Iraq's Crude Awakening

By Donald L. Barlett and James B. Steele

Just to look at Iraq today, one would never know that it's an oil giant. It's a country nearly paralyzed by an energy crisis. Everywhere, drivers sit in endless lines of cars, sometimes for days, to buy gasoline. Electricity comes and goes. Homes lack fuel for cooking. Iraq's oil industry, which in its heyday produced 3.5 million bbl. a day, now produces little more than 5% of that. Refineries operate at less than 30% of capacity. But the picture belies a deeper reality: Iraq is potentially the most important new player in the global oil market. Although each day brings fresh accounts of breakdowns in the country's crude-oil machinery--fractured pipe-lines, controls damaged by looters, rusting equipment, 1970s technology in the 21st century--Iraq is the only country capable of flooding the world with cheap oil on the scale of Saudi Arabia. And that poses a major test for Washington.

Defense Secretary Donald Rumsfeld has been firm and consistent on what the war in Iraq is not about. "It has nothing to do with oil, literally nothing to do with oil," he says. If it sounds as though he's protesting too much, it's because the Bush Administration is up against a prevailing world view that the burden of proof is on the U.S. to show that it won't exploit Iraq's underground riches. Hours after the invasion began, U.S. forces had seized two offshore terminals that can transfer 2 million bbl. daily to tankers. They secured the southern Rumaila oil field so swiftly that Saddam Hussein's retreating troops managed to set only nine wells ablaze, compared with 650 Kuwaiti wells during Gulf War I, and U.S. airborne troops took the northern oil fields at Kirkuk largely intact.

Three weeks later, when U.S. forces rolled into downtown Baghdad, they headed straight for the Oil Ministry building and threw up a protective shield around it. While other government buildings, ranging from the Ministry of Religious Affairs to the National Museum of Antiquities, were looted and pillaged, while hospitals were stripped of medicine and basic equipment, Iraq's oil records were safe and secure, guarded by the U.S. military. General Richard Myers, Chairman of the Joint Chiefs of Staff, had an explanation: "I think it's, as much as anything else, a matter of priorities."

Rumsfeld's disclaimer aside, the fact is that oil--who has it, who produces it, who fixes its price--governs everything of significance in the Persian Gulf and affects economies everywhere. While the Bush Administration has repeatedly asserted that Iraq's oil belongs to its citizens--"We'll make sure that Iraq's natural resources are used for the benefit of their owners, the Iraqi people," the President said--the stakes go far beyond Iraq. The amount of oil that Iraq brings to market will not just determine the living standards of Iraqis but affect everything from the Russian economy to the price Americans pay for gasoline, from the stability of Saudi Arabia to Iran's future.

Why is Iraq such a prize? Not only does it have the potential to become the world's largest producer, but no other country can do it as cheaply. That's because, for geological reasons, Iraq boasts the world's most prolific wells. In 1979, the year before Iraq's oil fields were devastated by the first of three wars, its wells produced an average of 13,700 bbl. each per day. By contrast, each Saudi well averaged 10,200 bbl. U.S. wells, which are gradually drying up, averaged just 17 bbl. It would take more than 800 U.S. wells to pump as much oil as a typical Iraqi well. Consequently, production costs in Iraq are much lower. The average cost of bringing a barrel of oil out of the ground in the U.S. is about $10. In Saudi Arabia, it's about $2.50. And in Iraq, it's less than $1, according to Fadhil Chalabi, executive director of the Center for Global Energy Studies in London and former Under Secretary of Oil in Iraq. What's more, most of Iraq's known oil deposits are waiting to be developed. That's why everyone has cast a covetous eye on the country. And why each one of the world's major powers and international groups has an agenda for Iraqi oil. Among them:

THE U.S.

For more than a half-century, American foreign policy involving oil has been cloaked in intrigue and deception, from the overthrow of the Premier of Iran in 1953 to the arming of Afghan rebels through the 1980s, from the permanent establishment of a military presence in the Persian Gulf to the early support of Saddam Hussein in Iraq. If Iraq is now handled openly--meaning the war really was about liberating Iraq from a dictator and the rest of the world from a security threat, as the Bush Administration asserts, and not about gaining control of oil reserves, as much of the rest of the world believes--it will be a historic first. The yardstick to measure U.S. intentions will be 1950s Iran. (See following story.) Before the U.S.-inspired overthrow of the Iranian government, American oil companies had no presence in that country. After the coup, five U.S. oil companies moved in and produced oil for the next 25 years. More dependent on imports than ever before, the U.S. today is seeking to diversify its sources.

RUSSIA

Before the U.S. invasion, so resolutely opposed by President Vladimir Putin, the Russians had signed contracts to develop new fields in Iraq and produce an additional 710,000 bbl. a day. Whether a new U.S.-sanctioned Iraqi government will honor those contracts remains to be seen. But beyond gaining access to Iraq's oil fields, the Russians have little interest in seeing Iraq become a major producer on the scale of Saudi Arabia. That's because Russia is a major exporter itself, earning billions in oil revenue. Though Russia might ultimately open its spigots wider than Saudi Arabia's, which it did as recently as 1991, it cannot produce crude as cheaply as Iraq.

SAUDI ARABIA

One would think that the world's largest oil producer would be financially secure no matter what the competition. But one would be wrong. In 2000, Saudi wells produced 8.1 million bbl. of crude oil a day; the country's high-quality Arabian light sold for an average $26.81 per bbl. That was enough to put the kingdom in the black, a rare achievement. In 16 of the past 17 years, the Saudi government operated at a deficit as its oil revenue failed to keep pace with its spending. As a result, the country that everyone thinks is synonymous with wealth is deep in debt. A few years from now, when Iraq begins to produce serious quantities of oil for export, it may be just enough to send the price down and put the Saudis in even deeper hock. For the royal family, which is walking a tightrope between its corrupt ways and an exploding population of Muslim extremists, that could spell trouble.

CHINA

Like Russia, China signed contracts with Saddam's government to produce oil, in China's case 90,000 bbl. a day. But unlike Russia, China needs all that oil, and much more, for its own growth. For many years, it was believed that China would be self-sufficient in oil. But that doesn't seem likely. China is already importing 2 million bbl. daily and is on its way to becoming the second largest importer after the U.S. China needs a new major producer to emerge.

FRANCE

The most strident critic of the war, France has long enjoyed a close trading relationship with Iraq. French oil companies have operated there for most of the past 75 years. Although no oil contracts were signed, the French and the Hussein government in the early 1990s entered into a memorandum of understanding calling for French companies to develop oil fields and produce 1 million bbl. a day. Like most of Europe, France relies on imported oil and petroleum products to meet its needs, which amount to about 2 million bbl. daily.

Finally, one other body has an interest in Iraqi oil: the United Nations. It would have to lift its economic sanctions for Iraq to begin exporting oil for cash. The Bush Administration last week introduced a resolution in the Security Council to remove the sanctions and give the U.S. and its allies broad control over Iraq's oil industry and government until a permanent government is in place.

For all its long-term prospects, the Iraqi oil industry is at the moment a shambles, unable to produce enough crude oil and refined products to satisfy domestic demand, let alone export to the world. As gas stations in Baghdad run out, a black market has sent prices skyrocketing. When the U.S. trucked in gas from Kuwait last week, prices began dropping. Refineries are limping along, largely because of a lack of electric power. The Basra refinery, Iraq's second largest, is running at less than half of capacity for another reason: lack of chemical additives for the leaded fuel that Iraq's cars still run on.

Besides technical problems, the oil industry has been plagued by looting that has failed to subside. Gary Vogler, a former ExxonMobil Oil executive who has been appointed senior adviser to the Oil Ministry by the Office of Reconstruction and Humanitarian Assistance, told TIME of looting at a compressor station in northern Iraq that disrupted operations there. "They took some motors and severely damaged the station," he said. "If we have many more of these incidents, it could have a major impact on starting up operations again." Vogler says the Oil Ministry is drawing up a list of sites that need to be protected by U.S. troops. "It looks like more damage is being done by the looting than during the war," he said. The key to getting the industry back on its feet is restoring Iraq's nationwide power grid, says Tom Logsdon, a U.S. Army Corps of Engineers official. "If you had that, you would reduce the looting, you'd have better civil control, and a whole lot of things become easier."

Yet the Bush Administration is optimistic about cranking up the flow quickly. Vice President Cheney recently said, "We ought to be able to get their production back up in order of 2.5 [to] 3 million bbl. a day within, hopefully, by the end of the year." For now, at least, U.S. policymakers envision Iraq as a swing producer, one that can provide just enough oil to even out world supply and demand and prop up prices. (If there were a truly free market in oil, crude would sell for $12 a bbl. or less instead of $26, and gasoline would go for less than $1 a gal.) Iraq's importance in filling this role was spelled out two years ago in a little-noted energy study issued by the Council on Foreign Relations and the James A. Baker III Institute for Public Policy of Rice University, named for the Secretary of State under President Bush's father. The report offered this snapshot: "Tight [oil] markets have increased U.S. and global vulnerability to disruption and provided adversaries undue potential influence over the price of oil. Iraq has become a key 'swing' producer, posing a difficult situation for the U.S. government."

Now that the war is over and the U.S. occupies Iraq, the country's role as swing producer presents a different set of problems. If Iraq limits its production to 2.5 million to 3.5 million bbl. a day, it will fail to generate enough revenue to rebuild its infrastructure, pay off at least a portion of the $400 billion it owes in debt and war reparations, modernize existing oil fields, open new ones and raise the living standards of its people. In fact, a State Department--sponsored advisory group of Iraqi exiles has concluded that the country needs to double its output by the end of the decade to "invigorate Iraq's economy and lift the Iraqi people out of a future of impoverishment." If Iraq does so, some experts believe, growing demand for oil around the world would eat up that new supply as quickly as it came to market, thus keeping prices stable. But in another scenario, oil prices could be pushed sharply downward, creating instability elsewhere, especially in Saudi Arabia. Which the U.S. will do almost anything to prevent--maybe.

But would the U.S. actually throttle a country's production to keep the peace? In Iraq, restricted production is an old story. It has often been the victim, ever since oil was discovered near Kirkuk in 1927, within miles of the biblical fiery furnace of Nebuchadnezzar. The Iraq Petroleum Co., jointly owned by U.S., British, French and Dutch oil giants, drilled the first well. It gushed at a rate of 100,000 bbl. a day. That much cheap oil was the last thing the international oil companies wanted. They clamped a lid on the well and sat on the field through the 1930s because the world was awash in oil, and prices were already depressed. Texas crude had fallen from $1.30 per bbl. to 5-c-.

Conditions improved in the 1940s and '50s, but only slightly. An October 1964 State Department memo noted that Iraq Petroleum Co. had long fixed production "in accordance with the overall worldwide interests of the participating companies, and not solely in accordance with the interests of Iraq." Later, production was curbed because of internal political turmoil during the '70s, the Iran-Iraq war in the '80s and U.N. sanctions from 1990 until today.

In short, Iraq has never come close to achieving its potential. Production peaked at 3.5 million bbl. daily in 1979. How much the new Iraq produces will turn on many variables: Whether a new government encourages foreign oil companies with the technical expertise and financial wherewithal to develop fields. Whether Iraq returns to its status as a dutiful member of OPEC and abides by the group's production quotas--or ignores them and produces whatever volume is good for Iraqi citizens. Whether Iraq forms alliances with Russia, France and China, among others, to manage production--and whether American and British companies get a piece of the action. In the years leading up to the war, the U.S. bought about 600,000 bbl. daily under the oil-for-food program, though no American oil companies operated there.

At stake is a big investment and a big potential payoff. Early deals to get the oil fields producing again, and to rebuild the country, might be an indicator that the U.S. is in no rush to bring foreign companies into the mix. Halliburton Co., the Houston oil-field supplier, and Bechtel Corp., the San Francisco engineering and construction firm, have been awarded contracts worth close to $800 million. Halliburton was headed by Dick Cheney before he joined the Administration, though the White House says he played no role in the selection.

Getting Iraq up to its recent production levels might cost only several billion dollars, but to fully exploit its reserves would require an investment of tens of billions. Because of that, Iraqi exiles--and the Bush Administration--want to see the Iraqi oil industry privatized in order to attract foreign investment, a radical notion among the heavily nationalistic oil-producing states. Issam Al-Chalabi, Iraq's Oil Minister from 1987 to '90 and a private energy consultant since in Amman, Jordan, told TIME that for Iraq to get production up to 6 million bbl. daily, "we will be talking [of an investment] in the region of $30 billion to $40 billion." A measure of Iraq's potential: only 17 of 80 discovered oil fields have even been developed. Another former Iraqi oil official estimated Iraq could produce as much as 12 million bbl. daily, easily making it the world's No. 1 producer.

If Iraq goes that route, the political fallout would be widespread. It would mean less money for the Russians, who are just beginning to get their economic house in order, thanks to oil exports. It would mean less money for an unstable Iran, which is suspected of developing nuclear weapons. It would mean less money for Texas oilmen and energy companies everywhere. It would mean less money for other emerging oil producers, which are betting that their more expensive-to-produce oil will be desperately needed. And most significantly, less money for Saudi Arabia.

That's something that the House of Saud cannot afford. The midpoint of the so-called acceptable selling-price range for world oil, $25 per bbl., is pegged to meet the essential demands of the royal family, whose corruption is so pervasive it would make Saddam Hussein envious. As the Saudi ambassador to the U.S. once explained, if $50 billion out of $400 billion goes for corrupt purposes, "So what? We did not invent corruption."

The "family" part of "royal family" is not counted in conventional terms. Unofficial estimates run from 6,000 to 30,000. Thus the need for all the oil money, which is now pouring in at the rate of $50 billion a year. That's about $6,700 for every Saudi of working age. But the income distribution doesn't work out that way. Most of the wealth is concentrated in the royal family. All that money has gone largely for two purposes. The first is to maintain the family's lavish lifestyle. Palaces abound, and when the King travels, his entourage numbers in the thousands, spending upwards of $4 million a day, not counting shopping expeditions. The second, and more important, is to control a fast-growing population of Muslim fundamentalists. Saudi Arabia has one of the world's highest fertility rates, 4.5%. Since 1980, the Saudi population has more than doubled, to 17.3 million, with nearly three-fourths under the age of 30. Despite all the oil billions, pockets of poverty have emerged, and debt has soared out of control. It stands at about $170 billion, matching the country's total annual output of goods and services. Gross national product per capita fell from $15,800 in 1980 to $8,200 in 2001. Unemployment is estimated as high as 30%. Much of the population is poorly educated. Says former CIA Director R. James Woolsey: "Most young Saudis are not equipped when they graduate from school to perform the jobs necessary to operate a modern economy. Instead, many are employed, if that is the right word, as religious police. Young Saudis' anger based on their lack of useful work and their indoctrination is palpable."

Among this growing discontented population, which is thick with disciples of Osama bin Laden and produced 15 of the 19 hijackers on Sept. 11, 2001, is a cadre that's intent on overthrowing the monarchy and severing ties with the U.S. The mission of these extremists would be made easier by any constriction of Saudi Arabia's cash flow, which would make economic conditions even more ripe for revolution, throwing into question the fate of 11% of the world's oil supply.

So what, then, is the U.S. agenda here? That's the test: of competing security interests, economic agendas and even some divisions within the Administration. The State Department would prefer to keep Iraqi production in check so that it can prop up its allies, notably Saudi Arabia and Russia. The Defense Department wants to see stepped-up production to build a strong new ally and move beyond U.S. dependence on Saudi Arabia. This would be good for consumers, good for diversifying U.S. supplies. But for some countries, like Saudi Arabia, it would usher in a new era of uncertainty. --With reporting by Laura Karmatz/New York, Terry McCarthy/Baghdad and Adam Zagorin/Washington, and research by Joan Levinstein

With reporting by Laura Karmatz/New York, Terry McCarthy/Baghdad and Adam Zagorin/Washington, and research by Joan Levinstein