The Fuse

ISIS and Low Oil Prices Cast Long Shadow Over Iraq

June 10, 2015

Guest Post by Matthew M. Reed | @matthewmreed

Matthew Reed is Vice President of Foreign Reports, Inc. and a non-resident fellow at New America and the Payne Institute at the Colorado School of Mines.

So far, the physical damage done to Iraq’s oil industry by ISIS has been limited. But the cost of fighting a bloody insurgency—when oil prices are low—has effectively taken the country’s investment plans hostage. There is no reason to believe ISIS will be defeated soon, and it will likely take much longer for Iraq’s production outlook to recover.

Although the major forecasting agencies expect Iraq to meet a significant portion of global oil demand growth through 2020, all costly projects are under special scrutiny due to the budget crisis, no matter how essential they might be towards bolstering supply.

The ISIS blitz in the summer of 2014 left the group in control of several Iraqi oil fields and tens of thousands of barrels in daily production (b/d). Following the collapse of the Iraqi army in the north, there was no telling where ISIS would stop. The group set its sights on Kirkuk and nearby oil fields, as well as Erbil, the capital of the oil-rich Kurdish region. Early on it seemed possible that ISIS could march on Baghdad and even threaten Iraq’s largest oil fields in the south.

The fall of Mosul in June 2014 sent shockwaves through the market: Benchmark oil prices surged to $115 per barrel in the aftermath. At its height, ISIS produced maybe 70,000 b/d in Syria and Iraq, according to the IEA. It is now producing only a fraction of that thanks to coalition airstrikes, Kurdish advances on both sides of the Iraqi-Syrian border, and recent offensives by Iraqi pro-government forces. ISIS has made inroads of late but its oil network appears severely constrained. What was a fountain of easy money has been reduced to a trickle.

In spite of the ISIS threat, Iraq actually increased oil production last year.

In spite of the ISIS threat, Iraq actually increased oil production last year. Total output from southern fields and Iraqi Kurdistan rose by 330,000 b/d in 2014. “Iraq was the second-leading contributor to global oil supply growth in 2014, behind only the United States” according to the EIA. Tensions remain but Baghdad and Erbil are now sharing a pipeline and exporting crude via Turkey. Exports reached a record high of 3.08 million barrels per day (mbd) in April.

Recent gains mask deeper problems, however. The conflict has jeopardized several longer-term investments—some of which were overdue, many of which could be set back by years. Iraq’s production outlook is further complicated by the steady slide in prices going back to last year.

Plans to develop natural gas fields were shelved when ISIS went on the offensive in Anbar province early last year and later threatened Diyala province. Production at the Akkas field in Anbar, near the Syrian border and deep inside ISIS territory, was supposed to reach 400,000 million cubic feet per day in September. Anbar is now an ISIS stronghold and, even if it is liberated soon, ISIS will likely remain a major presence in eastern Syria, meaning Akkas will remain within striking distance. Yet another casualty was the Mansuriya field in the east, close to the border with Iran. Field operator TPAO says work may not restart for another year but that was before ISIS launched a new wave of attacks in the area.

The fight against ISIS and the recent price collapse also threaten Iraq’s plans for increased oil production in the south, even though fields are safe there. “Unless there is a significant increase in oil prices, you won’t see any major increases [in oil production capacity],” Lukoil Senior VP Gati al-Jebouri said in April. Lukoil operates the giant West Qurna-2 field outside of Basra. “The priority now is to maintain steady production. You will not be seeing any incremental increases in 2015 or even 2016,” one unnamed oil executive told Reuters on April 22. “From where? Certainly not from the south. Who will increase?”

Without the Common Seaweater Supply Project, there is no way Iraq can double oil production by 2020 as planned.

The extremely important Common Seawater Supply Project (CSSP) is already three years behind schedule. When finished, it will pressurize the largest southern fields with 12.5 mbd of treated seawater, allowing the Rumaila, West Qurna, Zubair, Gharraf and Majnoon fields to all raise production and keep it steady. The price tag is at least $10 billion; without it, there is no way Iraq can double oil production by 2020 as planned.

The project’s scope and cost have inspired much bureaucratic foot-dragging over the years—and that was even before oil prices fell by half. As a result, international oil companies like ExxonMobil, Lukoil and Petronas have asked Baghdad for permission to build smaller water injection plants. None of these projects are designed to replace the CSSP. Instead, they will redirect much smaller volumes of water from rivers in order to raise oil output and delay the date at which it will plateau. In February, a U.S. firm was awarded a design and engineering contract for the CSSP, but it’s only a small step in the right direction. Iraq’s budget crisis means that any and all big ticket expenditures will come under special scrutiny, even if some investments are absolutely essential.

Oil Minister Adel Abdul Mahdi has made no secret of Iraq’s predicament. “I have been told in many fields the situation is not good….We have a big plan for [water] injection. But it will take many years and lots of money. We are moving on that,” he told Platts on the sidelines of last November’s OPEC meeting.

Iraq is already $9 billion in debt to oil companies and contractors for 2014.

In March, Abdul Mahdi painted a grim picture of state finances. Iraq is already $9 billion in debt to oil companies and contractors for 2014. Meanwhile, this year’s planned projects and services could add another $18 billion to the tab. But according to Article 34 of the 2015 budget, Iraq’s Oil Ministry can only borrow up to $12 billion to pay debts to international oil companies this year.

To be safe, the oil ministry has asked foreign companies to cut costs and reconsider their development schedules. Eighty-five percent of the 2015 federal budget is to be funded by oil revenues, however, under deals inked in 2009, more and more of Iraq’s revenue-generating exports are to be set aside as compensation for oil companies (i.e. payback oil). BP and Lukoil are considering hundreds of millions of dollars in investment cutbacks, but that may not be enough relief for the country’s oil production outlook.

Iraq’s potential is undeniable. But the future of its most important industry is in doubt.