Republican Reference - Area (sq.km) 438,317 - Population 30,399,572 - Capital Baghdad - Currency Iraqi dinar (IQD) - President Jalal Talabani

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Key Economic Data 
 
  2012 2009 2008 Ranking(2012)
GDP
Millions of US $ 210,280     46
         
GNI per capita
 US $ 5,870 110
Ranking is given out of 213 nations - (data from the World Bank)

UPDATE - FEBRUARY 2014

The Shi'ite coalition that has ruled for most of the post-Saddam years, has had economic successes, unsurprising since during the occupation, there were revealed vast oil reserves, comparable to neighbouring Saudi Arabia.

Politically however the uneasy relationship with the semi-autonomous Kurdish part of the nation always looks capable of a breakdown, with the greater informal 'Kurdistan' spreading over four neighbouring countries: Iraq itself; Syria- involved primarily defending their own, in the civil war; Iran; and Turkey, where there is an on-off understanding about the ceasing of hostilities with the Turkish army which have plagued the region and the nation for upwards of thirty years.

But currently Iraq's biggest problem is the civil war fomented by the Sunni tribes of western Iraq stimulated by Al Qaeda Islamicists, who prior to the US occupation did not exist in Iraq. But they have long been a major factor in bombings, killing many innocents and disrupting life in Iraqi cities and now have claimed to have control over Fallujah and other towns in southern Iraq, as well as having linked up with other Islamic rebels in the border area with Syria.

It seems obvious that the Al Qaeda in Iraq and similar Syrian-based Islamicists, are trying to secure de facto control of a sizeable Iraqi/Syrian 'Koranic space' - a Sunni theocracy, that they can call their own - no matter what Al Assad and the rebels elsewhere in Syria might agree to, if at all, without them.


Forecast 2013
What is in store for Iraq in 2013 is extremely uncertain, given Maliki's brinkmanship, the interference of regional powers and the complex Iraqi political scene. Plunging back into a full scale civil war is a possibility, even if right now nobody really wants that. Many want to see Maliki gone, but if Maliki does not graciously concede, then the worst could happen. The sectarian divide is still strong, despite some Shi'ites supporting politically the Sunni opposition, for opportunistic reasons (in order to get rid of Maliki). The fact that interest in the oil and gas sector is not diminishing suggests that most business observers do not think the worst will happen, somehow.

Should the flow of investment be maintained (it has in fact so far been relatively modest considering the size of Iraq's oil reserves), the economic prospects of Iraq are inevitably upbeat, despite the inefficiency of the government and the tendency to waste resources in patronage. The world now needs Iraqi oil to keep international prices down, so one should expect American, European and Chinese powers to do their best to help maintain a degree of stability.

But the game in Iraq is not being played by world powers: it is a regional game for supremacy, over which the rest of the world has little say.

Undaunted by the growing political mess, oil companies continue their labours to identify lucrative agreements which would justify their investment. Iraq just announced the first discovery of a new oil field in many years, the early result of renewed prospecting. BP seems interested in investing in the contested area of Kirkuk, which both Baghdad and Erbil claim as their own. Here oil fields are badly in need of overhaul to boost productivity. A Chinese company seems interested in replacing Exxon in West Qurna, partnering with Lukoil.

In the background, the Kurdish regional government has now suspended exports through the government pipeline, and is instead beginning to use tankers to move oil by road, as the dispute over payments with Baghdad has not yet been resolved.

The worsening violence however does not just affect civilians and the Iraqi security forces, but oil exports too. The pipeline to Turkey has already been attacked 38 times this year, compared to just 6 in 2012. Recently Basra's pipelines were also hit, although the drop in exports from the south was compensated by increased exports from Kirkuk. In part because of this, Iraq's oil production has been stagnating in recent months, after growing steadily in the first half of the year.

The other factor is a cracking infrastructure. Together these problems are expected to keep production flat this year, or even reduce it from just over 3 million bpd to 2.96 million bpd, against a government's target of 3.7 million bpd. Now the oil ministry talks of 3.4 million bpd as an achievable target for year end. Planned upgrades of the southern export terminal will in the short term cause further constraints. Should production remain flat or decline, the government will need to borrow money next year to realise its spending plans.

Attacks against oil infrastructure continued after July. A big hit in September forced a reduction in oil shipments to Turkey from 244,000 barrels in August to 110,000 in September. Leaks caused by ageing pipelines also contributed to keep exports down. In the south too pipeline leaks and works at the export terminal are constrained export volumes, cutting as much as 500,000 bpd, at a time when production is climbing up and prices are high, thanks to the Syrian crisis. Iraq needs investments for US$125 billion in the sector, in order to meet its revised but still ambitious production targets; the deteriorating security makes it increasingly unlikely that oil majors will want to invest anything like that amount of money, the more so since returns from Iraq are modest. It should be added that the massive expansion of oil infrastructure required (1,500 new wells) would imply a massive industrial effort worldwide.

Although in July oil exports generated US$7.27 billion, up from US$6.8 billion in June, actual export were slightly down from 2.33 to 2.32 million bpd; in June they already were down from 2.48 million bpd in May. There are however hopes for a new increase in production in September, when the Gharraf and Majnoon oil fields will start producing. Both fields are being developed by foreign investors.

The Iranians appear increasingly worried by Maliki's brinkmanship, which risks causing the disintegration of Iraq and civil chaos, something that Iran has no interest in. Maliki has benefited from extensive Iranian support in the past, but has by now managed to create his own power base, and is no longer so easily manageable by Teheran, whose attempts to defuse tension among Iraqi factions are not achieving much. In particular, the Iranians have sought to mediate between Maliki and the Kurdish regional government in the north of Iraq, with which they also have good relations. Their failure in this means that the Kurds are tempted to join an anti-Maliki coalition which is led by Arab Sunnis and is supported by Saudi Arabia, Turkey and Qatar. The Iranians seem to be undecided about what to do in the face of Maliki's stubbornness. They can see that Maliki, their other main ally in the region, after Bashir Al Assad in Syria, is now clearly at risk. Their influence is at jeopardy of being drastically reduced. Should they back-up Maliki with all means, risking another Syrian situation, or easier said than done, seek to engineer the replacement of Maliki with a more pliable Shiite politician?

Maliki has been facing civil unrest for weeks in the Sunni heartlands of Iraq's north, where the influence of the Syrian insurgents is beginning to be felt. (In fact the Al Qaida element in the Syrian insurgency originates from the Iraqi branch of Al Qaida, so the connection was always there). Recently however, the border tribes have shifted their support towards the Syrian insurgents, facilitating a spill- over into Iraq. At the same time the Kurdish militias and the Iraqi army are facing-off against each other, on the borders of the Kurdish region. Now one of the Shiite factions most uneasy about Maliki, Muqtada As-Sadr's movement, is also joining the opposition to him.

In January-August, the internecine violence caused 4,800 deaths in Iraq, compared to 2,000 during the same period of 2012. With Syria going the way that it is, the prospects for Iraq are dim.[ A recent study asserts that 10-15% of the Syrian insurgency is accounted for by Al Qaida-affiliated groups, with another 30-35% being accounted for by extremist Islamists not directly affiliated with Al Qaida. The first group is already active across the border with Iraq and second one might well be one day].

Maliki faces the risk of being impeached by the Parliament. His pressure on Sunni Arab politicians hostile to him has gone too far with the targeting of Al Issawi, the finance minister, and instead of splitting the Sunni opposition and co-opting part of it, the result has been tribal mobilisation in Anbar province, whose Sunni militias maintain considerable military power, certainly enough to start a new civil war in Iraq.

The on-going and worsening campaign of terrorist violence threatens to undermine Maliki's image of being a strong leader; he is now saying that he will revise his security strategy and that 'heads will roll' in the security apparatus. The number of those killed in the violence in April and May is now the highest in five years - although still well below the peak of violence of 2006-7. There is enough violence to make many fear that a serious insurgency might be taking off in the Arab Sunni heartland, and a Sunni-Shiite civil war might be in the offing in the country, as a whole. The situation is compounded by continuing street demonstrations by Sunni Arabs in Iraq ,and the bitter confrontation between Sunni and Shiites in next door Syria.

Maliki is still trying to shore up his position internally. The parliament voted at the end of January to bar him from running for a new term as Prime Minister, but Maliki and his party argue this vote is illegal and are challenging it in the federal courts. The fact that President Talebani remains sick and incapacitated after a stroke, is making it even more difficult than usual to mediate among factions in Iraq. Talebani was seen as one of the few Iraqi politicians with sufficient credibility to mediate. Maliki is increasingly being accused of asserting his direct control over the armed forces, thanks to the failure of the parliament to approve the necessary regulations which would at least in part insulate the armed forces from political interference. The country is still being shaken by constant demonstrations by antagonists and supporters of Maliki, who has been trying to remove from his post the speaker of the parliament, Nujaifi.

Another front still wide open is in Kurdistan. Maliki and his party, but also another Arab group in parliament, now want to reduce the Kurdish share of the state budget from 17% to 12%, a very significant reduction which is of course completely unacceptable to the Kurdish regional government, whose revenue would be reduced by almost a third. The 17% share had been agreed with the American occupation authorities, a fact that contributes to encourage many in the parliament to renegotiate it.

In particular, many Arabs object to the existence of autonomous Kurdish militias, which are paid through that 17%. In addition, there is a dispute over payments owed by Baghdad to Irbil over oil exports, with the Kurds claiming a figure five times higher (US$3.5 billion). All of this is seen as a provocation by the Kurds, at a time when the Kurdish militias and the Iraqi army are still facing off against each other in the disputed areas of the north.

Maliki was seeking to build bridges to some of his former allies in October. He was involved in an initiative to get Iraq's political leaders to sign a national honour code, aimed at establishing social peace in the country. Maliki's arch-rival Allawi, refused to sign and the Prime Minister happily singled him out for criticism, while at the same time praising the Sadrists for agreeing to support the initiative. The tone of Muqtada as Sadr is changing in the face of the wave of violence, which is mainly targeting Shiite communities - fighting the terrorist wave has become his main campaign, replacing Maliki as his major target. Overall however Maliki still seems to consider Muqtada as Sadr as an enemy. Although Prime Minister Maliki is appealing for national unity against the insurgents, he is actually pushing his power consolidation efforts further.

Recently the supreme court granted Maliki the right to run for a third term, which he will no doubt do, stoking fears of the slide of Iraq towards a new authoritarian regime. With parliamentary elections scheduled for March, there is also growing turmoil within the Iraqi National Alliance, which won the previous elections, but is now deeply fragmented internally. Members of the Alliance who are opposed to Maliki do not want to see the next elections so dominated by Maliki's party as the previous ones were. An axis between the Muwatin Bloc, the Sadrists and Fadila, might have the potential to undermine the dominance of Maliki's State of Law party within the Alliance. The lesser alliance 'within the Alliance' might even opt out and ally with yet other parties and groups, currently outside the Alliance. Reportedly Maliki is not lobbying Teheran to reduce or cut support for the Sadrists and transfer it to other groups which enjoy better relations with himself.

Maliki's real ace up the sleeve however, is his hope of a renewed alliance with the Kurdish leader Barzani. The Federal Court has annulled an article of the electoral law, which was required to verify voters' registration in disputed Kirkuk; it does not look like just 'chance'! It is also rumoured that Maliki promised Barzani concessions concerning the oil contracts of the Kurdish region, in exchange for Barzani agreeing to a third term for Maliki. Barzani has already formally withdrawn from the coalition of opposition groups, which was trying to bring Maliki down.

The plans of the Kurdish regional government to export oil towards Turkey have reignited the confrontation with Baghdad. Deputy prime minister Shahristani has stated clearly that if the Kurds start the direct export of oil, that would be considered as 'smuggling' and that legal sanctions would follow against both the Turks and the Kurds. Baghdad is worried about the ever intensifying economic links between Turkey and the Kurdistan region. Now Iraq is Turkey's second trading partner after Germany, but 70% of that trade goes to the Kurdistan region alone.

The Turkish government, whose AK party is particularly close to Turkey's oil firms, is working actively to finalise a deal with the Kurdish Regional Government in Iraq over the Kurdistan-Turkey pipeline, which would greatly help Turkey diversify its sources of supply. Among Iraq's Shiites there is a growing body of opinion which favours Kurdish independence - not out of sympathy but because without the Kurds, controlling Arab Iraq would be much easier for them. The realists among the Iraqi Shiites realise that they might not overcome a Sunni Arab-Kurdish coalition. Add in the deteriorating Turkish-Iraqi relations and the prospects for the Kurds and Baghdad growing further apart seem quite strong.

Maliki once again showed that difficulties do not intimidate him. He raised the stakes of the confrontation with the Kurds by replacing two Kurdish ministers, who were boycotting the meetings of the cabinet in protest at Maliki's attitude towards Kurdish rights in the production and export of oil. The ministers of foreign affairs and trade have been temporarily replaced by two cabinet colleagues. Probably in order to probe the intentions of the Kurdish regional government, the Cabinet decided to meet in Erbil, the capital of Iraqi Kurdistan. Many Kurdish MPs have voiced opposition to allowing this meeting and the reaction of the Kurdish authorities will be the litmus test of whether there is still some appetite for reconciliation. Perhaps Maliki has decided that he cannot fight on two fronts and that the resolution of the crisis with the Sunni Arabs has to take precedence over the confrontation with the Kurds. This is why many Kurds argue that moving towards reconciliation now will only serve to allow Maliki to squeeze his enemies one at a time.

The only positive side to the growing violence is the fact that it might be pushing Maliki and the Kurdish regional Government back together. The offensive of the Syrian Islamists against the Kurdish areas of Syria is pushing many Syrians across the border into Iraqi Kurdistan, and worries the Iraqi Kurds, who are aware of the growing linkage between the two countries' insurgencies. If Maliki might be closer to a rapprochement with the Kurds, he is also reacting to the growing pressure on him by trying to scapegoat his allies. He recently accused his deputy Shahristani of being responsible for the crisis in power generation. A wave of power cuts is contributing to undermine the credibility of the government.

The results of Iraq's local elections in April indicate mixed outcomes. Maliki's State of Law party got about 115 seats overall out of 378, probably less than they expected and a loss of 38 on the 2009 results. Its former allies of ISCI got 80 seats, improving their position significantly. The Sadrists, increasingly hostile to Maliki, got 50 seats, which represents a poor performance. The now fragmented Iraqiya list of Maliki's rival Allawi got 70 seats, but Allawi's own faction won very few of those seats. Two hard line Shiite parties, Badr Organisation and Fadhila, also did well; Badr is allied with Maliki. All the Shiite groups which expressed support for the Arab Sunni protesters against Maliki did badly in the elections: Allawi and Sadrists first of all. This is in part because the protesters have been openly rejecting de-Baathification and have expressed nostalgic views for the status quo ante (positions which cannot be popular among Shiites and Kurds). On the positive side for Maliki, a list of pro- Maliki Sunnis (a fraction of Iraqiya) did rather well, but the majority of Sunni votes unsurprisingly went to Mutahidun, the main anti-Maliki list. Among the smaller parties, a coalition of secular groups led by the Communists has also done rather well. Maliki's coalition wanted to gain control over the Shiite cities, but will instead have to rely of multiple alliances to run most councils. His pre-electoral alliances with a number of small groups has not paid off. In particular, he was weakened in Basra, where he lost 6 seats. If these results are projected onto the parliament (elections are due next year), Maliki might well fail to win enough votes to form a new majority, although it is not clear who could take the lead in his place.

The Sunni Arab and Kurdish blocks in the Iraqi parliament are trying to forge an alliance to bring Maliki down; the problem is that some Sunni Arabs have allied with Maliki and that the rest fear Maliki's retaliation, which could even be violent as a growing number of Sunni Arab leaders are being threatened with arrest. At a time when the Syrian insurgency is increasingly spreading across the border into Iraq, Maliki's approach could be seen as adding fuel to the fire, even if he would probably describe it as a pre-emptive strike. One splinter group of the Iraqiya alliance, called Li Haal, has allied with Maliki. There are divisions among the Sunni Arabs, which Maliki is exploiting to play 'divide and rule'.

The latest target of Maliki's wrath is former Minister of Finance Issawi, who is now under the protection of the powerful Sunni tribes around Al Anbar. Other tribes, however, are collaborating with Maliki in chasing him down. The Shiite Arabs are also divided, but Maliki has so far been able to prevent factions hostile to him from allying with the Kurds and the Sunni Arabs. For a while the Sadrists seemed to be about to link up with the latter two, but Sadr withdrew his offer to collaborate in the removal of Maliki at the last minute, possibly having come under pressure from Iran. The other main Shiite group, led by Jafaari, is no friend of Maliki either, but does not seem likely to agree to his removal, probably for the same reason as the Sadrists. The confrontation is leading to ever escalating tension between Baghdad and those Sunni governments in the region; after Turkey, Qatar has been recently accused by Baghdad of interference in Iraq's affairs. Regional politics does not help either: Iran is being drawn deeper and deeper into the Syrian civil war, playing a key role in the formation of Shiite militias allied with Assad but trained and advised by the Lebanese Hizbollah and the Iranian Pasdaran.

During spring, relations with the Sadrist movement of Muqtada As-Sadr worsened as they started threatening for a while to withdraw their ministers from the cabinet for good and vote against the government, a move which would deprive the government of its majority, as Kurds and most Sunni Arabs have already walked away. Commentators hint that Muqtada As-Sadr might be motivated by the fear of a poor electoral show in the late April local council elections; Muqtada would in this interpretation be making some noise to attract attention, but would not be seriously planning to opt out.

The growing pressure has probably played a role in Maliki's decision to ease pressure on at least one front: at the end of March he agreed to meet the demands of the Sunni Arab demonstrators in various provinces, which included amending arrest procedures, amnesty for prisoners, the release of female detainees, amending de-Baathification and direct negotiations with a delegation representing the protesters. It is not yet clear, however, whether this move will be enough to defuse the situation and whether it hails some kind of Sunni-Shiite détente.

As the provincial elections started, there were signs of weariness among voters and turnout was initially estimated at 34%. Maliki has been given up for finished several times in the past, but this man is resourceful! Maliki's State of Law electoral alliance has been expanded to include Shiite nationalists and former Shiite militia groups and the party expected to strengthen its position in the provincial councils. In addition, the new campaign of violence by Sunni extremists appears to be pushing the Shiites towards Maliki, whose popularity is on the rise. Regional politics, with growing Sunni-Shiite confrontations, also play into Maliki's hands: many believe a strongman at the top might be necessary for Iraq to survive. The main adversaries of Maliki (apart from the Kurds) have been marginalised (like Muqtada As-Sadr), or split internally by Maliki's shrewd manoeuvring. If 'State of Law' effectively gains ground, Maliki's consolidation of power will receive a new boost.

If Maliki stays on, he will increasingly benefit from positive economic news. (At least the economic forecast is positive). The IMF expects oil output to rise by 10% this year, to 3.3 million bpd. Inflation, a modest 6% last year, is expected to fall this year. The general economic trends are also positive. The IMF expects growth to reach 9% this year, up from 8.4% last year; oil production should reach 3.3 million bpd by end 2013. Inflation should remain under 4%. The Central Bank of Iraq had US$70 billion in reserves at the end of 2012, while the fiscal reserves of the Development Fund for Iraq have risen to US$18 billion (an increase of US$1.5 billion). However in recent months the Iraqi dinar has been suffering from violent fluctuations vs the dollar. The dollar is in high demand and is now in short supply. The rates enforced by the government are diverging from the black market ones and the dinar is weakening; in April it fell to 1,300 per dollar, from 1,200 in March.

The Iraqi government continues to announce steady progress in accumulating reserves of oil and gas. Recently gas reserves were revised upwards to 137 trillion cubic feet, while oil reserves have been revised upwards to 195 billion barrels. Of the latter, 45 billion are in the Kurdish autonomous region. The Kurdish regional government has recently announced that the pipeline being built to export oil to Turkey will be completed in September. When it will be fully operational in 2015, it will allow the export of up to 1 million bpd. At present its oil fields produce 300,000 bpd, but they are expected to reach 400,000 bpd by the end of the current year as six more oil fields will start production. Exports to Turkey are currently limited to 30,000 bpd, by tanker truck. By 2016 the region should also be able to start exporting gas to Turkey. Overall, Iraq's oil production reached 3.15 million bpd in May. In May Iraq shipped 2.62 million bpd, up 200,000 barrels from April.

The provincial elections show how the old political blocs are fragmenting internally, but the main sectarian divides remain alive and well. The Shiite parties, for example, will compete against each other in all the Shiite dominated provinces, whereas in the past they had formed Shiite coalitions. In the mixed provinces, though, they will again form Shiite only coalitions, as will their Sunni rivals and the Kurds. The latter are furious with Maliki after the new budget did not allocate enough funds for paying the oil companies operating in the Kurdistan region. This might force the Kurds either to reconcile with Baghdad on Maliki's terms (that is reduced autonomy), or start exporting oil to Turkey directly, without the government's authorisation. There are about 50 foreign firms now involved in the Kurdistan oil sector, with investments worth US$15-20 billion.

Inevitably Baghdad fumes at these ideas and diplomatic relations between the two countries are reaching the lowest level in many years. In fact there might already be a deal signed between Ankara and Erbil over the annual export of 10 billion cubic metres of gas, which would cover 20% of Turkey's consumption. Already in November Baghdad barred a Turkish oil company from bidding for oil field tenders in Iraq, in retaliation against Turkey supporting the Sunni opposition to Maliki.

To make matters worse, even Exxon seems to have made its final choice to invest in Kurdistan, rather than in southern Iraq, because the conditions offered by the Kurds are more generous. Chevron, Total of France and Gazprom Neft also appear to be shifting towards Erbil. Only BP among the majors seems to be betting on Maliki and is offering to work in disputed Kirkuk without going through the Kurdish regional government. If Maliki allows that to happen, it might then be too late to redress the situation and Erbil will be able to mobilise diplomatic support on its side. Overall oil exports from Iraq reached 2.35 million bpd in January, even if production declined slightly from 3.3 million bpd to 3.2 million, due to bad weather, sabotage and some technical problems.

Perhaps one way to chart the on-going dispute between Baghdad and Erbil can be looking at how oil majors have been lining up. Total has just bought a new stake in the Baranan block, in partnership with the Kurdish regional government. ExxonMobil , which was investing in the south as well, has put its stake in the southern West Qurna 2 field for sale, opting to stay in the north. Chevron too has not even invested in the south and has been blacklisted by Baghdad. It looks like the majors 'vote Erbil' rather than Baghdad.

After some hesitation, Maliki has also decided to go ahead with his Russian arms purchases (helicopters and missiles). This could easily be interpreted as a move towards re-aligning further away from Washington and closer to US rivals in the region and beyond (Iran in particular), although the immediate cause was Washington's refusal to sell the equipment itself, although that is about to change in respect of fighter aircraft.

Iraq is also targeting Saudi Arabia's oil market share, with an aggressive pricing policy which is aimed at securing new clients. For now the competition has been relatively subdued as declining Iranian exports have made enough room for Iraq's oil, but if Iraq were to increase production as planned, the competition could only intensify. The Saudis have already been offering discounts on their oil in response to Iraq's aggressive pricing. Iraq's market share on the Chinese market has already doubled and is rising in India as well. More to the point, some Indian importers are planning to reduce imports from Saudi Arabia and switch to Iraqi oil.

Even if Maliki were to eventually go, forging any new, functional coalition will not be easy. After all, Maliki's rivals already tried to do so after the last elections, but failed after months of efforts. Perhaps now, educated by the experience of Maliki's faltering effort to establish authoritarian rule, they will be wiser and readier to make compromises. One would be ill advised to bet on this, however.

Maliki's strength is that he manages to maintain the support of the US government, who would not like to see chaos in Iraq as well; and of Iran, who still see Maliki as the best way to further their interests and do not want chaos either. His other great strength is that he is skilfully playing the rising sectarian feelings in Iraq. The other main Shiite parties (the Sadrists and ISCI) have been pushed by Iran to keep supporting Maliki. The Sadrists have been gradually distancing themselves from Iran, but at the price of seeing Iranian patronage cut. This did not help them in the last regional elections. ISCI is very critical of Maliki, but will not defy Iran and challenge him openly. This among others, has resulted in the formation of a Baghdad local government which excludes Maliki's State of Law coalition and sees instead Sadrists and Sunni parties together. In the current context of rising sectarian strife, the Sadrists' efforts to undermine Maliki have been costing them popular support. Iraq is increasingly affected by the conflict in Syria, which is taking more and more a sectarian character. Now young volunteers are mobilised and deployed to Syria by Iraqi militias at the rate of 50 a week. They will eventually return to Iraq with even more reason to fuel the sectarian conflict there.


Summary 2012
While the Iraqi currency has been losing ground to the dollar in early 2012 because of the large scale smuggling of greenbacks into Syria and Iran (which suffer from international sanctions), the overall economic prospects of Iraq remain positive as oil production increases, albeit slowly and oil prices remain high. The Iraqi government plans to continue spending in excess of its revenue, but it expects its budget deficit to come down to 11% in 2012 compared to the 14% it reached in 2011. The IMF projects a 12.6% GDP growth for Iraq in 2012, with inflation remaining at a relatively modest 5%.

The government forecasts that oil production would rise to 3.4 million barrels of oil a day in 2012 and will exceed 4 million barrels a day in 2014. During 2012 three new mooring facilities will enter service off Iraq's southern coast, each adding 850,000 bpd to the country's export capacity. Whether these targets are achievable will also depend on the government's ability to secure the pipelines. Indeed political stability is once again the biggest question mark for Iraq in 2012.

At the June OPEC meeting, Iraq aligned with Iran against Saudi Arabia, opposing any increase in oil production and arguing in favour of a reduction. OPEC decided in the end to keep production stable, but Iraq's choosing to align with Iran was in part motivated by the political alliance between the two regimes against 'the common enemy Saudi Arabia', and in part by self-interest (push oil prices upwards). Maliki is also making more public statements against Saudi and Qatari interference in Syria and Iraq. The Iranians in return have been seen as propping up Maliki in his internal confrontation with other Shiite groups, whose hostility to the Prime Minister has been rising steadily; the parliament seemed ready to pass a vote of no-confidence in Maliki in May. Although at the moment Iraq is colluding with Iran within OPEC, at the same the increase in Iraqi oil production has allowed the market to absorb better than expected, the decline in Iranian exports. Iraqi production is now around 3 million bpd, of which about 2.5 million are being exported. Capacity to produce an additional 400,000 bpd should be added by 2013, according to the current plan. It is not clear therefore whether the alliance is sustainable: as Iraq expands its production, it will have to argue in the long term for either an expansion of production levels or for other countries to sacrifice some of their production quotas.

Oil company executives have in the past been dismissive of Iraq's plans and potential for recovery and expansion, but now admit that they are positively impressed by what has been achieved so far. Iraq has revised its old goal of producing 12 million bpd by 2017 downwards to 9.5 million bpd, a plan still considered to be too optimistic by most observers; 6 million bpd is judged to be realistic. The project to develop capacity by pumping seawater underground and increase pressure in order to keep pumping oil out is only progressing slowly, as the Iraqi state bureaucracy remains quite inefficient. Renegotiating Iraq's quota within the OPEC will also take some effort before more oil can be exported. Most importantly, foreign investors are still not too keen to invest in Iraq's oil and gas fields. Western and Chinese oil companies' modern extraction equipment has been key to the improved output.

Although oil production rose 15% in 2011, the Iraqi government has been slow in processing the new oil contracts and even more so in addressing the issue of old and decaying infrastructure and of bureaucratic inefficiency. The government has revised its original and wildly optimistic plans to expand production to 17 million bpd by 2017, down to just 7 million. The Iraqi insistence in keeping the revenue of oil investors as low as possible is keeping them away from the country; the contracts which award just US$2 per barrel of oil to the oil companies are turning out to not be very profitable, considering the state of Iraqi oil infrastructure.

Norwegian Statoil, for example, got rid of its stake in the West Qurna Phase 2 field, selling it to its partner Lukoil, and will invest instead in the US and in Norwegian offshore fields, whose oil is much more expensive to extract. Exxon Mobil also seems to be losing interest: it has won a share of West Qurna Phase 1, but in November it signed a deal with the Kurdish regional authorities to start drilling there. Baghdad, as a result, threatens to ban Exxon Mobil from contracts in the rest of Iraq, but perhaps Exxon secretly hopes that this will happen and so get rid of a non-profitable deal. Even Total is reportedly considering signing a deal in Kurdistan.

The Iraqi public remains hostile to offering more generous terms to the investors and some political factions would certainly be ready to ride a wave of popular opposition to the deals. The government tried to frame the new contracts as not much of an innovation, while in reality introducing an element of production sharing, which is what investors want. The problem of the weak infrastructure will however continue to bog down the development of the Iraqi oil industry and might discourage investors.

At the end of May twelve new gas and oil fields were tendered, mostly in the west and in central Iraq. 47 bidders had registered for the occasion. However, despite the more attractive deals now offered by the Iraqi Oil Ministry, investors seem to remain wary, both because of the political tension in the country and because of the lack of an Iraqi strategy concerning the utilisation of gas production. However, the late May tender for 12 more gas and oil fields went badly, as only three fields were awarded. Some of the fields were not attractive because of their location in remote areas, but the main problem is the terms offered by the Iraqi government. Regional instability (Syria, Yemen, Iran) also tends to discourage foreign investors, as does Iraq's continuing inability to approve an oil law and resolve the dispute between Baghdad and the Kurdish regional government over oil exports from northern Iraq. Erbil shows no sign of relenting and in fact argues that interest among investors for investing in Kurdish oil fields is at an all time high; Erbil expects production to reach 1 million bpd by 2015 at the latest.

A new licensing auction is not planned for late 2012 or early 2013, including those blocks which were not taken up in May, and others. The Oil Ministry now says that the terms offered in the next auction will be more attractive for investors. However many investors are put off by the existing clause that bans companies from investing in Kurdistan and there is no indication that that clause is about to be dropped. Tension with the Kurdish regional government runs so high now that Prime Minister Maliki even cancelled a visit by US vice-president Biden, upset that Biden had decided to visit Kurdistan as well.

Iraq in the meanwhile has replaced Iran as India's second largest oil supplier, (although this is mostly due to sanctions affecting Iran). With Iraqi production reaching 3.03 million bpd in April (7.7% more than in March), the country might well overtake Iran in terms of oil production before the end of the year. The two countries are nonetheless discussing plans to jointly exploit gas fields alongside their shared border.

Part of Maliki's plan to contain Kurdish ambitions, might include new oil incentives and production-sharing contracts to attract back the majors to southern Iraq, and away from the Kurdish zone, but Maliki is reportedly still considering such changes to the oil contracts. Oil exports from southern Iraq hit a new post-Saddam peak in August, at 2.25 million bpd, up from 2.22 in July.

However, exports from the northern region are falling because of a dispute over payments between Baghdad and Erbil - the Kurdish Regional Government is halting exports until the issue is resolved. It is estimated that northern oil exports might fall to 197,000 bpd in August, from 400,000 earlier this year. Oil production capacity in any case continues to grow, although Iraq is lagging behind in preparing the ground for the further, massive increases in production that it has been planning. Experts estimate that in order to bring production to the planned 12 million bpd, the country will need as many as an additional 150,000 additional skilled oil workers. Oil contracts stipulate that no more than 15% of the oil industry workforce may be composed of foreigners, so importing all the additional oil workers is not an option. There are in fact different estimates of how many oil workers may be needed, with Iraqi analysts estimating 10,000 oil workers per additional million bpd and international oil firms estimating 5-7,000 oil workers per million bpd. In either case a massive recruitment and training campaign will be needed and it has not even started yet. Awareness of these constraints is gradually making an impact: within the government there are voices which favour lowering the oil production target from 2020 to 9 million bpd from the current 12 million.

Economic reforms are on hold since last year, as the government fear that they could unleash popular protest. Far from abolishing subsidies and introducing taxation, the government has been handing out new subsidies, even more inefficient and wasteful than those already existing, while tax reform plans appear to have been all but forgotten.

The dispute over oil exports with the Kurdish regional government continued to worsen until the summer. The Kurds are now building their own pipeline into Turkey, which will become operational in 2013, and plan a second one to become operational by 2014. This will eventually allow them to export oil without going through Baghdad, a development which will certainly not please the Iraqi government. The Kurds also accuse Prime Minister Maliki of carrying out a purge of Kurdish officials from the central government. The Kurds are not completely united in their stand versus Maliki: the president of the Regional Government Barzani, has adopted a tougher rhetoric and in the past has even raised the prospect of a referendum over Kurdistan's union with Iraq; Iraqi President Talabani is more moderate and diplomatic in his rhetoric, as one would expect given his different role.

Prime Minister Maliki's efforts to isolate the Kurdistan region and roll back its growing success in attracting oil companies to invest suffered a blow in July, when Chevron agreed to purchase the 80% stake held by Indian conglomerate Reliance in two blocks in the Kurdish region in Iraq. With Chevron turning up in Kurdistan, Baghdad's campaign against Exxon, which was already present in Kurdistan, becomes more difficult to achieve, despite Maliki's claims that the Obama administration has endorsed his position and distanced itself from the Kurdish regional government. The administration indeed advised caution to the American companies involved in the Kurdistan region, warning them of the consequences of going against Baghdad's will. The strength of the Kurdish regional government is that it offers much better contracts to the oil companies than Baghdad itself. The Iraqi government has been signing several oil deals in recent weeks, all coming out of the latest (not very successful) tender for oil fields. Few oil majors play any role in these deals, particularly American ones. Of 12 oil blocks being tendered, only three received winning bids and one was awarded after the conclusion of the tendering process, as the Bashneft-Premier Oil agreed to significantly worse conditions. Now Baghdad plans to cut Chevron's contract to buy 167,000 bpd from Iraq in retaliation.

Maliki's growing assertiveness vis-à-vis the Kurdistan regional government begins to convince observers that he would consider the military option as well. Recently Baghdad has been lobbying for accelerating the delivery of the 36 F-16 fighter-bombers which it ordered in the US along with all the associated equipment. Maliki is also sparring with the Turkish government, which sympathises with the Kurdish and Sunni oppositions to Maliki in Iraq and their attempts to unseat him; Turkey's support for the anti-Assad opposition in Syria is another sore point, as Maliki instead supports Assad. The issue of Turkish cross-border raids into Kurdistan plays into Maliki's hands also because denouncing these incursions strengthens his nationalist credentials and undermines those of the Kurdish regional government, which has been very quiet about them recently.

In July the Kurdish militias prevented the Iraqi army from deploying in an area they control near the border with Syria; now Baghdad accuses the Kurdish militias aligned with the Regional Government of secretly buying anti-tank and anti-aircraft equipment; the implication of course is that the Kurdish regional government is getting ready to fight Baghdad militarily. Reportedly earlier this year the head of the Kurdish Regional Government tried to dissuade Washington from selling F-16 fighter-bombers to Baghdad. The Kurds accuse Baghdad of deploying tens of thousands of troops next to the border with the Kurdish region and say they are also deploying their militias there. Baghdad's irritation is only increased by the fact that in August a third oil major decided to disregard its threats and to sign an oil deal with the Kurdish government: this time it was Total, following up on Exxon's and Chevron's steps. It would appear that the majors calculate that the Kurds would emerge victorious from a confrontation with Maliki.

In September a deal was finally achieved between the Kurdistan Region and Baghdad over increasing oil exports from the north, which bodes well for a wider agreement on oil and gas exploration in the north. The deal was reportedly brokered by President Talabani, himself a Kurd, but also one of the most respected of Iraqi politicians. This deal would effectively end the dispute between Erbil and Baghdad, which seemed to be reaching close to armed confrontation in August. The deal agreed in September is about increasing the amount exported from 120,000 bpd to 200,000 bpd in 2012, rising to 250,000 bpd in 2013. As a result of the deal oil exports already rose to 140,000 bpd in September. Baghdad and the Kurdish authorities also formed a committee to resolve lingering conflicts on oil revenue sharing and payments. This development can be seen as a victory for Erbil and could result in more foreign oil companies making deals with the Kurdish regional government. Already Royal Dutch Shell, which had pulled back earlier from such deals, is reported to be considering to invest in Kurdistan again.

The Turkish government supports the opposition to Assad in Syria, while Baghdad supports Assad and fears an Islamist takeover in Syria would reinvigorate the Sunni opposition to him and provide them a safe hideout from where to subvert Iraq.

Moreover, Ankara support the Iraqi Kurds against Baghdad, although it is also trying to avoid the rift between the two from deepening too much, as it does not want to see an independent Kurdistan, which would further embolden Kurdish opposition inside Turkey. Baghdad has been recently accusing Ankara of treating the Kurdish Regional Government as an independent government, after Turkish Foreign Minister Ahmet Davutoglu, without even informing Baghdad, visited Kurdistan. In particular he visited the disputed city of Kirkuk, which the Kurdish authorities would like to incorporate into their region. Despite the widening gap between the Turkish and Iraqi governments, the economic influence of Turkey over Iraq is growing rapidly; in fact Turkey is already the dominant regional economic partner, having surpassed Iran. Turkey is also expanding its cultural influence and is beginning to dominate the airwaves as well.

After a lull in September, tension with the Kurdish regional Government over oil deals has resurfaced in October. A meeting to discuss the finalisation of the oil law in such a way to satisfy both sides has been cancelled. Now Baghdad demands to be allowed to deploy troops on the Turkish border, to prevent Turkish incursions for sure - but also to put pressure on Erbil. In a further reverberation of the Syrian conflict, Baghdad is reportedly considering to abrogate the agreement that allows Turkey to station troops inside Iraqi territory in pursuit of PKK insurgents.

Prime Minister Maliki is completing the synchronisation of Iraq's security establishment with his own personal power. The intelligence services, which had been managed de facto by the CIA after the fall of Saddam, are the last ones to be undergoing the process. The Americans had kept a lot of Saddam's agents in the service, because they thought they needed them to rebuild the organisation and probably also because they thought it would help them to keep the Iranians at bay. The two main branches of the service have since 2006 been dominated by Maliki and former Baathists respectively, often fighting real wars against each others with assassinations and arrests. Maliki has been directing most funding towards the branch loyal to him, allowing it to gain an edge over the rivals.

In the army the process started much earlier. The Kurds complain that they have been gradually purged out of the army. While the post-Saddam power sharing agreements envisaged a 23% Kurdish representation in the armed forces, Kurdish politicians now estimate that Kurds only account for 3-4% of the Iraqi army. The decline has been gradual and started before Maliki became prime minister, but has continued since he took over. Two of Iraq's 15 army brigades are commanded by Kurds, who are however said to have no real power and control over their units. More ominously, there were no Kurds among the top army appointments of the last two years. Maliki is also seen as trying to impose his control over the central bank, whose former chief is now the target of an arrest warrant. More in general the government is delaying the reform of the banking sector, because it prefers to have state banks in a dominant position and little transparency in the sector.

As he sees the distance with Washington growing because, among other things, of the Syrian crisis, Maliki has decided to rebalance his foreign policy and move closer to Russia, which is instead now aligned with Maliki in supporting the Syrian regime. After a successful trip to Moscow, Maliki signed major arms deal with Russia, including the purchase of anti-aircraft missiles and attack helicopters. The content of the deal is now just about accelerating Iraq's rearmament although is said to be 'on hold.' (Maliki is also signing a deal for 18 more American F-16 fighter bombers and for 24 trainers with the Czech republic), but also symbolically about Iraq's perceived threats: the advanced missiles it is buying from Russia only serve to defend Iraq against the US (or Israel), while the helicopters would be very useful in repressing internal resistance.

The shift is being mirrored by the exit of Exxon from the southern field of West Qurna 1. The rumours are that Maliki would like to give that to Russian Gazprom. For the moment however, Maliki is not yet ready to break with Washington altogether. He agreed for example to have Iranian planes bound for Syria checked, to make sure that they comply with the arms embargo against Assad's regime.

The Iraqi dinar was by April under growing pressure because of the high demand for dollars in neighbouring Syria, which is pushing the exchange rate against the dollar, up and up. The central bank of Iraq has tightened regulations, trying to make selling dollars more difficult, but this is now hampering legitimate business operations - sending money abroad has become much more difficult. On the positive side oil exports are reaching a new record in April, with almost 200,000 bpd more being exported from the south on average. The northern fields are averaging another extra 100,000 bpd. Exports of at least 2.5 million for April seem almost certain. Even better, later this year BP is expected to significantly increase production from the Rumaila field, which it is overhauling. The northern pipeline is now under threat from PKK guerrillas in Turkey as well, but the pace of sabotage is still well below the peak of a few years ago.

The Iraqi export target for this year, which is 2.6 million bpd, is well within target. These first positive signs of economic recovery are stimulating the development of a more positive attitude among foreign investors. They say that there is more political stability and that the infrastructure is also improving; regular waves of terrorist attacks are for the time being failing to kick- start a new civil war, perhaps because the country has already been de facto partitioned along sectarian lines.

The Iraqi government is about to launch a massive 5-years investment programme for US$250-275 billion, aimed at infrastructure projects and other investments over the next five years. It also plans to build a petrochemical factory in the south, with an investment of US$8-10 billion. However, previous efforts to invest in infrastructural development are reported to have produced little apart from massive corruption. The country already borrowed US$36.5 billion to complete projects disrupted by waste and corruption, including the building of 2.5 million residential units, 6,000 schools and road repairs, but even this money seems to have achieved little and in some provinces the projects are still just 6% complete. Prime Minister Maliki now proposes to borrow an additional US$37.5 billion to accelerate infrastructural development, but understandably there is scepticism as to the wisdom of this.

Prime Minister Maliki seems determined to assert his control and move towards greater centralisation. It might well succeed, as his adversaries are divided internally and their ranks are full of opportunists, who might decide to switch sides and join Maliki, while he marginalises the main political rivals. However, almost everybody outside Maliki's own party and even some within it, fear his rise to autocracy. He will face serious obstacles to consolidate his hold and might have to get through a new civil war. The attitude of the Kurds might be decisive: they fear Maliki's centralism as much as anybody else, but are not ready for the final confrontation with him because the regional environment is not conducive to enhanced Kurdish autonomy, not to speak of an independent Kurdish state.

Prime Minister Maliki continues defying predictions of his forthcoming demise by outmanoeuvring his rivals and consolidating his hold at every crisis he faces. Maliki's efforts to wreck the mainly Sunni coalition led by his rival Allawi appeared to have achieved his aims as the end of March approached. Vice-president Hashemi was not only on the run, but increasingly isolated as the Kurdish regional government appeared to reconsider the support they had been lending to him, after Baghdad shared evidence pointing to his actual involvement in political murders!

Most importantly for Maliki, many supporters of Allawi's Iraqiya coalition are now bitterly critical of Allawi's emotional reaction to Maliki's onslaught: the boycott of the parliament ended in failure and only showed how Iraqiya was not able to protect the interests of its own members and supporters. Iraqiya is now disintegrating, with some willing to reach an accommodation with Maliki and others more inclined to radicalise their opposition. This serves Maliki well: he needs some violent opposition to justify his increasingly authoritarian rule and indeed his determined crack down on Hashemi and his unwillingness to back track have been perceived positively among many Shiites: they think they might have found the strong leader they were looking for.

Another piece of good news for Maliki is the split within the Supreme Islamic Council of Iraq, whose Badr Organisation wing has now formally split from the main body. The division between the two is largely about the leadership of Al Hakim, judged weak and ineffective, by the leaders of Badr, but what matters for Maliki is that this weakens the Supreme Islamic Council, which was hostile to Maliki. The leaders of Badr are instead allies of Maliki. This follows other splits, which favoured Maliki by weakening other rival Shiite organisations, such as the Sadrists.

Maliki has also succeeded in establishing control over the judiciary, which is supposed to be' independent of political power' but has instead in recent months toed the Maliki line and quite openly targeted Maliki's political enemies for retribution.

Even Maliki's relations with the Sadrist bloc, a key Shi-ite ally, are worsening. The Sadrists even sympathise with their rival Kurds and the Iraqiya bloc in their conflict with Maliki, a fact which highlights how they too see Maliki as the main enemy. The Sadrists have always been in favour of a unified and centralised Iraq, so they never had very good relations with the Kurds, and are also opposed to the Iraqiya bloc, which contains many of their former Baathist enemies. Muqtada as-Sadr accuses Maliki of marginalising his supporters as well .He is now reportedly considering joining hands with Iraqiya and Kurds in a vote of no-confidence against Maliki. The Prime Minister has come under criticism even from other Shi-ite allies (the Islamic Supreme Council of Iraq), who are now trying to impose constraints on his freedom of action as Prime Minister. Maliki is also getting caught up in worsening relations with Turkey, who have been trying to defend Hashemi and other Sunni politicians. Maliki has been seeking the means to retaliate against Turkish interests in Iraq.

Maliki's rivals are no fools, however, and they can see how he is using 'salami tactics' to devour his enemies, one by one. The head of the Kurdish regional government has recently stated: "Where in the world can the same person be the prime minister, the chief of staff of the armed forces, the minister of defence, the minister of interior, the chief of intelligence and the head of the national security council?"

Maliki lost one minister in August, as communications minister Mohammed Tawfiq Allawi resigned accusing Prime Minister Maliki of being tolerant of high level corruption. Allawi is a relative of former prime minister Iyad Allawi, Maliki's chief rival, so his resignation does not come as a surprise. Maliki however is under growing pressure from the US and from his Sunni neighbours over the alleged transit of Iranian supplies for the Assad regime in Syria through Iraqi territory.

The latest in a series of moves by Prime Minister Maliki to centralise power in his hands, is the arrest of the head of the independent 'High Electoral Commission', which had a reputation for fairness and freedom from political bias. Maliki had blamed the Commission in 2010, when his party fell a few seats short of a plurality. Few believe that the charge of corruption is well founded. The Kurdish regional authorities were particularly vocal in voicing criticism at the arrest.

In order to highlight their opposition to Maliki's strengthening authoritarian tendencies, the President of the Kurdish autonomous region met fugitive Iraqi deputy prime minister Tariq al-Hashemi in Istanbul; the Turkish authorities have also taken sides, announcing that they would welcome al-Hashemi in Turkey if he decided to seek asylum there. Al Hashemi also visited Qatar, whose authorities have refused a request by Baghdad to extradite him. The Kurds particularly like Al-Hashemi because shortly before his fall 'in disgrace,' he had been advocating a federalist solution for Iraq, which the Kurds fully support.

Recently the Kurdish Minister of Armed Forces (Peshmerga) stated in public, that his forces are ready to repel any attempt by the Iraqi army to enter Kurdish territory; (it is now common for Kurdish politicians to refer to Prime Minister Maliki as an aspiring dictator). However, the Kurds have been steadily losing American support: Washington increasingly questions the wisdom of maintaining a special relationship with the Kurds, considering the diplomatic costs that it might entail.

Perhaps because Allawi's Iraqiya appears clearly to be fading as an alternative to Maliki, the Saudi government has recently initiated moves to improve relations with Baghdad. Saudi Arabia has finally appointed an ambassador to Baghdad, the first since 2003, and has welcomed an Iraqi delegation to Riyadh. Perhaps a factor in this rapprochement is the apparent greater willingness of Baghdad to distance itself from the Syrian regime, which Riyadh opposes and Teheran supports. Another move from Baghdad which seems likely to have displeased Teheran, is its willingness to replace Iranian oil supplies to Sri Lanka, after the South Asian country decided to comply with sanctions and stop purchasing Iranian oil.

Despite the multiple sources of pressure, the ailing Assad regime in Syria, and the key ally of Iran under an increasingly tight international siege, Maliki shows no signs of giving up - he has (temporarily?) patched up things with the Kurds and focuses for the time being on his Sunni Arab rivals. Vice-president Hashimi was sentenced to death in absentia, in early September, highlighting how Maliki is not willing to appease the concerns of his Sunni neighbours (principally Saudi Arabia). Indeed the sentence did little to improve relations with Turkey; Baghdad asked Ankara to return Hashimi and of course only obtained a refusal. In retaliation Iraq's Trade Ministry stopped registering Turkish companies in Iraq. Maliki has since last December brought the security forces largely under his control, appointing loyal generals at the head of each provincial command centre and making sure that the special operations forces and the security services are under his direct control.

The efforts to undermine Maliki seemed to be very close to deprive him of a parliamentary majority in June, when Muqtada As-Sadr had reportedly offered his support to Iraqiya and the Kurdish parties for a no-confidence motion against Maliki in the parliament. Then the Iranians intervened and started negotiating between As-Sadr and Maliki, as well as lobbying on the latter's behalf; the high level delegation included among others political heavy weight Ali Larijani. As a result As-Sadr has taken recently a step back and declared that if Maliki were to carry out a few reforms such as implementing article Article 140 of the Constitution, approving the oil and gas project and a few other minor things, then the Sadrists would not support the no-confidence vote. Maliki's willingness to abide to the conditions set out by the Sadrists was not clear at the time of writing. Maliki was threatening to dissolve parliament in front of the threat of a no-confidence vote. Maliki has also to face a recrudescence in violence: 234 Iraqis were victims of political violence in June alone. While most of these deaths are the result of Al Qaida's attacks on Shiites, the situation in Syria might also contribute in the near future to greater instability in Iraq.

The American withdrawal has been promptly followed by a resumption of attacks on oil pipelines. In December 2011, oil exports had increased by 1.9% to 2.175 million bpd, while production reached 2.705 million bpd.

Further increases in exports might be jeopardised if the government cannot safeguard the pipelines effectively. Attacks on civilians, particularly Shiites, also resumed on a large scale. Clearly, the terrorist groups are hoping to exploit Maliki's crackdown to reignite the insurgency. Maliki seems to think that he can crush them, together with Iraqiya's hard core, and co-opt the rest.

Perhaps his gamble will pay off and Maliki will emerge as the Middle East's first authoritarian leader after the Arab Spring trend.

If not, Iraq might fall back into civil war.

American influence in Iraq is evaporating quickly: even Allawi, their favourite, now talks of 'American failure' and of regretting having placed his trust in Washington. With the completion of American withdrawal in December, the Iraqis face the challenge of having to sort out their internal problems without any powerful mediator to strong-arm them into coalition making. That, of course, had to happen one day if Iraq was to fully resume its independent status, but many wonder whether Iraq is ready.

In fact, as the withdrawal neared, the ruling coalition already started fraying, as Prime Minister Maliki accentuated his centralist tendencies, without which he and his supporters think the country could implode. He wields his control over the security agencies to exercise pressure on his 'allies'; he started by having two bodyguards of Vice President Tariq al-Hashemi, a member of Allawi's party, arrested on charge of being involved in murders. During December Maliki's main rival, Allawi's Iraqiya party, threatened louder and louder to abandon the coalition, which it actually did on 19 December. It is also implicitly threatening to split the country, with provincial councils controlled by Iraqiya declaring autonomy from Baghdad, one after the other.

In November it was Salahuddin, in December Diyala. Ominously, in Diyala the Kurds supported Iraqiya's move, despite their lack of love for Arab Sunnis; they seized the opportunity to send a message to Maliki. Maliki reacted by arresting more and more members of Iraqiya and even issued an arrest warrant for Al Hashemi himself. Maliki also refused to collaborate with his critics within the government. Maliki as well tried to exploit fissures within Iraqiya, which in fact had to fire six of its MPs who refused to join its boycott of parliament.

In the meanwhile the Iraqi political scene has known some evolution. Towards the end of January the escalation in the confrontation between Maliki and the Sunni Arab factions reached its peak; the situation seemed so bad that even the Turkish government decided to intervene and warn Baghdad that sectarianism in Iraq would not be tolerated. Maliki responded aggressively to the Turkish move, but at the end of January the Sunni lawmakers ended their boycott of parliament and a few days later the Sunni members of the Cabinet also went back. It is not clear whether Maliki has promised concessions, or whether the Sunnis decided to try some confidence building steps in order to de-escalate and invite Maliki to reciprocate.

While tension between Maliki and the Kurdish coalition was rising fast last year, the main axis of conflict is now between Iraqiya and Maliki's State of Law; and also with the Kurdish region, after Maliki ordered Al Hashemi's arrest. Iraqiya vice president Hashemi took refuge in the Kurdish region. The Kurdish regional government has so far refused to hand him over, yet are trying to play a moderating role.

If Maliki mishandles the situation, Iraq might become the battlefield of regional hegemons. The Saudis could see the opportunity to roll back Iranian influence, already weakened by the crisis of their Syrian ally. The Iranians will not let their gains in Iraq go without a bitter fight, the more so as their international isolation has been growing. The Saudis distrust both Washington, whose intention they believe was to create an alternative pillar of its Middle Eastern politics in Iraq, to reduce dependency on Saudi Arabia, and Maliki, whom they view as an Iranian agent. Saudi support and encouragement for Allawi is increasingly obvious. The Saudis also wield the card of Iraq's US$20 billion debt with the Kingdom, which they refuse to cancel (like most other countries have done) as long as Maliki is Prime Minister. Saudi Arabia also uses its diplomatic weight in the region to keep Iraq out of the Gulf Cooperation Council, in fact humiliating it with the inclusion of Jordan and Morocco, which are well away from the Gulf. There are also indications that Saudi Arabia is backing up Kuwait's unwillingness to discuss its disputes with Iraq.


Forecast and summary 2011
During 2011 Iraq's new oil export infrastructure will start coming on line, allowing for Iraq's oil exports to rise significantly now that investment in oil production has started. In total, projects to raise the oil export capacity by 6.2 million bpd are underway, with 0.9 million bpd expected to be added in 2011. Many observers, having been sceptical this far, are beginning to think that oil exports will actually start rising seriously in 2011. Rising oil prices should also contribute to raise the Iraqi GDP growth to 11.5% in 2011 (IMF estimate). Inflation is expected to remain roughly stable at 5%. The new draft state budget show for 2012 a 36% increase to 131 trillion dinars (US$112 billion), including a deficit of 23.3 trillion dinars. Security and defence alone receive 20 trillion dinars in this budget. In this regard Maliki confirmed in September that the American troops will completely withdraw by the end of the year, even if discussions for the return of training and advisory elements are continuing. The US armed forces have already started packing up, closing down bases and from the end of September there will be just 40,000 US troops in Iraq.

In September Iraq's oil production capacity increased further to 2.95 million bpd, although the country is not able to fully exploit this capacity due to the limitation of its infrastructure, which only allows for the export of 2.2 million bpd. Production capacity is expected to reach 3 million bpd at the end of October, but the first of the four new oil export terminals under construction will be operational only in January. Each one of them will have a capacity of 0.9 million bpd and should therefore cater for available exports for years to come. In the Kurdish region there is an additional problem of a dispute over payments to the oil companies working in the region; in retaliation for the government's failure to pay, production is being curtailed.

The Iraqi foreign exchange market has been experiencing some foreign interest in 2010, with foreign buyers getting a net US$53 million of shares: a modest amount by any standard considering the total value of floated shares of US$3 billion, but after all, this is still a country affected by extreme violence and high levels of political uncertainty. In general the foreign exchange started 2011 in a very dynamic way, with volumes of trade having gone up by over 50% compared to the 2010 average. A few relatively large companies seem intentioned to float shares on the stock exchange in 2011, a fact which will contribute to attract interest.

Economic growth in 2011 is not expected to have a major impact on the very high unemployment level. In January the new Iraqi government announced that state employment is planned to increase by 171,000 in 2011, a modest amount when it is considered that the armed forces alone will go up by 100,000. That a relatively modest 71,000 jobs will be added to the various ministries is in a sense, good news, given that Iraq's public sector is one of the most bloated and inefficient of the world. The problem of unemployment however remains, as growth in the oil sector will not necessarily spread wealth around the population, oil not being a labour intensive industry. Yet such is the political and 'clan' structure, with all those nephews and cousins, 'Jobs for the boys' must be found.

Although not helped by a semi-paralysed government, Iraq continues to make slow progress towards reconstruction. An important step was in July the signing of a US$12 billion deal with Shell and Mitsubishi for the capture of presently flared gas from the southern oil fields, and the utilisation of this for power generation. The excess gas will eventually be liquified and exported. The joint venture is 51% owned by the Iraq government, 44% by Shell and 5% by Mitsubishi. Even the stock exchange has been growing steadily after the formation of the coalition government at the end of last year. Although still small with a capitalisation of just US$4 billion, some foreign companies like HSBC and France Telecom are beginning to invest in it. Investors know that last year Iraq's oil reserves were revised upwards to 143 billion barrels from 115 billion (despite the fact that at this time, just 20% has been explored for oil reserves).

Iraqi oil production reached a new height (compared to the post-2003 period) in September, when the output was 2.81 million bpd; the previous post-2003 record was 2.75 million bpd in July. Still some important fields continue facing major problems, in particular Rumaila where BP is trying to increase production but its efforts have been dogged by widely fluctuating pressure, to the extent that there were rumours that BP might try to renegotiate the terms of its contract with the Iraqi government. Problems like this, together with even greater infrastructural issues, make the oil majors believe that Iraq's plans of an output of 12 million bpd by 2017 are utopian and that at most, Iraq can expand its production to 6 million bpd. The Iraqi government for its part is hoping that a revised approach to oil bids will attract more foreign investment bigger and faster. The fourth auction for exploration rights will feature a new remuneration formula for the 12 exploration oil and gas fields, which are up for grabs. The formula deducts the value of sub-contracts from the remuneration, removing an incentive for bidders to overstate the value of the subcontracts, which has been a problem in the past. The contracts will also be longer, 30 years as opposed to 20 years in the previous auctions. As a result it is expected that the next auction will be a success; at least 46 oil and gas companies have already registered for attending.

What could still spoil the situation, of course, is the precarious political situation. The suspension of the export of Kurdish oil in September gave origins to a lot of speculation that the Kurdish Regional Government was protesting against Prime Minister Maliki's approval of the new oil law, without previous consultation with the Kurds. Later the Kurds stated that the suspension had been due to technical problems. What is certain is that the Kurdish Alliance has threatened to withdraw its support from the Maliki government, because the power sharing agreement with Maliki had included a clause of consultation. Maliki's act is only the latest of a series, which is increasingly earning him a nickname of 'the dictator'. Not only the Kurds accuse him of centralising tendencies, but even Muqtada as-Sadr has complained vociferously recently over the arrest of a MP, and Maliki's attempts to silence that part of the media not aligned with the government. The reference is to the assassination of prominent media critic Hadi al-Mahdi. Criticism of Maliki is not unheard of even within the ranks of his own party, Dawa.

Prime Minister Maliki has recently ordered the removal of Kurdish flags from government buildings in Diyala province, part of which is disputed and claimed by the Kurdish regional government. The Kurds are becoming very upset by this. From Maliki's point of view, however, it is probably a plot to consolidate his support among Arabs. Indeed in Kirkuk, another disputed region, the local Arabs who had supported the rival coalition of former prime minister Allawi are now shifting their support to Maliki, attracted by his tough stand against the Kurds. Allawi, by contrast, is trying to court the Kurds in order to undermine their support for Maliki as Prime Minister. Maliki's strong stance against the Kurds also make the Sadrist Shiites happy: Muqtada As-Sadr is a strong Iraqi Arab nationalist and has been fiercely critical of the Kurdish regional government. Sadr is also critical of Maliki, but the Prime Minister is positioning himself as the lesser evil for the Sadrists.

The persistent violence, if not as widespread, is not likely to succeed in igniting a new civil war, because the Shias and the Sunnis are now largely physically separated. However, the possibility of a revival of the insurgency in the Sunni Arab lands north of Baghdad, cannot be discounted. Inter-factional rivalry within the government adds another factor of uncertainty and instability that could discourage investment, even if as of early 2011 many investors seemed inclined to consider it political theatre, more than a serious threat.

Maliki finally managed to form his government before the constitutional deadline of 90 days. Allawi's group took the post of parliamentary speaker, the deputy premiership and the finance ministry, among other positions. The predominant character of the new coalition is centralist and Arabophile; the Kurds are part of it, but their federalist views have few allies now, as the other federalist groups have been weakened in the elections and have modest representation within the cabinet. The new Sunni Arab parliamentary speaker, is a vehement enemy of the Kurds and a strong centralist. The powers of the new National Council of Strategic Policies, supposed to be presided over by Allawi, have not been defined yet. Another possible point of contention is the power of Deputy Premier Shahristani, formerly oil minister: the Kurds were glad to see him going, as he had opposed their demands for autonomy, but now are being told that he will have an oil industry supervisory role in his new job. The followers of Muqtada As-Sadr, who are part of the coalition, are resolutely opposed to any American presence in the country and even opposed Vice-president Biden's visit to Baghdad in January. Sadr recently returned from Iran and has already begun agitating against the Americans and other demons; Maliki has been pretending not to see and not to hear and probably thinks that Sadr's sermons add to the Prime Minister's leverage when negotiating with Washington, but the game cannot go on forever without causing some damage. Perhaps the greatest danger we can foresee for the new government, is not disintegration, however, but a permanent deadlock where no serious decision on key issues can be taken.

The Iraqi political establishment was clearly impressed by the Egyptian and Tunisian developments and has been taking measures to highlight how it is more responsive to the needs of 'the man in the street'. Demonstrations in Iraq started in February and on some occasions turned violent, even if they did not attract anything like the crowds seen in Egypt. The cities of Kut, Diwaniya, Basra, Anbar have been affected. In some cases the demonstrators raised issues of 'freedom of expression' and civil liberties, as well as of corruption, but the poor quality of public services was the dominant concern. One of the key grievances was the lack of electricity and the fact that government officials are privileged in its distribution. The Shiite clergy has been demanding that the political class listen to the demands of the crowds. For the time being, the measures taken have been mostly symbolic: the salaries of government officials have been reduced by up to 50%, as in the case of Maliki himself. In reality, everybody knows that Iraqi politicians have sources of income beyond their salaries. The estimated savings coming with these measures are a paltry US$19 million; it is unlikely that they will either contribute to reduce the level of corruption, or improve the efficiency of the government.

Iraqi Prime Minister Maliki survived the protests of 4 March (Day of Rage), when thousands gathered together to protest the corruption of the regime. This followed another large demonstration on 25 February and many more sporadic demonstrations throughout February and March. Maliki's reaction to the protests was a nervous one, sometime panicky. An indication that the demonstration unnerved many within Maliki's State of Law coalition was the resignation of the governor of Basra, in whose council the State of Law coalition has 20 of 35 seats. State of Law has then struggled to find a replacement because of internal divisions. Even if the demonstrators were not asking for regime change, the police reacted often heavy-handedly over the last couple of months, when demonstration after demonstration the protests seemed to be gaining momentum; tens of demonstrators have been killed. Maliki tried to contain the protest by discouraging them with a series of intimidating television interventions, alleging infiltration by Al Qaida and Baathists, but to little effect. Maliki also tried to intimidate some of the small parties which have tried to ride the revolt, like the Communists, whose headquarters have been taken over by the government. Finally Maliki has continued to soothe the revolt by promising subsidies for the price of sugar and electricity. The government is also moving to improve food distribution, by decentralising it to the provinces, which will now be authorised to import, store and distribute the food items they consider to be necessary. Food rations for the poorest will also be improved, with the funds allocated for food distribution going from US$3 billion to US$5 billion. The poor quality of the rations was one of the complaints of the demonstrators.

The real danger to Maliki, however, does not seem to come from the streets, but from his uneasy allies in the new coalition government. Muqtada As-sadr, the radical Shiite leader, in the early weeks of the turmoil had appeared supportive of Maliki, giving him 6 months to show what the government can do to address the concerns of the demonstrators. Now he seems to be flirting with the idea of joining the opposition; Even the Kurdish coalition, which so far has been loyal to Maliki, is in trouble as it is being challenged in the streets of Kurdistan by its own opposition.

The political paralysis is however affecting the oil and gas sector in a number of ways. There is still a bitter debate going on, concerning the setting up of the National Oil Company, along the lines of what was done in the 1960s. Some argue that there is no need for that and that a number of smaller companies can do the job perfectly well, under the coordination of the Oil Ministry. Others argue that a National Oil Company is needed in order to formulate a coherent and comprehensive oil and gas policy. The Oil Minister is one of the opponents of the National Oil Company, because it would represent a form of competition with the Ministry itself. Maliki is trying to regain some political initiative by pushing through a proposal to downsize government, cutting the number of ministries from 46 to 30. It is also a convenient scapegoat which attributes the lack of improvement in the lives of ordinary Iraqis to a cumbersome government structure, implying that the leader is constrained by the need to collaborate with a disparate bunch of allies. If the plan was approved, it would mainly be ministries without portfolio to suffer.

A substantial measure taken in response to the Egyptian events and the riots in Iraq was in February the decision to postpone the acquisition of F-16 fighter jets and increase instead the amount spent on 'food subsidies for the needy,' from US$3 billion to US$4 billion. The budget deficit remains at US$13.3 billion; 6 million Iraqis are on the take. Another concession is the decision to grant 1,000 Kwh of free electricity to every Iraqi family, (that is if they have access to electricity at all). Finally, Maliki has reassured those who see him as an aspiring Mubarak if not as an aspiring Saddam Hussein, that he will not seek a third term.

Tension between Maliki's party and Allawi's continued to rise in July, with demonstrations pro- and against Maliki taking place in the country's capital. Maliki is also facing criticism and discontent per his failure to meet any of the promises made to the spring demonstrators, to punish those ministers who failed to improve public services within 100 days. The 100 days are over and nobody noticed any improvement, but the ministers are still in place and Maliki reneged on this promise, asking the population to be patient. Maliki is not keen to sack ministers because it would then be very difficult to put a new cabinet together, considering the effort that it took to get this cabinet going in the first place. There is potential for popular discontent to escalate again during the hot summer, as major shortages of electricity are expected again this year. Demand is expected to reach 12,500 MW, whereas supplies are projected at 7,500 MW, of which 950 MW will be imported. The government is investing in power generation, hoping to add 4,000 MW by the summer of 2012, but the trouble will be this summer. Demand rises continuously, because Iraqi families are buying a lot of domestic appliances. The government plans to fully meet internal demand by 2015, when power generation is expected to reach 16,000 MW. However, this requires US$4.5 billion of investment each year.

The Sadrists as usual threaten a return to violence if the Americans do not withdraw by the year's end - as it now seems to be in the cards! In reality, the Sadrist movement has been somewhat fraying internally, with some fractions already using violence occasionally against the Americans still in the country, and others closer to the Iranians than Muqtada As-Sadr himself. Muqtada has had to return to Iraq in order to clear the mess within his movement: the participation in the government has only increased the competition within it for jobs and positions. For the moment being, therefore, the Sadrists are not a major threat to Maliki.

The American presence seems now almost certain to draw down to nil in 2011, as far as troops are concerned; now it seems that the State department will maintain a presence through thousands of security contractors, in charge of training the Iraqi security forces. A few hundred from the military might also stay as part of a NATO mission. More and more the competition for influence in Iraq will be between the Saudis and the Iranians.

President Obama okayed the stay of US troops in Iraq beyond 2011, as long as the Iraqi government requests so, but it is no longer clear that Iraqi Prime Minister Maliki actually wants to make a formal request for them to stay. Within the Iraqi armed forces many would like to see the Americans stay, at least with a massive training effort, but politically for Maliki making such a request would be too costly. Indeed Maliki has already responded to American emissaries that Iraqi troops are ready to defend the country on their own, without external help. The Obama Administration talks of 15-20,000 US troops plus some Special Operations Forces who may stay in Iraq, perhaps because after the loss of important allies in the Middle East (Mubarak of Egypt) left the US position in the region significantly weaker, Maliki is increasingly under pressure and dependent on the support of the Sadrists for political survival, who have made their position very clear; Muqtada as-Sadr has discouraged his supporters from joining the street demonstrations of the last few months, decisively helping Maliki stay in the driving seat. The deployment of Saudi troops to Bahrain to repress the local Shiite majority has made Maliki's predicament even more difficult: the Bahraini Shiites enjoy widespread sympathy among their co-religionaries in Iraq and the failure of the US to condemn the repression has angered many (the Americans have an important military base in Bahrain). The Iraqi Shiites feel increasingly threatened by the Saudis, whom the Iraqi intelligence accuses of supporting the Sunni insurgents.

US Secretary of Defense Leon Panetta stated in August that the Iraqi government had finally agreed to keep US troops in the country after the end of 2011. The Iraqi government, however, has denied that a deal has been reached and simply states that negotiations are still going on. It appears that the Iraqis have expressed the desire to keep trainers for both Ministry of Defence and Ministry of Interior, but want to negotiate in detail the type of troops and their role.

How this will play out with the Sadrists is not clear yet. Prime Minister Maliki's State of Law and the Sadrists are already competing bitterly for the allegiance of the Shiite population. The Sadrists have a much stronger grass roots organisation and now are using the ministries they control (housing, water, municipalities and planning) to deliver projects in their fiefdoms, or in areas they are trying to conquer politically. In fact the Sadrist ministers have been the most pro-active within an otherwise paralysed government, except that Maliki is now trying to starve those ministries of funding. Maliki's efforts to compete with the Sadrists in the provision of patronage are hampered by the fact that he does not really have a grass root organisation. Often, it is the Sadrist local committees which take credit for anything that the Iraqi government is able to deliver.

Maliki's problem is that the confrontation with Allawi's coalition is as bitter as ever. A wave of terrorist attacks in August offered the opportunity to Allawi's group to criticise the weakness of the security apparatus, led according to them by proteges of the Prime Minister. Allawi's selection for a Minister of Defence was rejected by Maliki. On the positive side is a draft law for the formation of the National Council for Strategic Policies (NCSP), which Allawi is supposed to preside over according to the political agreement which led to the formation of the coalition government. Allawi had been complaining of the delays in setting up the NCSP as an attempt to sabotage the agreement. Maliki's people, however, have warned that the current draft conflicts with the Constitution on a number of points and it will have to be revised before a final approval. Allawi's Iraqiya alliance also suffered a blow when Maliki forced the electricity minister, Raad Shallal, a member of the group, to resign over irregularities in the signing of two contracts for the building of power generation stations.

Allawi in the meanwhile has publicly given up on being head of the yet to be formed National High Council for Strategic Policies, accusing Maliki of heading towards a dictatorship and calling for early elections. His Iraqiya coalition, however, says that it still wants the Council to be presided by one of theirs; there is a standstill in the parliament over the law establishing it. Allawi is now also competing with Maliki for influence over the Iraqi army, allegedly with a military coup in his mind. Maliki is countering such a threat, which he seems to be taking seriously, by posting units which he consider loyal around Baghdad. This is the main reason why the appointment of the minister of defence is taking so long - Allawi wants that position for one of his men, while Maliki sees that as a direct threat. Maliki is for the time being able to order the deployment of army units, but that may no longer be the case once a strong minister of defence is in place.

US military influence in Iraq is also diminished by the uncertainty surrounding the purchase of US weapons. The decision of the Arab Gulf states not to hold the next Arab League summit in Baghdad as planned has contributed to further anger the Iraqis, who see it as motivated by sectarian motives. The F-16 deal has been cut in size and in the quality of the weapons to be supplied, to a value that could be a quarter of the original US$4.2 billion; even the downsized contract is not certain, as Maliki to appease the population, seems to intend to build a new national power grid and needs to fund it.

If the American military might soon going to be out of Iraq, not so American firms. American oil companies won only one of the main oil contracts issued by the Iraqi government, but American firms are now making lot of money winning subcontracts with the companies which won the primary contracts. The Americans have the best drilling technology in the world and are called in even by Russian firms for lucrative contracts which are paid long before the primary contractors start making any money with the new oil fields. The Iraqi contracts require open tenders, which is favouring the Americans. In many cases, only American firms have been bidding for the sub-contracts. In fact, the sub-contractors may make more money than the primary contractors, because the Iraqis have been quite stingy in determining the share of the primary contractors, which are now hoping to renegotiate the terms of their contracts. This is likely to slow investment in the Iraqi oil industry, because the contractors have little leverage and can only exercise pressure by delaying investment. The Iraqi government is now in the process of signing the gas field contracts, awarded in October.

The killing of Bin Laden has barely left a mark whatsoever in Iraqi politics; even the local Al Qaida has scarcely made an effort to commemorate the dead leader with an intensification of violence. Eventually Prime Minister Maliki made public his decision not to ask to Washington to leave troops in the country, stating that he is keen on military ties with Washington but that politically it would not have been feasible to have the Americans stay. The Iraqi air force is acknowledged to be particularly in need of continued American support, but according to Maliki even any kind of direct support to the air force would have to be approved unanimously by the parliament, which does not seem very likely. In reality probably a majority of Members of the Iraqi Parliament would like to see the Americans stay longer in order to consolidate the gains in security, and to stabilise the polity. However, few of them dare say that in public.

A new round of oil and gas field auctions is now announced for the end of 2011. It appears that the contracts signed by the Kurdish regional government will be honoured by Maliki, probably the price to pay for Kurdish support in the new coalition. The government is preparing to establish serious barriers to imports, by increasing the custom rates on all goods and in particular on some goods that Iraq is supposed to be able to produce itself. Many fear an inflationary impact, compounding the situation for the poorest strata of the population. The move would also be a slap in the face to Washington, but this seems to be the fashion now in Baghdad: the city council recently demanded that the US pay US$1 billion in compensation for the damage inflicted to the roads by the American occupation forces.

If Maliki survives the current turmoil, he will benefit from an oil boom, both because oil prices are up and because exports are finally starting to increase. Exports for March are forecast to reach 2.2 million bpd, which if confirmed would represent the highest level since 1998; production stands at 2.6 million bpd. The recovery was slowed in February by a reprise of attacks on northern pipeline, which took 150,000 bpd out of the market. Now the Oil Ministry has decided to create reserves, which will help keep exports steady even in the presence of attacks on the pipelines. Gulf Keystone has also reported a likely discovery of a new big field in Kurdistan, which would add to the potential for future production.

The International Energy Agency has confirmed that Iraq increased its oil output by 350,000 barrels per day over the last 6 months, to reach 2.68m b/d. Progress is also being made on the formulation of a new oil-sharing legislation, mutually acceptable to Baghdad and the Kurdish autonomous region. While few continue to believe that the official target of 11 million litres is realistic (if nothing else because Iraq does not have the water required to pump the oil out), but the Iraqi oil industry is performing better than many had expected a year or two ago. The IEA now forecasts that oil production could rise by 1 million bpd by 2015, reaching 3.7 million bpd. If Iraq keeps doing well, however, it will come under pressure to re-join the OPEC quota system and the constraints that this entails. After pretending for many months that Iraq's very ambitious oil production targets were somehow realistic, during May even the officials of the oil ministry started coming to terms with reality and admitting that because of 'constraints in the pipeline and terminals infrastructure', the 12 million bpd in six years target is not achievable. In fact, Iraq is already near the limit of its export capacity and increasing that in the future to the levels planned would require an unprecedented level of infrastructural investment. Shahristani, the deputy Prime Minister for Energy, now says that even achieving half that target would be a remarkable success. It is believed now that Iraqi oil officials will soon start discussing a new, more realistic target with their partners in the oil industry. Moreover, political trouble is never very far away from Iraq's oil fields. In May oil workers were striking against alleged salary discrimination by oil multinationals like BP, who pay Iraqi oil workers much less than foreigners. BP has succeeded in increasing the production of the Rumaila oil field, but a wider presence of foreign investors could be politically very problematic in a country where oil nationalism has been a political staple for many years.

The rehabilitation of Iraq's industrial sector proceeds slowly. At present, the industrial sector accounts for just 2% of GDP. Despite pumping US$2 billion into some of its 260 factories, few have been reactivated! Only eight of them currently turn a profit, although the government hopes that by the end of 2011 that number will have grown to 20 as a result of the new investment. Most of these industries suffer from overstaffing; the government is reluctant to privatise because that would lead to massive sackings, with negative repercussions for the government's image. Foreign investment is growing nonetheless, after legislative reforms have made investing in Iraq a much more attractive proposition. Over the past eight years, foreign investment has grown from US$3.9 billion to US$42.7 billion. The high oil prices are driving up estimates for GDP growth this year: the IMF says 12.5%. The budget problems faced by the government last year seem over for now and Maliki is reconsidering his earlier decision to cancel the purchase of F-16 fighters from the US. Only instead of buying 18 as planned, now he wants 36 of them.

 

Background:
Formerly part of the Ottoman Empire, Iraq became an independent kingdom in 1932. A "republic" was proclaimed in 1958, but in actuality a series of military strongmen have ruled the country since then, the latest being SADDAM Hussein. Territorial disputes with Iran led to an inconclusive and costly eight-year war (1980-88). In August 1990 Iraq seized Kuwait, but was expelled by US-led, UN coalition forces during the Gulf War of January-February 1991. Following Kuwait's liberation, the UN Security Council (UNSC) required Iraq to scrap all weapons of mass destruction and long-range missiles and to allow UN verification inspections. Continued Iraqi non-compliance with UNSC resolutions during the past 12 years resulted in the US-led invasion of Iraq in March 2003 and the ouster of the SADDAM Hussein regime. Coalition forces remain in Iraq, helping to restore degraded infrastructure and facilitating the establishment of a freely elected government.

Summary 2003

International

During the first three months of military occupation, despite the appointment of General Jay Garner at the head of the Office of Reconstruction and Humanitarian Affairs and then of Paul Bremer to supervise the political transition and reconstruction efforts, little has been achieved in terms of either maintaining security for the civilian population or re-establishing vital supplies. As Iraqi households were rapidly running out of food, the second half of May proved especially critical in this regard. Nonetheless, behind the curtain an intense debate is taking place with regard to the issue of reconstruction and on the exploitation of Iraqi oil reserves. The expectation is that US companies will take the lion's share of both reconstruction contracts and exploitation rights, but both the Russians and the French claim the validity of existing contracts and the payment of outstanding debts. How this will be settled is unclear yet. Some officials in the Bush administration invited the creditors to waive Iraq's debts to help the reconstruction, but given the huge windfall expected once Iraqi oil production restarts in earnest, such position never had many chances of being accepted. Russia, France and Germany initially indicated that they would not forgive the debts, but only reschedule the repayments, which could also be capped at a certain percentage of Iraq's oil revenues. Overall, Iraq's debts, including war reparations, are estimated to amount to US$350-US$400 billion. By November the creditor countries were however accepting that a rescheduling is inevitable. The Bush administration and international financial organizations prefer to talk in terms of debt relief and cancellation, although the latter are somewhat less generous than the US government and ask for a writing-off of a 66-80% of the debt, depending on the institution.
With the approval of the US-sponsored resolution at the Security Council, during June international bickering around Iraq subsided, without disappearing altogether. There were unconfirmed reports that the Bush Administration has issued instructions to keep French companies out of the reconstruction business. However, most of the attention was focused in June on Russia, whose government officials repeatedly stated that they have been assured that there would be no discrimination against Russian companies in the reconstruction. Despite that, acting Iraqi oil minister Ghadbhan cancelled a maxi-contract with Lukoil, which threatened retaliation. Moreover, the fate of Iraqi foreign debt, owed mainly to Russia, France and Germany, is still not clear. At the beginning of June Paul Bremer called for more generosity by creditors, saying that the moratorium on service repayments, which they have offered, is not enough. During September the efforts of the US Department of State to involve more countries in its Iraq campaign yielded very little results, despite the support of a growing number of top brass. The Pentagon and vice-president Cheney are known to be contrary to the involvement of other countries and will not be too displeased by this lack of developments, but President Bush appears increasingly worried that Iraq might still be a bleeding wound by the time the campaign for next year's US presidential elections gets under way. For this reason, he requested in September US$66 billion for Iraq, significantly more than expected. The key countries targeted by the Department of State, namely India, Pakistan, Turkey, Germany and Russia, are all asking for rewards that have so far been judged excessive by the Bush administration. The positive development in September was that after much vocal protest, the Arab countries started cooperating openly with the Iraqi Governing Council and the newly appointed government. Not only did the Arab League let Iraq take part in its meetings, but Iraq got back its seat within OPEC. Now that an Iraqi interim government is in place, the IMF and the World Bank will be keener to start lending money.
During October the Bush administration relaunched on a large scale its efforts to pacify Iraq. On the one hand it created the so-called "Iraq stabilization group", on the other it succeeded in pushing through the Security Council of the UN a new resolution. The Iraq stabilization group reduced the influence of the Pentagon and in particular of Mr. Rumsfeld over the decision-making on Iraq, a development which in the view of many should contribute to make things better. The new resolution assured that the US will not be permanently stationed in Iraq and that the multinational force will leave once Iraqi rule is re-established. There are also indications that the US might be willing to accept to bring its troops under international control, according to a statement of Javier Solana, European Union foreign policy chief. It seems, however, that the US and their British allies still plan to maintain 6 military bases in Iraq and do not seem to be intending to discuss the issue with the future Iraqi sovereign government, a fact which casts some doubts on the character of that sovereignty. The decision of the Bush Administration to ban countries which opposed the war against Iraq from bidding for the reconstruction projects was a startling development in December, at least in terms of the attention that it attracted. As a matter of fact, few ever thought that countries like France, Germany and Russia would have been allowed to win any contract, although the fact that such a policy has been announced publicly does represent a surprise. Again, while the internal popularity of Bush might benefit from this, at least in the short term, declaring such a ban handed more arguments to those same countries for opposing the cancellation of much of Iraq's foreign debt. In the end, the forgiving of much of the debt remains very likely, but France, Germany and Russia might now be in the position of asking something in exchange.

Economy
The Iraqi economy has been steadily declining since at least 1991 and by 1999 was estimated to have fallen by 75%. Of course the latest war and the current virtual paralysis of economic activities have made the situation worsen further. The fact that the state used to control so much of the economy makes the political chaos all the more important in terms of negative impact. About 45% of the Iraqi workforce is directly employed by the state. Such schemes as the distribution of dollars to state employees by the occupation authorities are not much more than palliatives. Towards the end of the year the government was drafting plans to create jobs, such as one involving public-private partnerships to build residential complexes and employ 250,000 people. At the same time plans were being developed to pay out unemployment subsidies at the rate of US$700 million a month, which would represent a major part of the state budget.
The production of oil almost stopped during the war and it took time to restart it. The oil fields have been subjected to extensive looting and it will take time and money to repair them. Efforts to repair oil extraction and transport facilities began to produce results only during June, causing acute shortages of oil to hit the Iraqi internal market, to the point that officials in the oil industry stated the need to start importing oil from abroad. There were fears that petrol shortages would cause unrest and contribute to complicate the political situation. However, the oil industry has been paid much greater attention than the rest of the economy and by June the US administration and the Iraqi officials working for it could claim at least some relative successes. The situation started improving particularly rapidly towards the end of the year in the southern region, where looting has been contained and rehabilitation has been proceeding fast. The most significant improvements remain those recorded in the oil industry. In November 2.1 million bpd were produced, of which 1.5 million were exported. The impact on production was such that crude exports are expected to reach 1.7 million bpd already in December, which is the maximum export capacity given the current facilities. By 2004 it is likely that production will recover the pre-war level (2.5 million bpd) and the Iraqi Oil Marketing Organisation revised its forecast upwards in November, stating that 2 million bpd will be exported daily by March 2004. At present 300,000 bpd are still being injected back into the ground, because they cannot be used. The analysts expect rapid improvements in 2004 because developing the southern fields should be rather quick, given the presence of infrastructures in place and the low-level technology required, the increase in production is expected to continue even beyond the capacity levels of before the war. Saudi Arabia has already declared its intention to reopen the Iraqi pipeline that runs through its territory. There are however some shadows cast over the rapid recovery of Iraq's oil industry. The primitive technologies and dubious engineering practices used in the past several years to maintain production in the oil fields will demand significant additional investment to be remedied and some production potential is likely to have been lost for good. The rapid recovery will end relatively soon and major investments will soon be needed. The International Energy Agency released estimates in November that at least US$5 billion will be needed to bring production capacity to 4 million bpd. 
On the other hand, in the present political conditions, maintaining some semblance of a state in Iraq will be much more expensive to the US than it was to Saddam Hussein and even if the US$150 million that Iraq was earning every week from oil at the end of September were multiplied by three or four, it would still be far from enough. As a result, the budget for 2004, which is expected to range between US$13-14 billion, will still largely be funded through foreign aid. In November, as at the international donors conference in Madrid pledges of aid were higher than what the pessimists had forecast, with US$18.5 billion on top of the US$20 billion already pledged by the US, although only US$6 billion of this is in grants.
It has now been accepted that sufficient electricity production is not going to be reestablished in the short term and efforts are being made to start importing electricity from neighboring countries. Iran has already signed a contract, while Turkey seems to be about to sign a second one and Syria is negotiating another. The hopes that the northern oil fields would have given their contribution were quashed after they were sabotaged just a couple of days after their reopening. More guards are being recruited to help guarding the pipelines, but they might not be enough. Some experts say that to bring production to the 3.5 million bpd which was the original target will take as much as US$30 billion, which might not be easy to gather. Western oil companies are reported to have told the Bush administration that they are not going to make large investments in Iraq for the foreseeable future. Production is mostly concentrated in the North, where the disruption and looting caused by the war has been less severe. By mid-July, the Iraqi oil industry was still struggling to reach the targets set for June, as sabotage of the pipelines and administrative confusion prevent the full exploitation of this potential. Iraq has only been able to export oil stored in Turkey and in Iraq itself, while freshly pumped oil is being absorbed by internal consumption and smuggling. Even according to the most optimistic estimates, oil exports will not be able to contribute to Iraq's recovery before the end of 2004. The first budget was presented in August and covers the remainder of 2003. By far the single largest sector will be social expenditure, at US$1.35 billion. The budget is based on assumed oil rents of US$3.45 billion, which are expected to contribute 88% of all revenues. This in turn, is based on the expectation that oil production will reach 2.8 million barrels per day by March 2004, which is not unrealistic.
Towards the end of September a set of economic reforms was announced, including the freedom for foreign investors to buy Iraqi companies, except in the oil industry, but including banks. Foreign investors will be free to transfer their earnings abroad. The central bank will become independent, while a new, modest tax rate of 15% will be imposed on both individuals and companies. The custom rate will be just 5%, except for food and medicine which will be exempt. Earlier expectations that oil revenue would have been enough to fund the reconstruction are now giving way to concern that American taxpayers might have to pay at least part of the bill. Paul Bremer, the boss of the CPA, for the first time in August hinted that reconstruction could cost as much as US$100 billion. US$13 billion should be needed for the electrical grid and another US$16 billion for the water system. For the next year, the UN estimates a need for US$20 billion as a bare minimum and Iraqi revenues are not expected to exceed US$15 billion at best. The US$5 billion gap should be covered by donors. Inevitably, the US will have to contribute more money than it expected. The oil industry rehabilitation plan approved by the CPA and oil ministry already calls for the US to contribute US$1 billion, which had not been budgeted before the war. The Bush administration budgeted just US$2.4 billion, which moreover it is unable to spend because of the widespread insecurity. Only about US$250 million have been spent so far. 
The Iraqi power supply system appears to be a major problem for the American occupiers. Damaged by previous wars and lack of maintenance, the CPA has not been able to restore it in such a way to bring energy supply back to pre-war levels. Worse still, it seems resigned to not being able to do so. The building of new power stations is likely to take years and in the meanwhile the insufficient power supply will greatly hamper the economic recovery. Most of the telephone network is also in need of repair, while banks remain closed. Although trade businesses are reopening, many of them are reported to be on the verge of bankruptcy. The dinar, however, recovered from its low of 4,000 to a dollar during the war, to stabilise in June at 1,400. At least something has been done to help the moribund Iraqi agriculture. Production of grain is expected to be half that of 1990 this year and the distribution network has collapsed. The UN are launching the largest food aid program in the world to help the Iraqis, with a budget of US$1.3 billion. More importantly, the World Food Program will buy this year's harvest from Iraqi farmers, helping them to earn enough to sow the land for the coming year. 
One issue which is being raised is currency reform. At present there are three currencies in circulation, the dollar, the Iraqi dinar and the Northern Iraqi dinar. With inflation running at an estimated 70% a year, the need is felt for creating a single currency which would make it easier to stabilise money supply and fight inflation. 
The CPA claims that imports of medicines have increased sevenfold, that 1,000 schools have been rebuilt and that the irrigation ditches in southern Iraq are being cleaned up, but Iraqis are more concerned by the continuing lack of electricity and sometimes water. At present the CPA estimates that there is a 30% shortfall in electricity production. Just to meet demand investments of about US$2 billion will be needed.
Although the conditions of living of most Iraqis were finally showing some signs of improvement in October, the Food and Agricultural Organisation (FAO) and the World Food Program (WFP) claim that 13 million Iraqis still need food assistance. Chronic malnutrition of millions of people is reported. 
A typical paradox of the current situation in Iraq is the fact that thousands of workers are being imported from India and Bangladesh to work within the US military bases, while the unemployment rate among Iraqis has now reached an estimated 50-60%. Security reasons are cited as the reason for this choice, but this explanation was not enough to prevent massive demonstrations of unemployed Iraqis in front of American bases. About 500,000 of those who are employed work in inefficient or very inefficient state-controlled enterprises, while another 1,000,000 work in the state bureaucracy, which gives an idea of the size of the problem. The privatisation plan of the new government, sponsored by the Americans, would in the short term have a very heavy social impact. The World Bank estimates that in 2003 the Iraqi economy will shrink by 22%, after having lost 21% in 2002 and 12% in 2001. The average income is now estimated at between US$450 and US$610, down from US$3,600 in 1980. State food subsidies are worth about US$2 billion and it is expected that in 2004 US$10.6 billion of US$12 billion worth of oil revenue will be spent in salaries and subsidies. Just US$1.4 billion will be spent on reconstruction, even that assuming oil prices do not fall below the target level, cutting the expected oil revenue. The fact that state salaries have been increased up to 40-fold might have helped gain some popularity, but did not help the reconstruction effort. The lack of institutional capability will limit reconstruction expenditure to no more than US$5 billion in 2004 and US$8-9 billion in subsequent years, according to the World Bank, whatever the international community will decide to contribute. By October, reconstruction had barely started and even the telephone network is only 50% active even in Baghdad.
By the end of the year there was no doubt that consumer confidence was improving in Iraq and that consumer spending was up. However, this was an improvement from a very low level and few Iraqis were satisfied with it. Paradoxically, the recovery in consumer demand contributed to maintain energy and fuel shortages, since it stimulates demand. The establishment of the Trade Bank of Iraq was authorized at the end of November. It is expected to favour economic recovery, together with low corporate taxes, fixed at 15%.

Internal
Although the Baath state has been thoroughly defeated, the US-British military occupation is spread rather thinly throughout the territory, mainly because of security concerns. The CPA is becoming somewhat more efficient now, but the start was quite disastrous. The decision to privilege military personnel over civilian reconstruction specialists has proved particularly ill advised. Although a decrease in the looting activity was reported as the end of June approached, patrolling by American troops remained limited, both due to the insufficient number of troops available and to the unwillingness to risk even modest casualties. The about 30,000 Iraqi policemen taken back into service were not enough. Even the announced formation of a small Iraqi army to guard the country's borders will have no short-term impact, as will the formation of a 6,500-strong militia. Washington sources increasingly acknowledge that the Iraqi post-war plans were based on expectations which completely failed to materialise. It is reckoned that it will not be possible to reduce the level of troops committed to Iraq for several months to come at least, a fact that is pushing Pentagon expenditure in Iraq to around US$4 billion a month, roughly twice as much as it had been forecast. Some sources even claim that Bremer already asked for 50,000 more troops, to help secure the country. It is generally accepted that with current troop levels and given American wariness to risk losses, maintaining security throughout Iraq will not be possible. This left much room of action for several militias that have sprung up, mainly composed of Shiite Islamist militants, but also of neighbourhood associations which are trying to maintain security locally. Northern Iraq, of course, remains under the control of the Kurdish militias, as it has been for many years now. Following the attacks to the UN compound and the Jordanian embassy and a number of US civilians killed, plus the attacks to the pipelines and the US military, security became more than ever the primary concern of the US occupation administration during August. Unable to increase the level of US troops for reasons of internal policy and also because of objective overstretching of available resources, the Bush administration tried hard to convince more countries to send additional contingents, with little success.
There are several factors that are feeding the political instability. First of all is the fact that most parties and factions based in Iraq oppose to various degrees the military occupation. Also, there is tension between exile groups which are coming back to Iraq with the support of the US, and indigenous groups, which feel they are being overtaken by newcomers who know little of the reality of Iraq. Last, but no less important, is the fact that the internal opposition is by no means united. The centre stage in the first few weeks after the fall of Saddam's regime has been taken by Shiite religious groups, which moved quickly to occupy as much ground as possible. However, there are strong currents of secularism in Iraqi society and tensions might arise soon, especially if the Shiite parties tried to monopolise the political scene. At present, however, the competition is mainly among Islamic groups which claim to represent the Shiite community, a situation which has already led to clashes and even the killing of Abd al-Majid al-Khoi, a moderate Shiite leader. 
After more than two months of occupation, the political situation actually appeared to be worsening by the end of June. The US managed to alienate virtually all Iraqi Arab political forces, including the exiles whom they brought back to the country, by postponing the establishment of a proper Iraqi interim administration until after the political elections, which in turn are not expected before a year.
In the areas inhabited by Sunni Arabs, there appears to be starting a guerrilla insurgency, which could develop in a serious annoyance for the US occupiers. 
The political groups rooted among the Shiite majority have so far adopted a cautious approach. Despite not hiding their distaste of the Americans, they have refrained from armed opposition and are focusing on consolidating their hold on the population. In the short term, Shiite parties and their Iranian patrons have no interest in an open confrontation, but the potential threat to American interests will remain. Disappointed by the bickering and ineffective exile parties, the Americans appear to be turning to others in order to find some interlocutors. In particular there is a clear effort to establish links with the tribal chieftains, hoping that this could allow the maintenance of order without committing troops. The tribal chieftains are building up their militias, in a situation that could soon resemble the power-sharing deal with the warlords in Afghanistan. On the other hand, plans to rely on selected former Baathist officials are proving more difficult to implement that initially foreseen. Not only the majority of the population rejects these officials, but few have accepted to serve under the conditions imposed by the US, which include a clear and unequivocal rejection of the Baathist ideology. The presence of an armed opposition to the American occupation and the fact that several Baath leaders are still at large clearly represent a powerful disincentive for former Baathists to join the Americans, not least because of fears of assassination. 
By July the CPA had decided to take another path and it established the Interim Governing Council (IGC), made up of 25 Iraqis of different backgrounds. The establishment of the council itself can be seen as a concession from Paul Bremer, the head of the CPA. The potential contributors to the planned international fund to rebuild Iraq stated clearly that they would not even agree to meet until an interim government composed of Iraqis was in place. The IGC has the power to nominate ministry heads and form commissions to recommend policies concerning the reform of the Iraqi state. Even the composition of the IGC shows that Americans are moderating their earlier ambitions to reshape Iraq in their own image. Although pro-US Iraqi returnees from exile are still over-represented in the IGC, compared to what seems to be their actual following among the population, anti-US factions are fairly well represented too, including seven Islamists and a Communist. During August the Iraqi Governing Council (IGC) that they have established is slowly winning some support. The UN recognised it and although the Arab countries mostly refused do so, most Arab neighbours are accepting to deal with it on an provisory basis. 
Together with the government which was subsequently established, the Iraqi governing council seemed initially to be achieving some degree of support among the population, which is eager to see the reconstruction start. However, in order to legitimise themselves they are beginning to collide with US interests in Iraq. The possible future deployment of Turkish troops represented in October the first instance of a clash between the occupation authorities and the ruling Iraqi body. As the end of 2003 approached, various projects of restructuring the pro-occupation Iraqi authorities were being circulated, including a plan to expand the Governing Council to 100 members from the present 24, making it more representative in the process. Another plan called for the creation of a smaller 10 member body within the council. Plans to recreate an Iraqi Army have also popped up, but on the whole this multiplication of plans and options only confirms that the occupation authorities do not have a good grasp of the situation. 
The capture of Saddam Hussein by US forces in December was a major media event and it will certainly have a long-term impact, but it is not clear yet how. The hope among coalition forces is that the insurgency will rapidly subside. However, even if this happened, which is far from certain, the capture might lead to the emergence of as many problems as it resolved. The impact is more likely to be in terms of Bush's own internal popularity, rather than in terms of sorting out the Iraqi mess. Many, who were unwilling to play Saddam's game by opposing the occupation actively, might be tempted to do so now. In the weeks following the capture of Saddam, efforts aimed towards the Iraqization of the conflict suffered a blow when it emerged that the creation of a new Iraqi national army is not going according to the plans and many recruits are dropping out of the ranks. Plans to replace the Iraqi Governing Council with something more representative were also running into difficulties, as among the Shiite community there was a strong opposition to the type of indirect elections which is currently planned, both because they might be easier to manipulate and because they might deny them the majority that direct elections would ensure, since they account for 60% of the Iraqi population. On the other hand, replacing the IGC was seen by year's end as a necessity, because the Council was by then rapidly losing popularity among the Iraqis. The Bush Administration wants to hand over sovereignty to the Iraqis by July and cannot afford to wait and see whether the IGC manages to recover. Among the Iraqi business community strong opposition emerged to the new (very liberal) investment law presented by the Coalition Provisional Authority, which they fear will allow foreign firms to brush them aside. The slow improvement in the security situation as far as common crime is concerned is overshadowed by the repeated waves of indiscriminate terrorist attacks. Even Saudi Arabia, which otherwise adopted a much more pro-Coalition stance after the war than it had before, stated in December that it will withhold the US$1 billion in loans and credits that it had promised until the situation improves. Some companies involved in the reconstruction, like South Korea's Omu Electric Inc, are now planning to withdraw their workers. The UN and several NGOs have already largely done that.

Summary 2004

International
The ambition of the Pentagon to establish permanent military bases in the country appears in doubt, after President Bush accepted in November that power should be transferred to the Iraqis as quickly as possible and that foreign troops should be withdrawn. However, even if the Bush Administration stuck to this decision, US and other troops would remain in Iraq in large numbers for years to come, although likely with a reduced profile. Iranians, Syrians and other countries of the region will therefore not be able to relax and assume that the worst threat for them is over. They will be likely to maintain an active presence in Iraqi politics. Even if the Bush Administration is no longer so keen on a long-term presence in Iraq, it is too late for a disengagement which would not look like a defeat. The April crisis had a significant foreign policy impact. The most obvious one was the weakening of the compactness of the coalition, with a number of allies of the US starting to waver. The withdrawal of the Spanish troops was motivated by considerations of internal policy, but less so that of the troops of Honduras and Dominican Republic. More importantly, other allies appear likely to try to limit their involvement as much as possible, as in the case of Japan, South Korea, Ukraine and others. The relationship between Turkey and the US is also being tested by the Iraqi mess. Ankara is complaining about the plight of the Iraqi Turkmen population, not only at the hand of the Iraqi Kurds, but also of US troops, who have been carrying out military operations in their home areas.
The appointment of Allawi as Prime Minister in June represented a significant shift in US policy, away from the religious Shiite leaders, on which it had been relying until this spring, towards what is perceived as a more reliable politician like Allawi, despite his former membership in the Baath party. The appointment of Yawar as President was also significant. A Sunni with good tribal links, he is expected to help healing the relationship with his community. The occupation authorities handed over sovereignty to the Iraqis on 28 June, two days earlier than expected, in order to reduce the security risk. During the first month of post-occupation Iraq, the performance of the new government was in general judged rather positively. The last 11 ministries still controlled by occupation authorities (communications; defence; electricity; finance; higher education; housing and construction; human rights; interior; justice; labour and social affairs; trade) were all transferred to Iraqi control, but the focus remained on security. Allawi, whose personal past is not without stains, showed a remarkable awareness that the Iraqi population want above all security and in his public statements repeatedly insisted on this. He also strived to appear a strong leader who is actually in charge of the country, despite the overwhelming role of Coalition troops. In practice, the efforts of the new government will in the short term be focused on guaranteeing the safety of middle-rank officials, who are being targeted by the insurgents in an assassination campaign that if allowed to run unchecked would bring the state structure to its knees. 
On the other hand, Allawi has also been busy undoing many of the checks and balances that the occupation authorities had put in place to improve the quality of governance. Moreover, if Allawi fails to improve the security of ordinary Iraqis in the medium term, public opinion will likely turn against him very quickly.
A string of incidents between the end of July and the second week of August led to a war of words between the Iraqi and Iranian governments. As the end of August approached the confrontation between the two governments did not seem about to dissipate, not least because the Bush administration appeared keen to add fuel to the fire. At the end of August Iraq's vice-president Al Jafari traveled to Mashad, where he met Iranian president Khatami, while deputy prime minister Saleh visited Teheran a few days later. 
In the medium and long-term, US support for the Baghdad government might turn out not to be as solid as often assumed. After the Halliburton scandal, another issue was raised towards the end of August, concerning the inability of Coalition authorities to account for US$8.8 billion received from the US government. The money, which was channeled to the Iraqi ministries, is feared lost due to the endemic corruption of the Iraqi government. Many funds deriving from Iraqi sources, including oil revenues, are also unaccounted for. Many thousands of ghost employees exist in the ministries, allowing officials to easily misappropriate funds. 

Economic
Progress continued to be made on the debt front and the World Bank now estimates that between US$80 and 90 billion will be forgiven out of a total of US$120 billion. All the big creditors have already promised big reductions, but not as much as the US hoped. The French government took an open stand against the Bush Administration's call for 90-95% debt forgiveness to Iraq and claimed to have put together an alliance of creditors in favour of forgiving just 50% of the debt. France's and Russia's objections to the proposal to slash Iraqi debt by 80% were finally removed in December and a final agreement was reached. Iraq's debt towards the Paris Club will be cancelled in three stages between now and 2008 and will fall from the current US$38.9 billion to US$7.8 billion. It is believed that Russia finally agreed to the deal having received assurances concerning its Iraqi oil contracts.
In terms of economic reforms, the banking sector, which is considered to be completely unsuitable for a "liberal" economy, was at the top of the priorities. The Iraqi central bank announced the liberalization of domestic interest rates from 1 March, in the hope that rates will fall, making borrowing cheaper and therefore stimulating economic growth. At the same time, the first three foreign banks, HSBC, Standard Chartered and National Bank of Kuwait received their licences to operate in Iraq during February, with effect from 15 March and for a period of 5 years. 
As far as the oil sector is concerned, there was initially talk to expand production to as much as 6.5 millions in the near future. Production forecasts by the Oil Ministry were then reduced to 2.8 million bpd by March and 3 million bpd by the end of the year, reflecting expectations of slow growth throughout the year. Since domestic needs stand at about 550,000 barrels, the surplus for export would have been enough to keep the government running, but not to start reconstruction on a massive scale. Looting and sabotage continued in 2004, contributing to ensure that the original expectation, that oil revenues would have contributed almost all of the US$41 billion required for the reconstruction within the first two years of occupation, has now been completely abandoned. Moreover, due to damage to the oil fields, the price of Iraqi oil is now going to be lower than it used to be, because of higher sulphur content. Another issue appears indeed to be the lack of export routes, as active export facilities are now approaching saturation. Kuwait does not seem to be interested in helping to export Iraqi oil through its ports, in part at least because it is itself busy dramatically expanding its production. Iran, on the other hand, has accepted to import 350,000 bpd of Iraqi oil, which would free an equivalent amount of its own oil for export, but the Bush Administration opposes the deal, due to its sanctions against Iran. The 1.6 million bpd pipeline through Saudi Arabia is functional, but the Saudi government has not decided yet whether to allow Iraq to use it. Saudi Arabia of course fears Iraq as a future rival on the oil market. Iraq's own facilities at Khor al Amaya are being rebuilt, but it is not clear when they will be reopened. The Iraqi-Turkish oil pipeline was finally re-opened in March and started pumping oil. With its 320,000 bpd capacity, it would increase the current level of exports by 20%. The southern fields, on the other hand, are already exporting to full capacity and therefore offer little possibility to expand production further. Sabotage against the oil pipeline however will continue to hamper the attempt to increase exports. The Iraqi Oil Ministry had set a target of 2 million bpd to be exported in June, but it failed to meet it due to attacks to the pipelines.
In early 2004 the privatization of the oil industry was postponed and is no longer a priority for the government or for the occupation authorities, but given the internal political climate it was widely expected. The success of the Oil Ministry in bringing production up to 2.3 million bpd, exceeding the expectation of many, contributed to this decision, but crucial was the widespread opposition to the privatization move among Iraqis, including many members of the Iraqi Governing Council. The Bush administration is now advising the establishment of a state company, which will take over the management of the oil sector once power is handed over to the Iraqis. Moreover, foreign investment in the industry is still likely to be allowed, as far as the exploration of new fields is concerned. Later on some selling of oil assets like refining and distribution might take place, but extraction is not likely to be privatized for a long time to come. 
By the end of 2004, the Oil Ministry claimed that production has reached 2.8 million bpd and that it hopes to bring production to 3 million during 2005. If the government manages to attract foreign investment for an estimated US$7 billion, the plan was to boost production to 6 million bpd by 2010. Independent observers, however, were far less optimistic and thought that US$6 billion will be required just to bring the oil industry back to its pre-war levels, with another US$35-40 billion needed over a period of 10 years to increase production beyond that. Significantly, in September the Bush administration asked to divert an additional US$450 million to increase oil production. In July it was announced that the first three oil production contracts of post-Saddam Iraq will be awarded at the end of August. These contracts concern however three relatively small fields, worth US$80-150 million of investments each, and are struggling to attract the attention of the big multinationals. The fact that the contracts are relatively short term contributes to alienate the multinationals. The only known bidder so far is Irish Petrel. The prospects of easily and rapidly attracting investment to the Iraqi oil industry in the long term were also being damaged by the re-opening of the Libyan market to foreign investors. International investors are also held off by the fear that the future elected government might void the contract signed by the current interim one. The Iraqi Oil Ministry revised upwards its estimate of losses due to sabotage of oil facilities, claiming now that US$7 billion have been lost from March 2003. The spate of attacks to the pipelines increased after sovereignty was returned to the Iraqis. So far the government has been trying to enlist the help of local tribes to protect the oil infrastructure, but this proved ineffective. Tribal rivalries led to even more attacks and the already thinly spread National Guard was deployed to improve the security of pipelines and wells. 
Throughout 2004 the reconstruction of Iraq continued to lag. How slow the reconstruction is can be shown by the fact that just US$1.5 billion of US reconstruction funds out of US$18 billion have actually been spent. The fact that the cost of construction material is spiralling also mean that whatever money is spent, its impact is much less than what it would have been before the war. There are talks of costs having doubled or trebled and of course the cost of maintaining security has to be added too. The Center for Strategic and International Studies estimated that only 27% of the money spent by the US is reaching the Iraqi population, the rest being taken by security, waste and overheads. It also appears that local suppliers have artificially increased prices of construction material to maintain stocks in view of what they expect to be an imminent surge in reconstruction activity before the elections. Little real reconstruction or economic development is taking place. The faults of the reconstruction program put together by the occupation authorities are coming under increasing scrutiny. By August the job-creation schemes were supposed to have delivered 250,000 jobs, but in reality they have not exceeded 30-60,000. Reconstruction projects contracted so far leave little space to entrepreneurial Iraqis and the local workforce, privileging instead specialist contractors with international experience (i.e. mostly US companies). 
Private investors are even less keen to come to Iraq and plans for massive investments are on hold until security will improve. The difficult political situation also prevents the government from taking steps aimed at improving labour productivity, which now stands at abysmally low levels. The large majority of state employees are in fact virtually inactive and often do not even turn up at work. 
Outward signs of economic recovery are indeed more and more evident in Iraq. Growing imports of cars, satellite dishes, televisions and the fact that the demand for mobile phones is outstripping the supply are undeniable. However, this is mainly due to the increase in the wages of 1 million public employees, which dates back to a year ago, and not to any increase in actual production. While the Coalition and the government have been successful in stabilizing the currency, with inflation now below 30%, the industrial sector does not show any sign of recovery. The early plans to privatize the state industries were shelved after the transfer of power to the Iraqis, as they would entail a massive loss of jobs. Even cement companies remained inactive, despite the rising demand which has to be met with imports. As far as reconstruction went on, it involved few Iraqis, even among subcontractors. The prospects were not good for the immediate future either, since little effort at capacity building in the ministries was taking place and US assistance funds were still strictly monitored by US advisers. Despite the signs of recovery, almost all Iraqi households still received free food from the government, at a total cost for the government of US$3.8 billion, with considerable waste. The same applied to subsidies to the purchase of gasoline, which cost the central government US$5 billion. 
The World Bank recognised at the end of 2004 that the Iraqi economy had just reached the prewar output levels and that per capita income was still under US$800, but it also believed that in 2005 the economy will finally start growing quickly. Whether the economy will grow in 2005 and by how much, remains to be seen, but as of 2004 what was growing is the cost of living for ordinary Iraqis. The benefit of increasing salaries months ago is being eroded by spiraling prices of commodities and most importantly rent, especially in the capital Baghdad, where the population is rapidly growing. It is estimated that rental prices increased by at least 300% compared to the early months of the occupation and many families have been priced out of the market. 

Political
After a long wait, the draft Iraqi constitution was finally approved on 1 March. Its drafting was marred by the contrast between Islamists and secular members of the council and was also delayed by the Kurdish strong demand for autonomy. The latter issue was put on hold and will be decided by the first elected government, while the role of Islam as a source of legislation was addressed with rather ambiguous formulations, stating that it will be a source of legislation, rather than the only one. This made the constitution acceptable to all the members of the Iraqi Governing Council, but will likely lead to more debates in the drafting of future laws. The next step was meant to be the handing over power to the Iraqis at the end of June. The new Iraqi government, which is to be in charge of ruling Iraq from 30 June, is something quite different from what the UN envoy, Lakhdar Brahimi, had meant. Rather than being a technocratic cabinet, it will includes several old politicians, including some from the Iraqi Governing Council. The prime minister himself, Allawi, is a politician known for his links to the US, but also to the tribes, and president Yawer is the former head of the Council. Brahimi is said to have been taken aback by the development, in which the Council and the Bush Administration quickly reached a deal at the expense of the original plan. As a matter of fact, over the months that preceded the handover of 30 June, many functions of government were already transferred to the Iraqis, including the control of 12 ministries.
The Iraqi government appeared to have some potential to gain support from the population, but only if a minimum of stability can be guaranteed and the reconstruction started. The recent massive increases in the salaries of public servants, which reached in some cases as high as 40 times the previous salary, does not appear to have led to any significant increase in the popularity of the occupiers, not least because Iraqis think that this is their money anyway. Although the government of Prime Minister Allawi earned a significant degree of support among the middle classes and some tribes, it has been steadily losing support among the Shiite majority of the population, which was previously rather sympathetic to the occupation authorities and now feels that it does not have the degree of representation that it deserves. The violent confrontation with a radical Shiite cleric Muqtada al-Sadr led to a polarization between those Iraqis who support him and those who stand behind the government. The Kurdish parties remain on the government's side, but tension between them and Baghdad is also increasing, as the centralization efforts of the central government are not welcomed in Kurdistan. The latest row emerged in August, when the Iraqi oil ministry declared invalid the contracts signed by the local Kurdish authorities for the exploitation of oil fields. The Kurdish parties, of course, are very keen in establishing their own independent source of revenue. The occupying coalition forces are increasingly opting for the rapid rebuilding of Iraqi armed forces, which are expected to take over most of the security tasks during 2004. However, the effectiveness and reliability of these forces remain to be established. By the end of 2004 they are expected to number 200,000, but so far their contribution to the campaign against the guerrillas and the terrorists has been modest. The unreliability of the Iraqi pro-Coalition forces emerged clearly during the April crisis. Not only the level of violence reached new heights, but it spread to areas of the south where it had appeared to have been largely contained. For the first time, the Coalition encountered a strong opposition among the Shiite community. Even if Muqtada al-Sadr, who leads the Shiite opposition to the Coalition, has a limited following, a large number of Shiites are hostile to the American attempt to get rid of him. Other leading Shiite clerics too maintain an ambiguous relationship with the new government, never fully endorsing it, and Iran's influence seem to be growing following the decision of the Bush administration to rely mainly on the Sunni minority in the formation of the new government. One of the consequences of the new wave of violence and chaos was that opposition to US actions rapidly emerged within the Iraqi Governing Council, one of whose members suspended his membership and four more threatened to do the same.
The outcome of the convening of the national assembly in August was also seen by many as disappointing, not so much because of the turmoil caused by the supporters of Muqtada al-Sadr, who withdrew from it, but because of the failure to democratically elect the 81 members of the Iraqi National Assembly, which will act as interim parliament until the future elections. The vote was list-based and predictably ended with little space being left to smaller political groups and independent personalities. 
For a government which in August had seemed to be making efforts to move towards national reconciliation, the November offensive against the resistance stronghold of Fallujah marked a major turning point. The re-incorporation of baathist elements in the administration and security services and the offer of amnesty to rebels not involved in attacks against the civilian population were meant to pacify the Sunni Arabs, who are the main source of support for the insurgency. The assault on Fallujah represented the failure of such efforts.The base of support for Prime Minister Allawi among the Sunnis is now lower then ever and the operation was criticised by the main Shiite leaders too. The operation in Fallujah and the backlash to it exposed widespread sympathy for the rebels among Iraqi policemen and the government decided to sack thousands of them for dereliction of duty. The Committee of Muslim Scholars (the largest Sunni clerical association) threatened to call for an electoral boycott if the operation against Falljah was not halted. Moreover, the operation was criticised by the UN Secretary General too, out of fear that it might compromise the plans to carry out general elections at the end of January. 
In its attempt to stabilise the situation and to share the burden of managing Iraq, the Bush Administration succeeded in bringing the UN back, but with a role mostly limited to organising the January elections. For all the determination of the Iraqi interim government to claim that the elections planned for January 2005 will not be delayed, by September there seemed to be little hope that this would happen. The security situation showed no sign of improving. Despite the (temporary) end of the Shiite insurrection in the centre and south of the country, the number of attacks showed no sign of abating. Opinion was divided with regard whether elections should go ahead, leaving behind a quarter of eligible voters. Shiite parties and individuals, in particular the grand Ayatollah Al- Sistani, were strongly opposed to postponing the elections, but there were growing concerns in other quarters that such a solution would only increase the divide between the different communities. Political parties were in any case getting ready for the elections, forming alliances and trying to put together joint lists. For what they are worth, opinion polls suggested that only a couple of Shiite Islamist parties and the two main Kurdish ones would gather a significant share of the vote, with the rest being split among a myriad of groups, hence the need to form alliances. Some 217 political groups and parties registered for the elections, but the formation of coalitions and alliances proceeded rapidly and only three or four main contenders took part in the elections. The main Kurdish parties have formed their own block and the Shia religious parties have formed their own alliance. The list promoted by interim Prime Minister Allawi, also a Shiite, is the one most likely to attract the dissident and secular shiites. President al-Yawar is also trying to put together his own list, but he is extected to gather little support. Worryingly for the Coalition, the Allawi government, which still enjoyed a 62% support among the population in the late summer, was down to 43% in early October, as Iraqis started to think that it could not deliver. 
One positive sign towards the end of the year was that common criminality appears to be declining, although many Iraqis failed to notice due to the activity of politically motivated gunmen. The popularity of the government however continued to decline not only due to the Falluja operation, but also due to its inability to deliver tangible improvements in many key fields. The ministry for electricity for example admitted in November that Iraqis citizens will continue to experience power blackouts till the end of this decade at least. 

Summary 2005

Politics
The Iraqi elections of January 2005 were successful in general terms, but disappointed many. The only real winners were the Kurdish alliance, which took 75 seats and went very close to fulfilling its electoral potential. The Shiite list sponsored by Ayatollah Al-Sistani was the official winner of these elections, but its 48% fell somewhat short of the expectations of its promoters and denied the full legitimisation that would have derived from a 50+% victory. The Allawi list, with under 14%, failed to gain enough votes to prevent the Shiite religious list from having a majority in parliament, even if their majority remains quite thin (140 seats out of 275). All the other parties failed to achieve much, especially the secular ones. An obvious conclusion to be drawn was that Iraq's long-standing secular traditions are a thing of the past. Soon after the announcement of the results, negotiations started towards the formation of the new cabinet. Allawi, the Kurds and several members of the Shiite list claimed the top position, but it soon appeared obvious that one of the leaders of the Shiite religious parties which make up the unified list would get the job. As the end of February approached, that man looked increasingly likely to be Jafaari, the leader of the main Shiite party, Dawat. His choice represented a disappointment for the Bush administration, who having failed to get Allawi enough votes to get the job, now saw their second best choice, Adel Abd al-Mahdi, pushed aside too. Although Al-Mahdi also belonged to a religious Shiite party, he is widely seen as more cooperative with the occupation authorities than Jafaari. He even supported the privatisation of Iraq's oil industry, which is not a very common attitude in Iraq. One of the Kurdish leaders, Jalal Talebani, became the new president. The long delays in the formation of the new cabinet showed how difficult it might become to run Iraq in a consensual way. Earlier promises to reserve a fair place to the Sunni Arabs were not satisfied, as predictably a voracious appetite for cabinet posts was running high in both the Kurdish and Shiite alliances, which are both already under internal stress. 
The agreement on the names of Talabani as President and Al-Jafaari as Prime Minister did not resolve the impasse preventing the formation of the first post-elections cabinet in Iraq. Although an agreement was reached between the Kurds and the Shias with regard to the distribution of the cabinet posts among the ethno-religious groups, which assigned 16-17 seats to the Shias, 7-8 to the Kurds and 4-6 to the Sunnis, the agreement on the actual names proved much harder to reach. Even when that was done in May, the controversy was far from over, as the role of Sunni Arab politicians remained to be defined. Only four Sunni ministers were initially appointed to the cabinet, although it was agreed that a fifth, the minister of defence, would be appointed later. While five ministers would represent a fair proportion of the cabinet (out of 35 cabinet members) compared to just 17 Sunni Arab members of parliament, the number is widely seen by Sunni Arabs as thoroughly insufficient to represent the Sunni Arab population as a whole, which is generally reckoned to account for 20% of all Iraqis. The Sunni politicians had asked for 9 cabinet positions, which if achieved would have been a rather generous concession on the part of the Shiites and Kurds. Moreover, the two main alliances, and more specifically the Shiites, also had to accommodate the demands of several internal factions, of which four major ones exist alone within the Shiite alliance. At the same time, a number of Sunni notables have sprung into action and started negotiating a deal with the occupying US forces and the government, according to which at least part of the insurgency would give up the fight and more Sunni Arabs would be incorporated into the cabinet. 
During April the agreement on the name of Jafaari appeared increasingly shaky, as critical voices emerged against him even from within his own alliance. Both the more moderate or secular elements, consisting of about 45 members of parliament gathered around the Shia Political Council, and the more extremist ones, such as Muqtada As-Sadr's National Bloc (24 members), were threatening to quit the United Iraqi Alliance (UIA). Ayatollah Al Sistani's influence managed to prevent this from happening, but his role was also beginning to be challenged. Former Prime Minister Allawi, who appeared to be trying to form an alliance with the moderate elements of the UIA, implicitly criticised Al-Sistani's role in pushing Iraq towards clericalism. Allawi was invited to join the cabinet, presumably in order to prevent his anti-Jafaari manoeuvre, but he refused and openly stated that his political programme and that of the UIA were incompatible. Allawi appeared to be courting the Kurds, who are wary of Jafaari's Shiite fundamentalism, while the small Sunni bloc (17 deputies) was also angry with Jafaari because the UIA seemed increasingly inclined to concede just 4 ministers to the Sunnis, rather than 6 as they had for some time been given to expect. 
The political controversy between the Sunni bloc and the other groups (chiefly the Shiites) continued in May. The Shiites offered a new deal to the Sunnis, which would have included 15 seats out of 69 in the committee charged with drafting the constitution. However, some within the Sunni bloc opposed the offer and insisted that it would not settle for less than 25 seats. Kurdish leader and Iraqi president Talabani seemed to be ready to endorse a greater share of seats for the Sunnis, probably because he feels uneasy about leaving a majority to the Shiites in the committee. In the end, the majority of the Sunni bloc opted to accept the offer of 15 seats, but then issues arose concerning the selection process, which was judged not to be transparent enough by some.
Although both Kurds and Shiites agree that the long-lasting dominance of Arab Sunnis has to end, they did not necessarily like each other. The Shiite-dominated United Iraqi Alliance, which will provide the bulk of the next government, has made it clear that it rejects the clause, included in the Transitional Administrative Law by the occupation authorities, that grants the Kurdish minority a veto right over the new Constitution. Many members of the Shiite alliance who criticised the clause, had accepted it back in March, a fact that might point towards a more general "revisionist" attitude that the United Iraqi Alliance might adopt in the future. Among the Kurds, there was uneasiness throughout 2005 about the delay in unifying the two zones, ruled by the two main Kurdish parties, and about the attempt of the party leaderships to run the game without allowing the population much of a say. On the other hand, the contrast between Kurds and Turkomans, which had at some point looked on the verge of becoming open war, seemed to be easing out. The Turkoman Front, which delivered a disappointing performance in the parliamentary elections, showed signs of willingness to align with the Kurdish parties. Even Turkey, the Front's patron, was sending signals that it is no longer hostile to any hypothesis of federalism. Even some Arab Sunni parties, faced with domination by the Shiites, were becoming friendlier with the Kurds, although due to the presence of just 17 Arab Sunni members of parliament the impact of this development will be limited. The leader of the Islamic Party even endorsed the incorporation of Kirkuk into the Kurdish "zone", which it had earlier strenuously opposed. Tension remained however between the Kurdish and Shiite alliance over the role of Islamic law in government. Within the Shiite alliance, some groups like Hizbollah and SCIRI are pushing for an Islamic government, which is anathema to the Kurdish parties, the more so since it would be Shiite law.
The belief that elections in January 2005 will legitimise the government and therefore undermine the insurgency might well be misplaced. 
The constitutional debate dominated the news after the elections, mainly because of the delay in reaching a deal. The main stumbling blocks remained the same, namely federalism and the degree of autonomy to be granted to the Kurds. The Kurds had already won some concessions, such as the adoption of Kurdish as the second formal language of the country and the recognition of their Peshmerga militia as an official force to secure northern Iraq. However, they demanded more, including an increase of the share of state revenue coming from the northern oil fields from 17% to 50% and the inclusion of Kirkuk and parts of Mosul within the Kurdish region. Their main prize remains federalism, however, and for this they seem likely to settle for a 25% or so share of government revenue. Federalism is mainly opposed by Sunni politicians, who see it as a ruse to divide Iraq one day. Shiite and Kurdish politicians agree on federalism although with some qualifications, but are debating how much revenue should be left to the regions. 
The presentation of the final draft of the new Iraqi constitution in September did little to pacify the country. Instead, it appeared to set it up for increased trouble. As predicted, the Sunni Arab community was very unhappy about the shape taken by the new constitution, despite claims by its Shiite and Kurdish counterparts that a serious attempt to address the concerns of the Sunni community had been made. The issue of federalism and the purge of former Baathist members were the main controversial points. However, even within the Shiite alliance there is disagreement about the constitution. In the end, in the October referendum only two out of the three regions necessary to repudiate the draft constitution did so, although there were bitter recriminations from those Sunni who believe that they had a majority against and were cheated. However, at least temporary settling of the constitutional issue did not mean that political controversy was over. Throughout October, increasingly strong signals emerged of a widening rift between President Talabani and Prime Minister Jafaari. A Talabani spokesman even went as far as asking publicly for the resignation of Jafaari, although Talabani later distanced himself. Talabani was clearly trying to raise the profile of the presidency, a largely ceremonial post, by competing with Jafaari for the time and attention of foreign authorities. Neither seems able to impose discipline on the cabinet. At some point the Interior Minister went on the loose and stated that Iraq would not accept being taught by "a Bedouin on a camel" about human rights and democracy (meaning the Saudis), forcing the Foreign Minister to apologise the next day. There are also differences within the Shiite alliance. The largest component of the Shiite coalition (other than Jafaari's Dawa Party), SCIRI, was for a while even hinting that it might participate in the next elections on its own. The Kurds even accused Jafaari of ethnic prejudices against them, while women' groups have not forgotten his earlier calls for measures meant to curtail women's rights. Jafaari was also accused of not taking much interest in the constitution itself and of being a difficult character to deal with, as well as lacking dynamism. Finally, Jafaari and the government were accused of manipulating the judiciary against former Prime Minister Allawi's group, in order to discredit it. Allawi's defence minister, Al-Sha'lan, appears likely to be soon the object of an arrest warrant for corruption. 
Although officially disbanded, party militias continued to operate and to bully opponents. Corruption was also emerging as a major issue. The case concerning corruption at the Iraqi Defence Ministry gathered during August and several enquiries have now been opened. 
After the formation of the new government, Iraq began to slowly re-align its foreign policy. The hostility of the ministry of defence towards the Iranian government became a thing of the past. In July the two countries announced that Iran will contribute to the training of Iraq's military. Although the content of the deal was not actually clear, it was obvious that a rapprochement was taking place, which will not necessarily please the US government or its agencies here in Iraq.
As the elections to the new Iraqi parliament approached, parties and political groups started to realign to form new coalitions. Only the Kurdish-dominated alliance almost stayed the same, except for the defection of the Kurdish Islamists, who after doing well in the provincial elections earlier this year decided to stand on their own. The Shiite alliance instead changed significantly, with the split of Ahmad Chalabi, who was leading its secular component, and the official incorporation of the group of Muqtada al-Sadr. The alliance assumed then an even stronger religious leaning. Prime Minister Jafaari appeared to have been instrumental in bringing in the ambitious firebrand and vigorous opponent of the coalition, Muqtada al-Sadr, possibly in an effort to recover support following the lacklustre performance of his cabinet. For a while it even looked as if the alliance might have collapsed altogether, not least because its third major component, SCIRI, is on bad terms with Muqtada. In the event, all three groups agreed to a share of 30 candidates each on the joint list, a significant recognition of Muqtada's lasting popularity in the south and in Baghdad. In the previous elections, some of his supporters were also on the list, but without an official role. On the Sunni side, the fragmentation of the January elections was no longer there and two lists, an Islamic one and another secular nationalist, were formed. Another important development was that most secular groups allied around the group of former Prime Minister Allawi, including the left. Allawi's only real alternative among secularists was Chalabi's alliance, which is more moderate and includes some of the monarchists. Chalabi, who used to be a key ally of the Bush administration until his links to Iran emerged, appeared intent on positioning his alliance once again as the best option for the US. He spoke out against a withdrawal of foreign troops and against the involvement of religion in politics. 
The Shiite alliance began to manoeuvre to create the condition for a partial withdrawal of foreign troops. In particular, they would have liked to see the international force leave the south of the country, which is their main stronghold and which they would like to control without hindrance. They already dominated local institutions, the police and security forces and were confident that no external help was needed there any more. They were ready to accept US presence in the Sunni heartlands for longer, as long as they work to crush a largely anti-Shiite insurgency. 

Economy
Efforts continued in 2005 to get Iraq's remaining external debt cancelled, which could be as much as US$30 billion. 80% of the debt owed to the main industrialised countries, that is almost US$40 billion, has already been cancelled, but the remaining amount is still large enough to cripple the Iraqi economy for years to come. 
In terms of economic reforms, the banking sector, which is considered to be completely unsuitable for a "liberal" economy, remained at the top of the priorities. The privatisation of public companies finally started making its first steps at the end of June, with the announcement of plans for the first 10 companies to go through the process. However, the rest of the privatisation process was delayed because the draft privatisation law was been subjected to heavy criticism. Some aspects of the government's economic policies might just have done damage. The Iraqi market was flooded by cheap Chinese imports, especially clothes and electricals, following the liberalisation of imports. Local manufacturers were unable to compete, not least because they did not receive any support form the government. 
Even the recovery of the tertiary sector was called in doubt as the worsening security in the previously relatively safe areas of the south is driving down commercial activity.
Under pressure from the IMF and the World Bank, the Iraqi government started discussing a plan to phase out food and fuel subsidies towards the end of 2004. During that year the Iraqi government spent US$8 billion in subsidies, of which US$2.4 billion is just to import goods that it then distributes. 
60% of the population was still dependent on food handouts, but consumer goods like mobile phones were becoming widespread and import of cars continued to do well. 
Much of the US$18.4 billion allocated to reconstruction by the Bush administration was re-allocated to the improvement of security. The treatment of potable water was affected particularly hard and no new treatment sites were planned for this year. Moreover, US$5 billion were diverted to the Iraqi ordinary budget in order to make up for a shortfall in revenue, due to lower than expected exports of oil. Yet another reason for the slower pace of reconstruction was that the US Department of State decided to move funds away from large scale projects and spend more (US$832 million) on immediate job creation and training. Direct and indirect additional security costs accounted for another US$1.3 billion. Even the US, despite having hired plenty of private security guards, cannot spend the money they have pledged to help Iraq. Although the contracts have all been assigned to Western companies, the reconstruction effort employs 200,000 Iraqis. The ongoing campaign of sabotage, together with the stalling of reconstruction, explains why the economic situation is actually getting worse. Of 300 NGOs which were active before the campaign of kidnappings started, only around 100 were left in 2005. Between the end of June and mid July two donor conferences were held, which provided hints about the prospect of more money being pumped into Iraq soon. The Brussels conference, held at the end of June, did not bring much good news to Iraq. Existing pledges were confirmed, but donor countries remained shy of committing themselves to any delivery date, citing the security situation as a main problem. Another donors' conference was held in July in Amman and was much more productive, as Japan offered $US3.5 billion in low-interest loans for water, sewerage, road and other projects. 
The new cabinet faced in May the prospect of a budget deficit for 2005 that could reach US$4.4 billion, out of a total expenditure totalling US$23.6 billion. Such a large deficit would be the result of lower then expected revenue, which in turn was due to the failure to boost oil production, but even more of expenditure exceeding expectation. The fact that just US$6 billion out of US$33 billion of pledged aid have effectively been received also contributes to compound the problem.
One of the few success stories was the independence of the Central Bank, which was the key to the stabilisation of the currency, which has been trading at around 1,465 to the dollar since January 2004. In August the IMF issued a report on the Iraqi economy, which lowered the GDP growth forecast to 3.7% for 2005, down from an earlier forecast of 17%. Given the high oil prices on the world markets, this was hardly a sign of a positive trend, despite claims in part of the press that it showed how the Iraqi economy is not being destabilised by the insurgency. Moreover, the IMF report warned the Iraqi government of a likely shortage of cash in the second half of the year, as it predicted lower oil exports and tax revenues lower then expected. Finally, inflation was reckoned to have been at 37% in the year through to June, which makes earlier forecasts of a 15% inflation rate for 2005 unlikely to be met. According to the IMF report, contractors and donors now report that costs related to security and insurance account for 30-50% of the total. 
A positive development was that Iraq's electricity supply finally reached the pre-war level, at 5,350 megawatts. Electricity shortages, however, continued, due to the high summer temperatures which force many to use air conditioning. In part the improvement in supply was due to imports from neighbouring countries, with even more imports forecast for August, with the aim to increase supply to 6,000 megawatt. The problem is however that these imports are too expensive for a government which is widely expected to run a serous budget deficit. The forecast for next year is that US$1 billion will be spent in electricity imports. The increase in domestic production of electricity was much slower, with just a new turbine expected to become operational later this year. 

Oil industry
As far as the oil sector is concerned, the objectives for 2005 are now much more modest than originally planned. The old target of 3 million bpd for the end of 2004 was applied to the end of 2005 and still was largely missed. In fact, oil production declined in 2005, when it averaged 1.8 million bpd, down from 2 million in 2004. The state of the infrastructure is said to have worsened rather then improved. Production is declining not just because of sabotage, but also because the southern fields appear to have been overexploited in order to compensate losses in production in the north. Investors were deterred from investing not just by the awful security situation, but also by disputes such as that between the Kurdish regional government and Baghdad over the control of oil resources. Domestic needs stood at about 550,000 barrels in early 2004, with a tendency to increase since the number of vehicles in circulation was growing rapidly. 
After delaying deliveries and cutting contracts for several months now, the government finally decided to revise downwards its export plans for the second half of 2005, from 1.65 million bpd to 1.45 million. 246 attacks against pipelines took place in 2004, up from just 73 in 2003, resulting in the government's inability not only to meet export targets, but also to satisfy internal demand. 
Even if about 30 foreign oil companies had entered the Iraqi market by 2005 and done some work there, sometimes for free, almost all of these companies refused to go beyond technical training and consulting, aiming to establish a presence without investing large resources. At least one contract dating back to the Saddam era was confirmed already in 2003, with Indonesian Pertamina for a development in western Iraq, but the company had to suspend work due to security problems. Some more substantial, although still minor, contracts were awarded after the removal of Saddam from power, as in the case of a consortium including Shell, BHP Billiton and Tigris Petroleum reached a deal to boost production from the Maysan fields in the south. The other companies were instead busy courting the Iraqi government and hoping to win big contracts when the right time should come. However, the reluctance of the US government to guarantee strong legal protection to foreign companies working for the oil industry meant that few of them accepted to work on the improvement of existing oil wells. 
Due to higher oil prices, this year Iraq earned in 2005 about US$20 billion from oil, about the same as in 2004, when about US$7 billion were lost due to sabotage. By July 2005 the estimate of losses due to the sabotage of the oil industry had grown to US$11.35 billion. Attacks on oil infrastructure shifted towards power plants and domestic energy production, presumably with the aim of discrediting the government. It was not even clear who is carrying out all these attacks to the oil infrastructure. There were exchanges of accusations about responsibility, with the government accusing the tribal militias and the militias lamenting the lack of support from the regular army. This was not the only problem that the oil industry is facing, as estimates of oil revenue lost to theft and smuggling ranged from 5% upwards. Moreover, with the establishment of the new government, many technocrats in the oil ministry were replaced by cronies of politicians, increasing the chances of corruption. Rumours abounded of oil revenue having been siphoned off to foreign bank accounts. Finally, reconstruction aid could be spent on refurbishment of Iraq's oil wells yet because liability issues between US government and KBR (a subsidiary of Halliburton) had not been resolved yet. Between the end of December and the end of January the Iraqi government started signing oil deals, which could lead to increased production at some point in the future. Avrasya, a Turkish company, was awarded a US$136 million contract to develop an extension of the Kirkuk oil field. Ironhorse, a Canadian firm, won the bidding for the Hemrin field in northern Iraq, which is estimated to be worth around US$180 million. Another US$185 million contract to raise the output of the Suba-Luhais field is being finalized. 
The production of electricity, also targeted by the insurgents, actually declined from 2004 and businesses increasingly depended on privately owned generators. 
At the same time the government was planning to spend US$2.4 billion to import oil products in 2005, in order to make up for a shortfall in production which pushed prices as much as 10 times higher. The price of gas rose as much as 20 times. Apart from paying higher prices, Iraqis had to queue several hours before being able to fill the tanks. Moreover, electricity was not available to many houses, because the pipelines to the power stations have been sabotaged. 
Security concerns forced the Oil Ministry to adapt to the circumstances and switch to a tender system to sell its oil, which would allow to accumulate oil in the Ceyhan tanks and then sell it, avoiding the risk of being unable to fulfil contractual obligations in case of further sabotage. 
In April Iraq's foremost industry also became the object of a purge of corrupt elements and of individuals suspected of cooperating with the insurgents. At least 450 employees were fired, because they were selling fuel on the black market. This was part of a larger campaign against corruption in the government, which includes the obligation for state officials to declare their assets. The oil industry continued to operate in an environment that it would be a grotesque understatement to describe as unfriendly. Only 60% of the trucks carrying oil products away from the wells were reaching their destination, while the others were attacked or hijacked. Smuggling was of course encouraged by the low internal prices, to the extent that the director of the state oil industry suggested during April that prices should be increased. The state oil company was maintaining in April that exports in the range of 2 million bpd are easily attainable if security could be improved, which is of course a big if. As shown in a rare piece of investigative journalism published in the Los Angeles Times at the end of September, the US has already spent US$1.3 billion on the Iraqi oil industry, but this has had little impact due to mismanagement and wrong choices, including the decision to use American officials with little experience of the oil industry instead of officials from the Iraqi ministry. Many in the industry and beyond, including in the US Congress, started seeing the use of no-bid contracts won by cronies of the Bush administration as a major source of problems. Several scheduled repair projects have not been completed and in some cases have been abandoned, at a cost estimated around 500,000 bpd, worth US$8 billion a year. The unwillingness of the Iraqi government to commit resources to complete the necessary repairs, opting instead to spend its revenue in subsidies and salaries, compounded the situation. The damage done to some oil fields might be permanent, adding to the damage done in Saddam Hussein's years. According to UN estimates, in some oil fields it might be possible to recover just 15-25% of the oil, as opposed to averages of 35-60%. Further damage might have been done because of the practice of re-injecting oil which could not be immediately carried away because of sabotage and lack of storage facilities. Iraq was still re-injecting close to 200,000 bpd in 2005. 

Summary 2006
The prospects for improved security in Iraq are assumed to rest on the inclusion of the Sunnis in the new power alignment after the parliamentary elections, but radical insurgent groups are already positioning themselves for a continuation of the insurgency regardless, as long as the presence of foreign troops will continue. Tension among different sectarian and ethnic groups will likely continue to simmer in 2006, but an explosion is unlikely, at least not until the issue of Kirkuk comes to the fore. The different factions are positioning themselves to seize as much as possible of the renascent Iraqi state, in order to be able to maintain a degree of power even in case they were excluded from the executive. This will delay progress, but not lead to an open slash as long as foreign troops remain stationed in the country.

It is apparent that sectarian and ethnic fissures are being replicated in the new security services, casting gloom on the prospects of post-occupation Iraq. Despite the greater ideological homogeneity of the Shiite coalition, strong divisions remain between the followers of Al-Sadr and SCIRI, but also between Dawa and SCIRI, whose leader Al-Mahdi had hoped to replace Dawa's Jafaari as prime minister. Tensions between the Kurds and the Arabs, Sunni and Shiite, are exacerbated by the competition for the control of Kirkuk and its rich oil reserves. In 2006 a referendum will have to be held to decide whether Kirkuk it joins the Kurdish Regional government or not.

The official results of the Iraqi parliamentary elections, released on 20 January, confirmed the predictions that little would change compared to the previous elections, except for increased Sunni Arab participation. With 128 seats, the Shiite alliance lost just 18 seats compared to January 2005. The representation of the Shiite Islamic parties actually increased, as the alliance has in the meanwhile shed its secular and Sunni components. Ahmad Chalabi, who used to be part of that alliance and competed in these elections as the head of another, secular-leaning alliance, was utterly defeated and his alliance failed to win a single seat, including his own. Secular Shiite voters flocked instead towards the alliance led by former Prime Minister Allawi, which won 25 seats, with a loss of 15 seats compared to the previous elections, despite the enlargement of the alliance to include a number of secular and leftist groups. A similar secular-religious split took place among the Sunni electorate, with an alliance of religious groups getting 44 seats and another alliance of secular and nationalist groups winning 11. In the case of the Kurds, a split between secular and religious groups also occurred, but the proportions of it were inversed, with the secularists gaining 53 seats and the Islamist just 5. On the whole the vote showed increased sectarianism, with parties claiming to represent cross-sectarian and cross-ethnic interests gathering just over 10% of the vote.

Long and complex negotiations were needed in order to form a government. There are several main bones of contention. Both Shiite and Sunni groups obviously want to control the Ministry of Interior, whose involvement in the repression of the insurgency has led to widespread allegations of abuse. Between December and January several signals emerged from the Bush Administration that showed how it might be courting Sunni groups with an eye both at undermining the insurgency and weakening the hold of pro-Iranian groups (i.e. the Shiite alliance) on the Iraqi state. Ambassador Khalilzad insisted that in the future cabinet the Interior Ministry should be held by a non-sectarian, while it is currently held by a Shiite, who has been filling it with supporters of the Shiite alliance. At the same time, the ambassador also appeared to side with the Sunnis when their politicians claimed that large scale rigging had robbed them of a fair share of seats in the parliamentary elections. However, it remains to be seen how far the US embassy will be able to go in terms of successfully manipulating sectarian and ethnic divides in Iraq.

A sign of at least temporary success was in February, when Kurdish President Talabani went as far as stating that the Kurds will not participate in a government without Allawi. Also the formation of an alliance between Allawi and the two Sunni groupings, which counts on 80 seats in the parliament, was probably encouraged by the Americans, who are keen to limit the expansion of Iranian influence in Iraq. As a result the relationship between the Americans and the Shiite was rapidly deteriorating during the first 4 months of 2006, as the Shiites clearly believed that the US has engineered this alliance against them. Even moderate elements within the Shiite alliance started talking tough and hinting that a new insurrection might become a necessity. The ambitious Muqtada al Sadr, who still sticks to his agenda of expelling the "crusaders", was gaining consensus within the Alliance.

The US probably expect the forthcoming talks with Iran if they happen to address the issue of the deteriorating relations with the Shiites, but the announcement of direct US-Iran talks has not been welcomed by everybody in Iraq. Sunni Arab leaders were the most hostile to the talks, accusing Iran of interference. There were also fears that Iran might offer a Iraq-nuclear program trade off and that the Americans might accept it, sacrificing Iraq for the greater good of the freezing of the Iranian nuclear program. The Kurds, on the other hand, were either favourable to the talks or neutral, but some of them argued that Iraq should be represented at these talks, a position upheld by Allawi's secularists too. Among the Shiites, the most nationalist part of the Alliance, including Muqtada as-Sadr, opposed the talks on the ground that they would amount to recognition of Iran's interference. 

After an initial failure to select the alliance's candidate to the post of Prime Minister, an alliance within the alliance of Al-Dawa and Muqtada al-Sadr's group confirmed Jafaari as Prime Minister, defeating the ambition of Abdel Mahdi, one of the leaders of SCIRI, to replace him. The selection of Jafaari, who has bad personal relations with President Talabani, will represent a further incentive for the Kurds to expand the ruling coalition to other forces. Since the Sunni groups, now allied with Allawi, have little love for Jaffari either, the formation of a new government was stalled. While the Kurds, the Sunni and the Allawi bloc all opposed Jafaari as Prime Minister, they do not agree on an alternative candidate either, as the Kurds and Allawi might accept Mahdi, the other main figure within the Shiite alliance, while the Sunni absolutely oppose him. Even if a prime minister was chosen, there is another bone of contention which is the post of Interior Minister. The US and the UN appear to support Allawi for the job, or in any case a non-sectarian candidate, but he is strongly opposed by the religious Shia groups, especially al-Sadr's. The current Interior Minister, Shiite Bayan Jabr, has been the object of repeated calls to resign from the Sunni side, which accuses him of involvement in sectarian violence. Finally, the Shiite candidate, Jafaari, conceded in mid-April that the alliance might discuss choosing an alternative.

Jawad al-Maliki, from Jafaari's own party Dawa, was chosen for the job. He has a reputation of a strongman and Islamic activist. His selection appears to have broken the impasse, as the main groups in parliament approved it and declared their readiness to proceed with the formation of a government, but it is not clear whether he will be able to provide effective premiership in the future. In order to ease the process leading to a coalition government, in March the National Security Council was established, likely to be presided over by the secular former PM Allawi, who in this way would receive a senior job without being part of government. By the end of April the parliamentary groups are expected to start discussing the list of ministers, where more controversy is expected. 

As the end of May approached, the new Prime Minister Maliki was forced to present a partial cabinet to the parliament, with only interim Interior and Defence ministers. While an agreement had been reached about the appointment of non-factional Ministers of Interior and Defence, which was one of the key demands of the non-Shiite groups in parliament, there is still a difficulty in agreeing on the actual names of the ministers. Moreover, the two Sunni Arab alliances openly stated their unhappiness about the share of power reserved for them and some of their members walked out of the parliament at the time of voting the cabinet. One of the demands of the Sunnis was the post of deputy prime minister, which the Shiites and the Kurds wanted to give to Allawi, leader of the secular block. In the end Allawi was appointed to the newly established National Security Committee, but the Sunnis were still not satisfied. The tension was also high within the Shiite alliance itself over the name of the Oil Minister, one of the positions most sought after for rather obvious reasons. 

Only in June Prime Minister Al Maliki finally managed to complete his cabinet with the appointment of the three missing ministers. The Ministry of Interior was given to Jawad Polani, an independent Shia, while Defense went to Al Obeidi, an independent Sunni. The Ministry of Oil was given to Hussein Shahristani, a high profile member of the Shiite alliance (but not of any of the Shiite parties) who had previously been considered for the post of Prime Minister. Obeidi was criticised by some Sunnis because of his participation in the assault on Falluja, as an army officer, but all three candidates were smoothly approved by Parliament. The Sunni-nationalist Iraqi Front for National Dialogue remains however outside the cabinet and complains that the Shiite alliance demanded that it change its platform in order to be given a 'fair' share of cabinet posts. Also, Allawi has made openly sceptical statements about the chances of this government to succeed, despite taking part in it. The current line-up of the cabinet is 18 ministers of the Shiite alliance plus one independent Shia, one Shiite Turkoman and one Shiite Kurd, 7 Sunni Kurds (including 1 Islamist), 7 Sunni Arabs (of the Islamic Sunni alliance), 6 secular followers of Allawi and 1 independent Christian. 

In the current political debate, the main bone of contention is the fate of the factional militias, which the Shiite alliance is planning to incorporate into the security agencies, a move opposed mainly by the Sunnis. Not only the de facto civil war among Sunnis and Shias still goes on, but the issue of the fate of the militias is increasingly causing strife within the Shiite alliances. Despite some purges, it is still estimated that militias account for 70% of the police force. Al-Maliki is known to have confronted his political patrons in the Shiite alliance with the need to rein in the militias and a consensus seems to be slowly emerging that the militias have gone too far. Unfortunately, it might be too late as the political leadership of the factions seems to have lost control over many of the militias. In particular, it appears that Muqtada as-Sadr faces great difficulties with large groups of his loyalists, who have largely infiltrated the police. The attempt to coopt him into the government in order to mollify his radicalism in a way worked. He is now part of the establishment and preaches against sectarianism, but he has not been able to carry all of his followers with him. Sadr's attempt to discipline his forces and mould them into something more similar to Lebanon's Hizbollah is clearly failing. He has established new training courses for his cadres and has been sacking those who were not willing to follow the new line. However, these rejects have still the option of going it alone and they do. There are now just in Baghdad 23 different Shiite militias. The trend is difficult to reverse because the militias are actually popular within their own communities, as they offer protection and even some benefits while at the same time preying on other communities. Not only are the militias involved in intra-sectarian fighting, but they are also beginning to fight fellow coreligionists, with SCIRI and Sadr's groups being the bitterest enemies. 
The growing inter-Shiite rift was also evidenced by the resignation of three ministers (Transport, Tourism and Provinces) between the end of June and the end of July, all supporters of Muqtada As-sadr. As-sadr was likely positioning himself to capitalise on the unpopularity of the government, within which his influence was in any case weak and limited to junior ministerial portfolios. He had of course long been and remains, a consistent and virulent opponent of the US presence in Iraq. More significantly he is extremely combative and controls perhaps the biggest and best armed of all the Shi-ite militias. After much hesitation, during October finally the Iraqi government began to tackle the issue of rogue elements of the security forces pursuing their own private war against rival groups. Several high ranking police officers were removed and whole units suspended as part of an assessment of the performance of the forces of the Ministry of Interior. At the same time, efforts to disarm non-state militias were renewed, leading to bloody armed clashes in particular with Muqtada as-Sadr's men in a number of localities. However, in this case too there are widespread suspicions that what is really going on is the replacement of one faction with another. After the Sadrists broke with the government, they were singled out for a purge, while many Shia parliamentarians accuse the Minister of Interior Bolani of being intent on filling the police with old Baathists. 

This rise in the tension among Shiites happens at a time when the different constituent components of this alliance are fighting over the control of the governorate of Basra. The governor of Basra is trying to fire the chief of police and the commander of the 10th Division of the Iraqi Army. The relations between the Kurds and the Shiites also keep worsening. In particular, the Sadrist faction of the Shiite alliance, which espouses its own brand of Iraqi nationalism, is adopting an increasingly confrontational attitude towards the Kurds, having even deployed militiamen to the north in order to show their opposition to the Kurds' claim to Kirkuk. 

The growing trend towards a sectarian civil war pushed in July several senior Sunni notables to issue public statements in favour of American troops staying in the country, a position which until recently would have been seen as anathema by almost all Sunnis. They clearly fear that the Shiite militias are intent in wiping them out. On the other hand, Shiite politicians were issuing with increasing frequency statements against the interference of foreigners. There are indications that Iran, in line with its policy of controlled brinkmanship, has been resisting any drift towards a settlement between Sunni and Shiite groups in Iraq, presumably in order to make Iraq uncontrollable by the US. 

The Iraqi government re-launched its reconciliation efforts in August, but there were disagreements within it with regard to whom should be allowed to take part in them. Prime Minister Al Maliki was inclined to exclude resistance fighters, while Parliament speaker al-Mashadani, a Sunni, was in favour of including them. Prime Minister Al Maliki's efforts are seen by many as going in the right direction, but in practice he is achieving little. In December the government offered former Baathist army officers reintegration in the military, but few seem to have the intention to accept. Many consider the current government illegitimate and would not serve in the army as long as the country is militarily occupied. There is increasingly the feeling in Baghdad that while the Bush Administration continues to put pressure on Maliki to carry out reform, it has really lost hope in his ability or willingness to effectively break with sectarianism and is preparing for future scenarios. The Administration seems to be manoeuvring to organise Maliki's replacement by some other Shiite politician deemed to be more willing to form a genuine coalition government, sacrificing the residual unity of the Shiite alliance. However, it is known that Ayatollah Al Sistani has always previously opposed such a development as he prizes Shiite unity over anything. Moreover, the general perception among Iraqi politicians seems to be that the Americans are weaker and weaker, as even those who were their closest supporters, such as secular politicians, are beginning to feel abandoned and betrayed. Therefore, not many leading politicians at this stage might be willing to throw in their lot with what used to be the world's superpower.

Together with an ongoing civil war, inflation running at 50% and unemployment now estimated to run at 50% of the workforce (up from last year's 30% estimate), the health service is in deep crisis because of financial mismanagement and corruption and because 18,000 physicians have fled the country since 2003. Corruption is another source of discredit for the government. A current estimate is that government corruption accounts for 10% of GDP yearly. Corruption goes so far that it contributes directly to the violence: an estimated 14,000 weapons have disappeared from the government armouries, presumably to end in the hands of the militias and of the insurgents. Theft is not the only aspect of the decay of the Iraqi government. The government, filled with cronies and political appointees, does not even have the capacity to spend its own budget, so that this year an estimated US$8-10 billion will go unspent. The fuel shortages also contributed to shape a mood of impending collapse among the population. Under growing pressure because of the growing fuel shortages, the government was forced to approve a law allowing private companies to freely import and distribute fuel, previously a government monopoly. At the beginning of the summer Iraq's refineries, which overall are running at half capacity due to sabotage and other issues, were produce only 10 million litres of fuel per day. The country needs 22 million. During the summer the government doubled its budget for fuel imports, but corruption has prevented government imports from exceeding 7 million litres, leaving a gap that it is hoped private entrepreneurs will fill. In fact, by the end of August fuel imports had risen to 11 million litres, easing the shortages. A number of new oil refineries are being built in the north and they are expected to come on line soon, reducing the need to rely on fuel imports. Attacks on the oil infrastructure are also reported to be in decline, from five a week in the second quarter of 2006 to just two in the current quarter. 

Prime Minister Maliki announced in September that soon cabinet changes will be implemented, to deal with cases of low performance and others of disloyalty. Although he did not state it explicitly, as far as disloyalty is concerned he implied that Muqtada as-Sadr's group will be the main target, when he said that those who 'have a foot in the government and a foot outside' will have to make a choice. The Sunni speaker of parliament is also seen as likely to become a victim of the reshuffle because of his criticism of the ruling coalition. The news of the reshuffle comes at a time when the negotiations on the issue of federalism have been postponed due to differences within the Shiite alliance, where the groups affiliated with Muqtada al Sadr oppose federalism and Dawa and SCIRI are strongly in favour of it, highlighting how relations within the alliance are increasingly strained. However, Prime Minister Maliki himself is the target of criticism, particularly from the US, for his failure to rein in the militias which are driving the country towards a full-fledged civil war. Maliki's refusal to condemn Lebanon's Hizbollah and his trip to meet Iranian president Ahmadinejad did not contribute to endear him to the Americans, who now say their support is 'not open ended'. In September the control over the armed forces has been handed over to the government by the Americans, adding to a list of institutions, of which it is perhaps the most significant, whose control...will now be fought over by the competing vested interests. 

On 11 October the Parliament approved with a slim majority a law which divides the country in three regions and allows each of Iraq's governatorates to hold referendums about which region to join. A compromise with the Sunni leaders was achieved in September, on which basis the creation of the autonomous regions will be postponed until 2008, although that did not prevent the Sunnis from boycotting the voting of the new law. Federalism was approved with the support of the Kurds and the Shia factions, except for the two Sadrist groups in parliament. Secular non-ethnic groups also opposed the law. Sunnis seem now to accept some form of autonomy at last for the Kurds, but remain hostile to the idea of a Shia region in the south. They still seem to hope to be able to introduce amendments to the law to dilute federalism, possibly through popular referenda, but their chances of success appear slim. This issue will now dominate the formal political spectrum, as some limited form of salvation is perceived compared to the anarchic situation that prevails. 


Official efforts by the Iraqi authorities to check the spread of corruption peaked up in October, when the Commission on Public Integrity issued arrest warrants against 15 current and past ministers. The enquiry is also revealing the existence of many thousands of ghost state employees; of public servants who have conflicts of interests because they hold two public positions; and other improprieties. According to the Commission, there are 1,200 pending cases of corruption and US$7 billion are estimated to have been embezzled. The Commission accuses US and British authorities of doing little to help the investigation. It is not clear whether this is because some of their protégés are involved too, as implied by the Commission, or because, as several observers believe, the anti-corruption drive might be an expedient to rid key factions in the government of political rivals. The climate of uncertainty between the extreme corruption of the system and proclaimed efforts to reform is increasingly paralysing the government. State officials are afraid to spend money because they fear the new anti-corruption initiatives. This together with the difficulty of starting reconstruction projects due to the violence, has led to a budget surplus of US$15 billion, a paradox in a country where the living condition of the people are continuously deteriorating. With regard in particular to the oil industry, in the first six months of 2006 just US$290 million were spent of a budgeted US$3.5 billion. This is an even worse performance than in 2005, when about half of the budgeted US$2 billion were actually spent. It is therefore not surprising that oil production stagnates. 

The IMF forecasts that Iraq's economy will grow by 10 per cent in 2006. Next year's budget is projected to double to US$30.4 billion, while revenue is projected at US$23.7 billion, which implies a US$6.7 billion deficit. Oil is expected to contribute 93% of a projected US$19.4 billion revenue, to which international help should add another US$4.3 billion. However, the budget is based on oil at US$26 a barrel, which is a very conservative estimate. The deficit, therefore, might actually disappear if oil prices stay high. Hence the urgency to reduce the budget, even if the move will likely prove very unpopular. The industrial sector, moreover, has almost ceased to exist as factories closed down after the fall of Saddam and the entrepreneurial class has mostly fled the country, further reducing the prospects of economic recovery.

Before the US invasion three years ago, Iraq was pumping 2.5 million barrels a day. After touching the bottom in December last year, with just 1.1 million bpd exported, the oil industry is slowly climbing back. In January exports were still at 1.1 million bpd, but in February they rose to 1.42 million and this despite the fact that after having declined for some time, sabotage attacks against the oil and electricity industries were on the increase again, even if they have not reached the high levels of 2004. In March oil exports continued close to the level reached in February, at about 1.3 million bpd, but very worrying signs appeared of a shrink in annual production, which averaged around 1.8 million bpd. Most analysts now forecast that oil production in 2006 too will not exceed 2 million bpd and might even stagnate at 1.8 million bpd, frustrating any attempt of Baghdad to increase production. The government target for the end of 2006 is 2.6-2.7 million bpd, which should earn US$35 billion, much of which should be spent to improve the oil infrastructure. An unexpected lull in the sabotage of oil pipelines in the north has allowed oil production to reach 2.5 million bpd by the end of June, as after 4 months of repairs the pipeline became serviceable again. After stagnating at 1.5 million bpd since March, oil exports have correspondingly increased to 1.7 million bpd at the end of June. The current forecast is that Iraq will earn US$28 of oil revenues in 2006, up from US$24 billion in 2005, due to both increased production and higher prices. However, it is not all good news from the Ministry. American campaigning on the Iraqi oil industry has intensified over the last month. An American official, the head of the Government Accountability Office (GAO), has gone public to denounce the corruption at the ministry. He estimated that 10% of fuels refined in the country and 30% of those imported were being stolen. Much of this fuel is re-exported, due to the fact that the heavily subsidised Iraqi prices are about half the average for the region. GAO also reported the existence of many ghost employees in the Oil and other ministries. 

The US are also putting pressure for the drafting of a new law, which allows foreign companies to invest in the oil industry. Despite the crucial importance of approving Iraq's new oil law, the Oil Committee of the Iraqi parliament was still split over it as the end of December approached. The bone of contention is still the role of the regions in signing deals with oil companies, but a deal has been reached on revenue sharing, which had also been very problematic in the past. 

More in general, pressure is growing for the Iraqi government to start privatising the state industries and opening up the economy. The Iraqi government is not openly opposing such developments, but little action has been taken so far. Some resistance is showing with regard to the privatisations, with the Industry Minister stating that privatisation 'should not be rushed' and that it is not likely to happen for another five to ten years. In August the government increased oil prices to reduce smuggling and waste, with some success. Apart from increasing fuel prices, the Oil Ministry has also enacted a number of other measures to curb smuggling, such as suspending sales to companies blacklisted as smugglers. The struggle against corruption at the Ministry appears less successful, although contracts for purchasing fuel from abroad have been made more transparent. The inability to repair pipelines and continuing sabotage prevented however the Iraqi population from benefiting. Only 38% of planned reconstruction projects related to the oil industry have been completed. Even the new pipeline carrying oil from the Kirkuk fields to Bajii refinery is reported to leaky and unable to carry more then 500,000 bpd rather then 800,000 as planned. At the beginning of August, Shahristani announced that by October negotiations with international oil companies will start in order to develop Iraq's oil industry. The Kurdish regional government, on the other hand, is upping the stakes in its confrontation with the Ministry and has prepared a regional law which allows it to claim control over oil resources. The Kurds are also preparing a similar draft law to be presented to the national parliament, in a move which will inevitably stir controversy.

The International Energy Agency (IEA) does not expect production to reach 3.2 million bpd before 2010, which would allow Iraq to export 2.5 million bpd, whereas the government claims it will be 6 billion bpd, if it can attract foreign investment for an estimated US$7 billion. The International Monetary Fund now predicts that production will not reach 3.5 million bpd until 2009 and that the level of 5.5 million bpd is judged to be as far away as 2013-14. Independent observers think that US$6 billion will be required just to bring the oil industry back to its pre-war levels, with another US$35-40 billion needed over a period of 10 years to increase production beyond that. It might be necessary to lower production in order to carry out repairs which are badly needed, even before bringing into production new oil fields. Most likely, foreign investment will continue to trickle in, for example in the safer Kurdish region, but with little overall effect on production in the short term. Future projects for the Iraqi oil industry are not very clear, but foreign investment in the industry is still likely to be allowed, as far as the exploration of new fields is concerned. Later on some selling of oil assets like refining and distribution might take place, but extraction is not likely to be privatised for a long time to come. The Oil Ministry was losing US$700 million a month because of the smuggling of oil products, with some 100,000 barrels being smuggled every day, out of a total production now at 1.9 million bpd. Some observers believe that the problem is intractable because sectors of the government are involved in the smuggling, from which they derive resources to maintain and expand their patronage network. Oil production appears now to have reached a ceiling, due also to insufficient provision of electricity. Average production for the first six months of 2006 was 1.95 million bpd, up from 1.85 million bpd in 2005 but still below the 1.99 million bpd of 2004, not to speak of pre-war levels. The Oil Ministry was planning to produce 2.66 million bpd in 2006. These lower than expected outputs are in part the result of insufficient provision of electricity. Experts have recently revised upwards the investment required to rebuild Iraq's electrical system, to US$50-60 billion from the original US$20 billion estimated in 2003 by the World Bank.

The increasing difficult situation of the Iraqi oil industry was highlighted in January, when Oil Minister Bahr al-Ulum resigned after having been put on administrative leave by the government. Although he resumed his post after one week, the mood remained gloomy at the Ministry. Allegations flourished that the Ministry was under the control of gangs and losing its ability to manage the country's extraction and refining installations. The Ministry was forced to take the very unpopular measure of increasing the price of gasoline from US$0.01 per litre to US$0.80, while the price of petrol has gone from US$0.03 to US$0.09. These increases sparked the protests which forced the Minister to take his position against the increases, a move which in turn brought him the censorship of the government. 

Sources within the Oil Ministry expressed the fear that production might decline even further over the coming months. In any case, because Iraq has established a reputation of being an unreliable supplier, it has to sell its oil at a significant discount in order to attract buyers. The delays in forming a new government are having demoralising effects on the staff of the Oil Ministry, which also suffers badly from rapid turnover in the top positions. After three years of sabotage, wrong policy choices and ineffective management, the Iraqi oil sector looks in worse shape than ever. A report issued by an auditor of the Oil Ministry showed that delays in project implementation resulted in only about one third of the work plan for 2005 having been implemented. Some pipelines are in such a bad shape that they would not be able to handle a higher volume of traffic even if one day production of oil finally increased. Oil products whose worth is estimated at US$4.2 billion were smuggled out of Iraq last year, on top of crude stolen from the pipelines. 

Although the appointment of a new oil minister in June is seen by some as a cause for optimism, the Bush Administration seems increasingly worried by ongoing developments. Bush himself suggested in June that the Iraqi government set up a trust to share oil revenue with the whole population. The current ministerial plans are to approve a new law, which will facilitate foreign investment in the sector. Oil production shows some signs of increasing, but with significant fluctuations month on month. In April production reached 2.14 million bpd, but in May it was back to 1.9 million bpd, of which 1.5 million were exported. In August it had reached 2.2 million bpd, but preliminary data for September showed an average of 1.7 million bpd only. The new hydrocarbon law is expected to be approved by the year's end, but in reality the issue of the role of regional government in controlling oil revenue has not been sorted yet. By the end of September the Iraqi autonomous government was going as far as threatening secession over the refusal of the central government to agree to the Kurdish authorities' right to sign oil contracts. The Kurds exploit the ambiguity of the constitution with regard to the control over newly signed oil contracts (as opposed to existing ones) and claim that Kurdistan is the only region to have attracted any investment in the oil industry since 2003 (about US$100 million). The local authorities estimate reserves within the Kurdish region at around 45 billion barrels of oil and 100 trillion cubic feet of natural gas.

While US oil companies say that they are ready to send their people to Iraq despite the continuing violence, the lack of a clear framework regulating investment and ownership is still seen as the main impediment. The hydrocarbon law is still the object of negotiations among politicians, divided between those who wanted regional control, like Kurds and most Shiites, and those who want central control, like the Sunnis and a minority of Shiites. At the end of August it had been announced that an agreement had been reached on oil revenue sharing, but the fact that the details have not been divulged yet casts some doubts about the truth of this statement. The signs are that inter-regional tension is not decreasing at all. The Kurds escalated their claim to autonomy in September, when the leader of the autonomous region, Massoud Barzani, issued a decree not to fly the Iraqi flag and to replace it with the Kurdistan flag. Although he then claimed to have consulted with President Talabani and Prime Minister Maliki beforehand, his move predictably aroused a strong reaction in Baghdad, not only within the ranks of the government, but also within the diplomatic community. US Ambassador Khalilzad was forced to point out how the US government is committed to Iraq national unity and territorial integrity. 

In March it was confirmed that the US will not spend any more money in the reconstruction of Iraq. The Bush Administration expects other countries to make up for the loss, but it is not clear how many are willing to deliver aid money as long as the level of violence remains this high. 

Summary 2007
During 2006, all trends in Iraq were negative ones, a fact which is encouraging the doomsayers to foresee even worse for 2007. Since the Bush Administration shows little sign of being willing to change direction, they are probably right. The attempt to forge the desired (by the US) balance of factions and ethnic and sectarian communities will likely only produce the conditions for a never ending civil war, preventing any side from achieving victory but failing to shape an agreement between the blocs. As long as the violence continues and worsens, economic recovery will remain a dream. The main hope for change is that of a split in the Shia alliance with the defection of the elements more inclined to cooperate with non-Shia groups and with the Americans too. However, it is not clear whether this manoeuvre can work in a context of near civil war, rather than merely emptying the social base of those groups which quit the Shiite Alliance. The cleaning up of the police and armed forces of the factional militias and the fight against corruption are similarly unlikely to succeed without a strong authority, which the Americans do not want to emerge as it would likely ask them to leave the country completely relatively soon. If the situation continues to deteriorate during 2007, the Kurds will have a stronger and stronger incentive to remain aloof from developments in the rest of Iraq and build up their own autonomous polity in the north. To the extent that the Iranians are responsible for the current situation in Iraq, what they mean is to send a message to Washington, that Iraq cannot be stabilised without their help. Since the Iranians seem to have all the winning cards, either Washington reaches a deal with them or the mess will keep getting worse.

During December and January American despair at their own inability to control the situation in Iraq seemed to be getting out of hand. At the end of December the Iraqi government expelled two alleged Iranian spy operatives, who had been arrested by the Americans under the accusation of planning attacks on US forces. The Americans complained bitterly as they saw the expulsion as a favour to the Iranians. Then in January the Americans raided an Iranian unofficial consulate in the Kurdish area, arresting a number of Iranian diplomats whom according to the Kurds had been allowed to operate in the area. One interpretation for American willingness to antagonise Iraqi and Kurdish authorities is that they might be starting to build up a case for action against Iran later in 2007, or at least make the Iranians believe that such action might really take place. While these raids clearly will not be able to contain Iranian influence and activities, they might be more successful at highlighting the extent to which the Iranians are penetrating Iraq.
As the violence increasingly takes the shape of an inter-sectarian civil war, the Shiite front appear to be trying to find a way out of its own internal impasse. A number of politicians and MPs keep talking of a new coalition to form under PM Maliki, which would exclude Muqtada As-Sadr's group but include the Kurdish alliance and moderate Sunnis. As the end of January approached, sources within the different political groups maintained that the new coalition was virtually ready and just waiting the blessing of Ayatollah Al-Sistani, who is allegedly worried that this might imply a break-up of the Shiite alliance. As-Sadr initially seemed to be reacting to the risk of marginalisation by softening his stance and accepting talks to reintegrate his followers into the ruling coalition, after ending a boycott of parliament and proclaiming a cease-fire. In the end, however, the Sadrists quit the ruling coalition in Baghdad in protest at the ongoing operations against his militias. Until now, As Sadr had been withholding his men from fighting back, in order not to create too wide a gap with Prime Minister Al-Maliki, but there are now fears that violence might increase in the south. The Sadrist militias, however, might have decided not to fight back with a general insurrection, as they did already twice in the past, but with more refined guerrilla tactics in order to avoid heavy casualties. As-Sadr has openly invited his men to prioritise fighting the Americans as opposed to other Iraqis. Sensing Mailki's weakness, former Prime Minister Allawi stepped up his efforts to put together an alternative coalition and replace him. He claimed that he want to form a non-sectarian government, although his previous one was as sectarian as Maliki's. Amongst his battle horses are his support for repealing the de-Baathification laws and his contacts with the Sunnis, including sections of the insurgency. Prime Minister Maliki's main strength seems to be the absence of a strong alternative to his name. Deputy Prime Minister Abdul Mahdi offered his resignation from his post in June, the most prominent of a series of officials to quit in recent months. The bombing of the Samarra shrine on 13 June has been a turning point for Maliki's popularity among his own Shiites, not least because of allegations of complicity from within the ranks of the corrupt police force. The same bombing prompted yet another boycott of the parliament by the Sadrist group. As Maliki maintains control over the Dawa party, any determined attempt to push him out would likely break the Shiite alliance. This gives Maliki sufficient confidence to rebuff his critics, be they the Bush Administration or fellow Iraqi politicians. In mid-July, somewhat provoked and clearly near the end of his tether, he even told the Americans that their troops are not needed and that Iraqi security forces would manage on their own. Having insisted on establishing a democratic regime in Iraq and having hoped that democratic elections would have resolved all the problems, the Bush Administration is now finding major difficulties in managing its Iraqi counterparts.
Finally after long suffering, the Iraqi ruling coalition completely collapsed in August, with the Sunni bloc, the Sadrist Shia group, the Shiite Fadhila party and the Allawi secularist bloc all having walked out. Between those who left the government and those who were boycotting its meetings, during the first half of August 17 cabinet seats were left vacant. Maliki and the Dawa party however were not ready to give up, as they need to maintain their positions in government because they have no real back up position in society or in underground organisations. They have no militias and their popular base of support is not very large. Maliki fears that the Americans are plotting to replace him and that if he surrenders control, the role of the Sunnis in government might be boosted after a recent series of deal between tribal sheiks and the US forces in western Iraq. American insistence at allowing the Baathists back is also seen with suspicion by Dawa circles. 
With this in mind, in mid-August Maliki managed to form a new Shiite-Kurds coalition, which however includes no Sunni Arabs, to the irritation of Washington. Maliki threatened the Sunni Bloc to replace them with unspecified 'others', but the threat was not sufficient to bring them back into the government and many suspect Maliki might not have been too unhappy about this. Rumours concerning Maliki's impending departure continue to be rife, but there is no obvious replacement. American agencies predict that he might cling on to power, but grow even weaker over the next 12 months. The situation in Basra is now expected to worsen, after the British have withdrawn their forces to the airport and the various militias gear up for dividing the spoils. The impact of the assassination of Abd al-Sattar Abu Risha, the courageous leader of the pro-government Anbar Salvation Council, is obviously a reverse for the anti- al Qaeda in Iraq, campaign there. In other ways although still difficult to assess, it seems unlikely to contribute to the stabilisation of Anbar.

The feeling that the Iranians were heavily involved in the civil war and increasingly so, pushed the Saudis to issue unusual statements, implying that the country might start supporting the Sunnis in the event of an American withdrawal from Iraq. Iraqi Sunni politicians go as far as issuing endorsements of the armed resistance, like deputy president Al-Hahimi did in February. The evidence of Iranian weapons being smuggled into the country is by now overwhelming, although it is not quite as clear which agencies of the Iranian state are involved and whether the motivation is political or economic. In the Kurdish region, tension is also simmering up, particularly over Kirkuk. In February Iraqi Higher Committee for the Normalization of Kirkuk decided that thousands of Arabs transferred there under Saddam will be relocated to their place of origins and offered compensation. These are mainly Shias from the south, a fact which might embitter the relations between the Kurdish and Shiite alliances. Turkey has already been issuing blunt warnings about the status of Kirkuk, but it is not clear how far the Turkish government is ready to go in supporting its local Turkoman allies. The Sunni Arabs of Kirkuk are on quite good terms with the Kurds because they are originally from the region and do not face relocation. 
The level of violence in Iraq diminished during autumn and more markedly during the first half of October, in part possibly because of a lull in Iran's promotion of anti-US activities. The Iranians might have been trying to show to the Americans that they can deliver peace as much as they can deliver war. The political situation, however, remains as complicated as ever and possibly even more so. The Sunni insurgents who are making deals with the Americans maintain their autonomy, their weapons and their structure and are adding to the plethora of illegal but tolerated militias which dominate much of the country. Moreover, regional tensions are surfacing to complicate the scene. The Kurds were in the eye of the storm in October also because of the deteriorating relationship with Turkey. Following an attack by Kurdish nationalist guerrillas against Turkish troops, the Turkish government started gearing up for an incursion into northern Iraq to chase the guerrillas. This is unacceptable to the Kurdish provincial government, which is vowing resistance, while the central government is asking the Kurdish nationalist insurgents to leave Iraq, a request very unlikely to be fulfilled. Are the Turks bluffing or will they really invade? A limited incursion across the border is the most likely option and during mid-October the Turkish army was already shelling border areas of Iraq in a display of muscle.
Developments in December confirmed that the level of violence in Iraq was in marked decline. Whether the improvement was sustainable or not was not clear. Although a number of insurgents and of tribal militias were now cooperating with the Americans, they remained hostile to the Iraq government, which in turn objected to any prospects of them being incorporated into the Iraqi security forces. In practice, the relative peace was bought at the price of weakening the central government further and conceding local control to a wide array of militias of various kinds. Some of the remaining insurgents are lying low, inevitably waiting for 'the surge' in the presence of US troops to pass.

Only 25 of 40 members of the cabinet were currently attending its meetings as of November. Prime Minister Maliki managed to attract back into the government one of 6 former ministers belonging to the Sunni National Concord Front, but he has been expelled from the Front. Maliki was using strong-arm tactics to induce Sunnis to join the government. In November the main office of the Association of Muslim Scholars, one of the most influential Sunni organisations, was shut down by a government-sponsored Sunni religious foundation. The attempt seemed clearly to isolate elements who supported the insurgency or are ambiguous about it and encourage others who are more inclined to cooperate, but this approach was also fomenting conflict among Sunnis. A draft law meant to allow former Baathists into the government's ranks was re-submitted to the parliament, but its prospects of being approved were unclear. Instead Maliki seemed to have given up on Muqtada As-Sadr and his people; two of their ministers were replaced and Maliki was allegedly trying to replace the other three who quit the cabinet months ago. The government was signalling its determination to stamp on Sadrist violence by allowing the judiciary to arrest and try two former members of the cabinet who stood accused of having channelled funds to the Sadrist militias and having cooperated with them. Maliki could therefore only count on what was left of the Shiite Alliance and the Kurds to keep the government running. That did not mean that there were no problems on this front too, however. The Kurds were refusing to pay any contributions to the central government coffers; although the amount would be marginal, the refusal had symbolic value. The Kurds were also starting to develop their own power grid, as reliance on the national one meant constant disruption due to sabotage and inefficiency. Observers from Baghdad, however, suspected other motives for the Kurds' move, such as preparing the ground for ever increasing autonomy.

In the meanwhile, the Iraqi aid program is coming under growing criticism. Because of the lack of safeguards, nil transparency and the existence of many 'discretionary funds,' it is widely believed that much of the money will be used for patronage purposes or stolen outright. The Americans are asking donors to contribute to a new US$1 billion effort, but the response is so far muted. For good measure, the proposed budget for 2007-8 cuts the allocation of resources to the Public Integrity Commission, which is meant to fight corruption. On the whole the budget foresees a 21% increase in expenditure, much of which is supposed to go into improving infrastructure (+60%). However, last year US$8 billion were left unspent because of the security situation and of ministerial incompetence and ineffectiveness and it is difficult to see how this year it will be possible to make much progress in this regard. The Oil Ministry in particular spent just US$4 million (0.1%) of the US$3.6 billion which it was allocated to improve oil infrastructure. A particular controversial item was the allocation of US$230 million to a fund for the victims of Saddam Hussein, which irritated many Sunni MPs. More details are emerging about the massive size of oil thefts in Iraq. Due to the apparent inability of the Oil Ministry to repair oil meters or install new ones, monitoring what is effectively going on is very difficult. The most recent informed estimates of how much oil Iraq is losing every day to smugglers, range between 200,000-500,000 bpd or 10-25% of production, which is mostly taken out of the country through the overloading of tankers in the country's oil terminals. Of course, this can only happen systematically as it does, with the complicity of some senior officials of the ministry. It is also estimated that between 10-30% of Iraq's production of refined fuel goes straight into the black market. Typically, the state oil export organisation refuses to show its export contracts and to allow any transparency in its operations. It is no wonder that the post of oil minister is so keenly competed for in Iraqi governments. 

In June the first oil well dug by a foreign company in many years is scheduled to start pumping for the international market. The company is Norwegian DNO and it operates in the Kurdish autonomous region, although the amount will be mostly of symbolic value (15,000 bpd or less than 1% of total Iraqi production). In fact, the new development might contribute to increases in the tension surrounding the new oil law. Typically Baghdad refused to grant access to the export pipeline, so that the output will have to be carried by truck.. Armed with its own oil law, the Kurdish provincial government signed in October three more production agreements with a Canadian company (Heritage) and one with French company Perenco. Since Baghdad threatens to exclude companies signing deals with the Kurds from working in the rest of Iraq, it is not surprising that so far only minor players in the oil industry signed deals in Kurdistan. The Kurds have tried to attract the majors with attractive deals, offering 20-25% of production for the investors (as opposed to the 15% offered to the small players), but so far to little avail. A point of criticism is that the deals were bilateral agreements without any transparent and open bidding. Two more deals of this kind are said to be about to be announced. By 2012 the Kurds are planning to have reached a 1 million bpd output. The Kurdish provincial government has also announced plans to build two refineries, which are expected to satisfy 30-40 of local demand for fuel. 
The Iraqi cabinet of Al-Maliki is also under pressure to improve the performance of his cabinet and improve the welfare of the growingly frustrated population. The new 2007 draft budget doubles spending on education and health, but it will remain to be seen how effectively that money is going to be spent.
On the debt front too the initial optimism concerning a quick and easy cancellation of most of it appears increasingly ill founded. One of the main creditors, Saudi Arabia, is now hinting that its attitude towards cancellation will depend on the Iraqi government's willingness to take Sunni Arab interests in greater consideration. Other Arab creditors too are said to be pushing for Iraq to drop the de-Baathification law, disband Shiite militias and a distribution of oil revenue which satisfies the Sunni Arabs too.

Finally the Parliament approved a draft oil law at the end of February. The new law opens more than two thirds of existing fields and all future fields to foreign investment and guarantees that the distribution of revenue will take place on the basis of the population of the different regions. The Kurdish regional authorities will be allowed to continue signing oil contracts, a point which was the source of much controversy. While the new law elicited mostly positive comments abroad and in particular among oil investors, it generated rather negative feelings at home, where remains a strong commitment to nationalist economic policies. Oil Workers Unions have already threatened to go on strike, while in the parliament Allawi's secular bloc, the main Sunni alliance and sections of the increasingly fragmented Shiite alliance are opposed to the current draft, mainly on the ground of excessive concessions to foreign companies. Among the most controversial points are the lack of any provision forcing investors to reinvest earnings in the Iraqi economy, form partnerships with Iraqi companies or employ Iraqis. Moreover, oil companies will not have to start exploiting the fields immediately after signing the contracts and will be able to wait until they judge the situation safe enough. Contracts will be long-term ones (20-35 years) and will allow investors to exercise a large degree of control. In sum, the Iraqi oil law is one of the most business friendly of the world. The rationale for this is to give an incentive to investors to explore that 90% of Iraqi which has not been explored yet, as well as to offset any disinclination to invest in Iraqi because of the security situation and of the uncertainties concerning the future. Critics see US pressure as having played a key role in shaping the law and even sources close to Prime Minister Al-Maliki admit that the US embassy has made clear that unless the final version of the law is in place by June support for the Prime Minister will cease. Some companies are already beginning discussions about specific projects. Royal Dutch Shell, for example, is looking at the gas fields and is considering building a pipeline to Europe via Turkey.

At the beginning of July the Iraqi Cabinet finally approved the new oil law, which has now been passed on to the parliament for ratification. An oil workers strike in June highlighted how the government might be vulnerable to the requests of the Unions, which want to be consulted on the draft law. They oppose in particular the involvement of foreign companies and are threatening new and longer strikes (or even a 'mutiny'). Prime Minister Maliki is trying to appease the oil workers with a two-fold pay rise, but observers believe that the Union leaders are politically motivated and maintain links with ethnic and sectarian groups. Therefore, pay rises might not resolve the problem. Unions, moreover, are not the only source of opposition to the current draft of the oil law. Most Iraqi experts oppose the revised law, including those who helped draft the original version, mainly because of the compromise which gives some role in the management of the industry to the regional governments without appropriate check and balances, which leave the road open to massive corruption. The experts are appealing to parliament for a more accurate and detailed discussion of the oil law, regardless of the deadline set by the Americans for its approval.

Although in June the Baghdad government and the Kurdish autonomous government reached a deal over the oil law, new trouble arose because of the opposition of the powerful oil workers union, which criticises the draft law as too favourable to the interests of oil multinationals and too unfavourable to the workers. The technocrats at the oil ministry and outside it are now criticising the latest version of the draft because it gives too much power to the regions. At the same time the Maliki government is under ever growing American pressure to approve the law: Gates was only the latest in a series of US officials to visit Baghdad to remind the government that the approval of the law is of utmost importance to Washington.

The final draft of the still unapproved oil law differed sufficiently from what had earlier been agreed among parties, and now upsets the Kurds, who are particularly keen on securing a wide room of manoeuvre in exploiting local resources. They proceeded to send strong signals to Baghdad that they would not accept the changes. During the summer the Kurdish regional government signed a deal to develop gas reserves with Dana Gas of the Emirates, causing the Sunni blocs in the parliament, whose region has no proven oil reserves, to drop their support for the draft oil law. Then at the beginning of September the Kurdish regional government went even farther and signed an oil exploration contract with an American oil company, Hunt. The deal caused a major rift between Hussain al-Shahristani, the Iraqi oil minister, and the provincial government of Kurdistan. The Bush administration sided with Shahristani, despite the closeness between Hunt and President Bush. The issue is complicated by the fact that a law meant to be accompanying the oil law to specify how oil revenue should be shared out is not ready yet. It can safely be assumed that every one of the Iraqi power elite will be clustered around that particular negotiating table. 
Moreover, the draft law does not include any dispute resolution mechanism between centre and regions. Gaining both the Kurds' and the Sunni Arabs' support is going therefore to be problematic. The government is trying to square the circle by paying experts to review potential resources, in the hope that even the Sunni-dominated region might get its own fields. 
Even international oil experts are increasingly raising doubts about the draft oil law, which in their view does not provide sufficient guarantees to investors and is vague on a number of key issues. Big multinationals are unlikely to be willing to take the risks, although smaller oil companies and the Russians seem more interested. One such company is Petrel, an Anglo-Irish oil exploration company which has been in southern Iraq since 1999, hoping to make long-term profits. The company is actually losing money in Iraq, but like other smaller players its best hope of winning lucrative contracts is to be there finding niches, where the giants will not go. The other three companies already active in Iraq (DNO, Addax and Dana Gas) operate all in Kurdistan. Production in northern Iraq in the meanwhile continues to be prevented by sabotage. In September after long repairs the pipeline to Turkey was reactivated, only to be blown up again almost immediately.

Even before the oil law was finally approved, interest in the Iraqi oil industry increased noticeably. The Japanese government has agreed to lend US$860 million on very favourable terms to contribute to the rebuilding of the oil and power infrastructure. Japanese interest in Iraqi oil has been growing recently, because of the decision of the Iranian government to slash the share of Japex in the Azadegan oil field from 75% to 10%. Japex is already evaluating four oil fields in Iraq, but is negotiating an extension of its activities. Iraqi oil output has been pretty stable recently, although at low levels. Oil production was estimated in November to stand at 2.2 million bpd, but the prospects for improvements are dim. Even under the best circumstances production is not expected to exceed 3 million bpd before 2011 or 2012 and few believe that such optimistic scenario will be realized. The government has also invited bids for drilling 100 oil wells in southern Iraq and according to the oil ministry Syrian, Chinese and Iranian firms are involved in the negotiations. In general, while security and political concerns are keeping Western oil firms on the margins, Asian companies have been moving much more dynamically since the oil law has reached the draft stage. Oil industry experts believe that the first oil contracts will be awarded to Chinese, Vietnamese, Indian and Indonesian firms. These will be mostly small contracts, not exceeding 60-70,000 bpd each, but it also believed that the Asians will grab some of the largest contracts. Western firms will eventually get contracts, if for no other reasons than their technical prowess, but that might still be quite a while away.
Iraqi oil production hit a post-Saddam high in November, when it reached 2.3 million bpd. The increase was due to more steady output from the northern fields, where a lull in sabotage attacks is allowing for more exports to take place. Analysts believe that the higher production rates should be sustainable for at least 2-3 more months. 
Bigger increases are however unlikely, given structural problems and lack of investment in the industry. So far more investment is being channelled into the rebuilding of Iraq's tanker fleet, which was in a state of disrepair. New Chinese-built tankers are now beginning to be delivered. Talks on oil issues have recently been going on between Baghdad and the Kurdish regional government, but it is not clear whether any advance in ironing out the problems has been made.

The initial optimism about the near readiness of the new Iraqi oil law had largely evaporated by May. In its stead an increasingly acrimonious debate about the gaps in the law and the alleged bias towards US oil multinationals was threatening to prevent its approval from the parliament or at least several months of delay. Even in the US Congress there are growing doubts about the law, which many fear would not guarantee a fair distribution of oil revenue and consequently add new fuel to the ongoing civil war. There is also a sense that a law increasingly perceived as drafted to favour foreign interests will not help the task of pacifying the country. Despite earlier claims that the law had been sent to parliament, the government now says that it will not send the law until all parties will be satisfied with it. The Kurds still claim that the law will have to allow them to sign oil contracts in their autonomous region and threaten to reject the law in the absence of such a provision. In the current draft 93% of oil revenue would be controlled by the centre and just 7% by regional governments. Some, even among the drafters of the law, believe that for existing oil fields Iran's model should be adopted, that is short-term service contracts for foreign multinationals. We may see the US Oil industry supporters of Bush and particularly Cheney, kick up against this unattractive formula which is greatly unpopular with multinationals in Iran, where it was devised. This is not why they lent their support for this adventure in Iraq, and they can be expected to rattle their cages. Only for new fields longer-term contracts more favourable to the oil industry should be adopted.
In the meanwhile Baghdad continues to neglect its oil fields, as well as the rest of the country's infrastructure. Last year only 67% of the state budget was spent and most of that was salaries. Only 22% of the budgeted investments effectively took place; in the oil sector the percentage was as low as 3%. Although the Americans themselves have spent US$1.6 billion since the overthrow of Saddam Hussein, this is not sufficient to prevent a further deterioration of the infrastructure. To that, sabotage and theft have to be added, particularly in the north where most of the already reduced production fails to produce any revenue for the government because it is illeagally siphoned off.
Analysts are as divided with regard to the actual growth rate of the Iraqi economy, with estimates ranging between 4 and 17%, (as they are over any other statistics concerning Iraq). Estimates of the jobless rate are similarly wide, at 30-50%. What is certain however is that whatever growth is taking place is stimulated by high oil prices and the pumping in of reconstruction money. Even that did not suffice to resolve infrastructural issues such as the provision of electricity, which in Baghdad declined by 8% this year instead of improving. Higher government salaries and lower import tariffs have allowed an increase in the purchasing power of the average household, which is also being reflected in the massive increase of mobile phone subscribers, which has now reached 7.1 million, an increase of 900% over 2003. But the impact of violence is creating huge disparity in the economic performance of the different regions. The professional classes account for a large share of the 650,000 who have fled the country, both because they have better chances to find jobs abroad and because they feel that the militants are targeting them. About 2,000 physicians, for example, have been killed since the beginning of the insurgency. The long-term impact of this flight are grim: the flight of teachers has resulted in a 45% drop in the school enrolment date over the last two years. 

The latest IMF report on the Iraqi economy paints a rather dim picture. The IMF had expected Iraq to be able to increase oil production during the past year, but it failed to do so. Oil revenue has increased by just US$1.4 billion to US$28.6 billion. As result, the oil-dependent Iraqi economy registers a GDP growth inferior to the forecast, at just 6.2%. The inflation rate more than doubled in 2006, to almost 65%. The Central Bank is not having success in bringing inflation down, but it is expected that by the year's end it will hover at around 30% (it stands at 46% now), far too much for an effective stabilisation of the economy. Apart from the lowering of inflation, the forecast for the current year is not much more optimistic. GDP growth is expected at 6.3%. To compound the picture it can be added that the country's power supply system appeared on the verge of collapse as consumption peaked over the summer, with four national blackouts just during the first week of August.

Perhaps unsurprisingly given the state of the country, not much moves on the business front. An exception is the recent sale of three mobile phone licenses to as many operators for the sum of US$3.75 billion. Kuwait's Mobile Telecommunications Co (MTC), Qatar's Asiacell and Iraq's Korek won the auction, while mobile operator Orascom, which already has 3 million subscribers in Iraq on the basis of the initial short-term contracts issued by the government, dropped out of the race as the bidding was getting too expensive. With already 8 million subscribers, the market is still considered attractive, but concerns about the future dampened the enthusiasm of investors. According to the contract, 18% of the revenues will go to the Iraqi government, while profits will be taxed at 15%.
As of the end of the year the new law safeguarding investors' rights had not been implemented yet and even in the areas least affected by the insurgency, like most of the south, reconstruction has achieved little. Electricity supply has not even reached the pre-war levels yet. In Kurdistan, the city of Erbil has access to electricity just 7 hours a day, which of course is a major obstacle to economic development, even if the Kurdish regional government has big plans to turn Kurdistan into a business hub and agricultural provider for the region. For the moment being, the main priority seems to be to create jobs in the unproductive services sector: most of the money allocated from Baghdad (64%) to the Kurdish region is being spent on salaries, in practice almost eliminating unemployment.
The decrease in violence seemed to be injecting some confidence in the economy, as witnessed by the strengthening of the Iraqi dinar against the US dollar. The weakening of the dollar on the world markets contributes to the dinar's strength, as well as rumours that Baghdad wanted to appreciate its currency. The return of refugees might also be pushing the currency up, even if most of them do not seem to be coming back out of a newly found confidence in the country, but mainly because they are being forced back by their unwilling hosts! So far the dinar has gained 17% on the dollar since September 2006. The housing market also seem to be benefiting from the new situation: returning refugees started pushing prices up, leading to speculative moves as many Iraqis buy homes in the expectation of prices continuing to grow. The lack of alternative investment opportunities easily turns any prospect of making a profit into frenzy. However, this has not had any impact on the productive economy yet and there is no report of house building booming. As a result the impact in terms of job creation is still insignificant; unemployment is still estimated at 30-60%, depending on the source.

Summary 2008
Year 2008 began in an atmosphere of optimism in Iraq, after the levels of violence had been declining for several months and several of the groups previously involved in the fighting observing some kind of truce. Doubts remain however about the sustainability of the state of truce, particularly in the event of a significant reduction in the level of US troops, since the appetite for an internal confrontation seems to remain strong. The political scene in fact remains extremely confused and precarious. Attempts to unseat Prime Minister Maliki will continue and might even be eventually successful, but the numbers for a stable and coherent coalition do not exist in any case. Allawi' s secular front made a deal in January with the former Baathists of t he National Dialogue Front and most surprisingly with the Sadrists, who used to be the most bitterly anti-Baathist group in Iraq. The new alliance is meant as an Arab nationalist front opposing Kurdish attempts to wrest as much control as possible away from Baghdad and counts on 100 MPs out of 275, but it is still far from clear how solid this alliance might be. The Sadrists might just be trying to form alliances as a way to get some protection from their enemies in Al Hakim's group, which has successfully infiltrated police and army and uses its position to hunt down the Sadrists in the streets, with the help of the Americans. As-Sadr might be trying to buy time to re-organise his badly splintered forces and enhance his chances in the next elections, as Al-Hakims forces, paradoxically supported by both Americans and Iranians, are working hard to undermine its popular base, for example competing in the provision of services. In January the parliament finally voted to lift most restrictions on former members of the Baath to hold public offices, although the change is not quite as wide-ranging as some had hoped. Also the perception that the Shiite groups control the ministries is likely to discourage many from going back to work for the government. One of the two Sunni groups in the parliament, the Iraqi Accord Front, also said in January that it will rejoin the government, but there is no sign that the Sunni Awakening is about to sign a deal with Baghdad. Quite the contrary, many Sunnis complain that the government is sabotaging the pacification effort, for example in Falluja, where police forces are under-resourced. 

The political front showed some unexpected progress in February after the parliament approved three new laws, in an unusual spur of activity. Apart from the 2008 budget, the parliament also approved an amnesty bill and a provincial powers bill. The amnesty benefits the Arab Sunni minority and should allow thousands of prisoners linked to the insurgency to return home, but there are doubts about its effective implementation. The law on provincial powers should lead to new elections in October, which in turn could allow the Sunni Arabs to elect their own representatives to the provincial councils. Mailiki is also trying to appease his critics from within the running coalition by holding regular meeting with the President and the vice president. 

The Americans now hope to turn As-Sadr's mi litia into allies in a way similar to what they have done with many Su nnis militias. Already an estimated 20% of the militias recruited by the Americans over the last year are Shiite, although the extent to which they belonged to Muqtada As-sadr's group is unclear. American efforts seem to be receiving some encouragement as Muqtada renewed in February his six month ceasefire for another six months, despite grassroots support for a return to fighting in response to alleged targeting of Sadrists by the Iraqi security forces. He is trying hard to rein his militias and impose some discipline, weeding out the more extreme and unruly elements. Muqtada now talks of turning his movement into something more like a social solidarity organization and seems clearly worried about the war-weariness growing within the Shiite community, which reacted very negatively at episodes of clashes among Shiite militias. But his ultimate aims remain unclear. 

However March-April was marked by Prime Minister Al-Maliki's attempt to deal a final blow to the Sadrists, by challenging their control over a number of c ities including mainly Basra and some neighbourhoods of Baghdad. The operation seems to have been the result of the lobbying o f his allies in the Islamic Supreme Council who wanted to reclaim ground in order to consolidate their pro vincial councils positions in the forthcoming local elections. Maliki also seem to have conceived the effort as a demonstration of the growing strength and effectiveness of the state which he runs. Whatever the plan, it failed miserably, as the Iraqi army was pushed back by the militias and suffered significant levels of desertion. 1,300 army and police were sacked in the aftermath of the violence, for having failed to perform their duty. A humiliated Maliki was forced to allow Muqtada As-sadr led negotiations and re-establish the status quo. Maliki's position seems now weaker than ever; the fact that he was in Basra to personally direct the military operations made things look even worse. By contrast Sadr impressed the observers by succeeding in re-establishing some kind of discipline among his forces and gained considerable political capital. It remains to be seen whether he will be able to translate that into long-term gains. Rather than negotiating a more favourable power sharing deal with Maliki from this position of strength, he seems to be aiming at consolidating his popular support and translate it into an electoral triumph. He has most recently threatened all out war if the military is not called off from attacks on his people. It is widely believed that in the event of elect ions, Sadr's followers could make substantial gains. With the approval of the provincial powers law in April, provincial20elections are now expected to take place soon. 

The main political event in March was a national reconciliation conference, chaired by Prime Minister Maliki. Despite intense20US pressure towards a more determined effort at reconciliation, the conference was not very successful. Two of the main groups present in the parliament, the Sadrists and the main Sunni alliance (Accordance Front), stayed out of it, alleging that they were not even invited. Despite some progress towards satisfying Sunni demands, such as the law allowing former Baathists to hold government jobs and the amnesty to 3,500 prisoners, there are still several bones of contention pending, such as the pending execution of former defense minister Sultan Hashim al-Taie, whom Maliki refuses to spare as requested by the Sunnis. The sense that the progress recorded in recent months remains fragile is highlighted by a return of large scale terrorist attacks, as well as by the grumbling of the Sunni militias, unhappy about the precarious status and lack of recognition. Maliki traveled to the Sunni areas north of Baghdad to reassure the militias that they would be offered jobs and that the 'doors of all the establishments" would be open to them. 

Repeatedly given up as finished, Prime Minister Maliki surprised many by enjoying a surge in popularity both at home and abroad. Although his offensive against the Sadrists started badly, with the help of the Iranians and thanks to As-Sadr's long-term views, he managed to reassert government control over Basra and other Sadrist strongholds at least for the time being . This was seen as a display of determination and strength by the public and won him cross-ethnic and cross-sectarian support. Sunni parties, which have mostly been boycotting the cabinet, seem now increasingly inclined to rejoin it. To the extent that Maliki distances himself from what was seen as an implicitly pro-Shiite position, neighbouring Sunni governments have warmed to him. At the same time Maliki has not lost the confidence of the Iranian government, which expressed support for his efforts to rein in the factional militias. There is also optimism on a number of other issues, including the long-awaited oil law, which many now expect to be approved relatively soon. Whether Maliki can progress any further remains however to be seen. Integrating the Sunni parties into the government, including the new groups which are arising from the reconciled armed groups, will require the sacrifice of20positions of power and influence by the Shiite groups in the key ministries, a step which Mailiki will certainly need to struggle to secure. 

Prime Minister Maliki appeared to be still gaining popularity in June, as his crackdown on illegal militias continued to achieve successes. Even the Sadrist leadership supported the effort to rein in their own rogue elements and Maliki reciprocated by ordering the army not to target Sadrists indiscriminately. There are increasingly some signs that Maliki might be able to start a virtuous cycle on the strength of his recent achievements; for example the main Sunni bloc, happy to see the Shiite militias reduced, is now ready to rejoin the government, of course in exchange for a number of ministerial appointments. At the same time however, on a number of other fronts Maliki's leadership still appeared far from being decisive. About half of the cabinet posts were still vacant, as he avoided appointing replacements in order not to start quarrels with the different factions which support him. The government was still filled within competent party men, whom Maliki used to buy support in parliament among the factions. Even within his own party, Maliki had to please several different factions, which prevented him from getting competent administrators in the jobs and therefore from delivering an improvement in the quality and quantity of services to the po pulation. 

By autumn, Maliki, emboldened by his control of the premiership and his relatively good performance of the last several months, was trying to expand the base of his party and was making inroads into southern regions traditionally dominated by the Supreme Islamic Iraqi Council. Moreover, the Supreme Islamic Iraqi Council is in favour of creating an autonomous Shiite region in the south and needs a strong electoral performance in order to legitimise its demand. Dawa is opposed the autonomous region. Maliki, whose party has just 25 seats in the parliament, seemed to be preparing for a split with the Supreme Islamic Iraqi Council by negotiating again with the Sadrists and with the numerous independent Shiite lawmakers for an alliance in the forthcoming elections. 

Even in the course of the ongoing negotiations over a US-Iraq security pact, Maliki showed considerable skill. H e firmly opposed US demands, which include the right to arrest and detain Iraqi civilians as well20as immunity from Iraqi prosecution for US soldiers, and instead tried to get guarantees from the Americans that they will protect Iraq against any external and internal threat, which might be more of what Washington is ready to promise. 

Maliki's economic management also had some good points in the first half of 2008, succeeding in containing inflation. Although inflation reached 16% in June, up from 11% in January, it is believed that it would have been much worse if the government had not intervened. Maliki was quite skilful in having the central bank buy dinars to push the value of the national currency up, in order to limit prices increases. The dinar gained 20% to the dollar, after the bank spent US$1-1.5 billion each month to support it. 

In July Maliki achieved another success by bringing back into the cabinet the six ministers of the Iraqi Accordance20Front, which had been boycotting it for a year. They have been pacified by the release of many pris oners linked to the Sunni insurgency and by the crack down on the Sadrist militias. The emergence of a new Sunni political grouping, the Awakening, which is linked to the militias which now work for the Americans, might in the future complicate the political equation as its members are often at odds with the Accordance Front and the organisation is becoming increasingly bold in its efforts to consolidate its hold over the regions it controls. However, Maliki might even be able to exploits its rise as it offers additional room for manoeuvre when dealing with the Sunnis. 

Maliki's most publicised stunt in July was his endorsement of Democratic candidate Obama's platform with regard to his plans to withdraw American troops from Iraq by 2010. Maliki has been negotiating with the US for a while over the long-term presence of their troops in the country and he clearly wants them to leave relatively soon and without leaving any major presence behind. If Obama wins, he might get just that, which incidentally would also allow him to make the Iranians happy and create the conditions for his st aying in power. In the short term, however, what Maliki really wanted was to put pressure on Bush to come to terms with him on a withdraw al timetable. Washingto n was pacified by denying that the Prime Minister's words had been interpreted correctly, but his aims had already been achieved: the Bush administration is now beginning to move in the same direction as Obama and has agreed with Maliki to negotiate timetables for the reduction of US troops levels. 

Another success of Maliki's government in July was the approval of the long-delayed local elections law, despite the opposition of the Kurdish alliance, whose MPs withdrew from the parliament in protest. The new law will allow elections to provincial councils to take place, facilitating the integration of Sunni political groups in the political system. During August rising tension became evident with regard to the status and the future of the Sunni militias sponsored by the Americans. The Shiite-led government is now talking of disbanding these militias and sending their members back home. It may be remembered that when the US were administering Iraq they released 200,000 of Saddams soldiers onto the streets, together with their weapons! The accusation is that many of these militias en now are reformed insurgents and may have taken many lives in the past, although the more likely political rationale is that the militi as might represent a major obstacle to future Shiite domination of Iraqi politics. Better disband them now that the Americans are still in the country, than having to face them alone after 2011. Maliki and his supporters are increasingly confident in their national army, particularly after it somehow managed to handle the Sadrist militias earlier this year. Although they might be overestimating the power of the Iraqi army and superficially compare the capabilities of the Sunni and Shiite militias, it is clear that the government is increasingly self-confident and assertive. It will not be easy for the Americans to contain it and protect the Sunni militias, which they are sponsoring. Maliki seems to be deliberately manoeuvring in order to force the Americans to choose between him the Sunni militias. The militias are planned to disband by June 2009, but due to Mailiki's 'sabotage' so far just 9,000 of them have been absorbed into the armed forces of Iraq. Some observers are now beginning to fear that under the double pressure of the remaining insurgents (Iraqi and foreigners) and of the Shiites, many militiamen might soon return to the insurgency. On the other hand some Sunni, Shiite and Kurdish politicians criticise Maliki for being too friendly with 'tribal councils', which Maliki is creating out of the Awakening Movement. They fear that enlisting the tribal councils on the state pay book will create a link of dependency between them and Maliki.

The newly found assertiveness of the central government is having an impact also on the situation in Diyala province, which remains very tense as Kurdish forces and Iraqi government army threaten to fight over the control ofthe town of Khanaqin. The Kurds had evacuated most of the ethnically mixed areas of Diyala province at the end of August. Some Shiite legislators close to Maliki have gone as far as calling the Kurdish forces 'an outlaw militia', an affront that the Kurds have not taken well. The Iraqi army units entering the areas evacuated by the Kurds are reportedly claiming to have 'freed them from the militias'. The government is also casting the Kurds as the villains in the continuing delay of the oil law. Oil Minister Shahristani has recently declared that the reason why the parliament is reluctant to sign the law is the behaviour of the Kurdish regional government, which has been signing a number of oil contracts with small international partners, despite the objections of Baghdad. According to the Ministry, the parliament will not pass the law unless the Kurds cancel all the contracts they have signed. Since the Kurds are indifferent to the oil law a nyway, this is probably an attempt to place pressure on Washington to castigate the Kurds and force them to comply, in order to get the oil law going. The Kurds and particularly President Talabani are the most worried because of the conflict in Mosul and Kirkuk, but they are not alone. 

As the end of August approached, Washington and Kabul seemed close to reaching a deal on the future presence of foreign troops on Iraq's soil, after 10 months of tough negotiations. The Americans appears to have agreed to a complete withdrawal by a fixed deadline (2011), but the approval of the political leaderships is still being sought. Washington seems to have obtained some degree of immunity from prosecution for its troops, a point which has proved very controversial. The Iraqis would have liked a complete withdrawal of combat troops within two years, but seem to have settled for three years. The draft deal reportedly involves patrol activities of US troops ending by June 2009 and a withdrawal from Iraq's cities in the summer of 2009. They would then be concentrated in a few large bases, as we have long predicted, and be largely away from public view. The existing mandate for the20presence of US troops in Iraq ends in December 2008. In mid-October the Iraqi government almost immediately announced that after all, it was seeking a revision of the agreement. The deal on the table included a final American withdrawal by the end of 2011 and a purely theoretical right of the Iraqi authorities to prosecute American servicemen and contractors for crimes committed when off-duty. However, two large Shiite factions and several small Sunni groups opposed the deal. The main point of contention seems indeed the ambiguous deadline in the current draft, which leaves the possibility open of a prolongation of the stay of the troops subject to the agreement of the Iraqi government and features the right of the US to the long-term use of about 50 bases in Iraq.

After much tergiversation, a re-drafted Iraqi-US agreement was approved by a large parliamentary majority by the end of November. Just one of the 28 ministers still opposed the new version of the pact, which features major US concessions, such as placing US forces under the authority of the Iraqi government and the need of an order from an Iraqi judge and the permission of the government before US soldiers are allowed to raid Iraqi homes. A joint committee will apparently have control over US military operations, an American concession which has no precedents in US history. Opposition to the deal in the US Congress was already strong before the revision of the pact and is going to be stronger now, with some commentators even accusing President Bush of having exceeded his constitutional powers. Others, even among former hardliners, might reflect on whether Iraq was worth the money and the lives already spent. 

Iranian reactions were mixed, with some commentators judging the deal an achievement and other dismissing it as a surrender to US imperialism. Another key aspect of the security pact is that private security contractors will lose the immunity that they have enjoyed so far. The implications of this in terms of recruitment among the 175,000 employees of private security forms are unclear at this stage; much will depend on the implementation of the deal; The draft circulated in the public domain is a very short one and lacking in detail; its vague statements leave it open to conflicting interpretations. 

In the meanwhile the Iraqi government is trying to boost its armed forces, in order to make them autonomous from the Americans by the time of the withdrawal. This year's crackdown against the militias in Basra and a few other cities can now be seen as a political message sent to both the people of Iraq and to the Americans: American advisers strongly advised against the Iraq army moving in alone, but the government pressed on. Still, in terms of the development of capacity for fully autonomous operations, logistics and air support remain the key weak spots.

By autumn the mood in Washington was becoming much more sober concerning Iraq. After the triumphalism (the White House, Fox News etc; talking of "victory") of some months earlier, some agencies, particularly intelligence ones, started foreseeing a security crisis next year, according to leaks from the National Security Estimate. This leak might be part of the ongoing electoral campaign, with the Washington bureaucracy tired of irrational adventures and keen on a period of cautious foreign policy and consolidation, but nonetheless reflects a new trend. On the economic front, Iraq too was affected by the changing economic climate. As an oil producer, Iraq was still comparatively well off, but its 2009 planned budget of US$79 billion will have to be revised downwards in the face of falling oil prices. Iraq's plan to accelerate the annual increase in capital spending might be seriously affected by this revision; Baghdad has been increasing its capital spending by 30-35% each year since 2006.

Economic sentiment is likely to remain predominantly positive. The IMF forecasts a 9% GDP growth for the coming year, higher than earlier expectations, although the forecast for 2009 is lower at 7.3%, while it expects that oil production will be maintained at 2.2 million bpd. IMF forecast for 2007 show a disappointing 1.3% GDP growth, but Iraqi government sources believe that final figures will be better because the economy picked up during the last 6 months of the year. Oil production at the beginning of March was running at 2.4 million bpd, a slight increase on previous months, but nowhere enough to pacify all claimants to a share of Iraqi state resources. The increase remains mostly due to the improved security situ ation in the north, rather than to any technical breakthrough. Most natural gas produced is still being burned as20waste, because the facilities to export it are not in place. The urgency of getting more investment into the oil sector is demonstrated by the fact that US military commander Petraeus has been directly calling Western oil giants, inviting them to invest in Iraq. The unusual step might be a sign of despair at the failure of Iraq to approve the draft oil law. The Oil Ministry is still negotiating with foreign investors on the basis of the directives of Saddam Hussein's government, which allow only for limited two-year deals and are far from appetizing for the multinationals. The only achievement in these contacts with the oil companies has so far been serious negotiations with Shell, BP, ExxonMobil, Chevron and Total for the delivery of technical support for five of the existing oil fields. Such technical assistance should in the future lead to a 500,000 bpd increase in production. The oil ministry itself seems to have given up on the approval of the oil law and is now inviting oil companies to line-up for the development of existing fields, which will might authorised by the cabinet even in the absence of a law. The oil companies are wary of investing billions without an appropriate legal framework, but have to keep talking and negotiating in order to stay in the graces of the ministry. Future prospects of the oil sector are complicated by the fact that among Iraqis, nationalist positions withregard to the exploitation of natural resources are getting stronger. Even among Shias there is rising opposition to production-sharing agreements, which are what Western oil co mpanies want. The Kurds, who have the most conciliatory positions vis-à-vis foreign companies, will nonetheless be taking an estimated 87% of oil production in their autonomous region, a high share by the usual standards of production-sharing agreements. Even officials of the Iraqi National Oil Company now say that foreign investors will not be offered production-sharing agreements, but contracts based on fixed returns, arguing that the appetite for Iraqi oil is so great that the multinationals will still be willing to accept. 

High oil prices have contributed to lift Iraq's currency reserves to US$27 billion, US$7billion higher than a year earlier and significantly higher than expected. It is not clear, however, where the government's capacity to spend money and rebuild the country is improving. In fact, in the year to August, Baghdad has spent just 5% of its allocated reconstruction budget, even less than during the previous year. The Oil Ministry spent just 3% in 2006; although in 2007 it was reportedly doing much better and by July i t was said to have already spent 21%, there are doubts about the official figures. It is acknowledged that high levels of corruption and a dysfunctional diplomacy are preventing the government to spend more and better, contributing to leave high levels of unemployment, currently estimated at 40%. Nonetheless, capital expenditures for 2008 have been increased by 30%.

In August the Iraqi parliament approved a supplementary spending bill, bringing this year's budget from US$48 to US$70 billion, as a result of the unexpectedly high oil prices and of an increase in exports. There is still a significant surplus being accumulated, to the irritation of many American congressmen and senators, who complain about the US paying for reconstruction projects that Baghdad could well afford. However, there are serious doubts that further increases in production and export can be achieved, as the existing infrastructure might not be able to carry significantly greater quantities of oil. The Oil Ministry has not been able to invest more than a small percentage of its allocated budget so far, in part due to the loss of skilled employees and to political contrasts. Much of the investment is going towards the renovation of old refineries and the construction of new20ones, although in August the Oil Ministry also announced that for the first time after 20 years it was resuming oil exploration. There are also plans to rev ive a 1997 oil deal with China, for the exploitation of the 90,000 bpd Al-Ahdab field, south of Baghdad. The deal was never implemented due to UN sanctions. There are also signs of international investors' interest in non-oil sectors like fertilisers and finance, particularly in southern Iraq. Economic recovery seems to be underway in Baghdad too, where property prices have doubled in four months. 

There is still very little sign that the professional middle class, which fled the country during the worst violence, is coming back. Skills in sectors like health are still in short supply. At the same time the mostly US-funded reconstruction effort is still heading nowhere, with hundreds of projects having been abandoned because of security concerns or because of simple mismanagement. 

Although oil production has now climbed some way upwards and stands at 2.3 million bpd, future prospects of the sector are jeopardized by the20continuing failure to approve the new oil law. Earlie r optimism about its approval has now completely evaporated and the deadlock in the parliament seems irresolvable. There are reportedly four different drafts of the law in circulation, but none is supported by a majority. In the meanwhile Baghdad is trying to involve foreign oil firms by offering them a role in servicing the existing oil infrastructure. More than 70 companies have registered to compete in the forthcoming tenders. At the same time Baghdad is trying to prevent further deals between oil companies and the Kurdish regional authorities by using retaliation. The oil ministry has already halted oil exports to SK Energy (South Korea) and OMV AG (Austria), which it accuses of illegal oil deals. Figures for last year show that oil exports rose 9.2% to an average of 1.6 million bpd, a modest achievement given the potential. The reduction in sabotage activity against the northern Iraq pipeline is the main reason for this increase, as many of those attacking the pipelines have not been hired by the government to protect them, although US$560 million have also been spent on oil facilities upgrades by foreign companies. The oil ministry now plans to bring production to 3 million bpd by the end of the year, but these forecasts to say the least, lack conviction in the outside world. 

In mid-April a deal seems to have been finally reached on that part of the oil law between the central and the Kurdistan regional governments. The 'deal' also includes a method for determining the validity of the oil deals the Kurds have signed with foreign firms. Baghdad and the Kurdish regional government have also agreed to rely on UN mediation to determine the fate of the disputed territories of the Kirkuk region. However, in August tension between Baghdad and the Kurdish regional government increased as a brigade of Kurdish troops refused to obey the order of the Ministry of Defence to withdraw from the northern part of Diyala province, where the Kurds have territorial claims. The status of the city of Kirkuk is also preventing the approval of the electoral law. 

Some oil companies like Shell are allegedly already training oil workers. Some observers however believe that some controversial issues will resurface, such as the production sharing agreements which are at the core of the law. Many in Iraq argue that these agreements are far too favourable to international investors, given that the quality of Iraqi oil and the chances of successful drilling are much higher than average. Al though sporadic attacks on pipelines have also resumed after a lull, the oil ministry is determined to move on and has also finalised the list of companies which will be allowed to bid on oil contracts. 35 of the 120 companies which applied have been included in the list, among them giants like BP, Shell, ExxonMobil, Total, Petronas, Gazprom, Lukoil and CNOOC. Six giant fields will be offered on the market this year, while more bid rounds are planned for next year. Negotiations with the EU for the delivery of Iraqi gas to Europe also seem to be making steady progress although since the gas is currently being burned off there is still a way to go before there is any means of exporting it. 

Oil production stabilised at 2.5 million bpd by the summer and in order to achieve further significant improvements the government has adopted a two-fold strategy . Short term (one or two year) no-bid service contracts are now being negotiated with oil firms, while longer term contracts have now been opened for bidding to service six oilfields and two gas fields. These new contracts will be assigned only next June. The government appears to have run into some difficulties in its negotiations for the short term contracts as the oil companies are not very interested in merely servicing the fields, but want to get involved in oil production instead. 

Baghdad forecasts oil revenue for 2008 at US$70 billion and promises that exports will increase by 125,000 bpd in June. For the first time since the American invasion, Iraqi oil exports exceeded 2 million bpd in May. This is mainly due to the decline in sabotage of the oil infrastructure, with attacks falling from an average of 30 a month last year to just 4 in May. The benefit of increasing oil exports at a time of high prices is obvious. The plans of the Oil Ministry are however much more ambitious. The government is about to assign contracts for the maintenance of existing oil fields, hoping to boost production by 600,000 bpd. Rumours suggest that among the winners will be BP, ExxonMobil, Total, Chevron and Royal Dutch Shell. Each contract is worth a modest US$0.5 billion, but the winners will then be well positioned for more lucrative deals once the new oil law is finally approved. 

Foreign investment in Iraq has unsurprisingly been very low so far, reaching just US$272 million in 2006. Now there are signs of renewed interest of foreign investors in Iraq, in part due to the offers of incentives by the government, such as a 10-year tax break, and in part due to the decreasing tide of violence. Investments are not materialising yet, as shown by the fact that projects worth just US$418 million have been registered since December by the investment agency (including both foreign and domestic investment), but expectations are up. Electricity supply, although still falling much short of demand, has risen by 11% over the last year as the level of sabotage declined and better security allowed for crucial repairs to be carried out. At present Baghdad receives on average 10 hours of electricity each day. 

In August the Iraqi government reached its first real oil deal of the post-Saddam era. The agreement with China National Petroleum Corp was possible because it is in fact the revival of a deal signed in 1997 with Saddam but never implemented because of the embargo. The al-Ahdab oilfield will require the investment of US$3 billion and will produce 100,000 bpd at full regime. 

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