Oil Money and Federalism - Assessing the New Iraqi Oil Deal:

The New York Times has an important article on the new oil revenue deal about to be enacted by the Iraqi parliament. As I have explained in past posts, the distribution of oil revenue is the most vital part of setting up a viable federalism in Iraq, which in turn is the most important part of a stable political solution to the conflict between Iraq's contending ethnic and religious groups (see here, here, and here).

Iraq's population is roughly 60% Shiite Arab, 15% Sunni Arab (the group that dominated under the regime of Saddam Hussein), and 20% Kurdish, with Kurds being in the majority in the north, Sunnis in the center of the country, and Shiites in the south. Decentralized federalism under which each group gets a high degree of autonomy in its own region is the only way to prevent one from dominating the others and perhaps curb the ongoing violence. But at the same time, all three groups need access to Iraq's oil wealth, which accounts for almost all of the nation's income.Because the Sunni center of Iraq has very few oil deposits, the Sunni provinces are dependent on oil revenue from the fields in the north and south and cannot (at least for now) subsist on their own provinces' resources alone. The new oil deal tries to address these problems:

The draft law approved by the cabinet allows the central government to distribute oil revenues to the provinces or regions by population, which could lessen the economic concerns of the rebellious Sunni Arabs, who fear being cut out of Iraq’s vast potential oil wealth by the dominant Shiites and Kurds.

The law also grants regional oil companies the power to sign contracts with foreign companies for exploration and development of fields, opening the door for investment by foreign oil companies in a country whose oil reserves rank among the world’s top three in size......

The draft oil law says that all revenues from current and future oil fields will be collected by the central government and redistributed to regional or provincial governments by population, in theory ensuring an equitable distribution of oil.

Benefits of the New Law.

The draft oil deal has some important advantages, but also some drawbacks. On the plus side is the possibility (noted by the Times) that a guaranteed share of oil revenue might reconcile Sunnis to the new Iraqi government and persuade some of them to lay down their arms. That, in turn, will make it easier for US and Iraqi forces to break the resistance of the remaining bitter-enders.

In addition, there is unnoticed, but important advantage of giving provincial governments a financial incentive to avoid ethnic and religious cleansing. If a Sunni-dominated provincial government expels Shiites or allows private militias to do so, it will lose oil revenue under the proposed law. The same goes for a Shiite-controlled government that expels Sunnis.It may not be noblest motive for clamping down on ethnic cleansing, but the Iraqis should take what they can get in this area.

Third, allowing foreign private investment in Iraq's oil fields will be crucial to increasing the fields' productivity and generating greater prosperity for the country. This is essential for both economic and political reasons.

Drawbacks.

Unfortunately, the draft law also has some important shortcomings. First, all oil revenue will remain under government control, though mostly at the provincial level. This will inhibit the growth of Iraq's private sector, and carry with it all the familiar disadvantages of any large socialist economic enterprise. Moreover, many of Iraq's provincial governments are highly corrupt, and are therefore likely to squander much of the money for that reason alone. Allocating at least some of the revenue to an oil trust plan - which would have given each Iraqi citizen an individual share of oil revenue - would have been a far better choice.

A related problem is the fact that the plan leaves provincial governments with little incentive to adopt policies that promote economic development. A province that gets nearly all of its funding from oil revenue doled out by the central government has little need to grow its own tax base.

Third, the complex arrangement under which provincial governments have the power to sign contracts with foreign oil investors, but the central government will retain the vaguely defined power to "approve" any such agreements might deter investment by rendering contractual rights insecure or uncertain. A key question is whether the right to "approve" includes a power to "disapprove," and if so whether there are any limits on that authority.

Finally, even the best possible oil deal cannot in and of itself solve Iraq's problems. an oil deal is essential to any political solution, but there can be no effective political solution without improvements in the security situation, some of which will have to be brought about through victories on the battlefield. Military success and political success are complements, not substitutes.

Bottom line: the new oil law seems to be an improvement over the status quo, but much remains to be done.

NOTE: The above is based on press accounts of the law's content. I have not as yet seen the draft law itself, and it is possible that the details will change between now and the time when it is enacted.

Zalmay Khalilzad on Federalism and the New Iraqi Oil Law:

Zalmay Khalilzad, the US Ambassador to Iraq, presents an optimistic take on the new Iraqi draft oil law in this Washington Post op ed.

Here is his summary of the law's benefits:

· [The draft law] Reaffirms that oil and gas resources are owned by all the people of Iraq and contains a firm commitment to revenue-sharing among regions and provinces on the basis of population.

· Establishes a predictable framework and processes for federal-regional cooperation that demonstrate the government's commitment to democracy and federalism.

· Creates a principal policymaking body for energy -- the Federal Council on Oil and Gas -- that will have representatives from all of Iraq's regions and oil-producing provinces.

· Ensures that all revenue from oil sales will go into a single national account and that provinces will receive direct shares of revenue, thereby significantly increasing local control of financial resources.

· Establishes international standards for transparency and mandates public disclosure of contracts and associated revenue and payments. This is essential to build confidence in the new political order and to counter corruption.

As I explained in my post on the oil deal, I have several major reservations about it, and am therefore not as optimistic as Khalilzad is. Moreover, Khalilzad's official position probably precludes him from publicly expressing any reservations he might have. Nonetheless, I do agree that the law is an important step forward relative to the status quo.

Kurdish Leader Urges Decentralized, Free Market Policy on Iraqi Oil:

Qubad Talabani - the main Kurdish Regional Government representative in th US and the son of Iraqi President Jalal Talabani - recently called for decentralized control of Iraq's oil resources, and for a more free market policy on oil:

We're trying to modernize Iraq, build a new Iraq, built on new foundations, new policies. The symbol of this new Iraq will be how it manages its oil infrastructure," Talabani said. "And if people want to revert back to Saddam-era policies of a state-controlled oil sector with no accountability, with no accountability to the Parliament or the people of the country, with no oversight except from by one or two, then I'm sorry, that is not the Iraq that the Kurds bought into. That is not the Iraq that the Kurds would want to be part of."

"If a centralized oil regime is imposed on us, we will not participate in the state of Iraq," Talabani said. "And we have to make it absolutely clear to our friends in Washington, to our brothers in Baghdad, this is a make-or-break deal for Iraq."

He said Iraq needs to embrace the free market and break free from the nationalized mindset. Numerous oil and Iraqi experts as well as key Iraq oil union leaders have told UPI that Iraqis see nationalized oil with pride.

Free market reforms of the state run oil industry can help increase production and attract foreign investment. They can also prevent the central government from using its control of oil to dominate the country and stifle political opposition - as has happened in many other oil-rich nations, such as Saudi Arabia and Venezuela. As Talabani explains, it is essential to avoid an oil law under which the central government has complete control over the industry and its revenues:

We want to create an automatic payment mechanism where it doesn't rely on the goodwill of the finance minister or the oil minister for the regions to get their fair share," he said.

"Trust is lacking in Iraq, and unfortunately it's been Iraq's miserable history that has created this system, this society that mistrusts each other, which is why something as critical as oil can be a trust-building measure," Talabani said. "By putting in place mechanisms and institutions that can ensure that I will not get robbed again, that my resources will not be used against me again, will eventually over time build my trust."

Obviously, the new Iraqi oil law will also have to ensure that regions without oil wells of their own get some share of the revenue, particularly the majority-Sunni regions in central Iraq, where most of the insurgency is based. I discuss various ways to achieve this goal in several previous posts on federalism and oil in Iraq. See here, here, here, and here.