Its riches are there for the taking. But will Iraq's economic recovery go up in flames?

The country needs Western investment, yet it's a dangerous place to do business. Kotaro Miyata and Jason Nissé investigate

For once, the talk of the town in Madrid won't be David Beckham. On Thursday, the Spanish capital hosts the international donors' conference, where ministers from around the world will gather to discuss the thorny issue of aid to Iraq.

President George Bush was given a black eye by the US Congress when he asked for $20bn (£12bn) for the rebuilding of the war-torn country - it insisted half had to be in the form of a loan. Other nations are pitching in. Japan has promised $1.5bn, the UK £550m and the European Union €200m (£139m). Others, such as Germany and France, are more reluctant and there could be more shouting in the meeting room than there is at Real Madrid's Bernabeu Stadium.

Raising funds is one problem. Spending them wisely is another, bigger, one. The power sector alone, in a country ravaged by war, sabotage and looting, is expected to need $12bn in investment over the next four years. Developing the massive oilfields could cost more than $30bn. There is a lot of work to do. And a lot of concern about how contracts are being handed out.

The majority of the contracts announced so far have been awarded by the US Agency for International Development (USAID), and the most valuable ones have gone to big US contractors. Bechtel, the secretive construction group, was granted a $680m (£407m) contract for the repair of infrastructure networks including power and water. Halliburton, the company formerly run by the American Vice-President, Dick Cheney, won a contract worth more than $1bn to restore Iraq's oil industry and was last week accused by two Democrat politicians of overcharging for fuel used when working on these projects.

Last week, the British envoy to Iraq, Sir Jeremy Greenstock, attacked the pro-US bias in giving out business. "We do want to have a fairer share of the overall contracting position, as [our] people are putting lives and money into this whole thing," he said.

But while the torrent of aid money will continue to flow, Iraq is keen to attract foreign investment from the private sector. With the end of the war and the lifting of sanctions, there has been considerable interest in the business opportunities in Iraq. And last week a whole host of prominent Iraqis travelled to London to sell investment in the country to British companies at a conference called Doing Business in Iraq.

The two-day event attracted more than 80 firms. And the speakers included Raja Khuzai, a member of the Iraq Governing Council, as well as members of the Coalition Provisional Authority (CPA), Iraq's US-led government, delegates from the US Department of Defence, leading Iraqi business figures and representatives from Trade Partners UK, the DTI-sponsored body that has responsibility for promoting British business interests abroad.

But while the main aim of the conference was to highlight business opportunities, most people wanted to hear about the current situation on the ground and how problems such as security, power cuts and water shortages are being tackled. While the speakers tried to paint a rosy picture, the mood on the floor was more sceptical.

Oil, Iraq's biggest source of revenue, is an obvious area for foreign investment. The country has the second largest oil reserves in the world but in terms of actual production ranks only 11th, below Canada and the UK. If it could recapture its oil production heyday in the late 1970s of 3.5 million barrels a day, it would be the world's fourth largest producer, behind Saudi Arabia, the US and Russia. Iraqi oil production has resumed but is not expected to reach two million barrels a day before the end of the year. After decades of war and sanctions, the industry desperately needs investment.

Muhammad-Ali Zainy, who is a senior analyst at the Centre for Global Energy Studies and worked for 15 years at Iraq's Ministry of Oil, estimates that the rehabilitation of oil production will require $2bn, the refining capacity a further $5bn, and the development of new oilfields a staggering $25bn.

At present, international oil companies are not exactly queuing up outside the oil ministry in Baghdad. This is largely because the situation in Iraq remains dangerous and not conducive to foreign investment. Drive-by shootings and car-jackings are daily realities, and security forces continue to be attacked. Given the mounting death toll on the streets, a businessman would have cause to fear for his life, let alone his investment.

Not surprisingly, big international corporations such as Shell and Exxon-Mobil are reluctant to send people out on the ground when they cannot guarantee their safety. Mahdi Sajjad, director of international development at Gulfsands Petroleum, a US oil company, says: "The coalition forces are trying to establish the security necessary to run a typical business. However, even if the security situation were resolved tomorrow, Iraq lacks the infrastructure, legal system and financial depth to sustain a modern economy."

The bankers who would have to finance private sector investment think that any deal in the near future is unlikely given the many uncertainties. Simon Byrne of ABN Amro says: "We are many, many months if not years away."

The other big question is the legal situation. Last month the finance minister of Iraq's interim government, Kamil Mubdir al-Gailani, announced investment rules that allow foreign companies to repatriate all the profits they make from Iraqi contracts and pay just 15 per cent tax on their profits. On the face of it, this is highly attractive. But Paul Turner, a partner at Clyde & Co, a London law firm which has just opened an associate office in Iraq, points out that all is not what it seems. As the current administration is neither elected nor internationally recognised, "the laws are subject to revision, amendment or even cancellation by a subsequent elected government".

"I think most investors may hold back until 2004 when an elected government is in place," says Mr Turner.

Despite all these qualms, Richard Greco Jnr, an adviser to the US Defence Secretary, Donald Rumsfeld, remains optimistic. Mr Greco was assigned to Baghdad in May to assist Paul Bremer, who heads the CPA. He argues that political progress was being made in Iraq with the establishment of the Governing Council, and that economic progress was being made with the now-functioning banking system. As to the prospect of a free market economy, he is encouraged by the entrepreneurial spirit of the Iraqi people, typified by the restaurant in Baghdad that is knocking out 300 pizzas a day for aid workers and servicemen.

But Iraq isn't going to be rebuilt in a day, admits Mr Greco. "It will take a lot of time, patience and money." The problem is, if the rebuilding of Iraq takes too much time and too much money, who will have the patience?