Petro Showdown

April 2003: Saddam Hussein is on the run, and the sky over Baghdad is choked with black smoke as looters ransack and torch government buildings. But in one district, U.S. Marines stand guard on the steps of a large modern building, their weapons trained on the street and the footbridge outside. It is the Ministry of Oil. Let this treasure chest burn, the thinking goes, and Iraq goes with it.

Through more than four years of catastrophic violence in Baghdad, the building has survived intact. But a far quieter battle now rages inside its walls, one that could ultimately prove as critical to Iraq's future as the war: how to reorganize the country's mammoth oil industry after nearly 25 years of Saddam's dictatorship, international sanctions and bloody conflict. Oil revenues, which are potentially worth $70 billion a year--virtually all of Iraq's export earnings--are desperately needed to rebuild the shattered economy and end its overwhelming dependence on Washington. And oil companies from ExxonMobil to China National Petroleum Corp. are elbowing for position.

With stakes this high, Iraqi politicians have fought bitterly for more than a year over a new "hydrocarbon law," drafted last summer by veterans of Iraq's oil industry. The legislation is up for a vote in parliament when the fractious government resumes work after a bloody summer. Prime Minister Nouri al-Maliki has vowed to pass the law after delaying the vote twice this year; he is under intense pressure from President George W. Bush to produce results, as support for his leadership withers at home and in Washington. The vote is scheduled to take place just as Congress receives a progress report by the U.S. military commander in Iraq, General David Petraeus. If the fractiousness continues, however, well-armed regional powers could assert control over the wealth under their turf, adding economic momentum to a national bust-up.

U.S. officials have frequently cited the oil law as a key marker of progress, essential for building Iraq's future--and so setting a date for U.S. withdrawal. Without it, oil companies are unlikely to plow in the billions of exploration dollars Iraq needs because they will not be certain of the financial terms. "There is an enormous amount of pressure to get this law passed," says Alex Munton, a research analyst for Wood Mackenzie, a global energy consultancy based in Edinburgh. "Big oil companies are looking firstly for legal security before they consider venturing into Iraq--even leaving aside the violence."

Iraqi officials estimate it will cost about $20 billion and take five years to repair and modernize the industry, whose infrastructure had been rotting for decades because of international sanctions and Saddam's mismanagement. Insurgents have been attacking oil pipelines since 2003. A key northern line that leads to the export terminal in Ceyhan, Turkey, has lain idle for months since it was blown up. The industry also faces skills shortages. Years of suicide attacks and kidnappings have drained the country of its oil engineers, who have fled.

Still, Iraq has 115 billion bbl. of proven reserves and produces nearly 2 million bbl. daily, mainly from the Basra area in the south and Kirkuk and Kurdistan in the north. That's a sharp drop from about 2.8 million bbl. a day before the U.S. invasion in 2003 and an even steeper decline from a peak of about 3.7 million bbl. before the 1980 war with Iran. (From 100,000 to 300,000 bbl. a day are lost to smugglers.) The law would allow oil companies to explore hundreds of new oil fields under 10-year agreements and then 20-year production contracts in partnership with the government. Crucially, after paying a 12.5% royalty, foreign companies could export oil they find.

In drafting the law, officials had to tread carefully on explosive ethnic divisions. After decades in which Saddam barred Kurds from drilling in the resource-rich north, Kurdish officials suspected that the Shi'ite-dominated government in Baghdad would try to seize control of their resource. So the new law would let regional governments negotiate directly with foreign firms. Each contract would need approval from a new Baghdad-based Federal Oil and Gas Council, in which each ethnic group will be represented. The council has 60 days to challenge a contract and send its objections to arbitration. A separate revenue-sharing law aims to carve up billions of dollars in profits among each region--in proportion to its population.

By last February, that patchwork of compromises looked strong enough to win in parliament. Iraq's Cabinet approved the draft, and Oil Minister Hussein al-Shahristani promised U.S. officials that the law would be in place by the end of May. But months later, that confidence--and the deadline--has evaporated. Fierce arguments have raged over how much control Baghdad and the Iraq National Oil Co. should have over production. Oil workers' unions argue that the law gives Big Oil huge profits while potentially undercutting the interests of Iraqis. The major union staged a demonstration in July in Basra, calling for the law to be killed. Union leaders will convene a conference in Basra in early September to draft alternatives to privatizing the industry.

Exasperated by the delays, Kurdistan's powerful regional government--which had agreed to the law last February--simply passed its own legislation. It offers model contracts for oil firms, and the regional government's website has details of Kurdistan's oil blocks. Kurdistan has already signed five contracts and begun production.

The Kurds have greatly complicated al-Maliki's ability to pass national legislation and deepened a sense of crisis. "The government's credibility is at its lowest, and that makes things very, very difficult," says Tariq Shafiq, one of the authors of the bill and director of Petrolog & Associates, an oil consultancy in London. He believes the vote should be shelved until the violence subsides and the government is more stable. Many parliamentarians--most of whom spend months of the year outside war-torn Iraq--agree. Says Saleh al-Mutlaq, head of the National Dialogue Front party, which has 11 seats: "Even if it passes, companies will not have a good environment to work in. There will be strikes. There will be violence." His delegates intend to reject the law.