It has been a busy two years for the Oil Ministry’s legal department in Baghdad. Two licensing rounds have been concluded successfully, in which 10 oil fields were awarded to international oil companies (IOCs), and an eleventh awaits cabinet approval.

The law is essential to clarify the regulatory regime that will govern the exploitation of Iraq’s oil and gas resources

Baghdad is seeking to increase oil output from the current level of 2 million barrels a day (b/d) to 6 million b/d by 2016. The prize has brought serious international competition, but none of the 11 deals have yet been given parliamentary approval.

Iraqis went to the polls in March to choose a new government. The election was a close-run affair, and neither of the main political parties – lead by Ayad Allawi and current prime minister Nouri al-Maliki – were able to secure a majority. Five months later, the government is still crippled. Approval from the cabinet for the final oil field is unlikely to come quickly.

Iraq’s ambiguous constitution

The country’s oil and gas industry is set on dubious legal and constitutional foundations, says Thomas Donovan, a partner at Iraq Law Alliance, the only US law firm operating in Baghdad. The Iraqi Constitution, written in 2005 following the US-led invasion, contains several provisions that address, often in vague language, the control and distribution of natural resources.

I never thought they would shut her down like this. [Musawi’s] arguments definitely did have legal traction

Baghdad-based legal source

In terms of oil and gas, the ambiguity of the document has raised several points of contention. One is the role of the federal and regional authorities in making strategic decisions on the utilisation and management of the country’s most precious resources.

The constitution leaves the door open for regions to take the lead in developing new oil resources, says Donovan. Article 108 states that “oil and gas are the ownership of all the peoples of Iraq in all the regions and governorates”, while Article 109 tasks the federal government with “the management of oil and gas extracted from current fields”.

This language has led to contention over what constitutes a new or existing resource, a question that has profound ramifications for the ultimate control of future oil revenues.

It has led to deadlock between the federal government in Baghdad and Kurdistan Regional Governorate (KRG). The KRG governs upstream production in the provinces under its control – Dohuk, Erbil and Suleimaniyah – passing its own hydrocarbons law in 2007. It has since signed several production sharing, development and exploration contracts.

Baghdad maintains that the constitution does not allow the KRG to make unilateral decisions over its oilfields. Any contract signed after the draft oil law was agreed in 2007 is therefore viewed as illegal until it is approved by Baghdad.

As sources in Erbil will explain, it is not that simple – the constitution does not explicitly authorise the Oil Ministry to award oil contracts either. Either way, the impasse has been a major setback for the drafting of an oil and gas law that was intended to completely reform Iraq’s hydrocarbons sector.

A potential hydrocarbons law remains in draft form and has not been passed by parliament. This long-awaited package of legislation, comprises four separate laws that would set parameters for negotiating contracts and lay out the responsibility of the Oil Ministry, national oil companies and the role of international oil firms.

A draft was agreed in principle in February 2007, receiving approval from the Council of Ministers – the executive branch of the government – but has stalled in parliament for the past three years. The law is essential to clarify the regulatory regime that will govern the increased exploitation of Iraq’s oil and gas resources. As such, passage of the law will be among the top priorities of the new Iraqi government.

Rumaila oilfield

The gaping hole where a national hydrocarbons law should be became a serious issue in December 2009, when Sheda Musawi, a parliamentarian who did not stand in the March election, filed a lawsuit challenging the legality of the Rumaila oilfield licence. Prime minister Nouri al-Maliki and oil minister Hussain al-Shahristani were named as defendants in the case.

The service contract to develop the 17 billion barrel field was signed by the UK’s BP and its partner China National Petroleum Corporation (CNPC) in November 2009 as part of Baghdad’s first post-war oil licensing round.

The contracts awarded were 20-year technical service contracts (TSCs), based on IOCs accepting a fixed fee per barrel of oil produced instead of an equity stake. Under a TSC, the IOC effectively becomes a contractor to one of Iraq’s regional oil companies for the development of the field.

Musawi claims the contract violates Iraq’s constitution, as it does not have the approval of parliament and the provincial government in Basra was not involved in the contract negotiation process. Her counsel set out a seven-point challenge in Iraq’s Federal Supreme Court.

“In Mosawi’s view, and in a strict and literal reading of Law 97 of 1967, all contracts between Iraq’s Oil Ministry and any third parties must obtain a separate vote of approval from parliament to prove binding, legal and enforceable under Iraqi law,” says Donovan.

After delaying a decision on the case, at the end of April, Musawi was ordered to raise more than $250,000 in fees for a number of international consultants to assess the technical merits of her case. If not, the case was to be dropped. Given only two months to raise the money, the court’s decision effectively brought the controversial case to an end.

“What an odd ending to a very weird case,” one Baghdad-based legal source who followed the case told MEED at the time. “I never thought they would shut her down like this. Her arguments definitely did have legal traction and were sensible for the non-lawyers among us, although not very logically planned out.”

On 16 August, the Iraqi Federal Supreme Court dismissed the challenge. Musawi, who has received numerous death threats for her opposition to the deal, did not attend the final hearing.

Strategy rethink

Despite its ending, the Rumaila case has led to a major rethink in the Oil Ministry. On 21 July, the ministry asked BP and CNPC to convert the $500m signing-on bonus for the field, paid in the form of a soft loan to the government into a $100m unrecoverable payment. According to the Oil Ministry, the loans would require parliamentary approval, which would take considerable time in Iraq’s current political stalemate, with no functioning parliament in place.

The revision of the Rumaila deal will bring it in line with two other fields. US energy firm ExxonMobil was the first to renegotiate its deal for the 8.7 billion barrel West Qurna-1 field, says Donovan.

The ExxonMobil consortium with UK/Dutch Shell Group saw its signature bonus payment slashed to $100m from $400m in April. In the same month, payment for the 4 billion barrel Zubair field, won by Italy’s Eni, the US’ Occidental Petroleum and South Korea’s Kogas, was cut to $100m from $300m. Both were converted from soft loans to irrecoverable payments.

“[The revised signature payment] stems directly from the arguments in the Musawi case and it appears the lawyers involved saw this as a more advantageous way of ensuring these cases do not get wrapped up in an unenforceable and worse, illegal, category,” says Donovan.

One of Musawi’s central arguments was that the $400m signing-on bonus would be a loan to the government, which would circumvent the legal and constitutional safeguards. “This fact, among all others, seemed to resonate with the Oil Ministry and the IOCs involved,” says Donovan.

Nationalistic rhetoric

Beyond these specific legal challenges there are quiet rumblings among Iraq’s political factions about the possibility of reviewing the oil contracts once a new government is formed. Among the most vocal critics of the contracts is the young Shia cleric, Moqtada al-Sadr, who accuses the current government of surrendering the nation’s oil wealth to foreigners.

To what extent these comments are anything other than rhetoric appealing to nationalist tendencies is unclear. The current government has quietly assured IOCs that the legality of the existing contracts will not be challenged, as has Ayad Allawi, the main contender for the prime minister’s office. Their confidence seems to be based on the assumption that with Iraq’s economy crippled no one would jeopardise the development of the oil industry with another round of lengthy renegotiations.

With the US beginning to withdraw its troops, Iraq’s political and internal stability will depend heavily on its ability to increase export revenues to pay for the badly needed economic recovery and rebuilding of its crumbling infrastructure. Stability will also hang on Baghdad’s ability to share oil revenues among the regions.

Kurdish political factions were considered key to building a workable majority in the Iraqi parliament before the March elections. Their power has somewhat diminished since then, and they no longer occupy the role of kingmakers. But Baghdad has little it can use to deter the KRG from pressing ahead with its own oil strategy. Politics will continue to trump law in Iraq.

While Kurds and many Shias favour a highly decentralised structure, Sunnis in particular are excluded from much of the country’s oil revenues, which originate in Shia and Kurd-dominated areas. Almost 80 per cent of Iraq’s oil is produced in the Shia-led Basra province. This has done little to provide work for the unemployed young men in other provinces or quell the Sunni insurgency that still blights much of the country.

Without clearly defined legislation to develop and capitalise on its oil reserves, the political instability in Iraq is likely to continue.