely repatriate revenues barring FOGC actions in the future to the contrary.

Despite some media reports, the Draft Law cannot be read as providing for concession or any kind of private ownership of Iraqi oil assets.  Article 111 of the Iraqi constitution provides that oil and gas are the “property of all of the Iraqi people in all of the regions and governates.”  Legal title to Iraqi oil and gas may only be held by the Iraqi people, as principals, or to the Iraqi or regional governments of Iraq, as agents thereof. Concessionary systems are built upon the presumption that extracted oil is property of the concession holding company.  This very concern lead to the creation of the PSA by Indonesia in the 1960s.  Interestingly enough, Iran's constitution has a similar ban (Article 81), albeit more expressly that expressly forbids "concessions" but has been interpreted to extend beyond, to production share-type contracts.  Obviously, this federal government does not interpret its oil and gas ownership clause to include a ban on PSAs.

II. Issues and Ambiguities

1. The Role of Regional Governments

The Kurdistan Regional Government (KRG) has already passed its own Draft Petroleum Act[10]. Most importantly, the KRG asserts control over undiscovered fields in its territory. The KRG argues that this control is based on Articles 109 and 111 of the Constitution of Iraq[11]. Article 109 expressly reserved administration of “current fields” to the federal government and Article 111 provided that if a power were not reserved to the federal government, then that power is to be vested in the regional governments. Thus, the KRG argues, since only administration over “current fields” is expressly reserved to the federal government, other fields are under the exclusive jurisdiction of the regional governments.

Under Article 10(b) of the Draft Law, all exploration and production contracts must receive final approval by the FOGC in order to be legally binding. No distinction is made between regional prospecting area licenses and other contracts. Thus, under the current text of the Draft Law it appears as though the KRG has agreed to allow the FOGC to maintain at least veto power over any contracts it might enter into with IOCs.

2. Benefits

Iraq has the world’s second largest oil reserves, among the lowest lifting costs in the world, and, despite very favorable geological structures, much of it remains unexplored. The potential is obvious. The Draft Law provides for exploration and production contracts wherein IOCs will have actual title over the oil and gas they produce. Nonetheless, the Draft Law does not amount to a wholesale auction of the nation’s oil wealth.

The Draft Law provides for a flexible legal regime under the expert guidance of the FOGC. The oil block division in the Draft Law divides the nation’s oil fields into categories that correspond to the degree of risk and cost involved in bringing these fields on stream. The less cost and risk, the greater the role for the Iraqi National Oil Company (INOC). Conversely, the greater cost and risk involved in bringing production online, the more opportunities for the IOC.

On the one hand, the FOGC may give exclusive authority to INOC in producing from low risk, highly productive oil fields. These fields would provide the Iraqi government with a steady stream of income. Here, private companies can compete for service contracts of the form used extensively elsewhere in the Middle East. On the other hand, high risk, high cost, and lower productivity fields may benefit from less risk averse and more technically capable IOCs.  This flexibility stands in contrast with many of Iraq’s neighbors where exploration and production activities in marginal areas suffer under monolithic legal regimes.

3. Problems

The recent trend toward “resource nationalism” worldwide has again shown that governments will renege on their contractual obligations when it is in their short-term political or economic interest. Thus, the attractive terms of the exploration and production contracts, may prove to be too good to be true. One factor that may limit resource nationalist policy shifts in Iraq is the fact that the Iraqi government is decentralized. It may be difficult for such a complicated decision-making machinery to enter into contracts - just as well, it may be difficult for such a system to reach a consensus on exiting them.  At the same time, overlapping jurisdiction ensures that when a project is implemented, that the national and regional zones of impact are taken into account.

Although the loose federal structure of Iraq and the Draft Law creates potentially beneficial intra-governmental competition.  This competition may lead to more transparency as regional and federal authorities compete for legitimacy in the eyes of the public.  This competition may also lead to problems.  For example, under Article 10(a), the Oil Ministry, INOC, and the regional governments each have the power to sign contracts within the scope of their respective authorities. The cast of public entities with signing authority leads to an easily anticipated scenario wherein IOCs may obtain different terms from different entities negotiating separately, perhaps concurrently with another IOC for the same bloc. Ultimately, the Article 10(b) requirement that all contracts be approved by the FOGC will prevent competing contracts covering the same subject matter, nonetheless for the IOC there may be wasted time and expenditures in selecting the wrong entity with whom to negotiate.  

4. Prospects

The issue that will determine the success of this law will be the extent of federal authority over fields not subject to INOC management.  More specifically, the Draft Law’s passage will depend on reaching a compromise regarding (1) the extent of federal or INOC, on the one hand, and regional government authority, on the other, over the third and fourth field categories, not controlled by INOC as mentioned above, and (2) what fields are to be allocated to each field category. 

Iraq’s public sector is desperately in need of funding sufficient to allow it to provide for its people. The need for an effective oil and gas law is, thus, obvious. Indeed, the very existence of Iraq may depend on the passage of this Draft Law. If the Draft Law were to fail the outcome would be disastrous. The Iraqi government would continue to be dependent on foreign aid, instead of its own revenues, and thus subject to the whims of foreign creditors. The existence of the Iraqi state would also be threatened. The KRG would likely move towards secession absent an agreement on the division of the nation's hydrocarbon resources.  It has, indeed, threatened as much.

---

[1] B. Salman Banaei is a law clerk at Beatty & Wozniak, P.C. and a law and mineral economics student at the University of Denver Sturm College of Law and Colorado School of Mines.

[2] In the interest of conserving space, I have footnoted lightly.

[3] The Council of Ministers and the Prime Minister constitute

Iraq’s executive power. See Dustour al-Iraqi [Constitution of Iraq] 2005, Arts. 63, 73,available at tp://www.iraqigovernment.org/constitution_arabic.htm.  The best English translation of the Constitution (unofficial), in my opinion, is UNESCO’s.  See id, available at   http://portal.unesco.org/ci/en/files/20704/11332732681iraqi_constitution_en.pdf/iraqi_constitution_en.pdf.

[4] See Masodah Qanon al-Naft wa al-Ghaaz [Draft Oil and Gas Law] of 10^thWeek of 2007 (Iraq). In writing this paper, I used both the original Arabic and an impressive English translation by Ra’ed Jarrar.

[5] The Council of Representatives holds

Iraq’s legislative power. See Constitution of Iraq at Art. 46.

[6] See id. at Art. 13.

[7] See discussion infra Part II.1.

[8] See Draft Oil and Gas Law, supra note 4 at Art. 5(e). 

[9] Id. at Art. 10(b).

[10] See Petroleum Act of the Kurdistan Region of Iraq, Oct. 22 2006, available athttp://www.krg.org/pdf/Kurdistan_Act_COM_draft_22_October_2006.pdf.

[11] See Constitution of Iraq, supra note 3 at Arts. 109, 111.

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