Fri Aug 27, 2010 2:52pm IST
By Michael Christie
BAGHDAD (Reuters) - The end of U.S. combat operations this month places the onus of ensuring security squarely on Iraqi leaders, even though they have yet to form a new government almost six months after an election.
Continued divisions between Shi'ite-led and Sunni-backed political factions and persistent, devastating attacks by insurgents are creating an air of peril that has kept potential non-oil investors on the sidelines.
These factors could also affect the work of oil majors which have won significant oilfield development deals.
While there are still 50,000 U.S. soldiers in the country ahead of a full withdrawal due by the end of 2011, a perception that Washington under President Barack Obama has disengaged from Iraq could worsen sectarian differences.
Iraq has muddled on without a new government since the March 7 parliamentary vote that produced no clear winner.
Public sector salaries are being paid, the army and police continue to fight the Sunni Islamist insurgency and counter Shi'ite militias, and small development projects already in the pipeline are being pursued.
Projects Iraq has signed with energy majors such as BP and Lukoil that could more than quadruple oil output in seven years are moving ahead slowly.
But the longer the political impasse continues, the longer it will take to address public anger about poor public services, such as a lack of electricity in the stifling summer heat.
The perception may also grow that democracy in Iraq does not work, and Iraqi leaders are incapable of governing, raising the risks of public disturbances, coup attempts and increased meddling by often troublesome neighbours.
Iraq is isolated from world financial markets and has little credit. Only a few dozen companies are listed on the stock exchange. The Iraqi dinar is thinly traded and the exchange rate effectively determined by the central bank in its dollar auctions.
One place to take a punt from afar on Iraq's future is its Eurobond.
Below are some of the major risks facing Iraq 7-1/2 years after U.S. troops toppled Saddam Hussein.
POLITICAL SQUABBLING, POWER VACUUM
Because no single bloc won a majority in the 325-member parliament in the March election, coalition talks are key to forming a government.
Despite announcing a merger, the two main Shi'ite-led electoral blocs remain at loggerheads over Prime Minister Nuri al-Maliki's desire to serve a second term.
The Sunni-backed, cross-sectarian Iraqiya alliance which won the most seats in the election has also been unable to seal a deal with others to give it the majority needed to govern.
Iraqiya, led by former premier Iyad Allawi, a secular Shi'ite widely supported by Sunnis who view him as a strongman capable of countering Shi'ite power Iran, took 91 seats in the election. Maliki's State of Law bloc won 89 seats.
The Iraqi National Alliance, a Shi'ite bloc which includes anti-American cleric Moqtada al-Sadr, took 70 seats, while a Kurdish alliance picked up 43.
The long delay in forming a government could undermine security, and marginalising Iraqiya may anger Sunnis, just as U.S. troops leave.
What to look out for:
-- A flareup in sectarian violence, as happened during the five months it took to form a government after 2005 polls.
-- A failure by parliament, which cannot function without a government, to pass investment legislation, sending a negative signal to firms interested in Iraq but worried about legal risks.
A RETURN TO MAJOR VIOLENCE
Iraq is far less violent than when sectarian killings peaked in 2006-07. Maliki takes credit for security gains, but a U.S. troop rise and Sunni militia cooperation also played a big part.
Since March, Iraqi forces backed by U.S. troops have scored major victories against local al Qaeda groups, including the killings on April 18 of al Qaeda's leaders in Iraq.
Yet Sunni Islamist insurgents, who the government says are in league with Saddam's Baath party, still stage attacks.
The number of Iraqi civilians killed in July almost doubled from June to 396. Significant attacks in August included an Aug. 17 suicide bombing at a Baghdad army base that killed 57, and coordinated attacks on police throughout the country on Aug. 25 that killed 62.
The insurgents are expected to step up their attacks on Iraqi security forces after the formal end to U.S. combat operations.
Political feuds, Sunni discontent or an attack on a holy site could spark a renewal in broad violence, as could any Israeli strike on Iran. Such an attack might prompt Shi'ite militias to retaliate against the remaining U.S. forces in Iraq.
Any major violence will push up prices on global oil markets , as Iraq has the world's third largest oil reserves.
What to watch:
-- Attacks on oil facilities or foreign oil workers.
-- A successful strike against a major political player like Maliki or Allawi.
-- Signs of a return by militia leaders who fled after a 2008 crackdown on sectarian violence by Maliki.
-- Increased infiltration of the Iraqi security forces by militants or insurgents.
Tensions between Arabs and minority Kurds, who have enjoyed virtual autonomy in their northern enclave for almost 20 years, are festering. Kurds were massacred in Saddam's era, but have gained unprecedented influence since 2003 and hope to reclaim areas they deem historically Kurdish.
Arabs and Turkmen complain Kurds have exploited their new-found prominence at their expense. At the centre of the impasse is Kirkuk, which sits on rich oil reserves.
What to watch out for:
-- Clashes between the army and Kurdish Peshmerga forces.
-- Any breakthrough on oil. Iraqi Kurdistan, which estimates its oil reserves at 45 billion barrels, has signed deals with foreign firms that the national Oil Ministry labels illegal.
-- Passage of modern oil legislation, held up for years because of the Kurd-Arab feud. The delay has not deterred oil majors, but potential investors in other sectors view the laws as an indicator of stability and friendliness to business.
Iraq's democratic experiment is significant in a region where leaders often leave office only in a "coffin or coup".
Many Iraqis believe their country needs a strong ruler. The inability to form a government undermines faith in democracy.
What to watch:
-- Unusual Iraqi troop movements, in particular a lockdown of Baghdad's Green Zone where most government offices are.
-- Any effort to change the constitution to allow leaders to amass power or remain in office.