Development Fund for Iraq

Development Fund for Iraq Agreed-Upon Procedures Report For the period from 22 May 2003 to 31 December 2003 (Export Sales) KPMG Bahrain June 2004 This report contains 11 pages Development Fund for Iraq Agreed-Upon Procedures Report For the period from 22 May 2003 to 31 December 2003 (Export Sales) (all amounts are in US dollars) ________ 1 Key internal controls over the capture of export sales 1.1 Procedure We documented the key internal controls employed by the Coalition Provisional Authority (CPA) and the Iraqi State Oil Marketing Organization (SOMO), the sales arm of the Iraqi Ministry of Oil, over the capture of revenue from export sales of petroleum, petroleum products and natural gas and the subsequent cash deposits in the Development Fund for Iraq (DFI). 1.2 Key internal controls 1.2.1 The CPA issued Order Number 36, Regulation of Oil Distribution on 3 October 2003 to supplement Iraqi law and to support the Iraqi authorities in the lawful distribution of oil into, out of and throughout Iraq. It was designed to assist in preventing theft and smuggling of natural resources, pending the outcome of a full review of Iraqi law, provisions and instructions. 1.2.2 The CPA Senior Advisor to the Iraqi Ministry of Oil (CPA Senior Advisor) maintained a spreadsheet tracking ship movements intended to ensure that for all lifted petroleum and petroleum products: ships were nominated and authorized; loaded in accordance with contractual provisions; invoiced; and the sale proceeds deposited at the Federal Reserve Bank of New York (FRBNY). 1.2.3 Although we were not given access to the Coalition’s Naval Forces, we were informed by the CPA Senior Advisor that the Coalition’s Naval Forces monitored shipping in the Gulf and, where necessary, ensure that only authorized petroleum and petroleum products are shipped from Iraq. 1.2.4 The CPA Senior Advisor monitored the Ministry of Oil and SOMO, including reviews of oil production, as documented by the North and South Oil Companies, on a daily basis. 1.2.5 During August, the CPA engaged international security companies and local tribes to guard the pipelines and installations against sabotage. 1.2.6 The CPA has approved a budget to replace, repair and calibrate the metering system on the pipeline network. 2 Development Fund for Iraq Agreed-Upon Procedures Report, continued For the period from 22 May 2003 to 31 December 2003 (Export Sales) (all amounts are in US dollars) ________ 1.2.7 Export sales of petroleum and petroleum products are required to be exclusively arranged and invoiced by SOMO, which is the sales arm of the Iraqi Ministry of Oil. 1.2.8 SOMO accepts payments only through irrevocable documentary letters of credit, thus ensuring that all exports will be paid for. 1.2.9 Cash receipts were to be deposited directly into the Oil Proceeds Receipts Account (OPRA), at the Federal Reserve Bank of New York. 1.2.10 For each shipment, SOMO performs a matching process with Bills of Lading, Certificates of Quantity and Quality, Ullage Reports, Export Cargo Manifests and Master Receipts against invoices raised, designed to ensure that all shipments are appropriately invoiced. 1.2.11 Currently, there are no export sales of natural gas, as there is no Iraqi infrastructure for export of natural gas. 1.3 Findings Our findings are noted in sections 3 and 4. 3 Development Fund for Iraq Agreed-Upon Procedures Report, continued For the period from 22 May 2003 to 31 December 2003 (Export Sales) (all amounts are in US dollars) ________ 2 Key internal controls over the bidding process 2.1 Procedure We documented the key internal controls employed by the CPA and SOMO over the bidding on, and awarding of, export sales contracts. 2.2 Key internal controls 2.2.1 Basra light oil is sold through long-term contracts, primarily with well-known international oil companies. These contracts are subject to review on a regular basis by the contracting parties. For Basra light oil, while SOMO has a stated policy of only selling to end-users, certain reliable traders are also considered. 2.2.2 Contracts for Basra light oil are entered into based upon production plans and estimates of capacity received from the South Oil Company. The price of petroleum to be delivered under these contracts is SOMO’s Official Selling Price (OSP) for the scheduled month of loading. The OSP is required to be based on one of three international benchmarks, depending on the destination: WTI (second line) for North American destination; Brent dated for European destination; and, Oman/Dubai average for Eastern destination, as quoted in PLATTS daily publications. The OSP’s monthly price is required to be calculated using an average of PLATTS quotations, for the selected destination, for a certain number of days following the lifting of the petroleum. This average is then required to be entered into a price formula, which includes factors for quality differential from the benchmarks and transportation cost. This is a method employed by other major oil producers in the region. 2.2.3 Kirkuk petroleum is currently sold through a tender process, as transportation by pipeline was disrupted by sabotage. 4 Development Fund for Iraq Agreed-Upon Procedures Report, continued For the period from 22 May 2003 to 31 December 2003 (Export Sales) (all amounts are in US dollars) ________ 2.2.4 A Tender Committee is formed with 12 members from various divisions of SOMO. Bids received by facsimile are to be placed in separate envelopes and forwarded to the Tender Committee, who are to open the bids at an appointed time and ensure that all qualifying bids meet the stated criteria. Any bids received via means other than facsimile are to be excluded from selection. During 2004 SOMO updated its policies to accept bids submitted by email. 2.2.5 The Tender Committee recommends the successful bidders, based on a range of criteria, including price and the reliability, reputation and geographical positioning of the purchaser. For Kirkuk petroleum, SOMO has a stated policy of only selling to end-users. 2.2.6 The Committee’s recommendation is required to be sent to the Minister of Oil for final approval. Approval by the Minister may be verbal or in writing. Subsequent to approval, contracts are required to be signed with the successful bidders. 2.2.7 The CPA Senior Advisor reviews and concurs with the business policies utilized by SOMO. He also performs reviews of contracts signed and tenders awarded. 2.3 Findings Our findings are noted in section 4. 5 Development Fund for Iraq Agreed-Upon Procedures Report, continued For the period from 22 May 2003 to 31 December 2003 (Export Sales) (all amounts are in US dollars) ________ 3 Agreement of export sales to SOMO sales ledger and to FRBNY 3.1 Procedures 3.1.1 KPMG obtained from SOMO a list of export sales of petroleum (crude oil) and petroleum products for the period to 31 December 2003, and compared this total to the SOMO sales ledger. 3.1.2 Thereafter, KPMG compared the list of export sales to amounts deposited into the OPRA, established by the United Nations Security Council Resolution (UNSCR) 1483, held on behalf of the Central Bank of Iraq at the FRBNY. 3.2 Findings 3.2.1 Export sales of petroleum and petroleum products are required to be arranged and invoiced exclusively by SOMO, the sales arm of the Iraqi Ministry of Oil. We found that, for the period to 31 December 2003, all export sales of petroleum products (residual fuel oil) were undertaken through barter transactions. Additionally, as there is no Iraqi infrastructure for exports of natural gas, there were no export sales of natural gas from Iraq. 3.2.2 Export sales of petroleum recorded by SOMO in its accounting records for the period to 31 December 2003 amounted to $5,076,633,501. 3.2.3 Proceeds from export sales of petroleum are paid directly into the OPRA account, through irrevocable documentary letters of credit, with proceeds received approximately 30 days after the petroleum has been lifted. 6 3.2.4 3.2.5 Development Fund for Iraq Agreed-Upon Procedures Report, continued For the period from 22 May 2003 to 31 December 2003 (Export Sales) (all amounts are in US dollars) ________ We found that proceeds from export sales of petroleum for the period to 31 December 2003 were deposited in the OPRA account as follows: Year OPRA 2003 $ 3,922,391,000 2004 1,154,242,501 $ 5,076,633,501 SOMO also engages in barter transactions for exports of petroleum and petroleum products. Barter transactions consist of exports of residual fuel oil for light fuel products and the export of crude oil for electricity from Syria. The exports of residual fuel oil and crude oil, and the imports of light fuel products are recorded in the accounting records at SOMO. We found that the value of these barter transactions, as recorded by SOMO, for the period to 31 December 2003 was $120,906,678. As these were non-cash transactions, no proceeds were deposited in the OPRA account or in the Compensation Fund, established in accordance with the UNSCR 687 and subsequent relevant resolutions. The CPA believes that an unknown quantity of petroleum and petroleum products was illegally exported from Iraq (smuggling), especially in the early months post-hostilities, by- passing the authorized processes of marketing, sales and cash collection. Despite the key internal controls put in place by the CPA and SOMO, as noted in section 1.2 above, the CPA believes that internal control systems over the Iraqi oil industry were insufficient to ensure that all petroleum and petroleum products were accounted for. The CPA is unable to reliably estimate the amounts of petroleum and petroleum products that were illegally exported for the period to 31 December 2003. It was not practicable to extend our procedures sufficiently to quantify such amounts. 7 Development Fund for Iraq Agreed-Upon Procedures Report, continued For the period from 22 May 2003 to 31 December 2003 (Export Sales) (all amounts are in US dollars) ________ 4 Detailed testing over the export sales of petroleum and petroleum products 4.1 Procedures For all export sales of petroleum, including all barter transactions for petroleum, and for a sample of export sales of petroleum products covering 45% (by value), we performed the following procedures: 4.1.1 Determined whether the key internal controls, noted in section 2.2 above, for the bidding on, and awarding of contracts to which the sale related were followed; 4.1.2 Observed whether the contract and sales invoice were signed and approved by an authorized person in accordance with SOMO policies and procedures, and approved by the CPA; 4.1.3 Compared the quantity and price per the invoice to the sales contract, Bill of Lading, Certificate of Quantity and Quality, Ullage Report, Export Cargo Manifest and Masters Receipt; and 4.1.4 Recalculated the OSP, by reference to PLATTS publications, for each lift and compared to the price per the invoice. 4.2 Findings 4.2.1 We found that the key internal controls, noted in section 2.2 above, for the bidding on, and awarding of contracts to which the sale related were followed. We noted that during the period to 31 December 2003, 180,574,274 barrels of Basra light oil were sold through long-term contracts, and 9,928,899 barrels were sold through two tenders, to well known end-users and certain traders with whom SOMO has a long-term relationship (approximately 5%). In addition, 7,739,517 barrels of Kirkuk petroleum were sold through a single tender, exclusively to well known end-users. 8 4.2.2 4.2.3 4.2.4 Development Fund for Iraq Agreed-Upon Procedures Report, continued For the period from 22 May 2003 to 31 December 2003 (Export Sales) (all amounts are in US dollars) ________ Although SOMO does not have a formal, written delegation of authority or a list of signatories for certain documents, we found that all contracts and sales invoices were signed and authorized by one of five members of SOMO’s senior management. We noted that all contracts were approved by the Minister of Oil, or in exceptional cases by the Deputy Minister of Oil. We were informed by the CPA Senior Advisor that he undertakes a review of invoices issued and sales contracts signed. These reviews are not documented. For all export sales of petroleum and for our sample of export sales of petroleum products, we found that all the quantity and price per the invoice agreed to the other documents included in section 4.1.3 above. For all export sales of petroleum and for our sample of export sales of petroleum products, we found that the price per invoice agreed to the Official Selling Price recalculated using PLATTS publications. We also found that for export sales of residual fuel oil, a substantial discount is offered on the PLATTS prices, to entice purchasers to collect the fuel oil within Iraq and to ensure that the production of refined products is not interrupted. Additionally, we found that prices and discounts were published for monthly periods for all customers. These were dependent upon a mixture of security issues, forms of transportation and distances, and an assessment of the quality of the product. It was additionally noted that the Minister of Oil approved all prices and discounts. 9 Development Fund for Iraq Agreed-Upon Procedures For the period from 22 May 2003 to 31 December 2003 (Export Sales) ________ Appendix To assist the International Advisory and Monitoring Board of the Development Fund for Iraq and the Coalition Provisional Authority in determining whether the export sales of petroleum, petroleum products and natural gas from Iraq are made consistent with prevailing international market best practices, you have requested us to perform the following procedures: 1. Document the key internal controls, employed by the CPA and SOMO, over the capture of revenue from export sales of petroleum, petroleum products and natural gas (export sales) extracted from the ground, and subsequent cash deposits in the DFI. 2. Document the key internal controls, employed by the CPA and SOMO, over the bidding on, and awarding of, export sales contracts. 3. Obtain from SOMO a list of export sales, and agree the total to SOMO’s sales ledger and to the amounts deposited in the FRBNY. 4. For all export sales of petroleum and a selected sample of petroleum products: - Determine whether internal control procedures, noted in point 2 above, for the bidding on and awarding of contracts to which the sale related were followed, - Observe that contracts and sales invoices were signed and approved by an authorized person in accordance with SOMO policies and procedures, and approved by the CPA, - Agree the quantities and prices as per invoice to the sales contracts, Bills of Lading, Certificates of Quantity and Quality, Ullage Reports, Export Cargo Manifests and Masters Receipts, - Recalculate the OSP, by reference to PLATTS publications, for each lift and compare to the price per the invoice, and report any deviations noted. 11