The deal, which will see Shell supply the local market, is the second between the government and a foreign firm since the US-led invasion of Iraq in 2003.

It was signed by Iraqi Oil Minister Hussein al-Shahristani.

Iraq has enormous potential as an oil and gas supplier but has so far lacked the investment for it to be realised.

Under the terms of the deal, signed on Monday, Iraq will have 51% in the venture and Shell 49%.

The country will invest in natural gas in the oil-rich southern province of Basra.

International investment

The venture will initially focus on capturing some 700 million cubic feet of natural gas released per day as a by-product of crude oil extraction in the region.

But there are also plans to create a facility to produce liquefied natural gas – which is not a by-product of oil – for export.

With Europe keen to reduce its reliance on Russia for its energy supply, Iraq is seen as a viable alternative.

Iraq has proven natural gas reserves of about 112 trillion cubic feet, but analysts believe this is likely to represent only a fraction of what exists.

It opened its lucrative oil and gas fields to a select group of foreign companies in June to rehabilitate its ageing facilities.

The first foreign oil deal came when Iraq agreed a $3bn (£1.6bn) oil service contract with China.

News reported by The BBC

Iraq is seeking external help to boost output from six key oil fields and has attracted interest from leading US, Asian and European producers.

Oil production is currently at its highest since the 2003 invasion.

But political wrangling has so far prevented agreement over who should agree deals and how income is shared.

Political problems

Iraq has reserves of about 115 billion barrels, the world’s third largest, and the development of its oil facilities is essential to help to fund the country’s long-term reconstruction.

But huge investment is needed to modernise its infrastructure and Iraq’s Parliament has so far failed to agree a legal basis for who should agree contracts and how the country’s oil should be shared among different groups.

“It is not possible for Iraq, which has large oil reserves, to stay at the current level of production” Hussain al-Shahristani, Iraq oil minister

The authorities in Baghdad have long been at odds over the issue with the semi-autonomous Kurdistan regional government in the north of the country.

Production currently totals 2.5 million barrels a day and Iraq hopes to increase output to 2.9 million barrels by the end of 2009.

Iraq confirmed on Monday that it was seeking foreign investment to develop six of its most important oil fields – Rumaila, Kirkuk, Zubair, West Qurna, Bai Hassan and Maysan.

It has identified 35 foreign firms which are qualified to tender for the contracts, to be awarded next summer.

Amid concerns about foreign firms reaping huge financial rewards, Baghdad said the successful firms would have to have an Iraqi partner and give 25% of the value of contracts to locally owned firms.

Significance

The BBC’s Nicholas Witchell in Baghdad said the move was highly significant since it paved the way for large foreign firms to re-enter a market they have been effectively barred from since Saddam Hussein nationalised Iraq’s main oil company in 1972.

“It is not possible for Iraq, which has large oil reserves, to stay at the current level of production,” said oil minister Hussain al-Shahristani.

“Iraq should be the second or third source of oil exportation.”

Iraq’s courting of foreign investment is at an early stage but has already attracted controversy due to claims that some contracts might be awarded without competitive bids.

Reports suggested that officials were hoping to announce short-term service agreements – an interim measure pending political agreement over a national oil law – with Exxon Mobil, Shell, Total and BP on Monday.

The AFP news agency said Iraqi officials were unwilling to share revenue from oil sales with the firms, as reportedly sought by them, preferring instead to pay them consultancy fees.

However, negotiations over contract terms are believed to be continuing.

The reduction in violence in much of the country over the past year has helped the oil sector achieve greater stability.

On Saturday, Iraq announced it was setting up a third state-owned oil business to expand production from the Maysan region in the south east of the country.

With oil prices at record levels and, according to many experts, set to rise further, the prospect of increased output from Iraq will provide some comfort amid growing worries about whether global supplies can meet long-term demand for oil.

Officials hope the presence of multinational oil firms in Iraq will stimulate more foreign investment in Iraq, our correspondent added.

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