JCRED REVIEWS IRAQ ENERGY ISSUES

UNCLAS SECTION 01 OF 06 BAGHDAD 003562

SIPDIS

SENSITIVE

STATE FOR NEA/I, EB/EX WAYNE, D STAFF

E.O. 12958: N/A
TAGS: ETRD ECON ENRG EPET SOCI IZ ECON
SUBJECT: JCRED REVIEWS IRAQ ENERGY ISSUES

This cable is sensitive but unclassified. For government
use only. Not for internet distribution.

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Summary
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1. (SBU) U.S. and Iraqi delegations discussed Iraq
energy issues in Amman during an energy bilateral on July
10, and during the Joint Commission on Reconstruction and
Economic Development (JCRED) on July 11. The Ministry of
Oil plans to expand oil production to 2.5 million
barrels/day by year end, reestablish the Iraq National
Oil Company, and improve the transparency of oil
revenues. The Minister of Electricity stressed the need
to re-build base-load capacity through the use of thermal
power plants instead of additional gas turbines;
highlighted several projects that are critical to
increasing electricity production; and reported on
efforts to reduce electricity demand growth through a
public relations campaign. The Minister of Water
Resources discussed efforts to increase hydropower during
the peak summer season - including through agreements
with Turkey and Syria to increase water flows on the
Euphrates River - and highlighted the potential for
additional hydropower projects.


2. (SBU) In addition to security concerns, a lack of
capital investment is a major impediment to achieving
these goals. The Minister of Finance acknowledged that
he has been forced to cut the Ministry of Oil's capital
budget to finance Iraq's projected budget deficit, and is
looking for other ways to address the country's financing
gap. Deputy Secretary of State Robert Zoellick urged the
Iraqi delegation to address subsidies on refined products
and electricity, and to identify areas appropriate for
donor and private sector financing. DOE DAS John Brodman
also emphasized the need for tariff reform to rationalize
decision-making in the energy sector.

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OIL AND NATURAL GAS
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3. (SBU) Deputy Secretary Zoellick and Iraq's Finance
Minister, Ali Allawi, co-chaired meetings of the U.S.-
Iraq Joint Commission on Reconstruction and Economic
Development (JCRED) July 11, in Amman. In addition to a
plenary session focusing on the energy sector, DOE DAS
John Brodman led a USG team in energy discussions on July
10, and hosted several meetings with individual ministers
on the margins of the JCRED. In addition to
representatives from State, DOE, and Embassy Baghdad,
other participating agencies included USTDA, Ex-Im Bank
and Treasury. The Iraqi side was represented by Minister
of Oil Ibrahim Bahr Al-Uloum, Minister of Electricity
Mohsen Shlash, and Minister of Water Resources Latif
Rahid. The following summarizes discussions at the JCRED
plenary, with additional details gathered from the
various other meetings.


4. (SBU) Oil Minister Bahr Al-Uloum said that Iraq is
currently producing 2.1 million barrels per day (MBD),a
figure that is expected to rise to 2.5 MBD by year's end.
The target production rate for the end of 2006 is 3.0 MBD
and the Minister said that production could be restored
to 3.5 MBD within several years with an additional
investment of USD 4-5 billion. In the refining sector,
Iraq has a current capacity of 500-550,000 barrels per
day (B/D) in its large refineries and an additional
capacity of 150,000 B/D in several smaller ones.
Refinery utilization rate is only 70 percent, however,
and the short-term goal will be to increase utilization.
Over the longer term, Iraq needs to add conversion
capacity to existing refineries to enable them to produce
more gasoline and diesel, a project which the Minister
estimates will cost USD 1 billion. Ultimately, Iraq
needs to build a new refinery at an estimated cost of USD
3 billion.


5. (SBU) A significant portion of the discussions
focused on natural gas and its use in generating more
electricity. Dr. Radwan Al-Saadi, Director General for
Economics and Finance for the Ministry of Oil, said that
Iraq was currently producing an estimated 1200 million
cubic feet of gas per day (MMCFPD),but that only 40
percent of this was being utilized (i.e., 60 percent, or
720 MMCFPD, is being flared). The near term objective is
the full utilization of existing production, and Al-Saadi
estimated that Iraq's gas production would rise to 1600-
2000 MMCFPD by 2007-2008. Over the longer term, Iraq
could go beyond the production of "associated gas" -
produced with its oil - to exploit some of its
discovered, but undeveloped, natural gas fields. In
addition to satisfying its own internal needs, the
country intends to renew gas exports to Kuwait, which
reached 200 MMCFPD before the Gulf War. The Ministry has
also studied the feasibility of pipeline exports to
Turkey, according to Al-Saadi. Eventually, it is likely
Iraq will contribute some gas from its northern fields
into a proposed Arab gas grid linking Egypt and Syria.


6. (SBU) Bahr Al-Uloum detailed concerns and plans
regarding fuel subsidies. He noted that the consumption
of fuel in Iraq has risen from 21 million liters/day
(132,000 B/D) in April to 23.5 million liters/day
(148,000 B/D) currently. The rise, which he attributed
in part to increased use of fuel to power privately-owned
generators, could drive the total cost of importing
refined products to USD 3 billion this year, he noted.
To address this issue, the Ministry has drafted a decree
for cabinet approval to allow the private sector
importation and sale of refined products. Bahr Al-Uloum
said that the Ministry hopes to turn over importation of
product entirely to the private sector within the next
six to twelve months. The Minister also noted that a
series of gradual steps to raise the price of
domestically-refined product (which he referred to as the
"Iran model") would be useful. The Ministry has held a
series of conferences to prepare the public for these
steps. The Minister acknowledged that price rises would
be an unpopular move, but promised that the Ministry was
moving forward.


7. (SBU) Bahr Al-Uloum stressed the importance of
security to maintaining and increasing oil production.
He stated that there had been 75 attacks on pipelines in
Iraq over the previous five months, costing an estimated
USD 1.5 billion in lost revenues. The Kirkuk Field, in
northern Iraq, is capable of producing 250,000, but has
been shut in due to lack of a secure pipeline outlet to
Ceyhan, Turkey. Bahr Al-Uloum noted, however, that
recent efforts to improve security may be bearing fruit.
Over the last seven weeks, the National Energy Committee
has been working with the Ministry of Defense and with
MNF-I to upgrade security forces, and from June 24 to
July 4, there had been no attacks on northern pipelines.
"We depend heavily on this operation," he told the JCRED,
pointing out that exports through Ceyhan could generate
an additional USD 12 million/day, exceeding the total
cost of product imports.


8. (SBU) Noting that Iraq was the only major oil
producing country without its own oil company, Bahr Al-
Uloum stated that a principal objective will be the re-
establishment of the Iraq National Oil Company (INOC),by
year's end. In response to questions from DAS Brodman,
Al-Uloum clarified that the INOC would be in charge of
implementation of oil field development in Iraq, while
the Ministry of Oil would be restricted to strategic
planning for the sector. He added that INOC would focus
on production activities in existing fields, but could
and should compete with international oil companies in
development of new fields.


9. (SBU) The Minister told the plenary session that
Iraq's petroleum law has not yet been finalized, though a
number of suggested provisions had been reviewed. He
said that the petroleum law would govern how Iraq dealt
with foreign company investment in its oil sector, and
emphasized that foreign investment would be essential to
expanding the sector. Bahr Al-Uloum noted that no less
than USD 25-30 billion would be needed to raise Iraq's
oil production to 5 MBD, and that private sector
investment would be needed to reach this goal. According
to the Minister, the goal of the petroleum law will be to
prepare the investment climate.


10. (SBU) Bahr Al-Uloum told the JCRED that the
Ministry is reviewing the status of five to six contracts
for oil fields that were signed by the previous regime.
The contracts that were ratified by the Cabinet have a
legal status, he noted, but in recognition of the
political context under which they were signed, would be
reviewed to determine their legality and competitiveness.
If the contracts are found not to be competitive (Note:
We assume "competitiveness" to be according to current
industry standards. End Note.),they should be revised
to maximize the benefit for the Iraqi people. Bahr Al-
Uloum further noted that the Ministry of Oil had
expressed its opinion regarding contracts signed by
Kurdish authorities: that under the TAL, management of
natural resources falls under the jurisdiction of the
central government, and the Ministry of Oil is the
competent authority to address oil contracts.


11. (SBU) Bahr Al-Uloum reviewed for the JCRED his
ministry's efforts to improve transparency of oil
revenues, and Radwan Al-Saadi provided greater details
during energy bilaterals. The Ministry has decided to
sell primarily to major refiners, rather than oil trading
companies, due to their greater reliability for lifting
petroleum shipments. The Ministry is working to install
metering equipment at loading ports, and is looking to
hire a third-party to audit sales volumes. In the energy
bilaterals, Radwan Al-Saadi detailed the Ministry's
efforts to find the highest net-back prices, and
solicited DOE's assistance in evaluating market options
for Iraqi crude. Bahr Al-Uloum noted that, with the
exception of 14,000 B/D of production that is being
swapped with Syria for electricity, all oil revenues go
through the Development Fund for Iraq (DFI),held by the
New York Federal Reserve Bank.

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ELECTRICITY
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12. (SBU) Iraq's Minister of Electricity, Mohsen Shlash,
noted that wars, sanctions and limited investment have
degraded Iraq's generating capacity over the last 25
years, from a peak generating capacity of 12,000
megawatts (MW) in 1980. Iraq's current peak-load
capacity is 5132 MW, significantly short of the country's
estimated peak-load demand of 8250 MW. Moreover, this
understates what should be the real demand, he said,
since many of the country's factories are closed. Based
on the experience of other countries, Shlash estimates
that peak-load demand could rise to 15-20,000 MW by 2010.


13. (SBU) The Ministry has taken a number of steps to
try to address the shortfall over the short-term. Shlash
said that Iraq is extracting 500 MW more than normal (a
total of 1200 MW) from existing hydropower sites, in part
because Turkey had agreed to release more water into the
Euphrates River. (According to Iraq's Minister of Water
Resources, Latif Rashid, this measure also required the
cooperation of Syria to pass along these greater volumes
of water.) The Ministry of Electricity has also
increased its imports of diesel fuel to 7 million
liters/day (44,000 B/D) to get more electricity generated
out of gas turbines during the summer peak. Other short-
term measures include using 15 MMCPPD of natural gas that
normally goes to a fertilizer plant in Baiji and
connecting several gas turbines used for operations in
the Rumaila oilfield to the national grid. The Minister
hoped that these measures would provide 6000 MW next
month, enough to provide electricity on a 3 hours-on/3
hours-off schedule for the entire country.


14. (SBU) Over the next year, the Ministry hopes to get
more electricity from its neighbors. Iraq is interested
in discussing possible interconnections with Kuwait,
since the Kuwaiti high-voltage grid is only 100
kilometers from Iraq's. Shlash is not interested,
however, in a proposal from a consortium of Kuwaiti
businessmen because the price is extremely high. Iraq
also hopes to increase imports from Iran from 95 MW to
145 MW within the next several weeks. Shlash noted that
there should be enough differences in peak power demand
among the region's countries to allow Iraq to acquire
some surplus power generated by neighboring countries.
He expressed hope that he could negotiate country-to-
country agreements to get surplus power for free or at
low prices, or perhaps in exchange for Iraqi promises to
reciprocate in future years.


15. (SBU) Another priority for the Ministry of
Electricity is the greater use of natural gas for power
generation. Shlash pointed out three natural gas
projects that are a priority for his Ministry:
-- Repair of the strategic gas pipeline between Southern
Iraq and Baghdad;
-- Repair of gas compressor station number 2 at Kirkuk,
which could provide an additional 120-130 MMCFPD of gas
for power generation; and
-- Installation of a gas-oil separation unit in the East
Baghdad Field to provide fuel for power generation in a
strategic location in the country.


16. (SBU) Over the longer term, Shlash indicated that
his priority would be to restore baseload generation
capacity through the use of thermal (steam) power plants.
He told his interlocutors he does not want to see any
more gas turbines. While gas turbines can be more
efficient under ideal conditions, thermal plants are
simpler to operate and maintain and can use practically
any fuel (natural gas, residual fuel oil, or crude oil)
without problems. The Ministry has identified four
specific sites for power plants in the 1200-1400 MW
range. He said that one project, the Al-Shimal plant,
could produce 1400 MW with an investment of USD 850
million, with first production within 2 years. He is
also talking to one potential donor about rehabilitation
and expansion of another project, the Al-Musaib plant,
which could provide an additional 1200 MW.


17. (SBU) In addition to new supplies, Shlash believes
that a demand management strategy for electricity is
critical. He noted that Iraqis are buying
refrigerators, microwaves and air conditioners at a rapid
pace, and he has appeared on Iraqi television on several
occasions to urge Iraqis not to waste electricity.
Ultimately, however, the solution has to include the end
of heavily-subsidized electricity tariffs. Shlash
indicated that the Ministry is considering a plan to
provide a small amount of electricity (perhaps 400-500
kWh/month) to each household at current low prices, but
to charge significantly higher prices ("almost market
rates") for all power used beyond this level. The
objective would be to protect poorer Iraqi households
while charging higher prices for incremental volumes.

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Hydropower
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18. (SBU) Iraq's Minister of Water Resources, Latif
Rashid, stressed the potential for additional hydropower
developments in Iraq. Iraq currently has a maximum
installed hydropower capacity of 2500 MW, located at
eight dams, with 1200 MW now available (Note: We assume
this is due to seasonal factors. End note.) He said
that there are ten additional sites where large-scale
hydropower projects could be constructed in Iraq. The
most promising of these is the Bekma dam site, which the
Minister said could add 1800 MW of generating capacity
for an estimated investment of USD 1.5 billion. All
together, the ten sites could add 4000-5000 MW of power,
with an estimated investment of USD 6.0 billion. Rashid
asserted that hydropower was one of the cheapest,
cleanest alternatives for Iraq, but noted that
electricity was simply "too cheap" to fund future
developments. "No one pays," he lamented.

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Financing the Energy Sector
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19. (SBU) All three Ministers highlighted the problems
associated with a lack of funds. Minister of Oil Bahr
Al-Uloum said that, out of the USD 3.0 billion budgeted
for capital projects for the Ministry, only USD 200
million had been disbursed so far in the year. Minister
of Electricity Shlash noted that most of his budget was
absorbed by the costs of importing fuel for power plants.
Minister of Water Resources Rashid noted that much of the
USG's budget had been absorbed by extra security
expenditures, but that of the USD 4.7 billion that was to
be spent by 2006, only USD 300 million had been disbursed
so far. Rashid added that, of the USD 37 billion
promised by other donor countries, only USD 4 billion had
been disbursed.


20. (SBU) In his opening remarks at the JCRED plenary,
Minister of Finance Ali Allawi confirmed that he had been
forced to cut the capital budget for oil projects to
cover the financing gap in Iraq's budget. He noted that
Iraq's limited domestic banking sector could not finance
the deficit and said that he was looking for other
alternatives, including the possibility of issuing USD 5
billion in government bonds. For energy projects, Allawi
said that the government needed to create an
institutional framework for private sector investment. A
number of investors, for example, had proposed private
power stations for Iraq, and the Minister believes that
there is potential to use private sector financing
similar to programs done in Pakistan and Malaysia.
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USG Pushes Subsidy Reform, Transparency
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21. (SBU) Deputy Secretary Zoellick praised the Iraqi
participants for their efforts to work together through
the National Energy Committee (NEC) to meet summer
electricity demands. Over the longer term, however, more
must be done on the demand side. He noted that it is
difficult to justify putting billions of dollars into
Iraq's energy sector to support heavily subsidized
prices. Zoellick acknowledged the political difficulties
inherent in subsidy reform, but stressed the need for the
Iraqi side to move forward on a plan. Zoellick told the
Iraqis that the energy sector should be a rich area for
private sector investment and that there needs to be
greater clarity regarding the roles of donors versus
private sector capital. Finally, Zoellick emphasized the
importance of transparency to combat the huge
opportunities for corruption in the energy sector.


22. (SBU) DOE DAS John Brodman also congratulated the
Iraqi Ministries on their collaboration, and reiterated
USG concerns over energy subsidies. High energy prices
create a "catch-22" situation for Iraq, he said, with
higher oil revenues being offset by higher costs for
imported fuels. The lack of real prices creates
distortions and inefficient behavior throughout the
energy sector, Brodman noted. He accepted that tariff
reform would never be easy from a political standpoint,
but urged the ITG to set the stage for eventual
implementation of reforms. He stated that one key
element of any strategy will be a public relations
campaign to explain the need for reform to the Iraqi
people.

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Comment
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23. (SBU) There was a lot of good news at the JCRED
energy discussions. The three energy sector ministers
all appear to have a good grasp of the challenges facing
them, and they offered pragmatic solutions for most of
them. More importantly, there now seems to be much
closer coordination among the ministries to address
Iraq's electricity crisis. There also seemed to be a
clear understanding, across the board, of the need for
greater security along the northern pipelines. Finally,
all the participants appear to recognize the importance
of establishing an investment climate that will attract
private sector financing.


24. (SBU) On the downside, energy subsidy reform is
moving at a glacial pace. Bahr Al-Uloum's proposal, to
allow the private importation of refined product, has
been kicking around since January, and even if
implemented, would have a limited impact on the overall
cost of fuel subsidies. Similarly, while the Minister of
Electricity's ideas to increase rates are sound, any plan
will be difficult to implement until widespread theft of
power is addressed. Overall, the transitional government
has a lot on its plate - including finalizing a
constitution - and there appears to be little appetite
for taking painful steps to reduce subsidies before the
next election.


25. (SBU) The use of the Ministry of Oil's capital
budget to fund Iraq's budget financing gap even as a
stop-gap measure is also troubling. At the very least,
,
it will delay the expansion of Iraq's oil production and
related revenue. Given the dilapidated state of some of
the country's fields, the budget cuts could even threaten
current levels of production. While high oil prices have
made up for lower-than-anticipated production levels this
year, the failure to invest in 2005, particularly if
combined with a downturn in oil prices, could spell real
budgetary problems in the coming years. End Comment.


26. (U) This cable was cleared by Ross Wilson in D.

Khalilzad