All About The Oil

By Adam Zagorin/Washington

Eleven Iraqi exiles, as well dressed as they are well connected, flew into Washington late last month for a private two-day meeting at a nondescript downtown hotel. The Iraqis--engineers and economists invited by U.S. officials and intimately familiar with their country's oil industry--spoke in English, not Arabic, for the benefit of American observers. Most of the Iraqis insisted on keeping their identities secret to avoid retaliation from Baghdad. But there was no mystery as to their purpose: the men had gathered to prepare for the struggle over Iraq's oil riches that will start the day U.S. forces drive Saddam Hussein from power.

Iraq's proven oil reserves are conservatively estimated at 112 billion bbl. That's nearly five times larger than those of the U.S. and second only to Saudi Arabia's 262 billion. The Iraqi reserves could cover current U.S. imports for almost a century. Iraq has an additional 220 billion bbl. in probable deposits yet to be explored. All of that oil belongs to a regime that soon may not exist. So even though the U.S. confrontation with Saddam is about much more than oil, it's natural that Washington--and its allies and rivals as well as the people who will run Iraq in the future--are beginning to eye a division of the spoils.

But what is shaping up as one of the greatest black-gold rushes in a generation comes with a few big catches. First, billions of dollars will be required to repair Iraqi oil installations hobbled by more than a decade of neglect. And that's assuming Saddam doesn't torch and otherwise sabotage the wells, as he did in Kuwait at the end of the Gulf War. Tens of billions more will be needed to then develop Iraq's vast untapped oil fields.

Those costs aren't likely to stop global oil companies from rushing to Iraq on the heels of the U.S. Army. But they will need to be patient. Fadhil Chalabi, a former Secretary General of the Organization of Petroleum Exporting Countries and a member of the Iraqi exile group that met in Washington, tells TIME that it could take five years or more before Iraq can boost its output above levels first achieved more than two decades ago. And it will require the participation of foreign investors eager to repatriate profits from an Iraq mired in poverty and in desperate need of capital. "Rebuilding the oil industry is the only way to finance Iraq's return to democracy and some sort of prosperity," Chalabi says, "and it must be done to benefit the Iraqi people."

The closed-door meeting in Washington comes amid a frenzy of war preparations that has helped drive oil prices above $35 per bbl., from $20 a year ago. A one-third cutback in petroleum production by Venezuela, beset by a political crisis, has contributed to the price increase, leaving the U.S. more dependent on Middle Eastern crude. Americans are also weathering an exceptionally cold winter, which is boosting demand for heating oil. At the gas pump, the average price of regular unleaded gasoline is $1.53 per gal., up 43-c- from the price 12 months ago and 11-c- just since Jan. 1. To make matters worse, U.S. commercial oil stocks are near their lowest levels ever. As war seems increasingly likely, some major questions loom:

HOW HIGH COULD OIL PRICES GO?

That depends on how long the fighting lasts and how much damage Iraq's oil fields sustain. Even if a U.S. battlefield victory comes in just a few weeks--and there is no major sabotage to Iraq's oil fields--the country's production of 2.8 million bbl. a day is likely to shut down, perhaps for as long as three months. The oil fields will have to be checked for mines and other hazards before local workers and foreign experts can get down to business.

On the plus side, Saudi Arabia, with 2.5 million bbl. a day in spare capacity, has promised to make up part of Iraq's shortfall. The U.S., Europe and the major industrialized countries of Asia also have access to substantial oil stocks to help them weather the likely drought. President Bush has given orders to top off America's 700 million--bbl. Strategic Petroleum Reserve--enough oil to meet U.S. needs for 36 days. That process is about 85% complete. The most probable scenario, according to a study by the Center for Strategic and International Studies, a research institute in Washington, has oil prices running up a few dollars, to about $36 per bbl. As Saudi Prince Alwaleed bin Talal al-Saud, one of the world's leading stock-market investors, tells TIME, "Oil prices could shoot up initially not because there is a shortage but because of the perception there will be one."

But within a few months, with the prospect that Iraqi crude will start to flow again, prices might fall to about $25. By summer, the market could face a glut--and $20 crude. Moreover, says the Institute of Directors, a British employers group, a short war would actually be better for the global economy than the uncertainty and higher oil prices that would hang over it if war continues to be merely a possibility. For the U.S. economy, the study says, a war that resulted in lower oil prices would generate 2003 growth of nearly 3%, compared with the 2% currently forecast by many economists.

WHAT HAPPENS IF THE FIGHTING DRAGS ON?

Here's a nightmare scenario: Iraqi ground troops led by the Republican Guard resist to the bitter end. Saddam hunkers down in a densely populated section of Baghdad, broadcasting calls for sabotage against oil facilities around the Persian Gulf. Large-scale battles tail off in a few weeks, but sporadic attacks on U.S. forces and oil installations continue. Fearful workers and engineers refuse to operate Iraq's oil fields, which close down for as long as six months. In this case, experts say, prices would probably peak above $40 per bbl. and, once fighting ended, fall gradually by year's end to about $30.

WOULD SADDAM BLOW UP IRAQ'S OIL WELLS?

It's a risk. "Saddam Hussein might well see burning Iraq's oil fields, and chemical, biological, radiological or nuclear attacks on major Gulf oil fields as both a defense and a form of revenge," says Anthony Cordesman, an expert on the Iraqi military.

Saddam has tried it before. During the Gulf War, Iraqi soldiers set fire to 700 of Kuwait's wells using plastic explosives. Dense smoke caused health and environmental problems, as crude gushing from damaged facilities contaminated underground drinking water. Damage amounted to at least $20 billion, and more than a decade later, some of it still isn't repaired.

To stop Saddam this time, the Pentagon has contacted fire fighters like Boots & Coots International Well Control of Houston, which helped snuff out oil-well infernos during the Gulf War. It could take those operators a month to start work, especially if they are forced to drill for water to put out fires in arid regions of Iraq. The Pentagon hopes that won't be necessary. U.S. troops, including special forces, plan to descend on Iraq's oil fields in the conflict's early hours. "We would like to be able to very rapidly gain control over as much of that oil as we can to preserve it," says a senior Pentagon official.

But Iraq's oil fields are much larger than Kuwait's; they are spread across an area the size of Rhode Island in northern Iraq and over a region in the south about the size of New Jersey. U.S. military experts estimate Saddam could also dump up to 3 million bbl. a day into the Persian Gulf, shutting down up to 15 desalinization plants around the littoral and despoiling the shores and wildlife for decades. Cleaning up after Saddam could cost close to $50 billion and severely handicap Iraq's postwar economic recovery--not to mention America's.

If Saddam were able to sabotage not only his own oil fields but also those of neighboring nations, a major shortfall of up to 6 million bbl. a day--8% of world consumption--is foreseeable. To guard against this scenario, Kuwait is making emergency plans to export its oil safely. The U.S. and its allies have also announced that they will coordinate releases that could amount to several million barrels a day from strategic reserves. But the shock could still push up prices to $80 per bbl., tailing off to about $50 by year's end. That compares with an inflation-adjusted price of $47 per bbl. at the height of the 1973 oil crisis. That kind of spike would hit stock markets hard and could send the global economy into a deep recession.

WHO WILL CONTROL IRAQ'S OIL?

Army General Tommy Franks, who commands U.S. forces in the Gulf, will have the authority to make early decisions in this politically sensitive area. A provisional Iraqi government, once established, and the U.N., which currently supervises Iraq's oil exports, would presumably also have a role.

WILL IRAQI OIL HELP PAY FOR THE WAR?

Protesters chant, "No war for oil." White House spokesman Ari Fleischer replied last week, "If this had anything to do with oil, the position of the United States would be to lift the sanctions so the oil could flow. This is not about that. This is about ... protecting the American people."

The takeover and occupation of Iraq, perhaps for a decade or more, could cost American taxpayers up to $200 billion. Virtually none of that will be covered by the sale of Iraqi petroleum. At least that's what Secretary of State Colin Powell told the press recently. "The one thing I can assure you of is that the oil will be held in trust for the Iraqi people, to benefit the Iraqi people," Powell said. "That is a legal obligation that the occupying power will have."

WOULD U.S. COMPANIES HIT THE JACKPOT?

A post-Saddam government in Baghdad could be expected to favor U.S. companies. Ahmed Chalabi, a leader of the Iraqi National Congress, the most powerful exile group, has met with U.S. oil executives and promised that American oil companies would benefit following a campaign to oust Saddam.

Industry sources tell TIME that oil-service companies like Schlumberger, Baker Hughes and Halliburton as well as construction giant Bechtel Group could split contracts worth up to $2 billion for getting Iraq's oil infrastructure back in shape. U.S. and European oil conglomerates will scramble for rights to exploit Iraq's oil deposits. But the Europeans are worried that the U.S might see the postwar period as payback time for their governments' foot dragging on the war.

In recent years, the winners in Iraq have been foreign companies that don't abide by U.S. sanctions. Saddam has provided contracts worth $38 billion to firms such as Royal Dutch/Shell, Italy's Eni, Russia's Lukoil and France's TotalFinaElf. But those contracts could be worthless once Saddam is gone.

Russian companies could prosper if their government supports U.S. action against Saddam. The Kremlin has made clear to the Bush Administration its fear that postwar Iraq will pump too much oil, lowering the world price below $18 per bbl.--the level at which Russia's oil companies can no longer make a profit. That has led some industry officials to believe that Washington, eager to secure Moscow's approval for military action in Iraq, has quietly agreed to keep prices from falling too low and to help Russian oil companies win contracts in the new Iraq.

WILL OPEC GO BUST?

Not anytime soon. In the aftermath of war, Iraq could come under U.S. pressure to quit OPEC, but Baghdad is likely to resist because of its continued interest in maintaining higher prices. OPEC's share of world petroleum output has been slipping, however, from more than 50% in 1974 to about 42% today. And if cash-strapped Iraq eventually decides to boost production as high as 6 million bbl. a day, it could push world prices down sharply. So cheap oil may be on the way, but it could be a long time coming. --With reporting by Blaine Greteman/London, Scott MacLeod/Cairo, Andrew Purvis/Vienna and Mark Thompson/Washington

With reporting by Blaine Greteman/London, Scott MacLeod/Cairo, Andrew Purvis/Vienna and Mark Thompson/Washington