UN Compensation Award to Kuwait Faulted for multi-billion dollar errors


The UN’s multi-billion award to Kuwait is under scrutiny. Major errors, inflating the compensation due, have been identified. The report at question was issued by the United Nations Compensation Commission, mandated to settle claims against Iraq arising out of the Gulf War, last fall and stipulated $15.9 billion in damages payable to Kuwait from the escrow account into which 30% of Iraq’s oil revenues are diverted. This sum covered oil revenues which had been lost and for reserves which had been burnt off. But the calculations appear to be flawed é at least $12 billion in errors have been publicized é thus seriously overstating the amount due to Kuwait.

This is the first of the large claims reported by the UNCC. But the errors are also unprecedentedly large. The possibility that such large errors were committed and not caught reaches to the integrity of the Commission and to the credibility of the process itself which was established to compensate victims of Iraq’s aggression. The fact that Kuwait suffered losses is not generally contested é although Iraq alleges that some damage was due to US/Allied bombs and other due to Kuwait’s failure to mitigate. The question is “how much”.

Basic facts are clear. Kuwait’s oil exports were interrupted, first by the sanctions imposed against both Iraq and Kuwait. Income was zero. Further, losses continued after liberation, when Kuwaiti exports were no longer embargoed, because of the extensive damage to the oil field infrastructure and the raging well fires. Exports were resumed only slowly after mid-1991. Production was indeed restored to pre-war levels already by December 1992, but Kuwait had lost much its oil income during the preceding two years. This revenue outfall constitutes its first claim é Production and Sales Losses (“PSL”).

The second element is the value of the reserves destroyed. Here, too, there is no doubt that oil and gas was irretrievably lost during the well fires and spills. The UN determined that Kuwait in its claim had exaggerated the amount of oil burned off but nonetheless reckoned a physical loss of some 900 million barrels é gone forever.

At issue is the quantum of compensation é what was the economic value of the lost production and the lost reserves? The calculations involved new approaches because of the technical complexity of the case. Hitherto the UNCC had dealt with a myriad of small claims (well over one million as aggregated) é houses destroyed, payments to Kuwaitis and 3rd-country nationals which were forced to flee (excluding Palestinians), relocation costs, pain and suffering and other compensable losses as decreed by the Commission. The so-called “E.1 Claim” for lost revenues and reserves is different and is the largest by far of the types of loss for which the UNCC sought to determine fair compensation.

The principle of compensation has been accepted é at least in the case of Iraq’s aggression. The devil lies in the proverbial details. There the UNCC committed a set of errors which can easily be identified from its lengthy report. The first, easily quantifiable error, was actually in Iraq’s favour. The UNCC lost track of the number of barrels which had been burned off and decreed that Kuwait should be compensated for 79 million barrels é rather than the 912 million barrels which it found to have been lost. The reasoning is opaque.

The second set of elementary errors was in the opposite direction é both greatly inflated the amount due to Kuwait. First the Commission concluded, citing anonymous experts, that Kuwait had produced no more oil after the invasion than before. Thus there was no offsetting gain, no countervailing advantage. Second, the Commission valued the burnt-off oil as if that oil were instantaneously producible. It noted that reserves are producible only over time and with delay, yet proceeded to treat immediate physical losses as if they had been immediately commercializable.

The net effect of the errors was some $12 bn é the award is at least that much too high. The first error, in the direction of Iraq’s favour, was more than offset by the two, much larger errors which worked in the opposite direction.

The UNCC’s report is unusual in one key respect é it can be tested. The calculations and conclusions can readily be verified against information which is freely available in the public record — production data for Kuwait and other OPEC members, reserve lifetimes for Kuwait, and other such basic information which is not specific to Kuwait.

The largest error is the fact that the UNCC failed to recognize that Kuwait was able to produce more oil after the invasion, once reconstruction was complete, than was probable if the war and invasion had not occurred. Thus low exports during the period of occupation and rebuilding were offset by higher production thereafter. The principle of offsetting was not contested; the UNCC wrote:

“If Iraq’s absence from the crude oil market, which resulted from its invasion and occupation of Kuwait, allowed KPC to earn extraordinary profits from the production of crude oil, the Panel finds that it should consider whether such profits should be offset against its claim.”

Having enunciated the established principle, it then, however, got the numbers wrong. It concluded that there were no extra profits after 1991. The Panel said that Kuwait’s average share of OPEC production was no greater during 1991 to 1998 than it had been in prior test periods. No increased production (read market share), ergo no countervailing advantage. If this arithmetic comparison were correct, it would indeed have been true that there was no countervailing gain to offset the production losses due to the war.

The arithmetic was flwared. After the invasion in August 1990, most OPEC members increased production. They filled the large void left when both Iraqi and Kuwaiti exports were sanctioned. Saudi Arabia was the largest beneficiary, but Kuwait’s gain was deferred until after 1992, when Kuwait joined in being able share in that bonanza. After 1992 Kuwait increased its market share above historical levels to take advantage of the open window which persisted as long as Iraq’s exports were still curtailed. Simple graphs show that Kuwait increased both production and market share after 1992.

Mysteriously, the UNCC missed this trend, even though the public data are incontrovertible and easily accessible. The fact that other OPEC states enjoyed a windfall when they assumed part of Iraq’s market share was well known at the time and can be reconstructed from standard sources. The comparison of “before” with “after” is easy. In 1989 Kuwait produced 6.3% of OPEC’s crude oil output; during the years 1985-1989 its average share, including fluctuations, also happened to be the same é 6.3%. Both periods were invoked by the UNCC in order to establish whether Kuwait had gained after liberation and reconstruction. Between August 1990 and the end of 1992 Kuwait’s own production was rebounding from nil; market share was low. But, then, from 1993 onwards, Kuwait was ahead of the game. Kuwait’s OPEC share rose to 8%. Then its share was reduced slowly to circa 7%, as Iraq resumed production and the several OPEC states curbed their own output in order to make room for Iraq once more.

The arithmetic is compelling and is documentable from public sources. Kuwait’s output did increase due to the sanctions against Iraq. Before the invasion its expectation, based upon historical experience, would have been some 6.3% of OPEC output. After 1992 its produced averaged around 7.5%. The gain é a little more than one percent é was significant relative to expectations. That one percent of market share translated into additional output equal to 200-300,000 b/d. this windfall was the direct result of the sanctions against Iraq and thus a direct consequence of the war. The Commission erred grievously. That is all the more puzzling because one can deduce the correct result from snippets of their own report.

The second large error involved overvaluing the burned off oil. It is attributable to a fundamental misunderstanding of how oil reservoirs work é the fact that lost reserves reduce production or capacity only later in the life of an oil field. The delay is particularly long in the case of Kuwait, where reserves are produced very slowly é the reserve-to-production ratio, or “lifetime” of the fields, is well over 100 years according to Kuwait’s own data. The Commission stated the principle correctly and then, as above, got the numbers wrong. They valued the lost reserves at their contemporaneous price, ignoring the delay and the time value of money.

The third major error, that in Iraq’s favour, is no less puzzling. The Commission argued that Kuwait had overstated the amount of oil which had been burnt off. It reduced the claim from over 1,200 million to 912 mn barrels. But then it proceeded to calculate compensation for only 79 mn barrels thereof. The reasoning is incomprehensible to an engineer or economist, but may be a result of the same misunderstanding of reservoirs which led to the error noted above. In any case, this error by the UNCC understated Kuwait’s claim by possibly as much as $1.5 bn, after correction for both the erroneous volume and erroneous price.

Two additional oddities must be noted. The UNCC did not calculate compensation for damage to the reservoirs, other than that for the burned oil. Yet one would have suspected that such violent, wide-open production rates would have impaired longer-term operations of those fields. Second it reckoned lost refining profits é real enough é based upon a putative profit margin which was very high in a sector with notoriously fluctuating profit levels. There could be an additional element of overstatement of as much as $2 bn due to this effect, but this cannot easily be checked against publicly available information.

The award appears to be grossly inflated. About $12 billion in errors are easy to test and another $2 bn is possible, if not probable. Thus the readily rectified damages are in the range of $2-4 billion, very much less than the UNCC’s figure of $15.9 bn.

At this stage it is not clear what went awry. The UNCC relied upon consultants, but those consultants are up to now cloaked in anonymity. It noted its dependence upon Kuwait’s experts and consultants, plus some of its own, which it retained directly. These have not been identified. Iraq was out of the loop. According to a series of articles in le Monde Diplomatique, Iraq was either not allowed or not able to submit its own analyses and, reminiscent of star chamber proceedings, it did not have access to the corpus of studies used to justify the damages. The usual adversarial format, which provides some curb on junk testimony or miscalculations, was short-circuited, so a critical step in cross-checking arbitral arithmetic was omitted.

One aspect is ironical. Twenty years ago Kuwait was respondent in an arbitration over compensation for its nationalization of Aminoil. The company claimed $2.5 billion in losses é a figure which was inflated by a factor of ten as a result of rather creative calculations by Aminoil’s lawyers, although the figures were notionally attributed to well-known international consultants. The then minister, Ali Khalifah as-Sabah, fought the case, and a settlement was reached for a figure dramatically less than the exaggerated claim. This time Kuwait is on the other side of such computations.

A second aspect reaches to broader implications. The procedures at the UNCC, and the precedents it has established, extrapolate directly to potential claims by all of Israel’s Arab neighbors for compensation as a result of Israeli aggression and dispossessions. This set of precedents, combined with Jewish insistence that the statute of limitations be suspended, provides powerful ammunition for such claims. It would be indeed ironic if the case against Iraq becomes a springboard for cases against Israel.


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