May 27, 2010 / 7:08 AM / 9 years ago

Special Report: Between Iraq and a rich place

BAGHDAD (Reuters) - The first hint that Christopher “Kiffer” Andress is not just your average CEO is the 9mm automatic pistol at his right hip.

Employees of the internet service and Phone Company of Itisaluna work at the headquarters in Baghdad May 16, 2010. Backed by Middle Eastern investors, Itisaluna has spent $150 million to build its network and is close to breakeven point three years into the 15-year contract it purchased from the Iraqi government to provide data and voice services. REUTERS/Mohammed Ameen

“Regardless of the situation today, our security measures haven’t changed since 2007 at the height of the violence here,” said the head of AISG Inc on a tour of the firm’s yard in Baghdad where Iraqi workers were turning abandoned cargo containers into temporary housing units and storage rooms.

He looked down at the gun for a moment then grinned.

“So far, I’ve never had a reason to use it.”

Andress is accompanied by two bodyguards who both also carry pistols and always keep the CEO a set distance between them, eyes constantly on the move.

Some things haven’t changed for AISG, a U.S. contractor based in Iraq for the past six years. But much like Iraq, the company faces a major transition.

AISG has 500 employees, 80 percent of them Iraqis.

The company provides construction, security and “life support” services — food, water, waste management — to a single employer: the U.S. military. But seven years after the U.S.-led invasion to topple Saddam Hussein, the U.S. military is on the verge of halving its numbers to 50,000 troops and preparing to leave Iraq — where sectarian violence has abated but daily attacks and bombings are still a fact of life — by the end of 2011.

For AISG, which has its headquarters in Baghdad, and other firms like it employing 100,000 contractors here, that means looking for a new source of revenue.

“For those contractors that have survived this far, the choice is clear,” Andress said. “Either find a commercial line of business, or leave.”

Like Iraq, AISG is betting on the oil industry.

The country has the world’s third-largest known reserves and the current government has signed 11 ambitious oilfield development deals with major oil firms including Royal Dutch Shell, Italy’s Eni, Exxon Mobil, Occidental Petroleum Corp and South Korea’s KOGAS. In theory, those deals should take Iraq to second place among oil producing nations from 11th now and boost its capacity within seven years to just under Saudi Arabian levels of 12 million barrels per day from 2.5 million today.

Whether Iraq could or should make that target, however, is an open question — such a volume of oil could push prices down. What is not in doubt is a huge production boost is in the pipeline.

“Most people, myself included, think the Iraq targets are very optimistic and some would argue that they are over-optimistic,” said Samuel Ciszuk, an energy analyst at IHS Global Insight. “But unless things go very wrong in Iraq, it’s going to be huge.

“There’s just no other way to say it: it’s huge.”

RISING PROFILE

The oil majors and their service companies are here or on their way, preparing vast projects to revamp Iraq’s crumbling oilfield infrastructure and export facilities, plus build new capacity.

For AISG, this means new business. It is already working with oil industry firms to get them registered in Iraq and aims to provide the same services as it has for the U.S. military because Iraq is still a dangerous place.

“These companies want to know ‘How do we execute these contracts without having to look over our shoulder?’” he said. “That’s where we come in.”

The oil deals have also grabbed the attention of other investors because they could be the trigger needed for broader investment throughout the economy.

“The oil deals really raised the profile of Iraq in the international business community,” said Zaab Sethna, head of the Baghdad office of investment firm Northern Gulf Partners LLC. “When people see major household names sign huge deals to invest in Iraq, it really puts the country on the investment map.”

That interest, Sethna says, reflects the fact that after decades of war and sanctions, Iraq “needs practically everything”. That could mean hundreds of billions of dollars in infrastructure projects.

“The country is impoverished, but it has the potential to be rich.”

According to a November 2009 report from Dunia Frontier Consultants, after the energy sector more than 50 percent of nearly $160 billion in announced foreign investment projects last year involved commercial and residential real estate, plus “manufacturing, processing, service-sector and other productive infrastructure”. Most of that investment remains in the pipeline — hoped for rather than real — but the time for investors to take the plunge may be close.

Northern Gulf Partners looks for viable Iraqi investments of between $10 million and $30 million and helps Iraqi firms raise private equity for amounts above that. Where there is no local company providing a particular service, the firm sets up its own. Sethna said a heavy equipment leasing firm is in the works to provide machinery for the construction projects that lie ahead.

In the short term, some investors are watching to see how Iraq’s inconclusive March elections are resolved and whether the Iraqis can form a new government without a return to the wholesale sectarian violence that followed elections in December 2005.

RESOURCE CROSSROADS

Beyond the elections, the promise of oil money is also seen placing Iraq at a crucial crossroads — where it must choose between remaining a centrally planned economy that uses oil wealth alone to provide jobs and homes for Iraqis, or use it to fund public private partnerships and help kick-start free-market reforms.

Analysts say Iraq must diversify because its population is too large to be supported by oil money alone, making it dangerously reliant on high oil prices.

Another problem is that the oil industry employs relatively few people. Although oil contributed around 56 percent of Iraq’s gross domestic product in 2008, it employed only one percent of workers.

“Even though oil will generate a lot of revenue, it’s not going to generate a lot of employment,” said a U.S. official who was not authorized to speak to the media.

But becoming a free-market economy involves painful choices.

To succeed, the next Iraqi government must reform a labyrinthine bureaucracy, simplify red tape that makes it hard for investors to do business here, plus battle endemic corruption. The Iraqis have found it relatively easy to dictate tough terms to the oil majors because the country’s vast, high-quality and easily accessible reserves make it a rare and attractive prospect, but attracting investment beyond oil will take a lot of work.

The next government also faces a politically sensitive problem posed by some 200 state-owned enterprises that produce little but employ 800,000 people.

Officials like Sami al-Araji, chairman of Iraq’s National Investment Commission, insist while it will not be easy, the government is committed to reform.

“Everyone (in the government) wants to use oil to create a diversified economy,” he said, adding, “not just a one-way- ticket economy.”

But this needs to be done quickly because U.S. officials and others fear once oil money, which accounts for 95 percent of state revenues here, really starts to flow the Iraqi government will find it easier to rely on that wealth than enact reform.

“The choice is whether to become a petrostate or to open up the economy,” said Patricia Haslach, the U.S. embassy’s assistant chief of mission for assistance transition. “There is a small window of opportunity available to make this happen. Now is the time to focus on these issues.”

‘THE ONLY WAY IS UP’

After decades of war and sanctions, Iraq is a mess.

The country’s infrastructure is damaged or crumbling. Seven years after the U.S.-led invasion, basic services like electricity and water are intermittent and inadequate. Iraq badly needs new roads, bridges, hospitals, schools, railways and much else besides.

“This is a country that needs an awful lot of work done to it,” said Gavin Jones, a partner at Upper Quartile, which advises firms on investing in Iraq. “Iraq has a very long way to go.”

The people here have also suffered.

In an April 30 quarterly report to the U.S. Congress, the Special Inspector General for Iraq Reconstruction (SIGIR) estimated some 7 million Iraqis live on less than $2 a day.

The national unemployment rate is around 18 percent, but Mudher Kasim, a senior adviser at the Iraqi central bank, said including those employed at idle state-owned companies the real rate is 30 percent or more.

The good news is the situation here has improved since the height two years ago of sectarian bloodshed between once dominant Sunnis and majority Shi’ites propelled into power by the invasion. According to the SIGIR April 30 report, security incidents in Iraq including all reported attacks on civilians and Iraqi or U.S. forces hit an average of 884 per month in the first quarter, compared with almost 5,800 incidents per month in 2007.

“Back then, you wondered if you’d get through the day,” said Loay Almaleika, CEO of internet service and phone company Itisaluna. “But we have passed rock bottom. The only way now is up.”

Backed by Middle Eastern investors, Itisaluna has spent $150 million to build its network and is close to breakeven point three years into the 15-year contract it purchased from the Iraqi government to provide data and voice services. The work has been tough, but Almaleika said much of the company’s success has been down to its tenacious, informally trained engineers.

“Our engineers know how to work without electricity,” he said. “They know how to work under fire. They are capable of being Shi’ites when they need to be, or Sunnis or even Christians.”

“It’s amazing what they can achieve.”

AN ECONOMIC GOVERNMENT

Despite continuing attacks by insurgents, the improved security situation has left Iraqis longing for better services and economic growth.

“If there were a good standard of living here, I wouldn’t have to work outside my full-time job,” said Hassan Abbas, 37, a school teacher who sells fruit on the street in Baghdad to supplement his income. “My salary is not enough and I have a family of four to support.”

Abu Salah al-Rubaie, 60, bemoaned the fact that many Iraqis have been left destitute. “We want the government to improve the quality of life here by improving services,” he said. “We want them to find work for our jobless sons.”

Security specialists like Rohan Gunaratna, professor at the International Center for Political Violence and Research in Singapore, note a marked mood shift among war-weary Iraqis as the security situation has stabilized and the Americans get ready to leave by the end-2011 deadline.

“The Iraqi people are angry with the insurgents and they want peace and prosperity,” Gunaratna said. “They also now realize the Americans didn’t come here to stay or to take their oil, so they have a vested interest in making Iraq work.”

Polls ahead of the March election showed Iraqis want improved basic services and jobs. This was reflected in a shift in tone for the elections, with political parties promising to deliver just that.

“The next government will be an economic government, not a political one,” the central bank’s Kasim said. “The Iraqi people are fed up with politics.”

LULL IN INTEREST

But there’s no getting away from either politics or oil.

Iraq’s massive reserves will play a key role for the next government and for luring foreign investors to Iraq. According to the November report by Dunia Frontier Consultants, investors announced $156.7 billion worth of projects in Iraq in 2009 through to November — with the caveat that not all of those will necessarily come to fruition.

Energy sector projects alone accounted for $73 billion of that total.

Those deals have fueled interest in Iraq, but the post-election mess has led some investors to pause.

The cross-sectarian Iraqiya coalition, heavily supported by Sunni voters and led by former prime minister Iyad Allawi, took 91 seats in Iraq’s 325-seat parliament in the March 7 election, just two ahead of the Shi’ite-led State of Law alliance of Prime Minister Nuri al-Maliki. Neither had enough seats to form a government on their own.

That has resulted in weeks of uncertainty, interspersed by bomb attacks such as the ones that killed 56 people near Shi’ite mosques in Baghdad on April 23 and attacks across the country on May 10 that killed more than 100. These have raised the specter of renewed sectarian tensions.

“There has been a little bit of a lull in interest because of the elections and uncertainty over who will form the next government,” said David Tafuri, a lawyer at Patton Boggs LLP, who spent 15 months from mid-2006 in Iraq as the U.S. State Department’s rule of law coordinator. “Once the government is formed we should see interest go up again.”

Some government officials, like the National Investment Commission’s Araji, have been vocal about the need to court foreign investors.

But one of the main problems and an obstacle to greater investment here is corruption. According to anti-corruption watchdog Transparency International’s 2009 Corruption Perceptions Index, Iraq ranked 176th out of 180 countries, ahead of only Sudan, Myanmar, Afghanistan and Somalia.

Nonetheless, analysts say the government has made some progress, including holding auctions for oilfield service deals on live television.

“I was struck by how open the process was,” said Rachel Ziemba, senior research analyst for China and the oil exporting economies at Roubini Global Economics in New York. “But in the current global economic climate there is a lot of competition for investment, so Iraq has to present itself as more of a sure thing than a gamble.”

Another issue investors complain of is the sheer volume of red tape they must wade through at multiple ministries to start a business. Each official interprets the rules differently.

“We call this phenomenon the shifting sands of Baghdad,” AISG’s Andress said.

The World Bank’s Doing Business 2010 report ranks Iraq 153rd overall out of 183 countries, but 175th when it comes to starting a business. According to the report, it takes 77 days to start a business in Iraq compared with an average of 13 days among the member countries of the Organization for Economic Cooperation and Development.

Araji says the government is trying to create a “one-stop shop” whereby all procedures for setting up in Iraq will be under one office. But he said the country’s massive centrally planned bureaucracy — with its myriad different offices — was slowing that process down.

“It is not easy to penetrate that centrally guided way of thinking,” he said. “Some bureaucrats live in their own world and don’t want to give up their power.

“It’s not that anyone is against free-market reforms, everyone is in favor of them in theory,” Araji added. “But making it a reality and making everyone understand what the free market is will take some time.”

Kamal Field al-Basri, an economist who compiled the Iraqi section of the World Bank’s Doing Business 2010 report, said a lack of qualified personnel at government ministries is also a major problem. According to a study he compiled, in 2008 Iraq government ministries only used 68 percent of the funds allocated to them.

“The problem is that while they have the money, they are not able to execute,” he said.

Basri also warned of what he called “muhasaseh” once the next government is formed — whereby new ministers will replace skilled technocrats with their own loyalists.

“That will contribute to the low performance of the next government,” he said.

PRODUCTION SHARING

Most Gulf Arab producers are on a long drive to diversification and have used the oil income windfall they received during oil’s 2002-8 rally to build infrastructure and heavy industry as they look to wean themselves off dependence on oil revenues. Oil price falls in the past have forced them to cut state spending, which provides generous benefits for citizens.

Many of Iraq’s near neighbors such as Saudi Arabia and the United Arab Emirates have a mixture of free-market and state-planned economies, with the private sector confined to services and smaller industries and the state running oil, gas and heavy industry.

In Iraq’s case, for decades oil was used to prop up the rest of the economy. As it currently provides nearly all state revenue and the state employs some 60 percent of the workforce, some fear the government will stick to that easy path.

Countries that have become too dependent on oil have suffered for it. Russia, for instance, has become too reliant on oil and other commodities, while Nigeria’s failure to use its oil wealth wisely has resulted in intense poverty in its oil-producing delta.

Roubini’s Ziemba said Iraq’s large population of some 29 million is simply too big to be able to rely on oil in the long run.

“Government subsidies are not really sustainable in the long run because to make that model work you need ever-increasing oil prices and ever increasing production,” she said. “The oil buys the Iraqi government a little time as it has allowed them to avoid having to cut back on fiscal spending, but it won’t support them forever.”

While U.S. officials say that using oil revenues to create a free-market, diversified economy is what Iraq needs, it is also a matter for a sovereign Iraq to make that call.

“It’s not like in the days of the Coalition Provisional Authority (in 2003-4) where we could tell the Iraqis to fix this, or fix that,” said the U.S. embassy’s Haslach. “Now we have to persuade them that something is in their own best interest. “It’s really up to the Iraqi government.”

“It’s their oil and their resource.”

Araji and other reformers talk of using oil to prime the pump through public private partnerships that would entice foreign investors into Iraq to help rebuild the country.

He says he has a wish list of 750 infrastructure projects worth $600 billion — most but not all of which are included in a five-year economic plan approved by the government — which would include power generation, roads, bridges, hospitals, water treatment and housing.

“How many projects we will get will depend on how clever and how open we are,” he said.

The National Investment Commission’s plan for the roughly 200 dilapidated state-owned enterprises will be based on “production sharing”. Under this model these firms will not be sold but investors will be asked to restructure and operate them, then share the profits with the government.

France’s Lafarge, the world’s largest cement maker, recently launched a $200 million renovation of an Iraqi cement plant under just such an arrangement, potentially a watershed for non-oil investment in post-invasion Iraq.

“I think the majority of our state-owned enterprises can be salvaged in this way,” Araji said.

Ingo Sahlmann, CEO of construction company GSI Business Services and vice president of the International Business Council of Iraq, said that based on the experiences of eastern Europe following the fall of communism, many of those companies are beyond saving.

“But because they employ 800,000 people it’s too politically sensitive just to shut some of them down,” he said. “So the government will try to find a way to save as many jobs as possible and hope the construction boom will provide work for the others.”

Timothy Moore is the CEO of FastIraq, which is working to connect Iraq’s fiber-optic network to the rest of the world and thus improve its communications and internet access. The network is owned by the government and FastIraq has already secured connections through Turkey and Kuwait, plus will connect via Jordan by the fall and via a submarine cable by the end of the year.

Slideshow (7 Images)

Moore says that negotiating a deal with the Iraqi government was a “painfully slow process” and involved the state retaining ownership of the fiber-optic network.

“It took a long time, but it’s the Iraqi government’s resource and the model works,” he said. “The government is working out these things as it goes and is taking its time to try to get it right. It’s worth sticking around to see that happen.”

“Iraq is the world’s leading emerging market right now,” Moore added. “If you can’t get excited about that then you don’t understand what you’re looking at.” (Additional reporting by Simon Webb, Khalid al-Ansary and Michael Christie; editing by Janet McBride)

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