Blackwater could lose its licence to operate in Iraq, rendering it unable to provide security for US diplomats, a US State Department internal report says.
The report, commissioned by Secretary of State Condoleezza Rice, said the department should look for other ways to protect diplomats, US media said.
Ms Rice ordered a review of the use of private security firms after Blackwater guards killed 17 Iraqi civilians.
Five guards have been charged with manslaughter over the shootings.
The incident triggered outrage in Iraq and led to a debate about the role there of private security companies – upon which the US relies heavily.
Earlier, the Associated Press news agency reported that the report recommended against renewing Blackwater’s contract, citing an official linked to the report.
But that specific recommendation was not included in the report itself, AP said later. A recommendation would not be made until the investigation into the civilian shootings was complete, it quoted the same official as saying.
Based in North Carolina, Blackwater was one of the first private security firms to work in Iraq following the US-led takeover.
It provides guards and security for American and other diplomats in the country.
But the company has been under intense scrutiny since its guards opened fire at a busy Baghdad intersection in September 2007, killing 17 Iraqi civilians.
Blackwater says the guards’ convoy came under attack from insurgents.
Five of its employees have now been charged in the US with manslaughter and other offences, but the company itself has not faced charges.
Blackwater’s contract with the US government comes up for renewal early next year – so the decision on whether to renew it will be taken by US President-elect Barack Obama’s administration.
It is not clear how the US might replace Blackwater.
But the report recommended that the State Department increased the presence of its Diplomatic Security Service in Iraq, AP said.