On 30 June the last US troops will pull out of the Iraqi cities. America's great adventure in Iraq is ending. Already there are few US military patrols in Baghdad. The American-held area of the Green Zone, for long a forbidden city in the middle of the capital, has been squeezed in size. The hotel that Baghdad taxi drivers fondly believed was the headquarters of the CIA has removed the concrete wall protecting it and reopened for public business. The knowledge that all US military forces will be out of Iraq by the end of 2011 immediately reduces American influence in Iraq. No Iraqi wants to nail his flag to the mast of a departing ship, which is one reason why Washington for so long resisted setting a timetable for a US troop withdrawal.

American forces leave behind a country which is a barely floating wreck. Its society, economy and very landscape have been torn apart by 30 years of war, sanctions and occupation. I first came to Iraq in 1977 when its future looked rosy, but it turned out I was visiting the country at the high tide of its fortunes, a tide that has been ebbing ever since. Iraqis have been engulfed by successive disasters: the eight-year-long Iran-Iraq war starting in 1980; the defeat in Kuwait in 1991; the bloodily suppressed Shia and Kurdish uprisings the same year; UN sanctions amounting to a 13-year-long siege which ruined the economy and shattered society; the US invasion of 2003; the Sunni Arab war against the US occupation in 2003-7 and the Sunni-Shia civil war over the same period.

How many other countries in the world have endured such traumas? Is it any surprise that Iraqis are so heavily marked by them? The Iraqi government announces proudly that in May 2009 only 225 Iraqis died from war-related violence, a lower figure than we have seen in any month for at least four years. Of course this is far better than the 3,000 tortured bodies which used to turn up every month at the height of sectarian war in 2006-7. Baghdad is certainly a safer place these days than Mogadishu, though not perhaps as secure as Kabul, where violence, at least for the moment, is surprisingly limited. But the attitudes of Iraqis are not determined solely or even primarily by monthly casualty figures or even the current security situation. Their individual psychology and collective political landscape is shaped rather by the memory of the mass killings of the recent past and fear that they might happen again. Iraq is a country so drenched in blood as to make it next to impossible to reach genuine political accommodation between Shia and Sunni, Arab and Kurd, Baathist and non-Baathist, supporters and opponents of the US occupation. "How do you expect people who are too frightened of each other to live in the same street to reach political agreements?" asks one Iraqi friend in exasperation.

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People in Baghdad today are less tense and fearful than they were six months ago, but they are still wary and suspicious. They keep saying that what happened before could happen again. Probably, they are wrong, but it is impossible for anyone living in Baghdad today, having experienced the butchery of the recent past, not to live under its shadow.

I feel the same wariness when I visit restaurants in Baghdad where I used to eat four or five years ago. That I can do so at all is a sign of improved security. But even eating in a restaurant evokes memories of extreme violence. There is, for instance, a Kurdish restaurant in the al-Mansur district, which serves an astringent yoghurt-type drink that I like. But I find it impossible to forget that a couple of years ago a car bomb exploding just outside the restaurant tore the interior apart and killed half a dozen people. When I sit in the White Palace restaurant I remember that I used to go there after visiting a friend of mine, a stockbroker called Hussein Kubba who would tell me hilarious, if slightly bitter stories, about how American officials had taken charge of the Baghdad stock exchange and were running it into the ground. Later he was kidnapped, savagely whipped and forced to sell his house to pay his ransom. Driving into my hotel, the al-Hamra in the Jadriya district, I glance at a booth where an old man sells cigarettes. Inside the booth there is a picture of a teenage boy with dark curly hair. It is the man's son, from whom I once used to buy cigarettes. I gave up smoking at the end of 2003 and therefore I did not know for some months that the boy had been killed by a suicide bomb targeting the Australian embassy on the other side of the road.

Inside my hotel I always get a warm greeting from the receptionists who over the years have been invariably friendly and helpful. One of them lost his son – the body was never found – when the second building of the hotel was half-demolished by two suicide bombers, one with a 1,000 kilo bomb in his vehicle, in 2005. The son of a second receptionist had a job collecting money from shops to buy telephone scratch cards which he would then purchase from phone company at a slightly reduced wholesale rate. He was known to carry large sums of money, a dangerous reputation in Baghdad, and was seized by gunmen. After robbing him of $40,000, they let him call his father by phone to ask him to come to a certain square in Baghdad to pick his son up when he was released. His father went there as instructed, saw his son emerge from the gunmen's car, and then watched as they shot the young man in the back of the head.

I sometimes think I should not come back to Baghdad because I am burdened by too many grizzly stories like these. I wonder if another correspondent might be better able to write chirpy tales about how life here is getting better, as indeed, in a certain sense, it is. He or she, coming to Iraq afresh, would have no memories of friends killed and tortured and would respond sympathetically to feel-good stories pumped out by the Iraqi and US governments about how life here is improving. But then I recall that most Iraqis are influenced by the same experiences as myself. Almost every Iraqi I know has lost one or more members of their family. The bodies of many of the dead have never been found. It is all very well for American officials and diplomats, with their British equivalents trotting dutifully behind, to hector Iraqi leaders about reaching political agreements with their rivals. In a political universe bathed in so much violence this is difficult to do and, if done, it is almost impossible for leaders to deliver their own communities. Political paralysis at the top in Iraq, so often berated abroad, is only a reflection of the paralysing suspicions and hatreds within Iraqi society.

Iraqis will not come to love each other in the foreseeable future, but this does not necessarily mean they will try to kill each other. Iraqis have seen two wars since 2003. The first was waged by the Sunni Arabs against the US occupation. The Sunni guerrillas were highly effective and killed or wounded 35,000 American troops. The second conflict was a sectarian civil war between the Sunni and Shia communities which left tens of thousands dead and five million displaced. It was fought because after the overthrow of Saddam Hussein the Shia (60 per cent of Iraqis) had allied themselves to the Americans to displace the Sunni (20 per cent) as the predominant community in control of the Iraqi state. Both these wars are now over and both had winners and losers. The Shia defeated the Sunni and Baghdad is now at least three-quarters Shia. Much of the Sunni middle and professional class fled to Jordan and Syria and is unlikely to return. Facing defeat by the Shia and in revulsion against al-Qa'ida, the Sunni insurgents switched sides and allied themselves to their former American enemies. With their identities known and facing Iraqi government security forces 600,000-strong these ex-insurgents are unlikely to be willing or able to go back to war.

The one war which might still take place is between the Kurds and the Arabs. The Kurds were the heart of the old opposition to Saddam Hussein. They also had a stroke of luck in 2003. The Turks refused to join the US invasion of northern Iraq or allow their own territory to be used for an attack. The Iraqi Kurds, somewhat to the Americans' surprise, became the main US allies. The Kurds advanced south taking Kirkuk and Nineveh, mixed Kurdish-Arab provinces outside what became the highly autonomous Kurdistan Regional Government (KRG). They found they had bitten off more than they could digest. The Kurds are now very nervous as their power starts to decline as the Americans depart, the Arabs of northern Iraq organise themselves and the central government in Baghdad becomes militarily and politically stronger. "This is the day every day Kurd was afraid of," laments a Kurdish observer in Sulaimaniyah. "Once more we are alone and face to face with Baghdad." In Iraq everybody is paranoid and everybody has a reason to be so. In Nineveh, the capital of which is Mosul, the Sunni anti-Kurdish party al-Hadba won the provincial election in January and took over the local council. The Kurds are refusing to retreat from territory where they are in the majority. Last month the new al-Hadba governor of Nineveh, Atheel al-Najafi, accompanied by some 50 police cars, tried to enter a Kurdish-held part of his province, and was turned back by Kurdish forces. They said they had received orders, though everybody denies issuing them, "to shoot to kill" if he persisted. Has they done so there would have been general slaughter.

Iraqi Kurds and Arabs do not like each other. "You could win an election here on an anti-Kurdish ticket," says a politician in Baghdad. But leaders on both sides have good reasons not to fight each other. The government is a Shia-Kurdish coalition. The Kurds hold some of the most important jobs. Though keen to find oil within their own region the KRG depends on receiving 17 per cent of Iraqi oil revenues. Above all, as part of the Iraqi government the Kurds are much better placed to fend off interference from Turkey, Iran and Syria.

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When I first came to Iraq 32 years ago, diplomats cheerily forecast a prosperous future for the country because, however bloodthirsty the Baathist regime, it was "the only Arab country with plenty of oil and water and a large enough population to exploit both." Like many diplomatic clichés this turned out to be untrue on most counts. As violence ebbs, Iraqis are beginning to notice that the two main resources on which they entirely rely are both running short. The waters of the Tigris flowing past the concrete walls and watch towers of the Green Zone have become very shallow. Islands of sand and reeds break the surface in the middle of the river. Last week I was watching a small boy swimming from one of these little islands. He suddenly stood up and the water only came up to his waist, showing that it is just a few feet deep. This is the result of a prolonged drought and the construction of dams upriver. The problem is worse on the Euphrates. Mesopotamia, in Greek the land 'between the rivers', is drying up. Every week in Baghdad there are blinding dust storms which frequently shut the airport. The Iraqi Agriculture Ministry says that 92.5 per cent of the country is now subject to desertification and as a result between 40 and 50 per cent of what was Iraq's most fertile land as recently as the 1970s is falling out of production.

The main reason for this is the dams built in Turkey and Syria on the upper reaches of the Euphrates which are reducing the flow of water to a quarter of what it was 10 years ago. This is devastating for the farmers who live along the banks of the river. They can no longer grow rice because it uses too much water. Fruit is almost all imported from Syria, Jordan and Iran. Apples come from the US. Many farmers are abandoning their lands and moving to the cities. In the villages on the edge of the southern marshes snakes are leaving the dried out reed beds where they once had their dens and are attacking people and livestock. Turkey intermittently promises to let more water through its dams, but this only happens for a few days before the sluice gates are shut again. In the past Iraq has been able to get by through using water stored in its own reservoirs, but these are now heavily depleted. The Mesopotamian plain, one of the birthplaces of settled agriculture and irrigation, is turning into a dustbowl.

Fortunately, Iraq no longer depends on its own agriculture to feed itself. Instead it has become one of the world's largest food importers. The rationing system, at a cost of $6bn a year, gives Iraqis just enough cheap food to fend off starvation. But this food is paid for by oil revenues and these have been going down at frightening speed. A reason for this is the decline in the price of crude from $140 last year to less than half that today. But more devastating to Iraq is that production from their great oilfields is falling. These are the so-called super giants, nine oilfields with reserves over five billion barrels, which hitherto have been some of the most productive in the world. Oilfields like Kirkuk and Bai Hassan in the north and North and South Rumaila, West Qurna and Zubair in the south, appeared an endless resource which, in the long term, would bail Iraq out of whatever trouble it was in. But now even they are beginning to fail because of neglect, under-investment and mismanagement. Last year this did not seem to matter so much because the price of oil was high and the government supposed it was going to stay that way. It happily raised salaries and wages and increased the number of state employees to about two million, twice the number under Saddam Hussein. The Oil Minister Hussein Shahristani said in an interview with the oil expert Ruba Husari last July: "Iraq is in desperate need of modern technologies, not of capital investment, to arrest the decline in those fields [the super giants] and introduce enhanced recovery." Note that at this time Shahristani, a former nuclear scientist who was imprisoned and tortured under Saddam Hussein, thought that Iraq did not need capital investment. A year later the country is broke, has frozen government hiring, including extra police, and is negotiating a $5.5bn standby loan from the IMF. Oil production at the end of May was 2.41 million barrels, which is still less than the 2.58 million produced immediately before the 2003 war or the 3.5 million produced in 1979.

This is the background to an immensely important change in Iraq. On 29 and 30 June Mr Shahristani will award 20-year-long contracts to international oil companies to work in already developed oilfields, first to restore production to what it once was, and then to increase it. The companies will be paid in crude oil at a fixed price as a fee for extra output and will put up all the investment. Critics within the Iraqi oil industry say that the government is selling the farm, and that it should have confined the international oil companies to oilfields which had been discovered but not developed. The big producing fields it should have kept for itself, using the services of foreign engineering companies, consultants and contractors to raise output. At this stage, the government does not believe it has much choice but to go ahead with the contracts being awarded at the end of June, and even then it will be three years before any new oil is produced.

Surprisingly, these epoch-making developments in the way Iraq's oil wealth is controlled and exploited are hardly noticed abroad outside the oil industry and the specialist business press. Yet their outcome will do much to determine how people live in Iraq over the next century and will have an impact on the energy supply of the whole world. Iraq is currently estimated to have the third-largest oil reserves in the world, but the western and southern deserts are largely unexplored and may contain another 45 to 100 billion barrels of recoverable crude. "According to independent consultants," says the US Department of Energy, "the cluster of super-giant fields of south eastern Iraq forms the largest known concentration of such fields in the world and accounts for 70 to 80 per cent of the country's proven oil reserves." No wonder the determination of the international oil companies to get a stake in Iraqi oil development, even if the precise terms of the present contracts are not to their liking. Just how much oil the world possesses will be determined as they explore what deposits lie beneath the dreary deserts and salt marsh around Basra.

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I never thought that the US and Britain invaded Iraq for its oil. I believe that the US determined to invade Iraq in 2003 to re-assert America's sense of being the world's sole super power in the wake of 9/11 and that the overthrow of Saddam Hussein seemed an easy way of showing America's political and military strength. At the same time Iraq and the Gulf are important on the strategic map of the world almost entirely because of their oil. Had Iraq's main export been asparagus or dates then Washington and London would have been less interested in what happened there. It was oil revenues which fostered the once powerful militarised state which Saddam built because without it he could not have raised and equipped the armoured divisions which invaded Iran in 1980 and Kuwait ten years later.

The ability of Iraq to recover from 30 years of disaster all depends on how much money it has to spend. The re-stabilisation of the country over the last two years is partly the result of being able to pay for 600,000 men in the security forces and create hundreds of thousands of well paid-jobs in government. In terms of security provided, it makes a great difference that an Iraqi private soldier is paid about $600-700 a month and his Afghan equivalent only $120 for doing the same job. Everybody in Iraq wants a comfy and unsackable position in the government and not in the languishing and insecure private sector. The hatred and fear which divides Iraqis is the understandable reaction to decades of slaughter and is too intense and recent to be overcome in less than a generation. The exploitation and use of Iraq's vast oil wealth is not only the best, but is perhaps the only chance, of recreating a country in which people will want to live.