The 42-page draft report by the State Department's Inspector General says the department faces "numerous challenges" in dealing with the security situation in Iraq, including the prospect that Blackwater may be barred from the country. The department would have turn to other security arrangements to replace Blackwater, officials said.
The State Department had no immediate comment on the report itself, but deputy spokesman Robert Wood said that after the probe is done, officials would look at "whether the continued use of Blackwater in Iraq is consistent with the U.S. government's goals and objectives."
It is not clear how the State Department would replace Blackwater. It relies heavily on private contractors to protect its diplomats in Iraq, as its own security service does not have the manpower or equipment to do so. The report suggests that one way to fill the void would be for the State Department's Diplomatic Security Service to beef up its presence in Iraq.
"The department faces the real possibility that one of its primary Worldwide Personal Protective Services contractors in Iraq - Blackwater (Worldwide) - will not receive a license to continue operating in Iraq," says the recently completely report.
The report is labeled "sensitive but unclassified."
An official familiar with the report said initially that it would recommend that department not renew Blackwater's contract when it expires next year. But that specific language is not included in the document, a copy of which was obtained by The Associated Press.
The official said later that such a recommendation would not be made until after an investigation of last September's incident in Baghdad's Nisoor Square in which Blackwater guards killed 17 Iraqis is complete.
Hassan Jaber was wounded that day - shot in the arm and back as he tried to escape, CBS News correspondent Elizabeth Palmer reported earlier this month from Baghdad. Jaber, like other wounded victims, got $7,500 compensation from the U.S. Embassy in Iraq, which he used to pay for medical care. But his body is still full of shrapnel.
Five guards have been indicted on manslaughter and other charges stemming from that incident. The company was not implicated.
Terminating the North Carolina-based company's Iraq contract will be difficult for incoming Secretary of State Hillary Rodham Clinton because no other private security contractor has its range of resources, particularly its fleet of helicopters and planes.
Current Secretary of State Condoleezza Rice ordered a review of the department's use of private security firms after the Nisoor Square incident. The Inspector General's report is an analysis of how recommendations in that review have been implemented and includes several key findings, including that the department plan for the possibility that it may no longer be able to rely on private contractors like Blackwater.
Blackwater spokeswoman Anne Tyrell declined to comment, saying the company has not yet seen the report. The company has said in the past, though, that it plans to largely get out of the security contracting business to concentrate on training and other projects.
Blackwater has won more than $1 billion in government contracts under the Bush administration, a large portion of which has been for work in Iraq, where among its duties is protecting diplomats based at the U.S. Embassy in Baghdad.
State Department officials have praised Blackwater's work in Iraq, noting that no personnel under the company's protection has been killed. However, after Nisoor Square incident, the firm came under heavy criticism for the actions of its employees, which were immune from Iraqi law under legal protections dating from the U.S.-led occupation of the country.
Immediately after that incident, the State Department stepped up its supervision of Blackwater employees in Iraq, including posting a Diplomatic Security agent in every convoy the company escorts and installing video cameras in its vehicles.
And, the immunity enjoyed by Blackwater employees and other private security guards who protect civilians in Iraq will soon come to an end under a new U.S.-Iraqi security pact that will take effect on Jan. 1.
U.S. investigators have linked Blackwater guards to 70 shooting incidents involving civilians before Nisoor Square and only two since then.