COSTS OF INTERDICTION TO IRAQI OIL SECTOR

C O N F I D E N T I A L SECTION 01 OF 04 BAGHDAD 002869

SIPDIS

E.O. 12958: DECL: 07/07/2015
TAGS: ECON ENRG MASS MOPS SENV EFIN PREL IZ ECON
SUBJECT: COSTS OF INTERDICTION TO IRAQI OIL SECTOR

REF: A. BAGHDAD 2694


B. BAGHDAD 2787

C. BAGHDAD 2790 AND PREVIOUS

Classified By: Charge d' Affaires David M. Satterfield for reasons 1.4
(b) and (d)


1. (C) SUMMARY. The ITG is increasingly concerned about
attacks to its oil infrastructure. Security has become a
priority in recent ITG Cabinet-level meetings. DPM Chalabi
has led extensive ministerial discussions in the National
Energy Council, consisting of the Ministers of Oil,
Electricity, Water Resources, Industry and Minerals, Finance,
Interior, and Defense attempting to find a solution to the
infrastructure security problems in Iraq. Based on our
analysis, Iraq has lost over $19 billion in oil export
revenues, a significant portion of which is a direct result
of insurgent activity from June 2003 through May 2005.
Actual export volumes during this two-year period averaged
1.32 million barrels per day; well below our estimate of
Iraq's export capacity of 2.4 million barrels per day. The
primary causes of this reduction are the insurgency, looting,
and an aged infrastructure. There were over 500
interdictions against oil production and pipeline systems
between June 2003 and May 2005. The direct losses to the
country are both the foregone export revenues and the cost of
repairing the attack damage. Additional indirect losses
include lost productivity, loss of potential gains from
capital investments, and foregone infrastructure
improvements. END SUMMARY

-------------- --------------
IRAQI GOVERNMENT CONCERNED ABOUT INFRASTRUCTURE SECURITY
-------------- --------------


2. (C) Iraq continues to face enormous reconstruction and
economic development needs. At the same time, its main
source of revenue -- oil exports, accounting for 95 percent
of revenues in the 2005 budget, according to Finance Minister
Allawi, are dropping, primarily due to insurgent attacks. As
a result, Iraq will need to address a potentially serious
financing gap in 2005 - one that by some estimates could
amount to $2-3 billion. Against this backdrop, DPM Ahmed
Chalabi has led extensive ministerial discussions in the
National Energy Council (NEC),consisting of the Ministers of
Oil (MOO),Electricity, Water Resources, Industry and
Minerals, Finance, Interior, and Defense (MOD),in an attempt
to find a way to better protect Iraq's oil infrastructure and
increase production and exports. (reftels)


3. (C) The NEC has attempted to find a least-cost solution
to providing infrastructure security for the oil pipelines in
the north. They have authorized the establishment, funding,
and training of four Strategic Infrastructure Battalions
(SIBS) under the supervision of the Ministry of Defense.
These units are composed of tribal recruits from the vicinity
of the Kirkuk to Bayji corridor. The ITG has had little
success in improving infrastructure protection with these
units, and the level of successful interdictions has
increased. This has resulted in much talk in Baghdad between
the NEC and the MOD, but no results in the field (REF B).


4. (C) The DPM and the NEC ministers are frustrated with the
MOD, and their inability to use the still few fully
mission-capable Iraqi Army units to secure the
infrastructure, which are deployed by MNF-I to protect Iraqi
population centers from direct attacks by insurgents and
terrorists. The DPM and NEC ministers do not want to use the
tribal forces, and do not believe there will be any near-term
success using tribal based forces in the form of the MOD plan
based on the SIBS. (REF A, B, C). The DPM has frequently
stated the cost for the lack of security in the form of lost
export revenue exceeds $500 million per month, and that
security could be funded for a fraction of that amount. The
DPM said he would consult with MNFI to request assistance to
solve this problem. The Minister of Oil, in his meeting with
the Charge' on July 1, repeated the theme of asking that
trained Iraqi Army units currently under MNF-I's control be
tasked to guard the northern oil infrastructure with MNFI
assistance (septel). The
NEC, on July 4, was informed by the MOD of a proposed plan to
allocate Iraqi Army forces to assist in providing
infrastructure security for the northern pipelines. This
plan is under development at this time and proposes the use
of two Iraqi Army battalions under the control of the 4th
Iraqi Division in Kirkuk until new units can be formed and
trained (septel).


-------------- --------------
HISTORY OF INSURGENT ATTACKS ON OIL INFRASTRUCTURE
-------------- --------------


5. (C) Iraq's oil production capability in May 2003, at the
conclusion of combat operations, was nearly what it was
before the war began in March 2003. We did not intentionally
target the oil infrastructure during the war, recognizing the
importance of its contribution to stability and future
reconstruction efforts. There were a few unintended
exceptions including the bridge at Al Fathah, which carried
the main northern export pipeline. We did bomb the bridge,
and unfortunately interdicted the entire export capacity of
the Kirkuk oil fields, as well as the supply fuel line for
the Bayji power plant and refinery.


6. (C) The insurgent interdiction of the oil infrastructure
began in earnest in May 2003 with attacks along the strategic
pipelines in the south and north. From the beginning of the
war through June 2003, looting of oil field and plant
facilities, which has degraded Iraq's oil infrastructure and
has contributed to the loss in export revenues, and worker
absenteeism, attributed primarily to personal security
concerns, disrupted exports particularly in the south. From
June 2003 through May 2005 there were over 500
insurgent-related interdictions of oil infrastructure.
Although the average number of monthly attacks declined
between January and May 2005, the volume of lost exports
increased, which seems to indicate the insurgents have become
more effective, getting more 'buck' for their 'bang'.


7. (SBU) Oil production, pipeline, storage, and exporting
facilities are anywhere from 25 to 70 years old and
deteriorating. Iraq's oil infrastructure has undergone many
years of frugal operating practices and a lack of
maintenance. The dilapidated state of the infrastructure
contributes to a lesser, but no less critical, degree to the
drop in exports. It is difficult to isolate the effects of
deterioration from the effects of insurgency activity.
However, it would not be unrealistic to conclude that these
systems could have been improved over this same time given a
more secure environment.

--------------
VALUE OF IRAQ'S LOST EXPORTS
--------------


8. (C) We estimate the direct costs from lost revenue due to
oil infrastructure interdiction (including looting, theft,
and insurgent attacks) to be $19.1 billion for the two years
June 2003 through May 2005. Lost export revenues are $19.1
billion and repair costs are $64 million. Of $19.1 billion,
only 95 percent would have been available to the government
of Iraq because of the requirement to pay 5 percent of
revenues to Kuwait as war reparations.

--------------
IRAQ'S EXPORT POTENTIAL
--------------


9. (C) We estimate Iraq's total current potential export
volume at 2.4 million barrels of oil per day (mbbl/d); 2.1
mbbl/d from southern exports and 0.3 mbbl/d from the northern
route. We define potential exports as the volume of oil that
Iraq could export given the following five assumptions:
normal wear and tear, unlimited export demand, and an
increased domestic consumption of crude oil. We assume that
all planned maintenance, capital improvements, and
investments were executed. We also assume that it is
appropriate to use actual market prices for the period,
concluding that world prices for Basra Light and Kirkuk crude
would not be significantly different in either case. Note
that if we arbitrarily reduced Iraq's potential exports by 20
percent, to 1.96 mbbl/d, losses still would have exceeded $15
billion.


10. (SBU) We estimated potential export revenues by
multiplying the potential monthly volumes for each type of
oil by the monthly average of the daily actual prices of
each, adding back marginal production cost, and subtracting
the risk discount. Actual export revenues are estimated in
the same manner by multiplying the actual monthly volumes for
each type of oil by the monthly average of the daily actual
prices of each. Finally, total lost export revenue is
calculated by taking the difference between potential and
actual export revenues, adding back lifting costs and
subtracting the total risk discount. The Iraqi's have been
required to offer a risk discount per barrel of oil during
the period of insurgency. Estimates range from between $0.20
and $0.50 per barrel and are attribute to the unreliability
of supply.



11. (C) Although they represent a small contribution to
direct cost, repair costs are nonetheless relevant to our
analysis. PCO estimates the value of the TD Williamson
contract, which supported emergency repair of pipelines, at
$59M. After this contract expired, the Emergency Response
Pipeline Repair Operation (ERPRO) paid for repairs, and PCO
estimates the total receipts from those repairs are $5M.
Thus, the total spent by the USG for repairs is $64M plus any
expenses incurred by the Iraqi Ministry of Oil for which we
do not have an estimate. Significantly, however, only 10
percent of all repairs were paid for by the USG. The Iraqis
paid for the rest at a lower cost per repair.

--------------
INDIRECT COSTS
--------------


12. (SBU) The indirect costs of terrorist attacks on oil
infrastructure may be difficult to identify and even more
challenging to value, but they could also be greater in
magnitude than the direct components. If we measured the
effect of insurgent interdiction in terms of a loss in gross
domestic product (GDP) rather than a loss in export revenues,
the result would likely exceed our reported estimate because
of the effect of a government spending multiplier.
Productivity losses accumulate from the interruption of
normal business operations and the requirement to divert
labor and capital. There are potentially very larges losses
of gains from capital improvements and investment. Various
sources, including the Ministry of Oil, indicated that
planned but unrealized investments by domestic and foreign
sources would have yielded significant increases in daily
production. Most investors remain reluctant to commit
exploration and development funds, in part, because of the
lack of security.

--------------
FUTURE POTENTIAL
--------------


13. (C) The loss of so much revenue is almost impossible to
compensate for. However, we can forecast the volume of
exports that might be possible given an end to insurgent
attacks and the completion of the Ministry of Oil's plans for
infrastructure improvements. First, we estimate that if the
northern strategic pipeline system is secured, then Iraq
could immediately increase its exports by 300,000 barrels per
day. In addition, the Minister of Oil estimated that the
northern oil field systems could be improved to provide a
gradual increase over the next 6 months of an additional
200,000 barrels per day, and that beginning in January 2006
it could do similar infrastructure improvements in the south
that would eventually yield an additional 300,000 barrels of
oil per day. This would yield 800,000 bbl/d of increased
production available for export. (septel).
--------------
COMMENT
--------------


14. (C) COMMENT. From our study and analysis, the ITG is
correct to be so deeply concerned with the lack of security
for the key infrastructure of Iraq. In this brief analysis,
we have attempted to quantify the lost revenues resulting
from interdictions and the opportunity costs of a failure to
adequately protect Iraq's oil infrastructure. The discussions
at the NEC (reftels) demonstrate the Iraqi leadership's
concern on the lack of infrastructure security and the costs
to Iraq. The continued loss of oil revenues threatens the
viability of Iraq's reconstruction, recovery and development
-- and ultimately, its stability. END COMMENT


15. (U) REO BASRAH, REO HILLAH, REO MOSUL, REO KIRKUK
minimize considered.
Satterfield