Rebuilding Iraq: Governance, Security, Reconstruction, and	 
Financing Challenges (25-APR-06, GAO-06-697T).			 
                                                                 
The United States, along with coalition partners and various	 
international organizations, has undertaken a challenging and	 
costly effort to stabilize and rebuild Iraq following multiple	 
wars and decades of neglect by the former regime. This enormous  
effort is taking place in an unstable security environment,	 
concurrent with Iraqi efforts to transition to its first	 
permanent government. In November 2005, the President issued the 
National Strategy for Victory in Iraq. According to the strategy,
victory will be achieved when Iraq is peaceful, united, stable,  
secure, well integrated into the international community, and a  
full partner in the global war on terror. In this testimony, GAO 
discusses the key challenges that the United States,		 
international community, and Iraq face in rebuilding and	 
stabilizing Iraq. This statement is based on four reports GAO has
issued to the Congress since July 2005 and recent trips to Iraq. 
Since July 2005, GAO issued reports on (1) the status of funding 
and reconstruction efforts in Iraq, the progress achieved, and	 
challenges faced in rebuilding Iraq's infrastructure; (2) U.S.	 
efforts in the water and sanitation sector; and (3) U.S.	 
assistance for the January 2005 Iraqi elections, and (4) U.S.	 
efforts to stabilize the security situation in Iraq (a classified
report).							 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-06-697T					        
    ACCNO:   A52420						        
  TITLE:     Rebuilding Iraq: Governance, Security, Reconstruction,   
and Financing Challenges					 
     DATE:   04/25/2006 
  SUBJECT:   Critical infrastructure				 
	     Economic stabilization				 
	     Elections						 
	     Federal aid to foreign countries			 
	     Financial analysis 				 
	     Foreign financial assistance			 
	     Foreign governments				 
	     International cooperation				 
	     International relations				 
	     Performance measures				 
	     Security threats					 

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GAO-06-697T

     

     * Summary
     * Background
     * Iraq Has Made Some Progress in Political, Security, and Econ
          * Iraqis Have Increasingly Participated in the Political Proce
          * Iraqi Forces Are Increasingly Responsible for the Nation's S
          * Iraq's Economy Is Growing and Projects Seek to Improve Essen
     * The Iraqi Government and the United States Face Key Challeng
          * Sectarian Divisions and Immediate Challenges Will Confront I
               * Sectarian Divisions Delay Government Formation
               * Iraq's Government Faces Four Major Challenges to Unifying th
          * A Strong Insurgency and Increased Sectarian Violence Threate
               * Insurgency Has Intensified and Sectarian Tensions Increased
               * Poor Security Conditions Hinder Development of Political and
          * Reconstruction Goals Not Yet Reached Because of Security, Ma
               * Key Reconstruction Goals Have Not Been Achieved
               * Security Conditions Have Hindered Reconstruction Efforts
               * Project Management Challenges Also Affect U.S. Reconstructio
               * Iraq's Capacity to Operate and Maintain U.S.-Funded Projects
               * Limited Performance Data and Measures and Inadequate Reporti
          * Iraq Faces Challenges in Financing Future Needs
               * Iraqi Needs Are Greater Than Originally Anticipated.
               * Future Contributions for Iraq Reconstruction May Be Limited.
               * Iraq Must Address Budget Constraints to Contribute to Future
     * Conclusion
     * GAO Contacts and Acknowledgments
          * Order by Mail or Phone

Testimony

Before the Subcommittee on National Security, Emerging Threats, and
International Relations; Committee on Government Reform, House of
Representatives

United States Government Accountability Office

GAO

For Release on Delivery Expected at 10:00 a.m.

Tuesday, April 25, 2006

REBUILDING IRAQ

Governance, Security, Reconstruction, and Financing Challenges

Statement of David M. Walker

Comptroller General of the United States

GAO-06-697T

Mr. Chairman and Members of the Subcommittee:

I am pleased to be here today to discuss U.S. efforts to stabilize and
rebuild Iraq. The United States, along with its coalition partners and
various international organizations, has undertaken a challenging and
costly effort to stabilize and rebuild Iraq following multiple wars and
decades of neglect by the former regime. This enormous effort is taking
place in an unstable security environment, concurrent with Iraqi efforts
to transition to its first permanent government.

Between fiscal years 2001 and 2005, the U.S. direct financial commitment
to securing and stabilizing Iraq grew to $278 billion. Approximately $248
billion has been provided to support U.S. military operations and forces,
which currently number about 130,000 troops, and about $30 billion to
develop capable Iraqi security forces, restore essential services, and
rebuild Iraqi institutions. In February 2006, the administration requested
an additional $123 billion to support U.S. stabilization and
reconstruction operations in Iraq and Afghanistan in fiscal years 2006 and
2007.1 These amounts do not include future direct costs nor do they
include the significant, additional recapitalization and other longer-term
costs that will be incurred due to the Iraq conflict.

In November 2005, the President issued the National Strategy for Victory
in Iraq. According to the strategy, victory will be achieved when Iraq is
peaceful, united, stable, secure, well integrated into the international
community, and a full partner in the global war on terrorism. The new
strategy also aimed to provide a more comprehensive and coordinated focus
on U.S. stabilization and reconstruction efforts in Iraq. Success in Iraq
requires progress on the three tracks of the President's National Strategy
for Victory in Iraq. The strategy states that progress along one of these
tracks-political, security, or economic-reinforces progress along the
other tracks.

1A separate breakout for Iraq was not provided. For fiscal year 2006, the
administration requested $72.4 billion in supplemental funds, including
$38 billion for defense and intelligence operations in Iraq and
Afghanistan, plus $3.7 billion to develop Iraqi security forces and $3.3
billion for State to continue its operations in Iraq. For fiscal year
2007, the defense budget request includes $50 billion that the Office of
Management and Budget terms "bridge funding" to continue the global war on
terror in Iraq and Afghanistan. State's 2007 budget submission requests an
additional $836 million for reconstruction and embassy operations in Iraq.

My testimony today is based on the four reports that we have issued to the
Congress since July 2005 and on our recent trips to Iraq. Since July 2005,
we have reported on (1) the status of funding and reconstruction efforts
in Iraq, focusing on the progress achieved and the challenges faced in
rebuilding Iraq's infrastructure; (2) U.S. reconstruction efforts in the
water and sanitation sector; (3) U.S. assistance for the January 2005
Iraqi elections; and (4) U.S. efforts to stabilize the security situation
in Iraq (a classified report).

Based on these four reports and recent audit work conducted in Iraq,
including my most recent visit to the country earlier this year, I will
discuss the key challenges that the United States, the international
community, and the Iraqi government face in stabilizing and rebuilding
Iraq. We conducted our reviews for these reports under my authority as
Comptroller General in accordance with generally accepted government
auditing standards. In addition, we recently completed audit work in Iraq
in November 2005, January 2006, and March-April 2006.

                                    Summary

The war in Iraq will not be won by the military alone but only through an
integrated U.S., Iraqi, and international effort to meet the political,
security, economic, and other needs of the Iraqi people.

The United States, our partners, and Iraq have made some progress in
stabilizing and rebuilding Iraq. Iraqis have voted in increasing numbers,
with over 12 million casting votes in the December 2005 election. The
number of security forces that the coalition has trained and equipped has
increased from about 142,000 in March 2005 to about 242,000 in March 2006.
Finally, the United States has completed or has underway about 500 water,
oil, and electricity reconstruction projects.

However, this progress is tempered by the overwhelming challenges faced in
forming a permanent government, quelling the insurgency and sectarian
violence, providing basic services, and financing future reconstruction
efforts.

           o  Four months after the December 2005 election, Iraq is still
           forming a permanent government. Sectarian divisions have delayed
           the formation of a permanent government and created a political
           vacuum. Recent events provide some hope that a new government will
           be formed in the near future. Once formed, the new government will
           confront the enormous tasks of strengthening government
           institutions, disbanding the militias, resolving disputes over
           internal boundaries and oil revenues, and addressing corruption.
           Appointments to the key ministries of Interior, Defense, and Oil
           will be critical to unifying Iraq and minimizing sectarian
           violence. As the new government develops, the Iraqis will need
           assistance and training to strengthen their national and
           provincial governments. A transparent and accountable government
           will reduce corruption and deliver results to the Iraqi people.

           o  From 2004 to 2005, attacks against the coalition, Iraqis, and
           infrastructure increased 23 percent. Despite coalition efforts,
           insurgents continue to demonstrate the ability to recruit, supply,
           and attack coalition and Iraqi security forces. In addition,
           sectarian tensions and violence increased following the February
           2006 bombing of a Shi'a shrine in Samarra. Since then, Iraqis have
           become increasingly concerned that civil war may break out. Many
           Iraqis in Baghdad and the central and northern Sunni areas have
           lost confidence in the Iraqi army and police to improve the
           security situation. In some Sunni areas, support for the
           insurgents has increased, and Iraqi Shi'as have expressed greater
           confidence in their militias. The poor security situation in Iraq
           has impeded the development of an inclusive Iraqi government and
           hindered the development of effective Iraqi security forces.

           o  U.S. reconstruction efforts have focused on restoring Iraq's
           basic services, including refurbishing oil facilities, increasing
           electrical generating capacity, and rebuilding water treatment
           plants. As of March 2006, oil and electricity production were
           below pre-war levels and reconstruction goals for oil,
           electricity, and water had not been met. Iraq produced 2.6 million
           barrels of oil per day before the war; in 2005, production
           averaged 2.1 million barrels per day. Higher than expected
           security costs, funding reallocations, and inadequate maintenance
           have slowed the pace of reconstruction efforts and limited the
           impact of the services provided. For example, in the water sector,
           $1.9 billion was reallocated to the security and justice sectors,
           which delayed or terminated many large water projects. In
           addition, production levels alone do not measure the impact of
           reconstruction efforts. While U.S. efforts have helped Iraq
           produce more clean water, 60 percent is lost due to leakage and
           contamination. Continued focus on developing outcome measures is
           critical to ensure that U.S. efforts are making a difference in
           the lives of the Iraqi people.

           o  Iraq will likely need more than the $56 billion originally
           estimated for reconstruction and stabilization efforts, but it is
           unclear how Iraq will finance its reconstruction needs. U.S.
           commitments are largely obligated, and future commitments focus on
           sustaining existing infrastructure, strengthening ministerial
           capacity, and training and equipping Iraqi security forces.
           International donors are reluctant to commit additional funds
           until security improves and Iraq accounts for the donors' previous
           contributions. Iraq can only contribute to its future
           reconstruction needs if it increases oil revenues, reduces energy
           and food subsidies, controls government operating expenses, and
           minimizes corruption.

           From May 2003 through June 2004, the CPA, led by the United States
           and the United Kingdom, was the UN-recognized coalition authority
           responsible for the temporary governance of Iraq and for
           overseeing, directing, and coordinating the reconstruction effort.
           In May 2003, the CPA dissolved the military organizations of the
           former regime and began the process of creating or reestablishing
           new Iraqi security forces, including the police and a new Iraqi
           army. Over time, multinational force commanders assumed
           responsibility for recruiting and training some Iraqi defense and
           police forces in their areas of responsibility. The U.S.-led
           Multi-National Force-Iraq (MNF-I) conducts counterinsurgency
           operations and leads coalition efforts to train, equip, and
           organize Iraqi security forces.

           The Department of State (State) is responsible for all U.S.
           activities in Iraq except security and military operations.
           State's Iraq Reconstruction and Management Office (IRMO) is
           responsible for planning and prioritizing reconstruction
           requirements, monitoring spending, and coordinating with the
           military commander. Other U.S. government agencies also play
           significant roles in the reconstruction effort. The U.S. Agency
           for International Development (USAID) is responsible for projects
           to restore Iraq's infrastructure, support healthcare and education
           initiatives, expand economic opportunities for Iraqis, and foster
           improved governance. The U.S. Army Corps of Engineers provides
           engineering and technical services to USAID, State, and military
           forces in Iraq. In December 2005, the responsibilities of the
           Project Contracting Office (PCO), a temporary organization
           responsible for program, project, asset, and financial management
           of construction and nonconstruction activities, were merged with
           those of the U.S. Army Corps of Engineers.

           On June 28, 2004, the CPA transferred power to an interim
           sovereign Iraqi government, the CPA was officially dissolved, and
           Iraq's transitional period began. Under Iraq's transitional law,
           the transitional period included the completion of a draft
           constitution in October 2005 and two subsequent elections-a
           referendum on the constitution and an election for a permanent
           government. The Iraqi people approved the constitution on October
           15, 2005, and voted for representatives to the Iraq Council of
           Representatives on December 15, 2005. The Independent Electoral
           Commission of Iraq certified the election results on February 10,
           2006.

           The Iraqi government, in partnership with the United States and
           others, has made some progress in rebuilding and stabilizing Iraq.
           Since June 2004, Iraqis have approved a new constitution and
           increasingly participated in the process of forming the first
           permanent government under this constitution. The United States
           has helped train and equip a growing number of Iraqi security
           forces, and these forces have taken on increasing responsibility
           for the nation's security. Iraq's economy is growing and the
           United States has completed a number of projects to help Iraq add
           to, maintain, or refurbish its electrical, water supply, and oil
           production capacity. Although making progress in many areas, Iraq
           has also had setbacks.

           The U.S. goal is to work with the Iraqi government to form a
           permanent national unity government that is inclusive. According
           to the UN Secretary General, Iraq has met all key benchmarks for
           transitioning to a permanent government under Security Council
           Resolution 1546.2 In January 2005, Iraqis elected a transitional
           National Assembly. Despite intimidation and threats of violence,
           almost 8.5 million Iraqis (59 percent of those registered) cast
           ballots and elected the assembly. In October 2005, the
           transitional government endorsed a draft constitution that,
           according to the U.S. ambassador for Iraq, protects human rights,
           religious freedom, women's equality and Iraqi unity. Iraqis
           approved the constitution, with nearly 10 million voters casting
           ballots (63 percent of those registered). Then, in December 2005,
           over 12 million Iraqis (78 percent of those registered) voted to
           elect the first Council of Representatives. According to the
           National Security Council's Director for Iraq, the increasing
           participation of all Iraqis in the political process, especially
           Sunnis, demonstrates significant political progress. However, the
           majority of Iraqis voted along sectarian lines.

           U.S. goals are to defeat the terrorists and neutralize the
           insurgency, develop capable Iraqi security forces, and help the
           government advance the rule of law, deliver services, and nurture
           civil society. Over the last several months, the Secretaries of
           State and Defense, as well as MNF-I, reported progress in
           developing Iraqi security forces, saying that these forces
           continue to grow in number, take on more responsibilities, and
           increase their lead in counterinsurgency operations. The numbers
           of operational army personnel and trained and equipped police have
           increased from about 142,000 in March 2005 to about 242,000 in
           March 2006. However, as we have previously reported, the number of
           trained and equipped forces does not provide reliable information
           on their status. DOD reports the capabilities of Iraqi units using
           transition readiness assessments. This information is provided to
           the Congress in quarterly classified reports.

           In April 2006, MNF-I also reported that 52 Iraqi army battalions,
           14 Iraqi Army brigades, and 2 Iraqi Army divisions had taken the
           lead for counterinsurgency operations, with coalition support in
           areas of Iraq shown in figure 1 below. The Administration reports
           that these areas of operation cover about 18 percent of Iraq's
           territory, including about 65 percent of Baghdad. 3 According to
           the Director for National Intelligence, Iraqi security forces are
           taking on more-demanding missions, making incremental progress
           toward operational independence, and becoming more capable of
           providing security.

           Figure 1: Areas of Iraq Where the Iraqi Army Leads
           Counterinsurgency Operations with Coalition Support, as of March
           30, 2006

           Source: MNF-I Iraq Operational Update Briefing, April 13, 2006.

           However, according to a DOD report, Iraqi army units remain
           largely dependent on coalition support for key logistics and other
           combat enablers such as transportation and communications. Several
           problems have hampered the Ministry of Defense's ability to
           sustain Iraqi forces independently, including weaknesses in
           payroll, material readiness, contracting, and construction.
           Furthermore, although a concept of logistical support exists, the
           Iraqi army will continue to rely on a U.S. supply chain because
           Iraq does not have a defense industrial base.

           The U.S. economic goal in Iraq is to help the Iraqi government
           establish the foundations for a sound economy with the capacity to
           deliver essential services. The economy continues to grow; the
           International Monetary Fund estimated that Iraq's GDP in 2005 grew
           by 2.6 percent and estimates that it will grow by 10.4 percent in
           2006. While the Iraqi economy continues to be overwhelmingly
           dependent on oil exports, which are projected to accounted for
           approximately 90 percent of government revenue in 2006, other
           sectors have begun to pick up activity, including the trade and
           services sector. According to State and DOD reporting, the United
           States has completed or has underway about 500 water, oil, and
           electricity reconstruction projects. These projects have added or
           restored more than 2,700 megawatts of electricity generation
           capacity and improved other essential services. U.S. efforts have
           helped to restart Iraq's oil production and export capacity,
           including the restoration of the Qarmat Ali water reinjection and
           treatment plant, and several gas and/or oil separation plants near
           Kirkuk and Basrah. However, crude oil production and export and
           electricity production levels remain below pre-war levels,
           according to State.

           The United States and Iraq must address four key challenges if
           they are to successfully stabilize and rebuild Iraq. First, Iraq
           needs to form a permanent government. Second, Iraq and the United
           States must neutralize the insurgency and address sectarian
           violence. Third, the Iraqi government and the United States must
           restore and maintain basic services. Fourth, Iraq must secure
           funding to continue reconstruction efforts begun by the United
           States.

           Forming a permanent government in Iraq is critical to defeating
           the insurgency and securing the peace. However, sectarian
           divisions delayed the formation of a permanent government and
           created a political vacuum. Recent events provide some hope that a
           new government will be formed in the near future. Once formed, the
           new government will face four immediate challenges: building
           effective national and provincial governments, stemming
           corruption, disbanding militias, and resolving disputes on
           boundaries and ownership of future oil fields.

           Sectarian divisions delayed formation of Iraq's permanent
           government creating a political vacuum that increases the risk
           that terrorists and former regime elements will succeed in
           stopping Iraqi progress toward democracy. According to the Defense
           Intelligence Agency (DIA) Director, the December 2005 elections
           appeared to have heightened tension and polarized sectarian
           divides. In February, the Kurdish parties' nomination of Jalal
           Talabani to be president of Iraq was not challenged. However,
           Shi'a, Kurdish and Sunni parties could not agree on a prime
           minister. In this regard, the Secretary of State emphasized that
           the prime minister had to be a leader who could be a unifying
           force bringing stability to the nation.

           In February 2006, the holy Shi'a shrine in Samarra was bombed,
           intensifying sectarian conflicts. The bombing provoked violence
           and reprisal attacks in Baghdad, Basra, and other urban centers
           and almost daily reports of sectarian intimidation and murder,
           according to the UN. During March and April, the Iraqi parties
           continued efforts to identify a prime minister and a cabinet. On
           April 22, Iraq's legislative body selected their speaker and the
           Presidency Council. Also, a candidate for prime minister was
           nominated with support of the Sunnis, Kurds, and Shia coalition.

           According to the President of the United States, Iraq's leaders
           have 30 days to finalize the Iraqi cabinet. Among the ministries
           of key concern are Interior, Defense, and Oil, according to State
           officials. The Ministry of Interior was seriously compromised by
           sectarian influences of militias, corruption, and a culture of
           impunity, according to State's 2006 human rights report. Defense
           is responsible for the Iraqi military services, with over a
           100,000 forces and plays the primary role in stabilizing the
           country. The Ministry of Oil generates about 90 percent of the
           Iraq government's revenue and is the focus of considerable concern
           regarding oil smuggling and corruption.

           The new government will face four immediate challenges once
           formed.

           Developing effective national and provincial governments.
           Strengthening national and provincial institutions is a key step
           in improving governance and supporting efforts to build Iraqi
           self-reliance and defeat the insurgency. However, according to
           U.S. assessments, Iraqi ministries have limited capacity to
           provide government services to the Iraqi people. These assessments
           identified limitations in managers' skills and training; weak
           technical expertise; outdated work processes and procedures; and
           an inability to identify and articulate strategic priorities. In
           January 2006, State reported a new initiative to address Iraqi
           ministerial capacity development at 10 national ministries.
           According to State, Embassy Baghdad plans to undertake plans to
           provide key ministries with training in civil service policies,
           requirements-based budget processes, information technology
           standards, and logistics management systems.

           In addition to a weak national government, Iraqi provinces also
           have limited capacity to provide governmental services. A March
           2006 joint U.S. embassy and MNF-I assessment of stability in each
           of Iraq's 18 provinces showed varying levels of stability across
           Iraq's 18 provinces (see fig. 2).

                                   Background

     Iraq Has Made Some Progress in Political, Security, and Economic Areas

Iraqis Have Increasingly Participated in the Political Process

2U.N. Security Council Resolution 1546 endorsed a timetable for Iraq's
transition to a democratic government which included drafting a permanent
constitution for Iraq leading to a constitutionally elected government by
December 31, 2005.

Iraqi Forces Are Increasingly Responsible for the Nation's Security

3Six National Police battalions also conduct counterinsurgency operations
in Baghdad.

Iraq's Economy Is Growing and Projects Seek to Improve Essential Services

 The Iraqi Government and the United States Face Key Challenges to Stabilizing
                              and Rebuilding Iraq

Sectarian Divisions and Immediate Challenges Will Confront Iraq's Permanent
Government

  Sectarian Divisions Delay Government Formation

  Iraq's Government Faces Four Major Challenges to Unifying the Nation

Figure 2: Iraq Provincial Stability Based on Governance, Security, and
Economic Conditions, as of March 2006

As figure 2 illustrates, the three provinces in Kurdistan have fully
functioning governments, strong economies, and relative security. Eight
provinces have functioning governments with problems in delivering
services and dealing with security. The remaining seven provinces are in
serious or critical condition, with Anbar province rated as critical.

To help build government capacity at the provincial level, the U.S.
embassy in Baghdad and MNF-I are developing provincial reconstruction
teams (PRTs). These teams are designed to provide a link between
provincial and national level efforts to improve governance. These teams
are charged with helping provincial governments improve security, rule of
law, and political and economic development. State officials said that
U.S.-led PRTs in Hillah, Mosul, and Kirkuk have been fully operational
since December. Another PRT in Baghdad has been initiated but is not yet
fully operational. The anticipated four other U.S.-led, four
coalition-led, and six Iraqi-led PRTs have not been initiated. Each PRT
requires more than 100 staff and considerable financial and security
support. However, program documents indicate problems in providing funding
and security.

Stemming corruption. U.S. and international officials reported increased
concerns about corruption. In our discussions with IMF, World Bank, Japan,
and the European Union, representatives reported that "donor fatigue"
might limit their ability to provide future assistance to Iraq, especially
if the current security environment did not improve and the Iraqi
Ministries did not improve their procurement and financial management
practices. Corruption in the oil sector was cited as a special problem.
According to State officials and reporting, about 10 percent of refined
fuels are diverted to the black market, and about 30 percent of imported
fuels are smuggled out of Iraq and sold for a profit.

According to World Bank and UN specialized agency officials, public
tendering is still an "alien concept" within Iraq Ministries. These
officials reported several recent attempts by Ministry officials to
subvert the public procurement process. For example, World Bank financing
for two projects worth $40 million each was cancelled after Iraqi ministry
officials awarded contracts to firms that were not included in the
competitive bidding process.

U.S. officials also reported instances of corruption related to the
protection of essential infrastructure. According to IRMO officials, the
Ministry of Electricity contracts with tribal chiefs, paying them about
$60-$100 per kilometer to protect transmission lines running through their
areas. However, IRMO officials reported that the protection system is
flawed and encourages corruption. According to U.S. and UN Development
Program officials, some tribes that are paid to protect transmission lines
are also selling materials from downed lines and extracting tariffs for
access to repair the lines. IRMO officials stated that they want the
Ministry of Electricity to change the system so that tribes are only paid
when the lines remain operational for a reasonable period of time.

Disbanding militias. Disbanding the militias or integrating them into
Iraq's armed forces is a critical challenge facing a new Iraqi government.
Iraq's 2004 transitional law outlawed all militias not under the command
structure of the Iraqi transitional government, except where provided by
federal law. Iraq's constitution similarly states that formation of
military militias outside the framework of the armed forces is prohibited.
Despite these prohibitions, militias continue to operate throughout Iraq.
The largest militias include the Kurdish Peshmerga organization in
Kurdistan, the Shiite Badr organization in southern Iraq, and the Shiite
Jayash al-Mahdi (Mahdi Army) in central and southern Iraq. In March 2006,
the UN reported that militias challenge Iraq's rule of law and that the
consolidation of local militia power in southern Iraq is resulting in
systematic acts of violence against the Sunni community.4 Such
developments, including recent efforts to form a Sunni Arab militia could
undermine efforts to promote national accord. According to the Secretary
of State, controlling the militias is one of the new government's top
priorities.

Resolving disputes on boundaries and ownership of future oil fields.
Resolving disputes over territorial boundaries, especially in Kirkuk,
poses another challenge. The Kurds believe that this oil-rich region is
part of the Kurdish regional government's territory. According to the 2003
State Department Human Rights report, the previous regime had
systematically forced the removal of ethnic minorities under its admitted
policy of "Arabizing" arable land. Specifically, the regime "Arabized"
certain Kurdish areas, such as the urban centers of Kirkuk and Mosul,
through the forced movement of local residents from their homes and
villages and their replacement by Arabs from outside the area. According
to the U.N., resolution of the dispute over Kirkuk is an issue that needs
to be addressed.

4U.N. Security Council, Report of the Secretary General pursuant to
paragraph 30 of resolution 1546 (2004), S/2006/137, Mar. 3, 2006.

In addition, a new Iraqi government will need to agree on how to share the
proceeds from crude oil exports from both current and future Iraqi oil
fields. The constitution states that oil and gas are owned by the people
of Iraq in all regions and governorates. It also states that the federal
government, with the producing governorates and regional governments,
shall undertake the management of oil and gas extracted from the present
fields, provided that it distributes its revenues fairly and in proportion
to the population.5 However, the specific details of revenue sharing have
yet to be worked out, and the status of revenues from future fields is
unclear.

A Strong Insurgency and Increased Sectarian Violence Threaten Progress in
Political and Security Areas

Over the past 3 years, significant increases in attacks against the
coalition and coalition partners, as well as recent increases in sectarian
violence, have made it difficult for the United States to achieve its
political and security goals in Iraq. The insurgency in Iraq intensified
from June 2003 through October 2005 and has remained strong and resilient.
Sectarian tensions and violence recently increased following the bombing
of a holy Shi'a shrine in Samarra in February 2006. Poor security
conditions threaten to undermine the development of an effective Iraqi
government and the transfer of security responsibilities to the Iraqi
government.

  Insurgency Has Intensified and Sectarian Tensions Increased

The insurgency intensified through October 2005 and has remained strong
and resilient since then. The insurgency-particularly the Sunni
insurgency-grew in complexity, intensity, and lethality from June 2003
through early 2005.6 According to a late February 2006 testimony by the
Director of National Intelligence, insurgents are using increasingly
lethal improvised explosive devices and continue to adapt to coalition
countermeasures.7

5The constitution also states that the federal government shall specify an
allotment of the oil revenue "for a specified period for the damaged
regions which were unjustly deprived of them by the former regime, and the
regions that were damaged afterwards in a way that ensures balanced
development in different areas of the country, and this shall be regulated
by a law."

6For more information on security trends and the makeup of the insurgency,
see GAO, Rebuilding Iraq: Preliminary Observations on Challenges in
Transferring Security Responsibilities to Iraqi Military and Police,
GAO-05-431T (Washington, D.C.: Mar. 14, 2005).

7U.S. Senate, Senate Armed Services Committee, Current and Projected
National Security Threats to the United States (Washington, D.C.: Feb. 2,
2006).

As shown in figure 3, enemy-initiated attacks against the coalition, its
Iraqi partners, and infrastructure increased in number over time. The
highest peak occurred during October 2005, around the time of Ramadan and
the October referendum on Iraq's constitution. This followed earlier peaks
in August and November 2004 and January 2005. According to a senior U.S.
military officer, attack levels ebb and flow as the various insurgent
groups-almost all of which are an intrinsic part of Iraq's
population-rearm and attack again. Overall, attacks increased by 23
percent from 2004 to 2005.

Figure 3: Enemy-Initiated Attacks against the Coalition and Its Partners,
by Category, June 2003 through February 2006

aAccording to DIA officials, June 2003 data are incomplete.

bThe data did not break out attacks against Iraqi government officials
from attacks against Iraqi civilians in January and February 2006.

According to a March 2006 UN report, an increasingly complex armed
opposition continues to be capable of maintaining a consistently high
level of violent activity across Iraq. Baghdad, Mosul, and the western
province of Al Anbar have been experiencing the worst violence. Although
the southern and northern governorates are less affected, some areas,
particularly Basra and Kirkuk, have recently witnessed increased tension
and a growing number of violent incidents. A recent U.S. embassy-MNF-I
assessment showed that, of Iraq's 18 provinces, 1 province-Al Anbar-had a
security situation marked by a high level of insurgent activity,
assassinations, and extremism; 6 provinces, including Baghdad and Basra,
had routine insurgent activity, assassinations, or extremism; 8 provinces
had the security situation under control but conditions existed that could
quickly lead to instability; and 3 provinces in the north had a
semi-permissive security environment where local security forces
maintained the rule of law.

As the administration has reported, insurgents share the goal of expelling
the coalition from Iraq and destabilizing the Iraqi government to pursue
their individual and, at times, conflicting goals.8 Iraqi Sunnis make up
the largest portion of the insurgency and present the most significant
threat to stability in Iraq. In February 2006, the Director of National
Intelligence reported that the Iraqi Sunnis' disaffection is likely to
remain high in 2006, even if a broad, inclusive national government
emerges. These insurgents continue to demonstrate the ability to recruit,
supply, and attack coalition and Iraqi security forces. Their leaders
continue to exploit Islamic themes, nationalism, and personal grievances
to fuel opposition to the government and recruit more fighters.

According to the Director of National Intelligence, the most extreme Sunni
jihadists, such as al-Qaeda in Iraq, will remain unreconciled and continue
to attack Iraqi and coalition forces. The remainder of the insurgency
consists of radical Shi'a groups-some of which are supported by
Iran-violent extremists, criminals, and, to a lesser degree, foreign
fighters. According to the Director, Iran provides guidance and training
to select Iraqi Shi'a political groups and weapons and training to Shi'a
militant groups to enable anticoalition attacks. Iran also has contributed
to the increasing lethality of anticoalition attacks by enabling Shi'a
militants to build improvised explosive devices with explosively formed
projectiles, similar to those developed by the Lebanese Hizballah.

According to the March 2006 UN report, the deteriorating security
situation is further evidenced by the increased levels of sectarian strife
and the sectarian nature of the violence, particularly in ethnically mixed
areas of Iraq. The UN expressed concern about the role of militias and
irregular armed elements in the almost daily reports of intercommunal
intimidation and murder. These include regular reports of bodies of Sunni
and Shi'a men with signs of torture and summary execution in Baghdad and
its surrounding areas. Violence against Kurds and Arabs has also been
reported in Kirkuk, while the abduction and intimidation of ordinary
Iraqis is a growing problem. According to the report, repeated bombings
against civilians, mosques, and more recently against churches are
creating fear, animosity, and feelings of revenge within Iraq's sectarian
communities.

8Department of Defense, Report to Congress, Measuring Stability and
Security in Iraq, July 20, 2005. National Security Council, National
Strategy for Victory in Iraq, November 2005.

  Poor Security Conditions Hinder Development of Political and Security
  Institutions

According to UN and U.S. reports, the continuing insurgency and recent
increase in sectarian violence have impeded the development of an
effective, inclusive Iraqi government. In March 2006, the UN reported that
persistent attacks and terrorist actions by armed groups against the Iraqi
government in large parts of the country challenged the stability of the
country and the government's ability to protect its citizens. According to
a March 2006 State Department survey, Iraqis have become increasingly
concerned that civil war may break out. Iraqis in Baghdad and the central
and northern Sunni areas have lost confidence in the ability of Iraqi army
and police to improve the security situation. At the same time, support
for the armed resistance increased in some Sunni areas, and Iraqis in
Shi'a areas expressed confidence in two large Shi'a militias, the Badr
Organization and the Mahdi Army. In early April 2006, the State Department
reported that the recent terrorist activity and rise in sectarian violence
impeded efforts to further the understanding and trust between political
groups necessary to establish a government of national unity. The report
noted the importance of Iraq developing ministries that sectarian
interests do not control.

Recent U.S. reports have recognized that the security situation has the
potential to hinder progress in developing effective Iraqi security
forces, thereby delaying the transfer of security responsibilities to the
Iraqi government and the drawdown of U.S. forces. For example, in February
2006, the Director of National Intelligence testified that Iraqi security
forces are experiencing difficulty in managing ethnic and sectarian
divisions among their units and personnel, while the director of the
Defense Intelligence Agency reported that many elements of the Iraqi
security forces are loyal to sectarian and party interests. In the
November 2005 National Strategy for Victory in Iraq, the administration
cited a number of challenges to developing effective Iraqi security
forces, including the need to guard against infiltration by elements whose
first loyalties are to institutions other than the Iraqi government.
Moreover, in March and April 2006, a senior U.S. military officer stated
that to help quell sectarian tensions and violence, MNF-I increased the
number of coalition and Iraqi troops in Baghdad. These troops increased
patrols in areas that had been transferred to the Iraqi security forces.

GAO's October 2005 classified report and recent classified briefing to
your staff provided further information and analysis on the challenges to
developing Iraqi security forces and the conditions for the phased
drawdown of U.S. and other coalition forces.9 In response to a
Congressional mandate based on our report, the administration reported to
Congress additional details on the current U.S. mission and the conditions
necessary to transfer security responsibility to the Iraqi government,
including criteria used to evaluate progress.10

Reconstruction Goals Not Yet Reached Because of Security, Management, and
Sustainment Challenges

U.S. reconstruction efforts have focused on restoring basic services in
Iraq, such as repairing oil facilities, increasing electricity generating
capacity, and restoring water treatment plans. However, key reconstruction
goals in the oil, electricity, and water sector have yet to be achieved
due to security, management, and sustainment challenges in U.S.-funded
projects.

  Key Reconstruction Goals Have Not Been Achieved

U.S. electricity, oil, and water projects have focused on restoring
essential services, such as refurbishing and repairing oil facilities,
increasing electrical generating capacity, and restoring water treatment
plants but key reconstruction goals have not been achieved (see table 1).

9GAO, DOD Reports Should Link Economic, Governance, and Security
Indicators to Conditions for Stabilizing Iraq, GAO-06-152C (Washington,
D.C.: Oct. 2005).

10Department of State, Report to Congress submitted pursuant to U.S.
Policy in Iraq Act, Section 1227 of the National Defense Authorization Act
for Fiscal Year 2006 (P.L. 109-163) (Washington, D.C., April 2006).

Table 1: Reconstruction Goals Not Met for Oil Electricity and Water
Sectors

                                         Pre-War  Current (March Planned U.S. 
Sector      Metric                    (2003)   2006)          end state    
Oil         Crude Oil Production      2.6 MBPD 2.0 MBPD       3.0 MBPD     
               Capacity                                          
Electricity Peak Generation Capacity  4300 MW  4,092MW (5387  6,000 MW     
                                                  MW peak in     
                                                  7/14/05)       
Water       New or Restored Treatment Unknown  1.1 M m3/day   2.5 M m3/day 
               Capacity                                          

MBPD = millions of barrels per day

MW = megawatts

M m3/day = million cubic meters per day

Source: U.S. Embassy Baghdad, "Reconstruction Progress in Iraq," March 29,
2006

As of March 2006, oil, electricity, and water sectors were below the
planned U.S. end state. Before the war, oil production in Iraq averaged
2.6 million barrels per day (mbpd). In March 2006, State reported that oil
production was about 2 mbpd, significantly below the desired goal of 3
mbpd. A combination of insurgent attacks on crude oil and product
pipelines, dilapidated infrastructure, and poor operations and maintenance
have hindered domestic refining and have required Iraq to import
significant portions of liquefied petroleum gas, gasoline, kerosene, and
diesel.

In March 2006, electric generation capacity was about 4,100 megawatts.
This level was below the post-war peak of about 5,400 megawatts and the
planned U.S goal of 6,000 megawatts. Insurgent attacks have weakened the
grid and the lack of fuel and spare parts has contributed to disruptions
in service. In the water sector, the U.S. goal of providing 2.5 million
cubic meters of water per day has not been achieved. As of March 2006,
only 1.1 million cubic meters of water per day was produced.

Specifically, production levels for oil and electricity have consistently
fallen below their respective pre-war levels. As shown in Figure 4, since
2004, oil production levels have consistently averaged below pre-war
levels of about 2.6 mbpd. In addition, although the capacity for export is
theoretically as high as 2.5 million bpd, export levels averaged about 1.4
million bpd in 2005.

Figure 4: Iraqi Oil Production, Export, and Revenues, June 2003 through
March 2006

Note: March data as of March 24, 2006

In the electricity sector, production has largely fallen short of the
original target goal of producing 120,000 megawatt-hours of electricity
per day. In May 2005, agency reports show this target goal was reduced to
110,000 megawatt-hours. As shown in figure 5, this target goal was last
reached briefly in the summer of 2005 and has not been met since. In March
2006, about 89,000 megawatt-hours was produced. Agency reports have
attributed the downward spikes in production to several causes, including
planned and unplanned maintenance, fuel shortages due to insurgent attacks
on oil pipeline that supply fuel to power plants, and limited supply of
fuels.

Figure 5: Estimated Daily Electricity Produced in Iraq, January 1,
2004-March 23, 2006

Source: Department of State estimates.

Note: GAO has not assessed the reliability of the data provided by State.

Further, supply has not improved much over last year when judged by hours
of power. According to agency reporting, the national average of available
electricity was 12.3 hours per day in the last week of February, 2006, and
11.7 hours per day last week of March. The average for Baghdad was 8.1
hours per day in February 2006, and 5.7 hours per day in March 2006.
According to agency reporting, Iraqis have become greater consumers and
this had dramatically altered demand and diluted the effect of increased
generation capacity on actual results.

  Security Conditions Have Hindered Reconstruction Efforts

The security situation in Iraq has also affected the cost and schedule of
reconstruction efforts. Security conditions have, in part, led to project
delays and increased costs for security services. Although it is difficult
to quantify the costs and delays resulting from poor security conditions,
both agency and contractor officials acknowledged that security costs have
diverted a considerable amount of reconstruction resources and have led to
canceling or reducing the scope of some reconstruction projects. In
January 2006, State reported that direct and indirect security costs
represent 16 to 22 percent of the overall cost of major infrastructure
reconstruction projects.11 In addition, the security environment in Iraq
has led to severe restrictions on the movement of civilian staff around
the country and reductions of a U.S. presence at reconstruction sites,
according to U.S. agency officials and contractors. For example, in
February 2006 the Project Contracting Office reported that in October 2005
the number of attacks on convoys and casualties had increased from 20
convoys attacked and 11 casualties compared with 33 convoys attacked and
34 casualties in January 2006.

  Project Management Challenges Also Affect U.S. Reconstruction Program

While poor security conditions have slowed reconstruction and increased
costs, a variety of management challenges also have adversely affected the
implementation of the U.S. reconstruction program. In September 2005, we
reported that management challenges such as low initial cost estimates and
delays in funding and awarding task orders have led to the reduced scope
in the water and sanitation program and delays in starting projects. In
addition, U.S. agency and contractor officials have cited difficulties in
initially defining project scope, schedule, and cost, as well as concerns
with project execution, as further impeding progress and increasing
program costs. These difficulties include lack of agreement among U.S.
agencies, contractors, and Iraqi authorities; high staff turnover; an
inflationary environment that makes it difficult to submit accurate
pricing; unanticipated project site conditions; and uncertain ownership of
project sites. Further, between Jan 2004 and April 2006, the
Administration reallocated $3.5 billion from the water and electricity
sectors to security, justice, democracy and other programs which
contributed to the cancellation and delays of water and electricity
projects.

11Department of State, Report to Congress, Section 2207 Report on Iraq
Relief and Reconstruction, January 2006.

  Iraq's Capacity to Operate and Maintain U.S.-Funded Projects Presents
  Sustainability Problems

The U.S. reconstruction program has encountered difficulties with Iraq's
ability to sustain the new and rehabilitated infrastructure and address
maintenance needs. In the water, sanitation, and electricity sectors, in
particular, some projects have been completed but have sustained damage or
become inoperable due to Iraq's problems in maintaining or properly
operating them. State reported in January 2006 that several efforts were
under way to improve Iraq's ability to sustain the infrastructure rebuilt
by the United States.

           o  In the water and sanitation sector, U.S. agencies have
           identified limitations in Iraq's capacity to maintain and operate
           reconstructed facilities, including problems with staffing,
           unreliable power to run treatment plants, insufficient spare
           parts, and poor operations and maintenance procedures. In March
           2005, State reallocated funding from an electrical generation
           project and provided $25 million to USAID to support the
           operations, maintenance, and logistics for USAID's reconstructed
           water and sanitation projects for up to 1 year. According to a
           senior IRMO official, the U.S. government has allocated an
           additional $110 million to the Project Contracting Office to
           sustain water and sanitation facilities and equipment that were
           procured, constructed, or rehabilitated using IRRF monies. The
           program, expected to begin soon after the USAID effort ends in
           April 2006, will consist of two major components-operations and
           maintenance support and assistance and capacity development. The
           objectives of the program are to effectively operate U.S.
           government-funded facilities in the near term and to help the
           Iraqi government sustain these efforts over the long-term.

           o  The U.S. government purchased 41 natural gas turbines to
           support Iraq's efforts to generate more electricity, but Iraqi
           power plants are using fuel oil for all these engines due to
           limited access to natural gas. The use of oil-based fuels, without
           adequate equipment modification and fuel treatment, decreases the
           power output of the gas turbines by up to 50 percent, requires
           three times more maintenance, and could result in equipment
           failure and damage that significantly reduce the life of the
           equipment, according to U.S. and Iraqi power plant officials. IRMO
           estimates that the yearly cost of operating these turbines with
           oil-based fuels instead of natural gas totals $1.25 billion.12 If
           Iraq were able to capture the gas it currently flares and use it
           in these turbines, IRMO estimates that the annual operating cost
           would be about $81.8 million. However, this latter cost does not
           include initial capital expenditures for the infrastructure needed
           to collect and process the natural gas and transport it to the
           power plants. In addition, the IRMO analysis assumes that the cost
           of natural gas is zero since this gas is currently flared in
           Iraq's oil fields. These cost comparisons will be analyzed in more
           detail as part of our ongoing review of Iraq's energy sector.

           o  The Iraqis' capacity to operate and maintain the power plant
           infrastructure and equipment provided by the United States remains
           a challenge at both the plant and ministry levels. As a result,
           the infrastructure and equipment remain at risk of damage
           following their transfer to the Iraqis. U.S. officials have
           acknowledged that more needs to be done to train plant operators
           and ensure that advisory services are provided after the turnover
           date. In January 2006, State reported that it has developed a
           strategy with the Ministry of Electricity to focus on
           rehabilitation and sustainment of electricity assets.

           Problems with the turnover of completed projects, such as those in
           the water and sanitation and electricity sectors, have led to a
           greater interagency focus on improving project sustainability and
           building ministry capacity. In January 2006, State reported that
           it has several efforts under way focused on improving Iraq's
           ability to operate and maintain facilities over time. As part of
           our ongoing review of Iraq's energy sector, we will be assessing
           the extent to which the administration is providing funds to
           sustain the infrastructure facilities constructed or rehabilitated
           by the United States.

           While State has set broad goals for providing essential services,
           and the U.S. program has undertaken many rebuilding activities in
           Iraq, limited performance data and outcome measures make it
           difficult to determine and report on the progress and impact of
           U.S. reconstruction. In January 2006, State reported that it is
           currently finalizing a set of metrics to better track the impact
           of reconstruction efforts.

           In the water and sanitation sector, the Department of State has
           primarily reported on the numbers of projects completed and the
           expected capacity of reconstructed treatment plants. However, we
           found that the data are incomplete and do not provide information
           on the scope and cost of individual projects nor do they indicate
           how much clean water is reaching intended users as a result of
           these projects. Moreover, reporting only the number of projects
           completed or under way provides little information on how U.S.
           efforts are improving the amount and quality of water reaching
           Iraqi households or their access to sanitation services. For
           example, the United States reports that, as of March 2006, Iraq
           has the capacity to produce 1.1 million cubic meters of water per
           day. However, this level overestimates the amount of potable water
           reaching Iraqi households because U.S. officials estimate that 60
           percent of water treatment output is lost due to leakage,
           contamination, and illegal connections. In addition, potable water
           and sewage lines in Iraq are sometimes adjacent to each other,
           allowing leaking sewage to enter the water mains when there is
           insufficient pressure in the lines. In the absence of metering and
           quality measures, it is unclear how U.S. efforts are improving
           Iraqi access to water and sanitation services.

           Limitations in health sector measurements also make it difficult
           to relate the progress of U.S. activities to its overall effort to
           improve the quality and access of health care in Iraq. Department
           of State measurements of progress in the health sector primarily
           track the number of completed facilities, an indicator of
           increased access to health care. However, the data available do
           not indicate the adequacy of equipment levels, staffing levels, or
           quality of care provided to the Iraqi population. Monitoring the
           staffing, training, and equipment levels at health facilities may
           help gauge the effectiveness of the U.S. reconstruction program
           and its impact on the Iraqi people.

           In the electricity sector, U.S. agencies have primarily reported
           on generation measures such as levels of added or restored
           generation capacity and daily power generation of electricity;
           numbers of projects completed; and average daily hours of power.
           However, these data do not show whether (1) the power generated is
           uninterrupted for the period specified (e.g., average number of
           hours per day); (2) there are regional or geographic differences
           in the quantity of power generated; and (3) how much power is
           reaching intended users. Information on the distribution and
           access of electricity is difficult to obtain without adequate
           security or accurate metering.

           As the new Iraqi government forms, it must plan to secure the
           financial resources it will need to continue the reconstruction
           and stabilization efforts begun by the United States and
           international community. Initial assessments in 2003 identified
           $56 billion in reconstruction needs across a variety of sectors in
           Iraq. However, Iraq's needs are greater than originally
           anticipated due to severely degraded infrastructure, post-conflict
           looting and sabotage, and additional security costs. The United
           States has borne the primary financial responsibility for
           rebuilding and stabilizing Iraq; however, its commitments are
           largely obligated and remaining commitments and future
           contributions will focus on sustaining rebuilt infrastructure,
           building government institutions, and training and equipping Iraqi
           security forces. Further, U.S. appropriations were never intended
           to meet all Iraqi needs. International donors have provided a
           lesser amount of funding for reconstruction and development
           activities; however, most of the pledged amount is in the form of
           loans that Iraq has just begun to access. Iraq's ability to
           contribute financially to its additional rebuilding and
           stabilization needs is dependent upon the new government's efforts
           to increase revenues obtained from crude oil exports, and reduce
           expenditures.

           Initial assessments of Iraq's needs through 2007 by the U.N.,
           World Bank, and the CPA estimated that the reconstruction of Iraq
           would require about $56 billion.13 However, Iraq is likely to need
           more funding than currently available to meet the demands of the
           country. The state of some Iraqi infrastructure was more severely
           degraded than U.S. officials originally anticipated or initial
           assessments indicated. The condition of the infrastructure was
           further exacerbated by post-2003 conflict looting and sabotage. In
           addition, insurgents continue to target electrical transmission
           lines and towers as well as oil pipelines that provide needed fuel
           for electrical generation.

           Further, these initial assessments assumed that Iraqi government
           revenues and private sector financing would increasingly cover
           long-term reconstruction requirements. This was based on the
           assumption that the rate of growth in oil production and total
           Iraqi revenues would increase over the next several years.
           However, private sector financing and government revenues may not
           yet meet these needs. According to a January 2006 International
           Monetary Fund (IMF) report, private sector investment will account
           for 8 percent of total projected investment for 2006, down from 12
           percent in 2005.14 In the oil sector alone, Iraq will likely need
           an estimated $30 billion over the next several years to reach and
           sustain an oil production capacity of 5 million barrels per day,
           according to industry experts and U.S. officials. For the
           electricity sector, Iraq projects that it will need $20 billion
           through 2010 to boost electrical capacity, according to the
           Department of Energy's Energy Information Administration.

           The United States is the primary contributor to rebuilding and
           stabilization efforts in Iraq. Since 2003, the United States has
           made available about $30 billion for activities that have largely
           focused on infrastructure repair and training of Iraqi security
           forces. As of January 2006, of the $30 billion appropriated, about
           $23 billion had been obligated and about $16 billion had been
           disbursed for activities that included infrastructure repair,
           training, and equipping of the security and law enforcement
           sector; infrastructure repair of the electricity, oil, and water
           and sanitation sectors; and CPA and U.S. administrative expenses.

           International donors have provided a lesser amount of funding for
           reconstruction and development activities. According to State,
           donors have provided about $2.7 billion in multilateral and
           bilateral grants-of the pledged $13.6 billion-as of December 2005.
           About $1.3 billion has been deposited by donors into the two trust
           funds of the International Reconstruction Fund Facility for Iraq
           (IRFFI),15 of which about $900 million had been obligated and
           about $400 million disbursed to individual projects, as of
           December 2005. Donors also have provided bilateral assistance for
           Iraq reconstruction activities; however, complete information on
           this assistance is not readily available. Most of the pledged
           amount is in the form of loans that the Iraqis have recently begun
           to access. About $10 billion, or 70 percent, of the $13.6 billion
           pledged in support of Iraq reconstruction is in the form of loans,
           primarily from the World Bank, the IMF, and Japan.

           Iraq's fiscal ability to contribute to its own rebuilding is
           constrained by the amount of revenues obtained from crude oil
           exports, continuing subsidies for food and energy, growing costs
           for government salaries and pensions, increased demands for an
           expanding security force, and war reparations and external debt.

           Crude oil exports are projected to account for nearly 90 percent
           of the Iraqi government revenues in 2006, according to the IMF.
           Largely supporting Iraq's government operations and subsidies,
           crude oil export revenues are dependent upon export levels and
           market price. The Iraqi 2006 budget has projected that Iraq's
           crude oil export revenues will grow at an annual growth rate of 17
           percent per year (based on an average production level of 2
           million bpd in 2005 to 3.6 million bpd in 2010), estimating an
           average market price of about $46 per barrel. Oil exports are
           projected to increase from 1.4 million bpd in 2005 to 1.7 million
           bpd in 2006, according to the IMF. Iraq's current crude oil export
           capacity is theoretically as high as 2.5 million bpd, according to
           the Energy Information Administration at the Department of Energy.
           However, Iraq's crude oil export levels have averaged 1.4 million
           bpd as of December 2005, in part due to attacks on the energy
           infrastructure and pipelines. In February 2006, crude oil export
           levels averaged about 1.5 million bpd.

           While Iraq produces crude oil, its ability to produce refined fuel
           products, such as diesel and gasoline, is limited. According to
           State, the Iraqi Oil Ministry imported roughly $500 million of
           fuel each month in 2005. As a result, Iraq must import fuel to
           meet domestic demand. According to State, the imported fuel is
           sold at a subsidized price, further constraining Iraqi budgetary
           resources.

           Current government subsidies constrain opportunities for growth
           and investment and have kept prices for food, oil, and electricity
           low. Low prices have encouraged over-consumption and have fueled
           smuggling to neighboring countries. Food and energy subsidies
           account for about 8 percent of Iraq's projected gross domestic
           product (GDP) for 2006.

           As part of its Stand-By Arrangement with the IMF, Iraq plans to
           reduce the government subsidy of petroleum products, which would
           free up oil revenues to fund additional needs and reduce
           smuggling. According to the IMF, by the end of 2006, the Iraqi
           government plans to complete a series of adjustments to bring fuel
           prices closer to those of other Gulf countries. However, it is
           unclear whether the Iraqi government will have the political
           commitment to continue to raise fuel prices. The scheduled March
           increase in the price of diesel and gasoline was delayed until
           June 2006. Iraqis currently pay about $.26 per gallon for regular
           gasoline compared to about $.91 per gallon in neighboring
           countries.

           Generous wage and pension benefits have added to budgetary
           pressures. Partly due to increases in these benefits, the Iraqi
           government's operating expenditures are projected to increase by
           over 24 percent from 2005 to 2006, according to the IMF. As a
           result, wages and pensions constitute about 21 percent of
           projected GDP for 2006. The IMF noted that it is important for the
           government to keep non-defense wages and pensions under firm
           control to contain the growth of civil service wages. Under the
           IMF agreement, the Iraqi government must complete a census of all
           public service employees by June 2006. The census will help
           address the issue of ghost employees in Iraqi ministries-employees
           on the payroll but not working, according to a U.S. Treasury
           official.

           Iraq plans to spend more resources on its own defense. Iraq's
           security-related spending is currently projected to be about $5.3
           billion in 2006, growing from 7 to about 13 percent of projected
           GDP. The amount reflects rising costs of security and the transfer
           of security responsibilities from the United States to Iraq.

           The Iraqi government also owes over $84 billion to victims of its
           invasion of Kuwait and international creditors. As of December
           2005, Iraq owed about $33 billion in unpaid awards resulting from
           its invasion and occupation of Kuwait. As directed by the UN, Iraq
           currently deposits 5 percent of its oil proceeds into a UN
           compensation fund. Final payment of these awards could extend
           through 2020 depending on the growth of Iraq's oil proceeds. In
           addition, the IMF estimated that Iraq's external debt was about
           $51 billion at the end of 2005.

           Iraq is at a precarious stage in its emerging democracy and 2006
           will be a critically important year in its development. Continuing
           insurgent violence and growing sectarian divisions make it
           increasingly difficult to achieve the ultimate U.S. goal of a
           united and stable Iraq that is well integrated into the
           international community and a full partner in the global war on
           terrorism. The United States, Iraq, and our international partners
           face daunting challenges in achieving this goal and making a
           difference in lives of the Iraqi people. These include forming a
           national unity government, quelling the insurgency and sectarian
           violence, providing basic services, and financing future
           reconstruction efforts.

           In moving forward to achieve U.S. goals, it is important that the
           United States continue training and equipping Iraqi security
           forces and, more importantly, ensuring that these forces have the
           logistical capabilities to support and sustain themselves. The
           United States along with the international community should also
           help Iraqis develop the budgeting and administrative tools they
           need to run their national and provincial governments.
           Additionally, transparency and accountability mechanisms are
           essential given the legacy of corruption inherited from the
           previous regime. Efforts should also be taken to ensure that
           Iraqis are capable of maintaining power plants, water treatment
           facilities, and other U.S.-funded infrastructure.

           Although the United States has played a key role in addressing
           these challenges, it is important for the Iraqis to assume greater
           leadership and for the international community to increase its
           efforts. In assuming leadership, the Iraqis need to form a
           permanent government and address unresolved constitutional and
           budgetary issues. Of particular importance is disbanding the
           militias, reducing subsidies, and controlling a bloated
           bureaucracy. Even as they address these difficult challenges, Iraq
           must reengage the international community to fund the enormous
           reconstruction tasks that remain. This will not be easy since
           donors are demanding accountability for funding they have provided
           over the past 3 years.

           Collectively, Iraq's future requires strong Iraqi leadership,
           sustained U.S. commitment, and a reengaged international
           community. All these will be essential in order for real success
           to be achieved.

           Mr. Chairman and Members of the Subcommittee, this concludes my
           prepared statement. I will be happy to answer any questions you
           may have.

           For questions regarding this testimony, please call Joseph
           Christoff at (202) 512-8979. Other key contributors to this
           statement were Monica Brym, Lynn Cothern, Dave Groves, Patrick
           Hickey, Steve Lord, Micah McMillan, Judy McCloskey, Tet Miyabara,
           Kate Monahan, Mary Moutsos, and Audrey Solis. Jeanette Espinola,
           Ian Ferguson, Valerie Nowak, Jeff Phillips, Nanette Ryen, and
           Alper Tunca provided technical assistance.

           The Government Accountability Office, the audit, evaluation and
           investigative arm of Congress, exists to support Congress in
           meeting its constitutional responsibilities and to help improve
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  Limited Performance Data and Measures and Inadequate Reporting Present
  Difficulties in Determining Progress and Impact of Rebuilding Effort

12Total annual operating costs by type of oil used: (1) $228 million for
crude oil in 4 turbines; (2) $206 million for residual oil in 20 turbines;
and (3) $819 million for diesel oil in 17 turbines. IRMO based these
calculations on International Standards Organization rated capacity in
megawatts for each engine.

Iraq Faces Challenges in Financing Future Needs

  Iraqi Needs Are Greater Than Originally Anticipated.

13The October 2003 joint UN/World Bank assessment identified $36 billion,
from 2004 through 2007, in immediate and medium-term needs in 14 priority
sectors, including education, health, electricity, transportation,
agriculture, and cross-cutting areas such as human rights and the
environment. For example, the assessment estimated that Iraq would need
about $12 billion for rehabilitation and reconstruction, new investment,
technical assistance, and security in the electricity sector. In addition,
the assessment noted that the CPA estimated an additional $20 billion
would be needed from 2004 through 2007 to rebuild other critical sectors
such as security and oil.

  Future Contributions for Iraq Reconstruction May Be Limited.

14International Monetary Fund, Iraq: Request for Stand-by-Arrangement
(Washington, D.C.: January 2006).

15The IRFFI was established in response to the June 24, 2003, UN technical
meeting and the 2003 Madrid conference's calls for a mechanism to channel
and coordinate donor resources for Iraq reconstruction and development
activities. The IRFFI is composed of two trust funds, one run by the UN
Development Group and the other by the World Bank Group.

  Iraq Must Address Budget Constraints to Contribute to Future Rebuilding and
  Stabilization Efforts.

                                   Conclusion

                        GAO Contacts and Acknowledgments

(320429)

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Highlights of GAO-06-697T , a testimony before the Subcommittee on
National Security, Emerging Threats, and International Relations;
Committee on Government Reform, House of Representatives

April 25, 2006

REBUILDING IRAQ

Governance, Security, Reconstruction, and Financing Challenges

The United States, along with coalition partners and various international
organizations, has undertaken a challenging and costly effort to stabilize
and rebuild Iraq following multiple wars and decades of neglect by the
former regime. This enormous effort is taking place in an unstable
security environment, concurrent with Iraqi efforts to transition to its
first permanent government.

In November 2005, the President issued the National Strategy for Victory
in Iraq. According to the strategy, victory will be achieved when Iraq is
peaceful, united, stable, secure, well integrated into the international
community, and a full partner in the global war on terror.

In this testimony, GAO discusses the key challenges that the United
States, international community, and Iraq face in rebuilding and
stabilizing Iraq.

This statement is based on four reports GAO has issued to the Congress
since July 2005 and recent trips to Iraq. Since July 2005, GAO issued
reports on (1) the status of funding and reconstruction efforts in Iraq,
the progress achieved, and challenges faced in rebuilding Iraq's
infrastructure; (2) U.S. efforts in the water and sanitation sector; and
(3) U.S. assistance for the January 2005 Iraqi elections, and (4) U.S.
efforts to stabilize the security situation in Iraq (a classified report).

The war in Iraq will not be won by the military alone. Iraq's future
requires strong Iraqi leadership, sustained U.S. commitment, and a
reengaged international community.

The United States, Iraq, and its partners have made some progress in
stabilizing and rebuilding Iraq. Iraqis have voted in increasing numbers,
with over 12 million casting votes in the December 2005 election. Over the
past year, the number of security forces that the coalition has trained
and equipped has increased from about 142,000 to about 242,000. Finally,
the United States has completed or has underway about 500 water, oil, and
electricity reconstruction projects.

However, this progress is tempered by the overwhelming challenges the
coalition faces. First, sectarian divisions delayed the formation of a
permanent government and created a political vacuum. Recent events provide
some hope that a new government will be formed in the near future. Once
formed, the new government will confront the enormous tasks of
strengthening government institutions, disbanding the militias, resolving
disputes over internal boundaries and oil revenues, addressing corruption,
and delivering results to the Iraqi people. Of particular importance is
providing the Iraqis with the training and technical assistance needed to
run their national and provincial governments. A transparent and
accountable government can reduce corruption and deliver results to the
Iraqi people.

Second, the security environment continues to be a concern as insurgents
demonstrate the ability to recruit, supply, and attack coalition and Iraqi
security forces. From 2004 to 2005, attacks against the coalition, Iraqis,
and infrastructure increased 23 percent. Since the bombing of a Samarra
mosque in February 2006, Iraqis have become increasingly concerned that
civil war may break out. The poor security situation in much of Iraq has
impeded the development of an inclusive Iraqi government and effective
Iraqi security forces.

Third, higher than expected security costs, funding reallocations, and
inadequate maintenance have impeded U.S. reconstruction efforts. As of
March 2006, oil and electricity production were below pre-war levels and
reconstruction goals for oil, electricity, and water had not been met.
Iraq produced 2.6 million barrels of oil per day before the war; in 2005,
production averaged 2.1 million barrels per day. Production levels alone
do not measure the impact of reconstruction efforts. While U.S. efforts
have helped Iraq produce more clean water, 60 percent is lost due to
leakage and contamination. Continued focus on developing outcome measures
is critical to ensure that reconstruction efforts are making a difference
in the lives of the Iraqi people.
*** End of document. ***