Country Focus: Iraq's unenviable juggling act
Iraq's oil sector resembles a phoenix rising from the ashes, as two foes pull on its tail feathers: the low oil prices since mid-2014, and the economic and social destruction wrought by ISIS in the north.
An unfortunate track record means Iraq’s oil sector is increasingly characterised by its ability to bounce back from crippled finances and broken energy infrastructure. In 2003, Iraq had hundreds of burning oil wells, spluttering oil production, and the state-owned Iraq National Oil Company was in disarray. In 13 short years, OPEC’s second largest producer has bolstered oil production to a record high despite the heavy economic toll of ISIS’ swift march onto northern Iraqi soil in early 2014.
“Iraq has been plagued by the actions of ISIS. With major setbacks in the fight against the terrorist group in Iraq, the Obama administration has been faced with questions about its strategy,” Luis E Giusti, a senior advisor on energy and national security for Washington-based thinktank the Center for Strategic and International Studies told Oil and Gas Middle East. “But what is remarkable is how little the crisis is affecting Iraq’s oil sector, as the country has succeeded in steadily boosting oil output.”
Iraq’s current production, which includes output in the semi-autonomous region of Kurdistan, is around 4.5mn bpd. Kurdistan produced 567,000 bpd in June, according to the Kurdistan Regional Government’s (KRG) Ministry of Natural Resources. Iraq’s production has fallen slightly on the record high of 4.8mn bpd in January, due to power outages, infrastructure maintenance and unpredictable weather patterns. Still, current production marks a 7% increase on the 2015 average of 4.2mn is nearly double the 2010 average of 2.4mn bpd.
This bullish trend meant that Iraq and Saudi Arabia spearheaded the rise in OPEC’s average crude oil production of 31.8mn bpd last year – an increase of 800,000 bpd from 2014. Iraq’s exports from its southern ports are approximately 3.14mn bpd in June. Oil exports accounts for almost 90% of government revenues, with Baghdad making $3.845bn in June after selling at an average price of $40.37 a barrel. Baghdad must also meet swelling domestic energy demand, which is expected to climb by 4% a year between 2015-2035, according to energy consultancy Wood Mackenzie.
Iraq’s plans to bolster production capacity to as high as 6mn bpd – a 33% hike – by 2020 faces a barrage of cynicism, as energy stakeholders expect Baghdad to focus the country’s thinning cashflow on improving security. More than 250 people were killed on July 2 by the single deadliest of the many car bombings that have occurred in Baghdad since the 2003 US-led invasion, and 10mn of the country’s 37mn people need humanitarian assistance.
Meanwhile, the always tense and occasionally stormy relationship between Baghdad and the semi-autonomous Kurdistan Regional Government (KRG) continues. A brief illustration of the discord occurred last year, when the KRG independently sold off all of its own oil to raise cash without Baghdad’s permission after failing to receive the proper allocations in Baghdad’s 2014 and 2015 budgets. Baghdad countered that the KRG failed to deliver the agreed oil transfers. The KRG are revisiting plans to build a 250,000 bpd export pipeline of Kurdish oil to Iran in a bid to strengthen the government’s energy economics, which are also hampered by prolonged shutdowns on its sole export pipeline from Kirkuk to the Turkish port of Ceyhan. Mounting economic strain is also fuelling political bickering in the upper echelons of Iraq’s government.
“Politically, things have worsened dramatically in Iraq,” Richard Mallinson, an analyst at consultancy Energy Aspects told Bloomberg after protesters accusing the government of stalling reforms stormed parliament in Baghdad on April 30. “It is a negative for the country’s oil industry over the medium term. We are going to see production plateau and start to decline later this year, as government turmoil and spending cuts affect projects needed to maintain output.”
Iraq’s economy is nearing a precipice. Brent oil prices are hovering around $50 a barrel, which is 60% lower than in mid-2014 and more than a third below the estimated $81 a barrel that Iraq needs to keep its budget balanced. Plus, the Central Bank of Iraq’s stock of foreign reserves, which includes gold, fell from $78bn in late-2013 to around $50bn in May this year, according to ratings agency Fitch. The $50bn represents nine months of external payments under current conditions and does not account for a significant deterioration in security, or another sharp fall in oil prices.
In a bid to encourage growth and stabilise the financial sector, the International Monetary Fund (IMF) suggests that the legal framework of the Central Bank of Iraq needs to be strengthened, state-owned banks need to be restructured and exchange restrictions need to be gradually removed. The IMF also advises measures to prevent money-laundering, counter the financing of terrorism and strengthen the anti-corruption legislation. All good advice, but energy stakeholders wonder how quickly changes can be implemented considering the number of balls strained officials in Baghdad are already struggling to juggle. The IMF’s approval of a $5.34bn, three-year stand-by arrangement in early July should temporarily ease some pressure.
Iraq has the potential to recover from a low base and grow at 7.2 % in 2016 and hover around 5% in the next few years, according to the World Bank’s latest Iraq Economic Outlook report. The forecast relies on an increase in oil-related foreign direct investment (FDI), structural reforms, the implementation of IMF’s programme and an unlikely but possible reduction in ISIS’ influence. Equally, a weakening oil price, more social instability sparked by reforms – such as public pay structures – or ISIS’ capture of even one of Iraq’s giant southern oilfields would create a much more unnerving future.
Nurturing foreign allies
International energy companies’ support lies at the heart of Iraq’s ability to both sustain and ramp up oil output amid tremendous pressure. But it has not been an easy road. Iraq still had $3.6bn in arrears to pay to international oil companies as of late-June, which it has committed to paying off by the end of September by increasing oil allocations to the firms.
“The accumulation of large external arrears to international oil companies and domestic arrears in 2015 was unfortunate. Existing arrears should be paid down, following a due process of checking their validity and the implementation of controls to prevent the further accumulation of arrears to international oil companies and domestic suppliers,” Min Zhu, the deputy managing director and acting chair of the IMF’s executive board has said.
Financial and technological expertise provided by international oil companies have been deeply interwoven into the narrative of Iraq’s oil sector since the beginning – it is a relationship that Iraq cannot afford to jeopardise. BP’s involvement began in the 1920s, for example, when it helped Iraq locate, produce and export oil from Baba Gurgur, Kirkuk, which was the largest oilfield in the world at the time. The development of the Rumaila field decades later, which now accounts for a third of Iraq’s production, illustrates the integral role of foreign allies in providing financial springboards from which Iraq can strengthen its economy.
In 2009, a 25-year technical service contract (TSC) was signed between Iraq’s South Oil Company (SOC), BP (47.6%), PetroChina (46.4%) and the country’s State Oil Marketing Organisation (SOMO) (6%) to re-develop Rumaila. The Iraqi government receives around 98% of the revenue from the joint venture that was established in 2010 and spearheaded by BP to operate the field.
The TSC has been extended to 2034 with the aim of increasing production to 2.1mn bpd from the 1.34mn bpd in 2014, according to BP, which would mark a 57% increase in a decade. If the development is successful, it would more than double the 950,000 bpd produced at Rumaila in 2010.
Four other giant oilfields make up the majority of Iraq’s production. The 450,000 bpd from West Qurna 1 is developed by Exxon Mobil, the 405,000 bpd from West Qurna 2 is developed by Lukoil, with 220,000 bpd and 360,000 bpd from Shell’s Majnoon and Eni’s Zubair, respectively, as outlined by Hayan Abdulghani Abdulzahra, the head of the SOC to Reuters.
Iraq is expanding its oil storage capacity in the south by 21% to 14mn bpd by the first quarter of 2018, from today’s 11.5mn bpd, and plans are underway to build the country’s fourth single point mooring (SPM) facility by mid-2017. Aside from reducing the number of costly export bottlenecks, increasing storage capacity allows sellers to store their products and wait for the inevitable rise in oil prices before going to market. Widening the country’s export capacity will also enable Baghdad to take advantage of the growing number of energy supply deals along the ‘New Silk Road’, which stretches from Beijing to Lagos.
“Iraq’s Ministry of Oil appears to be laying the foundations to grow the country’s crude exports and production, having made output growth a top priority. By focussing on improving infrastructure, Iraq is showing a long-term commitment to international oil companies developing its largest oilfields,” Paul Hickin, the associate editorial director of Europe and Africa’s Oil News and Analysis at global energy pricing agency and news provider S&P Global Platts, told Oil and Gas Middle East.
“Finalising the southern infrastructure project with ExxonMobil and China National Petroleum Corporation by the end of the year would be a real statement of intent,” Hickin added.
The SOC is searching for investments to support the Integrated South Project, which consists of building oil pipelines, storage facilities and enhanced oil recovery (EOR) at several small southern fields, including the Luhais, Nassiriya, Tuba, Nahr Bin Umar and Artawi oilfields. The state of current negotiations is vague, despite initial plans to bolster production by 45% to 350,000 bpd this year.
Iraq’s ambitious tone is reassuring investors, but sentiment only goes so far. Shell has reduced its workforce at the Majnoon oilfield near Basra and Baghdad has asked to only pay the China National Petroleum Corp (CNPC) for its efforts to double production at the Halfaya oilfield to 400,000 bpd once oil is actually produced. Debt-ridden Gulf Keystone, which produces 40,000 bpd from the Shaikan oil field in Iraqi Kurdistan and has proven and probable reserves of 639mn barrels, completed a forced restructuring in mid-July. Bondholders swapped $500mn in debt for an 85.5% equity stake, while a $7mn payment from the KRG in mid-July for the Shaikan oil exports in May could also relieve some pressure.
The outlook for Iraq’s oil industry is too unpredictable to even speculate. Will ISIS push southwards and derail oil production, will social unrest escalate and force Baghdad to deepen spending cuts, will oil prices soften again, or will deteriorating relations between Baghdad and Erbil mark the start of a new chapter of challenges? In Iraq, uncertainty is the only certainty.