October 16, 2002 Oil Is Factor in Iraq War Equation [*] Regime change might mean a rise in output. For Russia, that could put prices, deals at risk. By Warren Vieth , Times Staff Writer WASHINGTON -- The prospect of military action against Saddam Hussein has touched off an international contest for Iraq's vast oil reserves and has complicated U.S. efforts to cultivate Russia as a major future source of oil. Moscow is seeking assurances from Washington that if Hussein is ousted, Western companies won't take away the lucrative oil-field development rights that Russian oil firms negotiated with the Iraqi president's government. Iraq's reserves are second in size only to Saudi Arabia's. Industry experts and insiders say the issue has become a potential sticking point in negotiations between the Bush and Putin administrations over Washington's efforts to obtain United Nations backing for its Iraq policy. "Russian companies are worried the new regime may discard previously signed agreements and favor the U.S. oil industry," said Fred Mutalibov, an oil-field services analyst for SWS Securities in Dallas. "To get Russia's support, or at least their silent agreement, the United States has to assure that Russian oil interests will be considered once the regime change has occurred." The stakes are high, particularly for Russia. Not only does its fledgling private- sector oil industry stand to lose future development windfalls, but its export- driven economy also would suffer if a new, pro-Western regime in Iraq pumped up current production and flooded world markets with crude. Although Iraq is a member of OPEC, there is no assurance that a new government would abide by the cartel's production restraints. "They're going to need to massively rebuild," said John Kingston, global oil research director at Platt's, an energy information service. "They're going to need lots and lots of money, and there's only one way to get it. They only have one cash crop, so they're going to want to produce as much as they can." Some analysts predict that oil prices would fall from about $30 a barrel today to about $20 as Iraqi production gradually increased from about 1.5 million barrels a day to about 3 million barrels over several years. Russia, which depends on oil for about 40% of its export revenue, would be hard hit by a price decline. In addition, Iraqi crude would be competing for the same European markets where Russia sells most of its oil. "The big blow will be for the Russian economy and the oil industry in general," said Nelli Sharushkina, who tracks the industry from Moscow for Energy Information Group. "The lower the prices are, the worse it is for the Russian economy." For the Bush administration, the issue presents complex political and economic ramifications. America's economy would benefit from lower oil prices, and U.S. oil firms might prosper if Iraq reneged on its deal with the Russians. But a brazenly U.S.-centric policy would not only damage relations with Russia, it could also undermine the legitimacy of a new Iraqi regime. "If the legacy of this war is the appearance that the United States is sacrificing Iraq's interests to suit American interests, all it will do is ensure that any government the United States sets up will be seen as a puppet government and will be torn down," said Anthony Cordesman of the Center for Strategic and International Studies, a Washington think tank. For the international oil industry, a regime change in Baghdad could put one of the world's most restricted petroleum markets into play. Iraq sits atop 11% of the world's proven oil reserves, about 112 billion barrels. At $30 a barrel, that's $145,000 worth of crude for every man, woman and child in the country. And Iraqi petroleum geologists believe there's at least twice that much in additional reserves still to be confirmed. (By comparison, the United States has 22 billion barrels, or about $2,300 per person.) Iraq's giant Kirkuk field was discovered in 1927, and U.S. oil companies played a big role in Iraqi oil development before the entire industry was nationalized in the 1970s. But eight years of war with Iran in the 1980s and 12 years of U.N. sanctions following Baghdad's 1990 invasion of Kuwait have destroyed much of Iraq's oil production infrastructure and restricted development of new fields to replace dwindling production from old ones. Iraqi officials have acknowledged that they lack the financial and technological resources to rebuild their oil industry. They estimate that as much as $50 billion of foreign investment would be needed to reach their production target of 6 million barrels a day over the next decade. "They're broke," said Matthew Simmons, who heads a petroleum industry investment banking firm in Houston. "They need money. They need help. They need technical assistance, and it becomes particularly urgent if in fact they really have destroyed the backbone of their existing fields." Five years ago, Hussein's government struck a 23-year, $3.5-billion deal with a consortium headed by Lukoil, Russia's largest oil company, to rehabilitate Iraqi oil fields. But the U.N. sanctions have prevented the work from proceeding. Baghdad has entered into smaller development deals with companies in Russia, China and France, in part to undermine political support for U.S. policy toward Iraq. All three countries have veto power on the United Nations Security Council. Some form of accommodation appears likely. "We are in conversation with our Russian friends about their interests, and we are taking into account their consideration," Secretary of State Colin L. Powell told the U.S.-Russian Business Council this month. Commerce Secretary Donald Evans said the issue came up in private talks with industry officials at a U.S.-Russia energy conference in Houston last week. Lukoil President Vagit Alekperov said Russian officials had assured him that his company would not lose its big contract in Iraq. "I suspect before the Bush administration gets its vote in the U.N., it's going to have to have something in writing with the Russians," said Newport Beach energy consultant Philip Verleger, a senior fellow at the Council on Foreign Relations. Many industry experts and foreign policy specialists argue that helping Russia hang on to its Iraqi interests would be the smart thing to do. "The administration should be thinking of a strategy to jump-start the Iraqi economy," said Washington attorney Mark Brzezinski, a former National Security Council staff member. "Russian energy companies have experience working in Iraq, and their knowledge of how to get things done could contribute toward the larger objective of getting the economy off the ground." Ensuring that Russia has a role in future oil development in Iraq would also advance the administration's efforts to promote more collaboration between U.S. and Russian oil companies and find new sources of oil outside the Organization of Petroleum Exporting Countries. Although the lack of big s upertanker ports prevents Russia from shipping much crude to the United States, Russian officials say planned improvements would allow them to satisfy as much as 10% of America's oil appetite in future years. One small sign of growing goodwill: For the first time, several hundred thousand barrels of Russian crude will be pumped into the U.S. Strategic Petroleum Reserve this month. "Everything that's happened since Sept. 11, 2001, makes it not just more likely, but more real that there will be increasing cooperation between the United States and Russia," said Joseph A. Stanislaw, president of Cambridge Energy Research Associates. "Iraq just adds to that. It adds to the imperative." Yet no matter what assurances the U.S. makes, there might be limits to how much it can deliver. The rehabilitation and development of Iraq's oil fields would take years and multiple contracts to complete. The U.S. would hold sway over a new government in Baghdad. But it would not want to alienate the Iraqi public by dictating oil policy, and its influence would inevitably wane. "This isn't the 1800s. We're not talking about a colony. We're talking about an independent country," said Amy Jaffe, senior energy analyst at Rice University's Baker Institute for Public Policy, site of last week's conference. President Bush "is not going to be president of Iraq." Copyright 2002 Los Angeles Times