Still waiting to cash in on Iraq's oil

Iraq's oil money was supposed to help rebuild the country, but war, squabbling and uncertainty leaves production lagging.

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NEW YORK (CNNMoney.com) -- With the war in Iraq now estimated to cost the United States nearly $2 trillion over the next ten years, many taxpayers are probably wondering what happened to all that oil money that was supposed to help pay for the war.

In selling the war to voters, Bush administration officials said overthrowing Saddam Hussein would cost as little at $50 billion, and that much of the reconstruction could be paid for with the Iraq's oil revenue.

It's true the country has the potential to pump lots of oil. Its estimated 115 billion barrels of reserves in the ground make it the second or third largest holder of crude behind Saudi Arabia or, possibly, Iran.

Some experts say the country could pump upwards of 6 million barrels a day, more than anyone but the Saudis and Russians, who each pump between 8 and 10 million barrels of the world's daily 85 million barrel output.

But Iraq is currently lucky to pump 2 million barrels a day. Decades of war and neglect have nearly halved production from a high of 3.5 million barrels in the late 1970s. Output is now below where it was when the United States first invaded in 2003, and some experts say that Iraq could see production fall by 200,000 barrels a day per year under present conditions.

Proceeds from Iraq's current oil sales - about $30 billion a year in 2006 - go to funding the Iraqi government. In fact, the Iraqi government is nearly entirely dependent upon oil for its funding, with crude accounting for at least 90 percent of its budget.

Boosting oil production seems to be in everyone's interest. Iraq would get more money, and the U.S. may have to pony up a little less for reconstruction. Total U.S. spending in the country, on both military and reconstruction, has now topped $368 billion through 2007, according to the Congressional Budget Office.

To raise production, nearly everyone agrees the security situation on the ground has to improve.

Currently all of the country's 2 million barrels a day are pumped by the national oil company.

A smattering of small foreign firms have signed contracts to pump oil in the country, mostly in the semi-autonomous Kurdish region in the north. But until pipelines stop blowing up and a stable national government is in place, the big western firms like Exxon Mobil (Charts, Fortune 500), BP (Charts), Royal Dutch Shell (Charts) and Chevron (Charts, Fortune 500) - and the big money they could spend on exploration and infrastructure - will stay away.

"You would need a very stable, long-term legal environment" for the big western oil companies to invest the tens of billion of dollars needed to really ramp up production there, said Greg Priddy, a global energy analyst at the Eurasia group, a political risk consultancy. "Everyone sees this as a long-term opportunity, but they have to get the political situation sorted out first."

Iraqi lawmakers attempted earlier this year to pass a law governing the way oil contracts and revenues are managed. But the law got bogged down in parliament after Kurds objected to the greater control it gave the central government in allotting oil contracts and doling out royalties. The Iraqi public - and many lawmakers - also saw it as giving away the county's oil reserves to foreign firms.

Critics of the proposed oil law said it gave foreign firms control over production on individual fields and did not require them to hire Iraqi workers or share technology.

"It really is a dream law for the companies," said Antonia Juhasz, a fellow at the research and advocacy group Oil Change International. "And privatization is not viewed as a good thing by most Iraqis."

But the law could impose high royalties, such as the 90 percent tax on oil profits in places like Russia and Libya, which would return most of the money to the Iraqi people. Some analysts say passing a national oil law and opening up the country to foreign firms is essential.

"The sort of investment they would need would be tens of billion of dollars," said Priddy. "It would be very difficult for them to do that on their own."

But others say the Iraq national oil company could do the job themselves, given the resources to invest, renewed training overseas, and, of course, a more peaceful environment.

"They don't need investment by big oil companies," said James Placke, a senior associate at Cambridge Energy Research Associates who specializes in the Middle East. "They need to fix the present oil infrastructure."

Placke said war, lack of investment, and a shortage of properly trained technicians is leading to production declines of 200,000 barrel per day a year.

Under the right conditions, he thinks the national oil company could produce four million barrels a day in five or six years time.

But the right conditions, of course, remain elusive. And given the current political environment, Placke wasn't optimistic.

"If you project the present into the future, I don't see them ever getting to three million barrels a day," he said.