The Heritage Foundation

Executive Summary #1730 on Iraq

March 4, 2004

March 4, 2004 | Executive Summary on Iraq

Executive Summary: Models and Policies for Oil Production, Revenue Collection, and Public Expenditure: Lessons in Iraq

Countries in both the developed and developing worlds rely on a stable and secure supply of oil. However, abuses and misallocations of oil revenues often lead to social and political instability and, at times, armed conflict. The broader the political cooperation and public consensus, and the greater the transparency in the management of oil revenues, the greater the chance that the supplier will remain stable.

The challenge of devising models and policies for oil production in developing or transitional economies is formidable. Resource-rich countries tend to fall behind non-oil economies in economic development, rate of growth in gross domestic product (GDP), GDP per capita, and human development. Oil often derails democratic development, causing civil strife and civil war. Other problems such as graft and "rent-seeking behavior" regularly accompany oil exploration and exploitation.

A private and transparently managed international oil and gas sector is vital to global energy security and, thus, in the national interest of the United States. Returning Iraqi oil to the international oil markets is important for the Iraqi people, the United States, other Western countries, and the global economy.

Creating the New Iraqi Oil Industry 
The Coalition Provisional Authority and the Iraqi Governing Council should:

  • Initiate a public debate about development of the rule of law and property rights, including mineral rights. This should include Western economists, Iraqi officials, and the public and should cover the future of oil production, taxation, and the distribution of income. As part of the debate, the CPA and IGC should conduct a comprehensive public campaign aimed at privatization of oil and gas industry assets and reserves as well as broad institutional reform. Many Iraqi officials and other members of police and media elites are not aware of the macroeconomic factors that support privatization. It keeps the oil revenue out of government's hands and institutes publicly accountable and transparent decision-making processes on oil production.
  • Bolster property rights and the rule of law, including enabling legislation and regulations on oil and gas production that allow private ownership of all productive assets and minerals. This also involves fostering an independent judiciary, training judges to handle complicated civil litigation such as energy law, and allowing international arbitration as well as enforcement of arbitral awards.
  • Conduct a comprehensive audit of state-of-the art techniques of oil privatization, revenue generation, and management. This information should then be disseminated to the Iraqi political leadership, management of the oil and financial sectors, and broader elites. U.S. institutions (e.g., the CPA and U.S. Agency for International Development), major oil companies, nonprofit organizations, the International Monetary Fund, and the World Bank should all be involved in this undertaking.
  • Ensure that privatization is both transparent and perceived as being in the interest of the Iraqi people.
  • Develop safeguards to prevent smuggling and diversion of oil and refined products from "well to wheel" and create a law enforcement climate in which the diversion for private use and theft of crude oil, refined products, or revenue is reported, prosecuted, and punished.
  • Improve revenue collection, such as taxation of oil sales, by establishing independent audit procedures, supporting public supervision by bona fide non-governmental organizations (NGOs), and developing an independent media.
  • Assist in creation of a national, private, professionally and independently managed oil fund. This could be a modified version of the Alaska arrangement, allowing for direct deposits of revenues into the private bank accounts of the Iraqi people, and would go a long way toward legitimizing the future Iraqi government and privatization of oil assets.
  • Develop open budgetary and legislative processes for oil revenue. As part of the open budgetary process, budgetary drafts must be prepared by legislative and governmental budgetary offices and publicly available before the final vote. NGOs should be allowed to participate in such discussions, thus enhancing the development of civil society in Iraq.

Conclusion
Privatization should be undertaken only after a public education campaign and good-faith effort to build a consensus among the Iraqis that private ownership of industrial assets, including commodities, is economically more efficient than a government-owned system.

Oil revenue from Iraqi oil should be transparently managed, adequately taxed, and protected from government abuse and corruption. To facilitate this process, a professionally managed oil fund should be seriously considered. Such a fund would protect oil revenues from the long hands of the Iraqi politicians. As in the Alaska model, part of the revenue should be distributed directly to the bank accounts of every Iraqi.

These are only some of the answers and challenges facing state oil revenue management. Those tasked with solving these problems owe the people of Iraq their best efforts not to repeat the abuses of the past.

Ariel Cohen, Ph.D., is Research Fellow in Russian and Eurasian Studies and International Energy Security in the Kathryn and Shelby Cullom Davis Institute for International Studies at The Heritage Foundation.

About the Author

Ariel Cohen, Ph.D. Visiting Fellow in Russian and Eurasian Studies and International Energy Policy in the Douglas and Sarah Allison Center for Foreign and National Security Policy, a division of the Kathryn and Shelby Cullom Davis Institute for International Studies, at The Heritage Foundation
Douglas and Sarah Allison Center for Foreign and National Security Policy