Why Iraq oil money hasn't fueled rebuilding

First, the good news: With oil prices at record highs, Iraq is on track to bring in $20 billion or more in oil revenue this year.

That may sound like a lot of petrodollars, especially for a war-torn country with tremendous needs in infrastructure repair and services delivery.

But the bad news is that very little, if any, of that money will actually be used in the country's stalled reconstruction - despite past lofty predictions that oil-rich Iraq would be financially self-sufficient by now.

Dealing with Iraq's insurgency is a chief reason for the gap between oil revenues and improving living conditions. But another reason for the lag is a growing problem of income loss from smuggling and outright theft of the revenues.

One worrisome consequence of the inability to turn higher oil revenues into street-level improvements is the impact on the Iraqi public's faith in the country's new government and direction.

"The insurgents know that oil is the lifeblood of the Iraqi economy, and that keeping it from improving daily life is key to building up the frustration and sense of helplessness and lack of faith in the new government - all of which they are out to encourage," says Gal Luft, codirector of the Institute for the Analysis of Global Security in Washington. "Unfortunately, I don't see the government taking advantage of what should be a good time for an oil-producing country to make some money and move forward."

As the country with the world's second-largest known oil reserves, Iraq should be sitting pretty at a time of $60-a-barrel oil, analysts say. But they quickly add that Iraq's potential has been tamped down by a continuing failure to invest in renewing the country's decrepit oil infrastructure and an ill-conceived strategy of placing exports above oil-field modernization.

In addition, some experts say that the problem of petroleum-products smuggling and oil- revenue theft is increasing as the highly centralized and dictatorial regime of Saddam Hussein is replaced by one with less authoritative control and more room for tribal and partisan interests.

"In many cases, the technocrats are no longer in charge, so you have a lot of potential for partisanship and local interests to win out over the common national good," says Jamal Qureshi, an oil-market analyst with PFC Energy, an international consulting firm.

Mr. Qureshi says that most of Iraq's oil income will pay for a national budget of about $18 billion - about 80 percent of which is earmarked for government salaries, food and fuel subsidies, pensions, and other government operating costs. That leaves little money, even without considering the rising problem of oil-revenue theft, for reconstruction needs.

After Bush administration officials originally predicted that Iraq would be able to meet its own postwar reconstruction needs within months, another scenario emerged. In the fall of 2003, the United Nations and World Bank estimated that essential reconstruction over the next four years in Iraq would cost $55 billion. Of that amount, the State Department says in its Iraq country report that the US has already appropriated $21 billion, with other substantial amounts coming from international development institutions and other pledges.

Qureshi says the early rosy predictions of Iraq's ability to rebuild itself were "always off base," but he adds that the country should be able to take on more of the burden - if it weren't losing potential revenues.

He estimates that perhaps 5 percent of oil revenues are being lost to theft and product smuggling, although estimates from other experts range much higher.

Recently, for example, hundreds of millions of dollars in oil revenues were found after they were "misplaced" in unauthorized Iraqi and Jordanian bank accounts, according to some press reports.

The artificially low prices that the government keeps on gasoline and other products inside the country are one reason for the rampant smuggling of such products. Entire smuggling rings have developed around delivering subsidized products to neighboring countries where prices are higher. At the same time, many Iraqis are willing to pay a premium for black-market gas to avoid long and sometimes dangerous lines at gas stations.

Mr. Luft of Global Security says it shouldn't surprise anyone that such corruption and profiteering are flourishing in a traditional tribal society - especially one recently released from the ties of a dictatorial regime. "Corruption will always be part of tribal societies," he says. "There is no allegiance to the state."

Luft also says that his institute's tracking of attacks on oil infrastructure shows a shift in targets - from export-oriented installations like pipelines to power plants and other facilities for domestic energy production. The aim: to dim any public confidence in the government's ability to meet its needs.

But experts emphasize that some of the oil sector's problems have nothing to do with insurgents. The state is placing revenue production over maintenance and modernization, they say, risking long-term damage to oil fields. For example, water-injection systems that extend a well's production life are not being kept up in the major southern oil field. Even the State Department has recently red-flagged this and similar problems in Iraq's oil sector.

The failings of Iraq's oil sector are of international concern, experts note, in part because lost production there contributes to a higher price tag on a barrel of oil. "Iraq is a big enough player in the international market that better performance there would have had an impact on price increases," says Qureshi of PFC Energy.

Driving oil prices higher is apparently another objective of Iraq's insurgents. "I've seen it on websites affiliated with the insurgency - the praising of attacks on facilities as a way to drive oil prices up and thus hurt the US and Western economies," says Luft. "Coupled with the goal of raising the Iraqi public's frustrations, they see these attacks as a way to kill two birds with one stone."