i Certain key historical and constitutional matters
Prior to 2003, when the government headed by Saddam Hussein was replaced, Iraq was governed by a socialist-leaning government with a very limited private sector in place. This has continued to be the case since the overthrow of the monarchy in 1958. A series of steps were taken by the various republican governments that nationalised the principal components of the economy, culminating in the 1972 nationalisation of the oil sector. Iraq had therefore become a centralised economy, with various ministries controlling most aspects of the economy.
Between 1980 and 1988, Iraq was involved in a war with the Islamic Republic of Iran, which was followed in 1990 by the invasion of Kuwait and the subsequent Gulf War I. Immediately after Kuwait was invaded, a series of UN Security Council resolutions imposed sanctions on Iraq, which were followed by a series of nationally imposed sanctions. These sanctions were widespread and extended into most imports, including key oil and gas and technological imports.
Following Iraq's expulsion from Kuwait, the sanctions continued (until 2003), but more importantly, the central government lost effective political and security control over a significant portion of Iraq, to be referred to as the Kurdistan Region. In 2004, the Transitional Administrative Law (the Interim Constitution) recognised the boundaries of the Kurdistan Region, with the same boundaries adopted in the Permanent Constitution of 2005 (the Constitution). The Constitution was structured in a way that provided limited powers to the central government and shared certain powers between the central government and regional governments (the Constitution provides that other regions could be formed). All remaining powers are to be vested in the regional governments.
The matter of oil was hotly debated in the constitutional process, with a compromise reached that provided that the existing fields continue to be managed by the central government, and new fields are jointly managed with the revenues going to the central government. However, in the event of a dispute between the central government and the regional government over the development of new fields, the decision of the regional government would prevail. Issues relating to gas are treated in the same way. The Constitution further provided that Iraqi oil and gas is owned by the Iraqi people, and that the management of the oil fields is to be based on a federal oil and gas law that, to date (nine years after the Constitution was approved), has not been passed.
There have been disputes between the Kurdistan Regional Government (KRG) and the central government on a number of oil and gas issues, in particular those relating to the development of new oil fields. The KRG has entered into production-sharing agreements with a substantial number of oil companies, agreements that the Iraqi Ministry of Oil (MOO) has been critical of. As a result of these disputes, the MOO has claimed on a number of occasions that the KRG has been selling its oil directly in the oil markets (through Turkey) and keeping the income from such oil sales. In response, the KRG has claimed that the central government has withheld amounts owing to it in the budget. Despite certain interim deals, the disagreements between the central government and the KRG continue at the time of writing. These continuing disagreements have led to various court and arbitration claims in various jurisdictions. These disputes have also involved the Republic of Turkey in connection with disputes relating to the Iraq-Turkey export pipeline, from which both Iraqi and Kurdish crude is exported to Ceyhan, Turkey.
In light of the constitutional separation of powers between the central government and the KRG, the electricity sector is effectively two separate sectors: one for the areas governed by the central government, and the other governed by the KRG. Each has developed in a different manner over the past few years.
ii Developments in 2014
The year 2014 saw two key developments: the takeover of certain parts of Iraq by the Islamic State and the drop in the price of oil.
In June 2014, the Islamic State took over significant areas in Western and Northern Iraq, such as the cities of Mosul, Tikrit and parts of the governorate of Tikrit. These areas were mainly governed by the central government, and therefore the central government was unable to continue providing electricity services to those areas that fell to the Islamic State. Simultaneously, in the governorate of Kirkuk, the Islamic State took over certain oil fields and was able to sell crude oil directly. Ultimately, troops belonging to the KRG were able to take back some of these fields, which are now under their control. Constitutionally, these fields are to be managed by the MOO (through North Oil Company) but, following certain negotiations, the KRG was unwilling to hand these back to the MOO, and is now operating the fields itself. This has increased tensions between the central government and the KRG.
As for the drop in oil prices, the impact has affected the Iraqi budget significantly, and therefore the MOO is considering amending the terms of its existing service contracts with the existing international oil companies. To that effect, it is looking at different alternatives to propose to the international oil companies. Moreover, parliament has asked the MOO to address the amendments of the technical services contracts.
iii Developments in 2015
The year 2015 saw several developments that affected the energy sector, in particular the continued drop in oil prices, which affected the Iraqi economy significantly. On the positive side, there were various offensives against the Islamic State that ended up with the recovery of certain towns and cities that had fallen to the Islamic State, including Tikrit and Al-Ramadi. These victories were coupled with an almost total destruction of the capacity of the Islamic State to produce oil from fields under its control.
In order to address significantly reduced oil revenues, the Iraqi government significantly reduced its expenditures, in particular its capital expenditure on infrastructure projects. The impact of such reduced infrastructure expenditures on the growth of the Iraqi economy has not been positive as projects stalled, causing significant arrears to Iraqi companies and, more importantly, to international oil companies. The latter, accordingly, began to reduce their expenditures in the oil fields under the technical services agreement.
iv Developments in 2016
The year 2016 was a year in which the fiscal consolidation that commenced in 2015 became more entrenched, but was also a year in which Iraq engaged with the International Monetary Fund in a Stand-By Arrangement (SBA).
As oil prices dropped further in early 2016, the government decided to commence negotiations with the International Monetary Fund (IMF) for an SBA programme that would not only lead to loans from the IMF of US$5.4 billion over a three-year period, but also would unleash facilities from the international community for a total of approximately US$18.6 billion over a three-year period. The IMF programme is premised on three pillars:
- the maintenance of sustainable debt over the next five years;
- the repayment of arrears as well as the non-incursion of new arrears; and
- the maintenance of decent levels of central bank reserves.
In order to achieve these goals, a principal condition precedent was that the MOO was required to become current on its arrears to the international oil companies by the end of 2016 (which it did). The IMF programme also required a restructuring of the Iraqi economy away from a state-controlled economy and also towards increasing non-oil revenues.
Throughout 2016, the government was able to stabilise its expenditures. However, it was also required to carry out an audit of all of its arrears, which it was able to do. These proved to be larger than expected and therefore Iraq's investment expenditures, including those in the oil and electricity sectors, were required to be reduced.
At the same time, the MOO began to consider some new large-scale investment projects, including the Basra-to-Aqaba pipeline. Moreover, there have been proposals relating to the refinancing of some large infrastructure projects, in particular, the Karbala refinery.
v Developments in 2017
The year 2017 saw a number of major developments in Iraq on a number of fronts. First, the government was able to recapture all of the territory that had been held by the Islamic State in previous years, including the city of Mosul. This allowed for large-scale returns of refugees to their homes. However, it also clarified the enormous requirements in order for Iraq to rebuild its destroyed infrastructure (with the estimated needs being US$50–90 billion). Second, and more closely linked to the energy sector, following a referendum in the Kurdistan region and disputed areas in September 2017 that was opposed by the central government, the central government recaptured the city of Kirkuk and adjoining oil fields (which had been under the control of the Kurdistan regional government from late 2014). The effect of this was twofold. First, the exports of oil from the Kirkuk fields (approximately 300,000 barrels per day) effectively stopped. Second, as a result of such stoppages, the revenues of the Kurdistan regional government from oil exports declined dramatically and the Kurdistan regional government began to face a very difficult financial situation. Since the budget deal between the central government and the Kurdistan regional government had not been implemented since 2015, the halt in oil revenues from the sale of Kirkuk oil has reduced the revenues of the Kurdistan regional government by over 60 per cent. Discussions between the two parties commenced but, by the end of 2017, no new deal had been reached.
In 2017, Iraq also completed its first real entry into the international financial markets. In January, it sold US$1 billion in bonds guaranteed by the United States Agency for International Development. This was followed in August by an offering of US$1 billion in unguaranteed bonds. The average interest rate was approximately 4.5 per cent. The banks who arranged the offerings for the Republic of Iraq were Citibank, Deutsche Bank and JP Morgan. Iraq also commenced a series of transactions with export credit agencies to complete various projects in the electricity sector, with support coming from UKEF, SACE, Euler Hermes, SERV and EKN. This is being followed by other financings for other sectors.
Ii THE IRAQI ELECTRICITY SECTOR
i The Ministry of Electricity – Baghdad
The Iraqi Ministry of Electricity's (MOE's) role in the electricity sector is, to say the least, all encompassing, with it being the principal policy maker, power producer, service provider, regulator and operator. As with most other ministries in Iraq, the MOE is beset with bureaucracy and corruption, and therefore is not conducive towards structural innovation and reform. The senior staff of the MOE are, by contrast, technically trained to a good standard and have significant knowledge of technical developments in the electricity sector.
The legislative basis for the MOE is currently vague, which has made it difficult to clarify its powers.2 Accordingly, the MOE's powers are somewhat broad in the power sector. In recent years, however, it (together with the various arms of the executive branch) has prepared two drafts of an MOE law. In late 2016, the draft law was passed. The following is a brief summary:
- The MOE is designed to organise the electricity sector in Iraq, including the introduction of the private sector into the generation and distribution sectors. In connection therewith, one of the goals of the law is to transfer the electricity sector from a purely public enterprise to a mixed or private sector enterprise.
- It is also designed to make the electricity sector less centralised (with everything controlled by the office of the Minister of Electricity), by among other things encouraging the role of the provincial governments.
- It is designed to encourage renewable energy.
Administratively, the MOE is currently divided into various central departments (generation, transmission, distribution, etc.) and various regional departments (e.g., south generation). The passing of the law, which has not yet been implemented, has at the time of writing not amended too much administratively within the MOE. In an effort to carry out the above, the electricity law keeps more or less the same central departments within the ministry (generation, transmission, distribution, etc.) but then plans to convert the regional departments into public companies. In total, there will be 10 such separate public companies (mirroring the existing departments now). The idea is that assets of each of the departments would be transferred to the relevant public company. Ultimately, the law proposes that these companies would be converted into publicly owned companies (listed on the Iraq Stock Exchange).
The law also contemplates opening private investment opportunities in the electricity sector. These include the introduction of private companies in the electricity distribution sector, which will charge tariffs. This could be a problem for such companies and for the MOE. In early 2015, the MOE announced the introduction of higher tariffs to be paid by the consumers. (Currently, only a small percentage of consumers pay what they actually consume in electricity, principally because of meters that are old and have been tampered with, corruption in the collection of electricity bills (which are manually collected) and rewiring of home electricity lines.) The introduction of higher tariffs caused public uproar as the public at large felt that the new tariffs would be unduly burdensome at a time of economic hardship, an uproar that was picked up on by powerful political actors who ended up opposing the new tariff. The MOE was therefore forced to withdraw this proposal. Later in the year, as part of Iraq's entry into the IMF SBA, the Iraqi cabinet voted on a resolution that reintroduced higher tariffs. These new higher tariffs were structured to be less strenuous on the poorer elements in Iraqi society. Transferring this task to the private sector may work better, as the private sector may prove less responsive to political pressures; but at a time in which electricity shortages and cuts are the norm, the public at large may not favour such a move. In 2016, the MOE embarked on a pilot programme in a neighbourhood in Baghdad to privatise distribution and collection of electricity tariffs. This programme was followed by a wider plan, announced in the form of a 'request for information', for privatising the collection of electricity tariffs throughout the country. By early 2017, the tariff collection programme was introduced into several areas, although there have been demonstrations against the introduction of the programme in cities such as Basra.
The law has the right intentions, but it suffers from some of the same legislative basis that makes it difficult for the private sector to flourish in Iraq. Or rather, although the draft law itself may have the right incentives, there are a large number of legal and regulatory hindrances that make it difficult for the private sector to carry out business in Iraq. For example, there is a law in Iraq (Law No. 56 of 1977) that provides that the government or any governmental entity need not obtain judicial decisions prior to attaching private assets if they are seeking to recover their debts. Coupled with the fact that Iraq is not party to the New York Convention on the Recognition and Enforcement of Foreign Arbitral Awards, such laws make it very hard for international financial institutions and investors to feel comfortable doing business in Iraq generally.3
ii The private sector in the Iraqi electricity sector
There were significant developments in the private sector entering the electricity business in 2014. First, however, by way of background, there are a few matters to keep in mind:
- The Iraqi transmission and distribution network is owned completely at this stage by the MOE. There is no direct private ownership interest in the transmission and distribution sector. The MOE, in conjunction with the World Bank, has indicated that it intends to privatise these two sectors, although no concrete steps have been taken in connection with it. Accordingly, other than as mentioned above with respect to the attempted privatisation of the collection of electricity tariffs, the only private sector involvement in transmission and distribution has been in the fulfilment, construction and implementation of MOE procurements orders.
- In 2010–2011, the MOE conducted a tender for four independent power producer (IPP) projects in the generation sector, using GE Frame 9E turbines that had been recently acquired by the MOE (and which it was to sell to the winning bidders). The total of these projects combined was 2,750MW. However, owing to certain structural difficulties, in particular to do with the supply of fuels (the MOE did not want to assume the risks of supply and requested that the developers enter into separate supply agreements with the MOO), there was little or no international interest in these tenders. Accordingly, only local companies bid (with some international participation in the consortiums) and, with one exception, these bidders had no experience of the IPP sector. Shortly after the bids were analysed by the MOE's IPP team, a new minister was appointed who was not in favour of these projects. He therefore cancelled the tendering process, and ran tenders to award these as engineering, procurement and construction contracts.
In late 2013, the Iraqi cabinet instructed the MOE to commence negotiations with three independent Iraqi companies to develop independent power plants in Iraq. In February 2014, the Iraqi cabinet passed resolution 90 of 2014, authorising the MOE to enter into power purchase agreements with these three companies, pursuant to which these companies were to develop up to 9,000MW. Some of the locations were allocated in the cabinet resolution. In particular, one of the developers was to develop a 3,000MW power plant in the Al-Rumailah area of the Basra Governorate, while another developer was to develop a 1,500MW power plant in the Besmaya area south of Baghdad (adjacent to a new real estate development project), subsequently extended to 3,000MW. In April 2014, two of the developers entered into heads of terms with the MOE and the National Investment Commission to develop combined cycle plants, which were followed in June 2014 with the execution by the MOE of power purchase contracts with these two developers.
In late 2015, two further projects were entered into with one developer. These projects, one of which is in Al-Rumailah and the other in Shatt Al-Basra, are somewhat uniquely structured. They involve the expansion of open cycle power plants to combined cycle power plants, with ownership of the open cycle power plants remaining in the hands of the MOE and ownership of the steam turbine portion of the plant remaining in the hands of the developer, with the developer operating the whole plant. This structure has many of the characteristics of a build-operate-transfer structure. Although negotiations have been completed with respect to these two projects, at the time of writing, there are various practical and technical matters that are still being discussed.
In late 2016, a fourth developer, Raban Al-Safina, entered into a power purchase contract to develop a 750MW combined cycle plant in the Maysan Governorate in Southern Iraq. At the time of writing, the developer has not yet identified the equipment to be used in this plant or the principal construction contractor.
From a regulatory perspective, key issues facing these projects include the following:
- There have been difficulties in transferring the land to the projects. Again, by way of background, the vast majority of land in Iraq is owned by the Iraqi Ministry of Finance (MOF), which has been somewhat reluctant to transfer land (even by way of lease) to developers of various projects, including electricity projects. Other government entities have followed the lead of the MOF. This matter has proved to be a hindrance to private investment in Iraq in general.
- Although a grid code has been developed by the MOE, which the companies have been willing to comply with, in practice this has not been tested by the private sector and it seems certain integrating difficulties are being experienced at the early stages of these projects.
- The companies have covenanted to comply with the environmental laws and regulations in Iraq, which have generally been developed by the Ministry of the Environment. The process will entail the projects having to obtain environmental licences from the Ministry of the Environment, which grants these after conducting an examination similar to a Phase I environmental impact study. However, the Ministry of Environment is not very experienced in the electricity sector and has not developed specific regulations for this sector. In practice, therefore, at this stage, environmental compliance is still untested and, since the financing of these projects are not contingent on international project finance, one is not sure whether these projects would comply with the World Bank Group Environmental, Health and Safety Guidelines.
- Learning from the experience of 2011, the MOE has assumed the obligation of providing fuels to these companies. The MOE is looking at ways of securing these fuels, including the natural gas that Iraq lacks. Although both the MOO and the MOE are experienced with respect to the laying out of pipelines (and have processes for usage of the land on which the pipelines may be located), difficulties could arise in particular due to the security situation in certain parts of Iraq. Certain difficulties have also arisen with respect to the supply of water, in particular with respect to the needs of steam turbines (in the combined cycle power plants).
- The cabinet further approved the issuance by the Ministry of Finance of payment guarantees to the developers, which are the international norms for such power purchase contracts. These payment guarantees have been issued and, to date, they have been accepted by the lenders to these projects.
- The tariffs were agreed between the cabinet and the developers, and therefore were not left for market forces. These tariffs were not divided into capacity charges and output related charges, but one tariff was agreed for the production of each of the simple cycle and the steam turbines productions. These tariffs have since become the benchmark, although there are new tenders in various stages of development that could impact these benchmarks.
- As the first two projects are groundbreaking projects, the licensing processes have not been tested out and are not fully clear. The National Investment Commission established a one-stop shop mechanism to assist in moving matters forward, but this has not been successful. As a result, there have been substantial delays in every single step. Indeed, Iraqi bureaucracy is stultifying. For example, in discussing with international oil companies the difficulties that they face, near the top of the list is always the matter of obtaining visas. Whereas in most developed countries, the process for obtaining visas is a relatively simple process, the Iraqi Ministry of Interior intentionally makes things difficult, ostensibly for security reasons.
The first IPP in the electricity sector, in the town of Besmaya, near Baghdad, commenced production in the second quarter of 2017, and by the end of the year it was producing approximately 1,500MW. The plant will produce another 1,000MW by mid-2018. Another power plant, in Al-Rumaila, Basra Governorate, will be producing another 1,000MW by the end of 2018.
As these new projects move forward and get implemented, Iraq would be faced with a significant portion of its power generation sector in private hands, and with the MOE paying significant sums for electricity under the various power purchase contracts. However, the transmission and distribution side of the grid requires significant upgrade to be able to receive the additional generated power. Accordingly, at this stage, the focus is on moving forward with the transmission and distribution side of the electricity sector.
There is significant potential for investment in the transmission and distribution side of the electricity sector; yet, at this stage, there is no regulatory framework for this. Accordingly, the MOE continues taking steps to improve its transmission grid, which it owns. The plans to privatise this sector have not been adopted, despite proposals introduced by international experts. As for the distribution sector, Iraq is still reliant on old technology, with little introduction of more modern technologies such as smart meters. Having stated this, in 2013, the MOE launched a pilot project for smart meters; but this was a pilot project that was not very clearly part of a structured plan.
At a time when Iraq is facing serious budgetary difficulties, the MOE tried unsuccessfully to launch tariff increases but had to withdraw them in some areas owing to political pressures. This leaves Iraq collecting very low levels of income from its electricity generation (with significant subsidies going to loss-making state-owned enterprises belonging to the Ministry of Industry and Minerals). In connection with the stand-by arrangements with the IMF, the issue of electricity tariffs and their collection is being addressed, as non-oil revenue is required to increase.
Coupled with this, the lack of natural gas and, due to the mature state of the refineries, limited availability of refined products, Iraq imports refined products and increasingly uses other less efficient products (such as heavy fuel oil) to fuel its generators. The imports of products such as diesel (which fuels a large number of small production generators) ends up exacting even more pressure on the state budget. Electricity, therefore, continues to be a major drain on the state budget.
iii The Ministry of Electricity – Kurdistan
The evolution of the electricity sector in the Kurdistan Region has been somewhat different. As it became apparent that the central government's generation capacity was not going to meet sufficient demand in the areas under central government control, the KRG decided to develop its own generating capacity and, realising it had limited funding to do so, requested that the private sector do so. In addition, the KRG took over the existing grid and began to develop it. In doing so, it relied on the existing central government grid code and practices.
In 2007, the KRG entered into its first power purchase agreement with Mass Global, a private sector company owned by a reputable Kurdish businessman for the development of a 500MW plant in Erbil, which is the capital of the Kurdistan Region. Although this power purchase agreement was designed on a similar basis to international standards, its terms were more favourable to the developer. As the power plant was implemented quickly, the KRG entered into two other power purchase agreements, each for 500MW, with the same company to develop generation plants in the other two major Kurdish cities – Suleymaniyah and Dohuk. As these plants were also set up quickly, it became apparent that demand had increased and therefore the capacities of each of these plants was significantly increased. At the time of writing, the International Finance Corporation acquired from Mass Global a portion of the project company operating the Suleymaniyah power plant. In addition, the KRG entered into power purchase contracts with other developers more recently.
The critical issue for the development of these plants was that the KRG assumed responsibility for bringing natural gas to these plants, and it did so from one of the undeveloped natural gas fields in the Kurdistan Region, the Khor Mor field. Lacking money, it entered into development arrangements with a Sharjah-based company, Dana Gas, in order to develop the fields. Dana Gas carried out the development and was able to supply, through self-funded pipelines, the natural gas to the various power plants. This was one of the success stories of the KRG, in that not only were untapped gas deposits utilised but they were done so to bring power to the Kurdistan Region, which currently has 24 hours of electricity a day. However, a dispute arose between Dana Gas and the KRG, which went to arbitration, and in November 2015, Dana Gas was victorious in the arbitration and was awarded approximately US$2 billion in damages. In addition, due to the budgetary difficulties faced by the KRG, owing to its dispute with the central government (over the division of oil revenues) and lower oil revenues in general, the KRG has begun to default on certain financial obligations. It is unclear how that will impact on its obligations under the power purchase contracts, as well as its ongoing relationship with the gas suppliers.
iii The Iraqi oil sector
i The Ministry of Oil
In federal Iraq, Iraq's Ministry of Oil administers the oil sector. Under the Constitution, Iraq's oil belongs to the people of Iraq. With respect to the upstream sector. the constitution provides that existing fields will be managed by the federal government, whereas new fields will be jointly operated by the federal government and the regional governments – and in the event of dispute, it is the regional government that has the decision-making powers. Accordingly, with respect to new fields in the Kurdistan region, the KRG's interpretation is that it has the power to manage fields. The constitution goes further and provides that exports are to be coordinated by the central government's apparatus (i.e., the State Organisation for Marketing Oil (SOMO)). Relying on this interpretation, the KRG passed an oil law in the Kurdistan region, providing that the KRG can enter into production-sharing agreements with international oil companies developing and operating new fields in Kurdistan. The agreement between the central government and the KRG at the time was that the oil being produced in the KRG would continue to be marketed and sold by SOMO, and that the central government would pay an agreed share of the expenditures in the budget to the KRG. Over the past few years, there continued to be disputes between the KRG and the central government over the appropriate payments to the KRG in the budget, and therefore, with the exception of a short period in late 2014–2015, this budget agreement has not been implemented. The KRG has therefore continued to export oil through the pipeline in Turkey. After the Islamic State took over large areas of Iraq in 2014, the Iraqi government pipeline to Turkey was damaged and stopped exporting oil. It had been used to export oil from the Kirkuk fields. The Islamic State was expelled from certain areas around the fields of Kirkuk, which fields were taken over by the KRG. As a result, an agreement between the central government and the KRG was reached allowing the KRG to export oil from Kirkuk and keep the majority of its revenues, together with the revenues from the oil produced in fields in the Kurdistan region. This agreement was changed in 2017 (see Section I.v, above).
The Ministry of Oil, which administers the oil sector, is divided into a number of directorates and companies. The Ministry is run by a Minister, who has four deputies (production, refinery, gas and distribution). The upstream oil fields are each administered by an oil company that is owned by the Ministry. Therefore, for example, the oil fields in Basra are administered by the Basra Oil Company. With respect to the other sectors, for example, the refineries sector, again the refineries are owned by government-owned companies, with ultimate control residing with the deputy minister of oil for refining, reporting to the Minister of Oil.
In 2009, the Ministry of Oil commenced a series of bidding rounds for technical services agreements to develop the oil fields under its control. A number of IOCs won these bidding rounds and entered into technical services contracts with the relevant government-owned oil company administering the relevant fields. The bidding rounds and the administration of the technical services contracts are carried out by the Petroleum Contracts and Licensing Department.
As for gas, the Ministry of Oil carried out a two-pronged approach. Three gas fields were awarded to bidders under the bidding rounds, although two of the fields were in territories that fell under the control of the Islamic State, leading to their abandonment. These areas have since been captured by the government and the government is considering new approaches to the development of these fields. As for the oil fields, the Ministry of Oil, through the South Gas Company, entered into a joint venture with Shell and Mitsubishi (called the Basra Gas Company) to capture and treat associated gas from three fields – Rumailah, West Qurna I and Zubair. The gas produced by the Basra Gas Company is currently being sold to the Ministry of Electricity. The Ministry of Oil is currently considering other approaches for the capturing of associated gas in other fields.
With respect to refineries, the Ministry of Oil carried out and continues to carry out a series of policies. Unfortunately, one of its main refineries (Beiji) fell to the Islamic State and was recaptured in late 2015 (having been badly damaged). Steps are being taken to rehabilitate it although this may take significant time and costs. The Ministry, in reliance on Law No. 64 of 2007 (as amended), which addresses investment in oil refineries, entered into two agreements with private companies (in Maissan governorate and Kirkuk governorate). To date, actual work has not commenced on these projects. The Ministry also embarked on a new 150,000 barrels per day refinery near Karbala, owned by the Ministry, which is currently in the construction phase and is expected to be completed in 2021. Once completed, this refinery would significantly reduce Iraq's imports of refined products.
At the time of writing, the Iraqi parliament passed a law establishing the Iraqi National Oil Company (INOC). The company is expected to become operational in late 2018. INOC is mainly focused on the upstream oil sector and will become the owner of the various government-owned upstream oil companies, as well as SOMO. It is intended that INOC will become independent of the Ministry of Oil, although the legislation provides for significant controls by the council of ministers.
ii Energy markets
Development of power markets and contracts for sale of power
At the time of writing, with limited exceptions discussed below, electricity in Iraq is provided by three types of providers – the MOE, one independent power producer and private unregulated owners of generators scattered across the country. The MOE's supply was discussed above and, owing to the fact that it cannot supply electricity 24 hours a day across the country, there are thousands of private owners of generators who have developed their own neighbourhood grids. These private owners of generators are unregulated and therefore they do not comply with any of the government-imposed regulations. Owing to the general security breakdown in the country, and coupled with the fact that the central government has not been in a position to provide electricity 24 hours a day (especially in the hot summer months), the government has allowed these private generator owners to carry out their unregulated neighbourhood activities. Generally, there is no uniform pricing mechanism for these private owners, but through conversations with these private participants, it seems that after covering their costs (maintenance and diesel costs), they are making profit margins of 30–40 per cent. The suppliers of diesel are also making similar profit margins, as the risks of supply are significant.
In addition to the above, there is effectively a third limited producer of electricity in federal Iraq: the international oil companies who are producing electricity for their own use. Since these fields have not developed completely, electricity production has not reached its capacity. Under the technical services agreements between the international oil companies with the companies belonging to the MOO, the plants are owned by these government-owned companies (such as the South Oil Company), with the power produced only being used in the relevant oil fields. Although this is not necessarily ideal or efficient, the grid between oil fields is not well developed or integrated, and therefore electricity production is limited to the individual field where such generation plants are located. Again under the relevant technical services agreements, the government counterparty is required to provide electricity or to reimburse the international oil companies for the costs of electricity production. The costs have been relatively high because the international oil companies have been using smaller diesel generators. The regulatory framework for this electricity generation has been very limited, and the MOE is not involved in these activities as its grid is not used. The only regulations applicable are environmental, but these are not applied uniformly.
As for the main power suppliers who have entered into power purchase contracts with the MOE, as indicated above, these companies are not allowed to sell their production other than to the MOE (as buyer under the power purchase contracts). As generation capacity increases over the next few years, it is anticipated that this may change. In the Kurdistan Region, the matter is slightly different. As other private plants have emerged, the KRG is only committing to purchasing a minimum percentage of generated electricity, and the developers are allowed to supply power to third parties, including the international oil companies developing the fields in the Kurdistan Region. The problems with this are mainly related to the grid, as it is still relatively undeveloped and there are technical difficulties in the private sector development. Independent electricity producers in the Kurdistan region commenced supplying power to liberated areas, like the city of Mosul.
The reduction in the price of crude oil in 2014–2015 caused major budgetary problems in Iraq, and therefore certain existing obligations of the state were delayed or amended. For example, there has been speculation that the structure and terms of the technical services agreements between the international oil companies and the MOO may be amended. Moreover, the delays in the development of the oil fields may cause the collection and treatment of the associated gas from the oil fields to be delayed. At the time of writing, however, and based on discussions with personnel from the MOO, the South Gas project with Shell Oil (to gather and treat the associated gas from several giant oil fields) is still on track.
The deterioration in the security situation, especially in the western desert areas of Iraq, has caused delays in the development of some of the gas fields in the areas, such as Akkaz. Moreover, the strategic pipeline project to Jordan has also been delayed owing to the fact that there are large tracts of land not under government control.
In light of the budgetary constraints in 2015 and 2016, Iraq may begin entering into loans and other types of borrowing in the international financial markets. In addition, various ministries including the MOE may enter into vendor financing agreements for the supply of equipment, in particular for the transmission grid. At the same time, owing to the difficult environment in Iraq (legal, regulatory and security), traditional project finance may not be available and accordingly non-traditional forms of financing would be required to be made available (or more aggressive lenders, such as Chinese financial institutions).
Iv RENEWABLE ENERGY
The Iraqi renewable energy sector is still in its infancy, without any significant renewable energy projects in place. At the time of writing, the MOE intends to enter into agreements with two sets of developers for a total of 100MW. The basis of these new contracts are still being negotiated.
V CONCLUSIONS AND OUTLOOK
The Iraqi electricity and oil sectors have significant opportunities. However, there are current obstacles – legal, regulatory and financial (as well as the lack of natural gas and refined products) – that can delay the development of the electricity and oil sectors in Iraq. Coupled with the above is the significant corruption that exists, which makes it reasonable to conclude that development would move at a measured pace.
1 Salem Chalabi is a partner at Stephenson Harwood Middle East LLP.
2 The Ministry of Electricity (MOE) was established during the time of the Coalition Provisional Authority (2003–2004). Prior to that, the various components of the MOE, which were organised as state-owned enterprises, were part of the Ministry of Industry and Minerals. Once the MOE was established, such state-owned enterprises were de facto converted into directorates of the MOE.
3 Recently, in an effort to ensure a more advantageous dispute resolution venue for international investors, Iraq joined the International Centre for the Settlement of Investment Disputes, which is a part of the World Bank.