JERUSALEM — An Israeli source said Monday that sometime in 1985 U.S. Atty. Gen. Edwin Meese III advised Shimon Peres, then the prime minister of Israel, that government-to-government contacts about a proposed billion-dollar Iraqi oil pipeline should bypass Secretary of State George P. Shultz because of a potential conflict of interest.
According to the source, who briefed reporters on behalf of Peres, now the foreign minister, Meese asked in a handwritten letter to Peres that further Israeli communications on the proposed pipeline be referred to the National Security Council.
The source said the potential conflict concerned Shultz's former position as an executive with Bechtel Corp., the huge San Francisco construction firm, which had submitted a bid to build the pipeline.
His account appeared to raise new questions about Meese's role in the project and it brings Shultz's name into the matter for the first time.
The proposed Iraqi pipeline has become the focus of an ongoing investigation of Meese by independent counsel James C. McKay. Government sources familiar with the inquiry told The Times in Washington last week that a memo to the attorney general from his close friend and lawyer, E. Robert Wallach, suggests that payments might have been made to Peres to get his support for the pipeline.
The pipeline was to skirt Israeli territory and Iraq reportedly sought assurances that Israel would not sabotage the project, which could have become critical to Baghdad's economic survival. In 1981 Israel had bombed an Iraqi nuclear reactor that was under construction.
Peres has denied that he was offered or received a bribe, and his spokesman's approach Monday was intended primarily to repeat, "in the strongest possible terms" that any suggestion otherwise is "ludicrous, outrageous and completely unfounded."
Payments to foreign officials or political parties to gain or retain business are prohibited under the 1977 Foreign Corrupt Practices Act. Even if no payment was made or offered, the question has arisen whether Meese acted improperly by allegedly failing to report the suggestion contained in the Wallach memorandum.
The Foreign Ministry source said Monday that Israel was first approached on the pipeline project by a representative of Bechtel, believed to be Bruce Rappaport, an Israeli-born Swiss financier who agreed with Bechtel to become a partner in the project. Wallach represented Rappaport in the pipeline matter.
Became Government Matter
However, the source said: "Our problems (with the pipeline proposal) were problems that only government channels can handle. So it became a government-to-government matter" between the United States and Israel.
The proposed project was meant to protect Iraq's vital oil exports from any Iranian threat by routing them through a 540-mile pipeline to the Jordanian port of Aqaba. Iran and Iraq have been at war in the Persian Gulf since September, 1980.
The border between Israel and Jordan bisects the northern tip of the Gulf of Aqaba, with Aqaba on the east and the Israeli port and resort of Eilat on the west. The waterway is thus crucial to both. Israel was particularly concerned, the Foreign Ministry source said, about the ecological problems of a possible oil spill.
"The whole question of the ecology was brokered with Jordan through the United States," he said.
Senior officials said here Sunday that the Israeli government agreed not to interfere with the pipeline project primarily out of deference to Jordan, which is a close ally of Iraq and the key to most Israeli visions of some future Middle East peace agreement.
Official Stationery Used
"At a certain stage, Mr. Peres received a handwritten letter from Meese saying that George Shultz cannot handle the affair because of the possibility of a conflict of interest," the Foreign Ministry source said Monday. He said that the letter was written on Meese's official stationery but that he did not know the exact date on it.
The source said he could provide no explanation for why Meese would send such an official letter, in longhand, to a foreign head of state. Meese and Peres are not personal friends, he said.
The source suggested that Meese may have been responding to an inquiry from Peres about the proper address for contacts on the oil pipeline. He said he had been told that such a Peres letter to Meese exists, although: "I've never seen it." If true, he said, he assumes that the Israeli official contacted Meese "in his capacity as the legal adviser to the U.S. government." But the source said he could offer no explanation for why Peres might have been concerned about communicating through more normal channels.
Question of Earlier Contacts
The timing of the Meese letter, "sometime in 1985," also raises the question of whether Shultz may have been involved in earlier government-to-government contacts regarding the pipeline. Israeli officials have said previously that such contacts date from at least as early as late 1984.