WASHINGTON, Dec 17 (Reuters) - A U.S. government report raises the possibility that private security firm Blackwater could lose its license to protect U.S. diplomats in Iraq and advises making contingency plans, two sources familiar with the matter said on Wednesday.

Five Blackwater guards were charged on Dec. 8 with killing 14 unarmed civilians and wounding 20 others in a 2007 Baghdad shooting that outraged Iraqis and raised questions about the firm's ability to keep working in Iraq.

The State Department relies heavily on North Carolina-based Blackwater and other private security companies, many of which are staffed by former U.S. soldiers, to protect its diplomats in Iraq, the West Bank and other dangerous places.

The two sources described the draft report prepared by the State Department Office of Inspector General (OIG) on condition that they not be named because it has yet to be made public.

"The department faces the real possibility that one of its primary worldwide personal protective services contractors in Iraq -- Blackwater USA -- will not receive a license to continue operating in Iraq," said the report, referring to a license issued by the Iraqi authorities, the sources said.

The OIG is a quasi-independent office whose mission includes preventing fraud, abuse and mismanagement as well identifying vulnerabilities and recommending solutions.

The sources stressed that the report did not recommend dropping Blackwater, the largest security contractor in Iraq. One source said that inspector general reports typically recommend that agencies prepare for "worst-case" scenarios.

A State Department spokesman said the department will not make a decision whether to retain the company's services in Iraq until a Federal Bureau of Investigation probe into the 2007 incident is completed.

The shooting occurred as Blackwater guards escorted a convoy of U.S. diplomats through Baghdad on Sept. 16, 2007. The guards, U.S. military veterans, were responding to a car bombing when shooting erupted in a crowded intersection.

In a 35-count indictment, the U.S. Justice Department charged the guards with 14 counts of manslaughter, 20 counts of attempt to commit manslaughter and a weapons violation count.

When the charges were unveiled, Blackwater said it believed the guards acted "acted within the rules set forth for them by the government and that no criminal violations occurred."

Undersecretary of State Patrick Kennedy, who led the State Department's original investigation into the 2007 shooting, said the department is always ready to protect its diplomats.

"The State Department takes very seriously its obligation to provide security for its personnel around the world in an appropriate manner," he said. "We are always prepared to deal with changing circumstances." (Editing by Eric Walsh)

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