Rebuilding Iraq: Serious Challenges Impair Efforts to Restore	 
Iraq's Oil Sector and Enact Hydrocarbon Legislation (18-JUL-07,  
GAO-07-1107T).							 
                                                                 
Rebuilding Iraq's oil sector is crucial to rebuilding Iraq's	 
economy. For example, oil export revenues account for over half  
of Iraq's gross domestic product and over 90 percent of 	 
government revenues. This testimony addresses (1) the U.S. goals 
for Iraq's oil sector and progress in achieving these goals, (2) 
key challenges the U.S. government faces in helping Iraq restore 
its oil sector, and (3) efforts to enact and implement		 
hydrocarbon legislation. This statement is based on our May 2007 
report and updated data, where appropriate.			 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-07-1107T					        
    ACCNO:   A72870						        
  TITLE:     Rebuilding Iraq: Serious Challenges Impair Efforts to    
Restore Iraq's Oil Sector and Enact Hydrocarbon Legislation	 
     DATE:   07/18/2007 
  SUBJECT:   Budgeting						 
	     Critical infrastructure				 
	     Crude oil						 
	     Crude oil pipeline operations			 
	     Federal aid to foreign countries			 
	     Federal funds					 
	     Foreign governments				 
	     International organizations			 
	     Iraq War and reconstruction			 
	     Oil resources					 
	     Petroleum legislation				 
	     Smuggling						 
	     Strategic planning 				 
	     Corruption 					 
	     Iraq						 
	     Iraq Relief and Reconstruction Fund		 

******************************************************************
** This file contains an ASCII representation of the text of a  **
** GAO Product.                                                 **
**                                                              **
** No attempt has been made to display graphic images, although **
** figure captions are reproduced.  Tables are included, but    **
** may not resemble those in the printed version.               **
**                                                              **
** Please see the PDF (Portable Document Format) file, when     **
** available, for a complete electronic file of the printed     **
** document's contents.                                         **
**                                                              **
******************************************************************
GAO-07-1107T

   

     * [1]Summary
     * [2]Background
     * [3]Iraq's Oil Production Goals Have Not Been Met and Oil Produc

          * [4]U.S. Oil Goals Have Not Been Met
          * [5]Iraq's Crude Oil Production May Be Overstated
          * [6]Metering of Oil Production and Distribution Network Has Been

     * [7]Security, Corruption, and Funding Challenges Hinder Reconstr

          * [8]Poor Security Conditions Have Slowed Reconstruction and Incr
          * [9]Corruption and Smuggling Reduce Oil Revenues
          * [10]Future Funding Needs Are Significant but Funding Sources Are

     * [11]Challenges Impede Efforts to Enact and Implement Comprehensi
     * [12]Conclusion
     * [13]Recommendations for Executive Action
     * [14]Agency Comments
     * [15]GAO Contacts and Acknowledgments
     * [16]Appendix I: Data on Iraq's Crude Oil Production and Exports

          * [17]Order by Mail or Phone

Testimony

Before the Subcommittee on the Middle East and South Asia and the
Subcommittee on International Organizations, Human Rights, and Oversight,
Committee on Foreign Affairs, House of Representatives

United States Government Accountability Office

GAO

For Release on Delivery
Expected at 2:00 p.m. EDT
Wednesday, July 18, 2007

REBUILDING IRAQ

Serious Challenges Impair Efforts to Restore Iraq's Oil Sector and Enact
Hydrocarbon Legislation

Statement of Joseph A. Christoff, Director
International Affairs and Trade

GAO-07-1107T

Mr. Chairmen and Members of the Subcommittees:

I am pleased to be here today to discuss U.S. efforts to rebuild Iraq's
oil sector and Iraq's efforts to enact hydrocarbon legislation.

The oil sector is critical to Iraq's economy, accounting for over half of
Iraq's gross domestic product and over 90 percent of its revenues. The
timely and equitable distribution of these revenues is essential to Iraq's
ability to provide for its needs, including the reconstruction of a
unified Iraq.

The Iraqi government inherited oil infrastructure that was greatly
deteriorated due to the previous regime's neglect; international
sanctions; and years of conflict, looting, and vandalism. For fiscal years
2003 through 2006, the U.S. government made available about $2.7 billion
in reconstruction funds to help restore Iraq's crude oil production and
exports. The United States spent an additional $2.8 billion in Iraqi funds
on the oil sector through the end of 2005; however, these funds were used
primarily to purchase petroleum products because Iraq does not have
adequate domestic refining capability.

My testimony discusses (1) U.S. goals for Iraq's oil sector and progress
in achieving these goals, (2) key challenges the U.S. government faces in
helping Iraq restore its oil sector, and (3) efforts to enact and
implement hydrocarbon legislation.

This statement is based on our May 2007 report^1 and updated data, where
appropriate. To accomplish our report objectives, we reviewed and analyzed
U.S., Iraqi, donor government, United Nations (UN), International Monetary
Fund (IMF), and World Bank reports and data. During two trips to Iraq and
Jordan, we met with Iraqi, UN, IMF, World Bank, donor country (Japan and
European Union), private sector, and U.S. officials. We also analyzed data
on Iraqi oil production from the Department of State and the Department of
Energy's Energy Information Administration (EIA). This work was conducted
in accordance with generally accepted government auditing standards.

^1GAO, Rebuilding Iraq: Integrated Strategic Plan Needed to Help Restore
Iraq's Oil and Electricity Sectors, [18]GAO-07-677 (Washington, D.C.: May
15, 2007).

Summary

Despite 4 years of effort and $2.7 billion in U.S. reconstruction funds,
Iraqi oil output has consistently fallen below the U.S. goals of producing
3 million barrels per day (mbpd) and exporting 2.2 mbpd. For 2006, State
Department data show that crude oil production and exports averaged 2.1
mbpd and 1.5 mbpd, respectively. However, the State Department's data on
Iraq's oil production may be overstated since data from the U.S.
Department of Energy show lower production levels--between 100,000 and
300,000 barrels fewer each day. Inadequate metering, reinjection,
corruption, theft, and sabotage account for the discrepancy, which amounts
to $5 million to $15 million daily, or about $1.8 billion to $5.5 billion
per year. Comprehensive metering of Iraq's oil production has been a
long-standing problem and continuing need.

Poor security, corruption, and funding constraints continue to impede
reconstruction of Iraq's oil sector. The U.S. reconstruction effort was
predicated on the assumption that a permissive security environment would
exist. However, a deteriorating security environment continues to place
workers and infrastructure at risk while protection efforts have been
insufficient. Widespread corruption and smuggling continue to reduce oil
revenues. According to State Department officials and reports, about 10
percent to 30 percent of refined fuels is diverted to the black market or
smuggled out of Iraq and sold for a profit. Moreover, Iraq's needs are
significant and future funding for the oil sector is uncertain as nearly
80 percent of the U.S. funds for the oil sector have been spent. Iraq's
contribution to improving its infrastructure has been minimal with the
government spending less than 3 percent of the $3.5 billion it approved
for oil reconstruction projects in 2006. Further, the international
community has not provided any grants to develop the oil sector, and Iraq
has not accessed nearly $500 million in loans from international
contributions to the oil sector. U.S. and international officials stated
that international donors have not provided funds for the oil sector
because they expected that Iraq and the private sector would provide the
needed resources.

Iraq has yet to enact and implement comprehensive hydrocarbon legislation
that defines the distribution of future oil revenues and the rights of
foreign investors. Until this legislation is enacted and implemented, it
will be difficult for Iraq to attract the billions of dollars in foreign
investment it needs to modernize the oil sector. According to the State
Department, as of July 13, 2007, Iraq's cabinet had approved only one of
four separate but interrelated pieces of legislation-- hydrocarbon
framework legislation that establishes structure, management, and
oversight for the sector. This draft legislation is currently being
considered by Iraq's parliament (Council of Representatives). A second
piece of legislation, the revenue-sharing legislation, has been drafted
but not approved by Iraq's cabinet (Council of Ministers). Two other
pieces of legislation that would restructure the Ministry of Oil and
establish an Iraq National Oil Company have not been drafted. According to
a State Department and a Kurdistan Regional Government (KRG) official, the
passage and implementation of all four laws is essential to achieve
increased transparency, accountability, and revenue management. However,
poor security, corruption, and lack of unity and trust will likely impede
the implementation of the legislation.

In our May 2007 report, we recommended that the Secretary of State work
with the Iraqi government and particularly with the Ministries of Oil and
Electricity to (1) develop an integrated energy strategy for the oil and
electricity sectors; (2) expedite efforts to establish an effective
metering system for the oil sector; (3) develop fair and equitable
hydrocarbon legislation, regulations, and implementing guidelines; (4)
expedite efforts to develop adequate budgeting, procurement, and financial
management systems; and (5) implement a viable donor mechanism to secure
funding for Iraq's future oil and electricity rebuilding needs.

In commenting on our prior report, State agreed that all the steps we
included in our recommendations are necessary to improve Iraq's energy
sector but stated that these actions are the direct responsibility of the
Government of Iraq, not the Department of State, any U.S. agency, or the
international donor community. We recognize that these actions are
ultimately the responsibility of the Iraqi government. However, the U.S.
government wields considerable influence in overseeing Iraq stabilization
and rebuilding efforts.

Background

Iraq's oil infrastructure is an integrated network that includes crude oil
fields and wells, pipelines, pump stations, refineries, gas oil separation
plants, gas processing plants, export terminals, and ports (see fig. 1).
This infrastructure has deteriorated significantly over several decades
due to war damage; inadequate maintenance; and the limited availability of
spare parts, equipment, new technology, and financing. Considerable
looting after Operation Iraqi Freedom and continued attacks on crude and
refined product pipelines have contributed to Iraq's reduced crude oil
production and export capacities.

Figure 1: Overview of Iraq's Oil Network

Iraq's crude oil reserves, estimated at a total of 115 billion barrels,
are the third largest in the world. However, Iraq's ability to extract
these reserves has varied widely over time and has been significantly
affected by war. Figure 2 shows Iraq's daily average crude oil production
levels annually from 1970 through 2006.

Figure 2: Crude Oil Production Levels in Iraq, 1970 through 2006

Iraq's crude oil production reached 3.5 mbpd, its highest annual average,
in 1979. In September 1980, Iraq invaded Iran and production levels
plummeted. Although the Iran-Iraq War continued until 1988, production
levels grew steadily after 1983, peaking at 2.9 million barrels per day in
1989. The Gulf War began the following year when Iraq invaded Kuwait. In
January 1991, the United States and coalition partners began a
counter-offensive (Operation Desert Storm). Crude oil production once
again dropped precipitously and remained relatively low from 1990 to 1996,
while Iraq was under UN sanctions. Under the UN Oil for Food program,
Iraqi crude oil production began to rebound, peaking at an annual average
of 2.6 mbpd in 2000. In the 5 years preceding the 2003 U.S. invasion of
Iraq, crude oil production averaged 2.3 mbpd. In 2003, crude oil
production dropped again to a low of about 1.3 million barrels per day
(annual average) but then rebounded.

Iraq's Oil Production Goals Have Not Been Met and Oil Production Figures May Be
Overstated

Despite U.S. and Iraqi government efforts to reconstruct Iraq's key
economic sector, oil production has consistently fallen below U.S. program
goals. In addition, production levels may be overstated and measuring them
precisely is challenging due to limited metering and poor security.
Comprehensive metering has been an outstanding goal of the United States,
the international community, and the Iraqi government.

U.S. Oil Goals Have Not Been Met

Key reconstruction goals for Iraq's oil sector, including those for crude
oil production and exports, and refined fuel production capacity and stock
levels, have not been met. U.S. goals for the oil sector include reaching
an average crude oil production capacity of 3 million barrels per day
(mbpd) and crude oil export levels of 2.2 mbpd.^2 However, in 2006, actual
crude oil production and exports averaged, respectively, about 2.1 mbpd
and 1.5 mbpd. Figure 3 compares Iraq's oil production and exports with
U.S. goals (the data for this figure are presented in appendix I). As the
figure shows, production and exports for the first five months of 2007
were still below U.S. goals. In August 2003, the CPA established a U.S.
program goal to increase crude oil production to about 1.3 mbpd. The CPA
increased this goal every 2 to 3 months until July 2004, when the goal
became to increase crude oil production capacity to 3.0 mbpd.^3

^2U.S. goals differ from the government of Iraq and IMF targets. According
to the State Department, as of January 2007, Iraq's production goal is 2.1
mbpd and its export goal is 1.7 mbpd.

^3Production capacity differs from actual production. Production capacity
is the maximum amount of production a country can maintain over a period
of time. For example, EIA has defined production capacity as the maximum
amount of production that (1) could be brought online within 30 days and
(2) sustained for at least 90 days. Since Iraq has been trying to increase
its production of crude oil, we use actual production as an indicator of
Iraq's production capacity in this report.

Figure 3: Iraqi Reported Crude Oil Production and Exports and U.S. Goals,
June 2003 through May 2007

Besides production and export of crude oil, the CPA also established goals
for the production of natural gas and liquefied petroleum gas (LPG), as
well as the national stocks of refined petroleum products (such as
gasoline) that are used to generate energy by consumers and businesses.
These CPA goals were to increase production capacity of natural gas to 800
million standard cubic feet per day (mscfd); increase production capacity
of LPG to 3,000 tons per day (tpd); and meet demand for benzene
(gasoline), diesel, kerosene, and LPG by building and maintaining their
stock levels at a 15-day supply.

However, the 2006 averages did not meet these goals. To increase the
stocks of petroleum products and their availability to consumers, Iraq
legalized the importation of petroleum products by private companies to
supplement its own production and state-owned company imports. For 2006,
the IMF estimated that Iraq's state-owned companies imported about $2.6
billion of petroleum products. At the recommendation of the IMF, the Iraqi
government has been reducing subsidies for refined oil products, which
raises the prices consumers pay. In the past, refined oil products in Iraq
had been highly subsidized, which led to increased demand. Reduction in
domestic demand for refined oil products would allow additional crude oil
to be exported for revenue rather than refined in Iraq.

Iraq's Crude Oil Production May Be Overstated

Iraq's crude oil production statistics may be overstated. We compared the
State Department's statistics to those published by the EIA, which are
based on alternate sources.^4 Part of EIA's mission is to produce and
disseminate statistics on worldwide energy production and use. While these
two data sets follow similar trend lines, EIA reports that Iraqi oil
production was about 100,000 to 300,000 barrels per day lower than the
amounts the State Department reported. At an average price of $50 per
barrel, this is a discrepancy of $5 million to $15 million per day, or
$1.8 billion to $5.5 billion per year. Figure 4 shows these two data sets
over the time period (June 2003 to March 2007) for which data from both
State and EIA were available. The data for this figure are presented in
appendix I.

^4EIA uses its own analysis and a variety of sources, including Dow Jones,
the Middle East Economic Survey, the Petroleum Intelligence Weekly, the
International Energy Agency (IEA), the Monthly Oil Market Report from
OPEC, the Oil & Gas Journal, Platts, and Reuters.

Figure 4: Comparison of State Department and EIA Data on Iraq's Crude Oil
Production

According to EIA, several factors may account for the discrepancy. One
factor is the lack of storage facilities for crude oil in Iraq. Crude oil
that cannot be processed by refineries or exported is reinjected into the
ground.^5 Another factor affecting the discrepancy may be differences in
the frequency and timing of the data. The State Department's data are
reported daily in real time, while EIA produces monthly data that have
been reviewed and corroborated from several sources. This lag in reporting
and longer time period may allow analysts to address inconsistencies such
a double counting and reinjection. In addition, the State Department
regularly reports on sabotage and interdictions to crude oil pipelines and
other disruptions in the crude oil production process. Also, under Saddam
Hussein, Iraq had a history of diverting crude oil production to
circumvent UN sanctions. Therefore, it is possible that corruption, theft,
and sabotage may also be factors in the discrepancy.

^5Reinjecting crude oil--and, more commonly heavy fuel oil (residual
oil)--into wells is one way to maintain pressure in the wells for
extraction. However, this practice can also damage the wells and reduce
the value of the remaining reserves.

Metering of Oil Production and Distribution Network Has Been a Long-standing but
Unmet Goal

Reliable information on Iraqi's oil production is further complicated by
the lack of metering. According to a State Department oil advisor, meters
are in place at many locations but are not usable in many instances due to
the difficulties in obtaining needed replacements and spare parts. Without
comprehensive metering, crude oil production must be estimated using less
precise means, such as estimating the flow through pipelines and relying
on reports from onsite personnel rather than an automated system that
could be verified.

An improved metering system has been a U.S. and international donor
priority since early 2004, but implementation has been delayed. In 1996,
the UN first cited the lack of oil metering when Iraq was under UN
sanctions. In 2004, the International Advisory and Monitoring Board (IAMB)
for the Development Fund for Iraq recommended the expeditious installation
of metering equipment. According to IAMB, in June 2004, the CPA had
approved a budget to replace, repair, and calibrate the metering system on
Iraq's oil pipeline network. However, the oil metering contract was not
completed due to security and technical issues. In June 2006, IAMB
reported that the Iraqi government had entered into an agreement with
Shell Oil Company to serve as a consultant for the Ministry of Oil. Shell
would advise the ministry on the establishment of a system to measure the
flow of oil, gas, and related products within Iraq and in export and
import operations. The U.S. government is assisting in this effort by
rebuilding one component of the metering system in the Al-Basrah oil
port--Iraq's major export terminal--and expects the project to be complete
in July 2007.

Security, Corruption, and Funding Challenges Hinder Reconstruction Efforts

The U.S. government and Iraq face several key challenges in improving
Iraq's oil sector. First, the U.S. reconstruction program assumed a
permissive security environment that never materialized; the ensuing lack
of security resulted in project delays and increased costs. Second,
corruption and smuggling have diverted government revenues potentially
available for rebuilding efforts. Third, future funding needs for
reconstruction of Iraq's oil sector are significant, but the source of
these funds is uncertain.

Poor Security Conditions Have Slowed Reconstruction and Increased Costs

The U.S. reconstruction effort was predicated on the assumption that a
permissive security environment would exist. However, since May 2003,
overall security conditions in Iraq have deteriorated and grown more
complex, as evidenced by the increased numbers of attacks (see fig. 5).
The average number of daily attacks in June 2007 was about the same level
as the prior high of about 180 attacks per day that occurred in October
2006 around the time of Ramadan. Overall, the average number of daily
attacks was about 50 percent higher in June 2007 than in June 2006.^6

Figure 5: Enemy-Initiated Attacks against the Coalition, Iraqi Security
Forces, and Civilians (May 2003 through June 2007)

Note: Attacks against infrastructure account for less than 1 percent of
enemy-initiated attacks.

The deteriorating security environment has led to project delays and
increased costs. Insurgents have destroyed key oil infrastructure,
threatened workers, compromised the transport of materials, and hindered
project completion and repairs by preventing access to work sites.
Moreover, looting and vandalism have continued since 2003. U.S. officials
reported that major oil pipelines in the north continue to be sabotaged,
shutting down oil exports and resulting in lost revenues. For example,
according to the Army Corps of Engineers, although eight gas oil
separation plants in northern Iraq have been refurbished, many are not
running due to interdictions on the Iraq-Turkey pipeline and new
stabilization plant. The Corps noted that if the lines and plant were in
operation today, an additional 500,000 barrels per day could be produced
in northern Iraq.

^6While the data on attacks provide a reasonably sound depiction of
security trends, DOD documents and officials acknowledge that these data
provide only a partial picture of violence in Iraq because not all attacks
against civilians and Iraqi security forces are observed by or reported to
coalition forces.

The U.S. government has developed a number of initiatives to protect the
oil infrastructure and transfer this responsibility to the Iraqi
government.^7 Such efforts include fortifying the infrastructure and
improving the capabilities of rapid repair teams and protection security
forces such as the Oil Protection Force and the Strategic Infrastructure
Battalions (SIB). The U.S. government has paired these security forces
with coalition partners and has trained and equipped the SIBs. However,
U.S. officials stated that the capability and loyalty of some of these
units are questionable. According to Department of Defense (DOD) and
Center for Strategic and International Studies reports,^8 these security
forces have been underpaid, underequipped, and poorly led, and are
sometimes suspected of being complicit in interdiction and smuggling.
Additional information on the nature and status of these efforts and the
SIBs is classified.

Corruption and Smuggling Reduce Oil Revenues

U.S. and international officials have noted that corruption in Iraq's oil
sector is pervasive. In 2006, the World Bank and the Ministry of Oil's
Inspector General estimated that millions of dollars of government revenue
are lost each year to oil smuggling or diversion of refined products.
According to State Department officials and reports, about 10 percent to
30 percent of refined fuels are diverted to the black market or are
smuggled out of Iraq and sold for a profit. According to State Department
reporting, Iraqi government officials may have profited from these
activities. The insurgency has been partly funded by corrupt activities
within Iraq and by skimming profits from black marketers, according to
U.S. embassy documents. According to a June 2007 DOD report, a variety of
criminal, insurgent, and militia groups engage in the theft and illicit
sale of oil to fund their activities. For example, DOD reported that as
much as 70 percent of the fuel processed at Bayji was lost to the black
market--possibly as much as $2 billion a year. As a result, the Iraqi Army
assumed control of the entire Bayji refinery, and equipment is being
installed to prevent siphoning.

^7The Special Inspector General for Iraq Reconstruction (SIGIR),
Unclassified Summary of SIGIR's Review of Effort to Increase Iraq's
Capability to Protect Its Energy Infrastructure, SIGIR-06-038 (Washington,
D.C., Sept. 27, 2006).

^8Anthony Cordesman, Center for Strategic and International Studies, Iraqi
Force Development and the Challenge of Civil War: The Critical Problems
and Failures the U.S. Must Address If Iraqi Forces Are to Eventually Do
the Job (Washington, D.C.: Nov. 30, 2006). Department of Defense,
Measuring Stability and Security in Iraq (Washington, D.C.: June 7, 2007).

One factor that had stimulated black market activities and fuel smuggling
to neighboring countries was Iraq's low domestic fuel prices, which were
subsidized by the government. However, under the IMF's Stand-by
Arrangement with Iraq, the government has already increased domestic fuel
prices several times, significantly reducing the subsidy for many fuel
products. The Iraqi government intends to continue the price increases
during 2007 and encourage private importation of fuels, which was
liberalized in 2006. The purpose is to decrease the incentive for black
market smuggling and to increase the availability of fuel products.

Future Funding Needs Are Significant but Funding Sources Are Uncertain

While billions have been provided to rebuild Iraq's oil sector, Iraq's
future needs are significant and sources of funding are uncertain. For
fiscal years 2003 through 2006, the United States made available about
$2.7 billion, obligated about $2.6 billion, and spent about $2.1 billion
to rebuild Iraq's oil sector. According to various estimates and
officials, Iraq will need billions of additional dollars to rebuild,
maintain, and secure its oil sector. Since the majority of U.S. funds have
been spent, the Iraqi government and international community represent
important sources of potential future funding.

However, the Iraqi government has not fully spent the capital project
funds already allocated to the oil sector in Iraq's 2006 budget. In 2006,
Iraq planned to spend more than $3.5 billion for capital projects in the
oil sector. This amount accounted for about 98 percent of the Ministry of
Oil's total budget ($3.6 billion) that year. As of December 2006, the end
of Iraq's fiscal year, only 3 percent of oil sector capital project funds
had been spent.^9 While Iraq's inability to spend its capital budget may
not directly affect U.S.-funded projects, U.S. investment alone is not
adequate for the full reconstruction and expansion of the oil sector.
Therefore, Iraq's continued difficulties in spending its capital budget
could hamper efforts to attain its current reconstruction goals.

According to U.S. officials, Iraq lacks the clearly defined and
consistently applied budget and procurement rules needed to effectively
implement capital projects. For example, the Iraqi ministries are guided
by complex laws and regulations, including those implemented under Saddam
Hussein, the CPA, and the current government. According to State
Department officials, the lack of agreed-upon procurement and budgeting
rules causes confusion among ministry officials and creates opportunities
for corruption and mismanagement. Additionally, according to the State
Department and DOD, personnel turnover within the ministries, fear of
corruption charges, and an onerous contract approval process^10 have
caused delays in contract approval and capital improvement expenditures.

Furthermore, the Iraqi government has not made full use of potential
international loans, and future donor funding for the oil sector remains
uncertain. Donors other than the United States have not provided any
grants to develop the oil sector, and the Iraqi government had not taken
advantage of $467 million in loans from Japan to develop a crude oil
export facility and upgrade a refinery. According to U.S. and
international officials, donor funding has been limited because of an
expectation that sufficient funds would be provided through Iraq's oil
revenues and private investors.

Moreover, it is unclear to what extent the International Compact with Iraq
will serve as a viable mechanism to obtain additional donor support for
Iraq, particularly for the oil sector. Launched in May 2007, the compact
was intended to secure additional funding for Iraq's oil, electricity, and
other sectors. However, the extent to which the compact will stimulate
international assistance for the oil sector remains uncertain.

^9Although U.S. advisors are aware of various Iraqi ministries' limited
spending in areas such as capital projects, we cannot verify the precision
of these numbers. For the purpose of this testimony, we only use these
data, in conjunction with U.S. advisors' reports, to identify limited
spending as a potential challenge for Iraq should it rely on its
ministries' own budgets to fund future reconstruction projects.

^10According to the State Department, the Contracting Committee
requirement for about a dozen signatures to approve electricity and oil
contracts exceeding $10 million further slows a bureaucratic process.

Challenges Impede Efforts to Enact and Implement Comprehensive Hydrocarbon
Legislation

The World Bank reports that additional incentives are needed to stimulate
oil production and investment, including a clear legal and regulatory
framework; clearly assigned roles for Iraq's ministries, state agencies,
and the private sector; and a predictable negotiating environment for
contracts. Iraq has yet to enact and implement comprehensive hydrocarbon
legislation that would define the distribution of future oil revenues and
the rights of foreign investors. According to U.S. officials, until such
legislation is passed and implemented, it will be difficult for Iraq to
attract the billions of dollars in foreign investment it needs to
modernize the oil sector.

As of July 13, 2007, the Iraqi government was in various stages of
drafting and enacting four separate, yet interrelated, pieces of
legislation: hydrocarbon framework legislation that establishes the
structure, management, and oversight for the sector; revenue-sharing
legislation (the draft "Law of Financial Resources"); legislation
restructuring the Ministry of Oil; and legislation establishing the Iraq
National Oil Company (INOC). According to the State Department, to be
enacted as law, the four pieces of legislation must be approved by Iraq's
cabinet (Council of Ministers), vetted through the Shura council,^11 and
then submitted by the cabinet to a vote by Iraq's parliament (Council of
Representatives). If the laws are passed, they are then made publicly
available in the Iraqi government's official publication, known as the
Official Gazette. Figure 6 shows the status of the four proposed pieces of
legislation as of July 1, 2007.

^11According to a State Department official responsible for monitoring the
hydrocarbon legislation, the Shura Council is the committee to ensure
constitutionality and avoid contradictions with the Iraqi legal system
(including Islamic law).

Figure 6: Status of Iraq's Hydrocarbon Legislation, July 1, 2007

Note: According to a State Department official, as of July 13, 2007, the
annexes may have been dropped from the hydrocarbon framework legislation
because agreement could not be reached on the allocation of petroleum
fields and exploration areas. It remains uncertain how this reportedly
contentious issue will be resolved.

The draft hydrocarbon framework is the furthest along in the legislative
process and is currently before Iraq's parliament, according to a State
Department and a KRG official. According to these officials, it provides
an overall framework but lacks key details that will be addressed in the
financial resources and other legislation. The UN reported in early June
2007 that there had been no decision on whether the hydrocarbon framework
legislation would be voted on as a part of a larger energy package with
annexes and supporting legislation or voted on separately. The KRG has
published the negotiated "agreed-to" text for the revenue-sharing
legislation, which has not yet been approved by the cabinet. Negotiated
text of the draft legislation for restructuring the Ministry of Oil and
establishing INOC have yet to be developed and published. According to a
State Department and KRG officials, the passage and implementation of all
four pieces of legislation is essential to achieve increased transparency,
accountability, and revenue management.

Moreover, enacting and implementing hydrocarbon legislation and subsequent
regulations and procedures will likely be impeded by some of the same
challenges, such as poor security and corruption, that affect achieving
program goals and reconstruction of the oil sector. According to U.S.
officials, sectarian attacks and the lack of national unity and trust have
resulted in competing sectarian interests and wariness of foreign
investment. Also, according to U.S. officials, opportunities to profit
from corruption and smuggling reduce the incentive for greater
transparency and accountability in oil resource management. U.S. officials
recognize that significant implementation challenges will remain once the
draft legislation is enacted into law.

Conclusion

As we recently reported, the United States has spent billions of dollars
to rebuild Iraq's oil sector, but billions more will be needed to surmount
the challenges facing Iraq's oil sector. Iraq's oil sector lacks an
effective metering system to measure output, determine revenue trends, and
identify illicit diversions. Opaque laws governing investment have also
limited foreign investment in this critical sector. The passage of
comprehensive Iraqi hydrocarbon legislation could serve as an important
impetus for stimulating additional investment if and when security
conditions improve. The development of the sector is also hindered by weak
government budgeting, procurement, and financial management systems and
limited donor spending. The absence of an integrated strategic plan that
coordinates efforts across the oil and electricity sectors is essential
given their highly interdependent nature. Such a plan would help identify
the most pressing needs for the entire energy sector and help overcome the
daunting challenges affecting future development prospects.

Recommendations for Executive Action

In our May 2007 report, we recommended that the Secretary of State, in
conjunction with relevant U.S. agencies and in coordination with the donor
community, work with the Iraqi government and particularly the Ministry of
Oil to:

           1. Develop an integrated energy strategy for the oil and
           electricity sectors that identifies and integrates key short-term
           and long-term goals and priorities for rebuilding, maintaining,
           and securing the infrastructure; funding needs and sources;
           stakeholder roles and responsibilities, including steps to ensure
           coordination of ministerial and donor efforts; environmental risks
           and threats; and performance measures and milestones to monitor
           and gauge progress.
           2. Set milestones and assign resources to expedite efforts to
           establish an effective metering system for the oil sector that
           will enable the Ministry of Oil to more effectively manage its
           network and finance improvements through improved measures of
           production, consumption, revenues, and costs.
           3. Improve the existing legal and regulatory framework, for
           example, by setting milestones and assigning resources to expedite
           development of viable and equitable hydrocarbon legislation,
           regulations, and implementing guidelines that will enable
           effective management and development of the oil sector and result
           in increased revenues to fund future development and essential
           services.
           4. Set milestones and assign resources to expedite efforts to
           develop adequate ministry budgeting, procurement, and financial
           management systems.
           5. Implement a viable donor mechanism to secure funding for Iraq's
           future oil and electricity rebuilding needs and for sustaining
           current energy sector infrastructure improvement initiatives once
           an integrated energy strategic plan has been developed.

Agency Comments

In commenting on a draft of our May 2007 report, the State Department
agreed that all the steps we included in our recommendations are necessary
to improve Iraq's energy sector but stated that these actions are the
direct responsibility of the Government of Iraq, not of the Department of
State, any U.S. agency, or the international donor community. The State
Department also commented that U.S. agencies are already taking several
actions consistent with our recommendations. We recognize that these
actions are ultimately the responsibility of the Iraqi government.
However, it remains clear that the U.S. government wields considerable
influence in overseeing Iraq stabilization and rebuilding efforts. We also
believe additional actions are warranted given the lack of progress that
has been made over the last 4 years in achieving Iraq reconstruction
goals.

Mr. Chairmen, this concludes my statement. I would be pleased to answer
any questions that you or other Members may have at this time.

GAO Contacts and Acknowledgments

For questions regarding this testimony, please call Joseph A. Christoff at
(202) 512-8979 or [19][email protected] . Other key contributors to this
statement were Stephen Lord, Assistant Director; Lynn Cothern; Kathleen
Monahan; and Timothy Wedding.

Appendix I: Data on Iraq's Crude Oil Production and Exports

Table 1 provides the data used in figures 3 and 4 of this testimony.
Department of State data on Iraq's crude oil production and exports are
collected by State Department officials in Iraq through Iraq's Ministry of
Oil. We calculated Iraq's production for domestic consumption (the amount
of oil produced that remains in the country) as the remainder of Iraq's
production of crude oil after exports, based on State Department's data.
Data from the Department of Energy's Energy Information Administration
(EIA) are based on EIA's own analysis and a variety of sources, including
Dow Jones, the Middle East Economic Survey, the Petroleum Intelligence
Weekly, the International Energy Agency, OPEC's Monthly Oil Market Report,
the Oil & Gas Journal, Platts, and Reuters.

Table 1: Iraq's Oil Production, Exports, Production for Domestic
Consumption (millions of barrels per day)

                         State Department Data                       EIA Data 
                                  Production for Domestic                     
Month/Year  Production Exports             Consumption Production          
Jun-03           0.596   0.200                   0.396      0.452          
Jul-03           0.927   0.322                   0.605      0.572          
Aug-03           1.408   0.646                   0.762      1.050          
Sep-03           1.705   0.983                   0.722      1.399          
Oct-03           2.046   1.149                   0.897      1.749          
Nov-03           2.124   1.524                   0.600      1.848          
Dec-03           2.278   1.541                   0.737      1.948          
Jan-04           2.406   1.537                   0.869      2.103          
Feb-04           2.289   1.382                   0.907      2.003          
Mar-04           2.421   1.825                   0.596      2.203          
Apr-04           2.445   1.804                   0.641      2.303          
May-04           2.149   1.380                   0.769      1.903          
Jun-04           1.899   1.148                   0.751      1.703          
Jul-04           2.210   1.406                   0.804      2.003          
Aug-04           2.148   1.114                   1.034      1.803          
Sep-04           2.539   1.679                   0.860      2.303          
Oct-04           2.435   1.607                   0.828      2.203          
Nov-04           1.916   1.351                   0.565      1.703          
Dec-04           2.156   1.607                   0.549      1.903          
Jan-05           2.076   1.367                   0.709      1.903          
Feb-05           2.103   1.431                   0.672      1.903          
Mar-05           2.091   1.394                   0.697               1.903 
Apr-05           2.121   1.398                   0.723               1.903 
May-05           2.127   1.308                   0.819               1.903 
Jun-05           2.140   1.440                   0.700               1.903 
Jul-05           2.172   1.550                   0.622               2.003 
Aug-05           2.153   1.504                   0.649               1.903 
Sep-05           2.089   1.609                   0.480               2.053 
Oct-05           1.944   1.239                   0.705               1.803 
Nov-05           1.981   1.168                   0.813               1.703 
Dec-05           1.978   1.071                   0.907               1.653 
Jan-06           1.713   1.094                   0.619               1.603 
Feb-06           1.829   1.473                   0.356               1.803 
Mar-06           2.072   1.325                   0.747               1.903 
Apr-06           2.183   1.596                   0.587               1.903 
May-06           2.131   1.507                   0.624               1.903 
Jun-06           2.221   1.702                   0.519               2.153 
Jul-06           2.226   1.685                   0.540               2.203 
Aug-06           2.238   1.582                   0.656               2.203 
Sep-06           2.348   1.740                   0.608               2.153 
Oct-06           2.247   1.511                   0.737               2.103 
Nov-06           2.097   1.436                   0.660               2.003 
Dec-06           2.156   1.450                   0.706               2.003 
Jan-07           1.597   1.292                   0.305               1.753 
Feb-07           2.084   1.494                   0.590               2.003 
Mar-07           2.073   1.571                   0.502               2.053 
Apr-07           2.141   1.491                   0.650                     
May-07           2.024   1.631                   0.393                     

Source: State Department and U.S. Energy information.

Note: EIA data on Iraq's crude oil production are available only through
March 2007.

(320516)

This is a work of the U.S. government and is not subject to copyright
protection in the United States. It may be reproduced and distributed in
its entirety without further permission from GAO. However, because this
work may contain copyrighted images or other material, permission from the
copyright holder may be necessary if you wish to reproduce this material
separately.

GAO's Mission

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 the performance and
accountability of the federal government for the American people. GAO
examines the use of public funds; evaluates federal programs and policies;
and provides analyses, recommendations, and other assistance to help
Congress make informed oversight, policy, and funding decisions. GAO's
commitment to good government is reflected in its core values of
accountability, integrity, and reliability.

Obtaining Copies of GAO Reports and Testimony

The fastest and easiest way to obtain copies of GAO documents at no cost
is through GAO's Web site ( [20]www.gao.gov ). Each weekday, GAO posts
newly released reports, testimony, and correspondence on its Web site. To
have GAO e-mail you a list of newly posted products every afternoon, go to
[21]www.gao.gov and select "Subscribe to Updates."

Order by Mail or Phone

The first copy of each printed report is free. Additional copies are $2
each. A check or money order should be made out to the Superintendent of
Documents. GAO also accepts VISA and Mastercard. Orders for 100 or more
copies mailed to a single address are discounted 25 percent. Orders should
be sent to:

U.S. Government Accountability Office 441 G Street NW, Room LM Washington,
D.C. 20548

To order by Phone: Voice: (202) 512-6000
TDD: (202) 512-2537
Fax: (202) 512-6061

To Report Fraud, Waste, and Abuse in Federal Programs

Contact:

Web site: [22]www.gao.gov/fraudnet/fraudnet.htm
E-mail: [23][email protected]
Automated answering system: (800) 424-5454 or (202) 512-7470

Congressional Relations

Gloria Jarmon, Managing Director, [24][email protected] (202) 512-4400 U.S.
Government Accountability Office, 441 G Street NW, Room 7125 Washington,
D.C. 20548

Public Affairs

Paul Anderson, Managing Director, [25][email protected] (202) 512-4800
U.S. Government Accountability Office, 441 G Street NW, Room 7149
Washington, D.C. 20548

[26]www.gao.gov/cgi-bin/getrpt?GAO-07-1107T .

To view the full product, including the scope
and methodology, click on the link above.

For more information, contact Joseph A. Christoff at (202) 512-8979 or
[email protected].

Highlights of [27]GAO-07-1107T , a testimony to the Subcommittee on the
Middle East and South Asia and Subcommittee on International
Organizations, Human Rights, and Oversight; Committee on Foreign Affairs,
House of Representatives

July 18, 2007

REBUILDING IRAQ

Serious Challenges Impair Efforts to Restore Iraq's Oil Sector and Enact
Hydrocarbon Legislation

Rebuilding Iraq's oil sector is crucial to rebuilding Iraq's economy. For
example, oil export revenues account for over half of Iraq's gross
domestic product and over 90 percent of government revenues.

This testimony addresses (1) the U.S. goals for Iraq's oil sector and
progress in achieving these goals, (2) key challenges the U.S. government
faces in helping Iraq restore its oil sector, and (3) efforts to enact and
implement hydrocarbon legislation. This statement is based on our May 2007
report and updated data, where appropriate.

[28]What GAO Recommends

In our May 2007 report, we recommended that the Secretary of State, in
conjunction with international donors, work with Iraqi ministries to
develop an integrated energy strategy, expedite efforts to establish an
effective oil metering system, and enact and implement fair and equitable
hydrocarbon legislation. State commented that the Iraqi government, not
the U.S. government, is responsible for taking action on GAO's
recommendations. GAO believes that these recommendations are still valid
given the billions made available to date and the U.S. government's
influence in Iraq.

Despite 4 years of effort and $2.7 billion in U.S. reconstruction funds,
Iraqi oil output has consistently fallen below U.S. program goals. In
addition, the State Department's data on Iraq's oil production may be
overstated since data from the U.S. Department of Energy show lower
production levels--between 100,000 and 300,000 barrels less per day.
Inadequate metering, re-injection, corruption, theft, and sabotage account
for the discrepancy, which amounts to about $1.8 to $5.5 billion per year.
Comprehensive metering of Iraq's oil production has been a long-standing
problem and continuing need.

Poor security, corruption, and funding constraints continue to impede
reconstruction of Iraq's oil sector. The deteriorating security
environment places workers and infrastructure at risk while protection
efforts have been insufficient. Widespread corruption and smuggling reduce
oil revenues. Moreover, Iraq's needs are significant and future funding
for the oil sector is uncertain as nearly 80 percent of U.S. funds for the
oil sector have been spent. Iraq's contribution has been minimal with the
government spending less than 3 percent of the $3.5 billion it approved
for oil reconstruction projects in 2006.

Iraq has yet to enact and implement hydrocarbon legislation that defines
the distribution of oil revenues and the rights of foreign investors.
Until this legislation is enacted and implemented, it will be difficult
for Iraq to attract the billions of dollars in foreign investment it needs
to modernize the sector. As of July 13, 2007, Iraq's cabinet has approved
only one of four separate but interrelated pieces of legislation--a
framework that establishes the structure, management, and oversight.
Another part is in draft and two others are not yet drafted. Poor
security, corruption, and the lack of national unity will likely impede
the implementation of this legislation.

Comparison of State and Energy Department Data on Iraq's Crude Oil
Production

References

Visible links
  18. http://www.gao.gov/cgi-bin/getrpt?GAO-07-677
  19. mailto:[email protected]
  20. http://www.gao.gov/
  21. http://www.gao.gov/
  22. http://www.gao.gov/fraudnet/fraudnet.htm
  23. mailto:[email protected]
  24. mailto:[email protected]
  25. mailto:[email protected]
  26. http://www.gao.gov/cgi-bin/getrpt?GAO-07-1107T
  27. http://www.gao.gov/cgi-bin/getrpt?GAO-07-1107T
*** End of document. ***