The Fuse

Long Term Political, Economic and Security Challenges Hit Iraq’s Oil Sector

by Nick Cunningham | April 05, 2016

Oil prices have increased nearly 50 percent since early February due to a variety of reasons, including falling U.S. oil production, a weakening U.S. dollar, technical trading and the prospect of an OPEC production “freeze.”

But another under-reported reason for an uptick in oil prices is the unexpected supply outages, particularly from a few key OPEC producers. Iraq, Nigeria and the UAE combined for oil production losses of about 350,000 barrels per day in February, unanticipated outages that caught oil markets by surprise and more than overwhelmed Iran’s output gains.

Iraq, as the largest source of OPEC supply growth in 2015, is particularly important to watch. Security-related challenges have disrupted Iraq’s production in the short run, but fiscal pressure and political gridlock threaten to do lasting damage to Iraq’s ability to substantially ratchet up oil production in the years ahead.

Pipeline disruptions

Iraq’s oil production fell by 210,000 barrels per day in February, down from a record 4.43 million barrels per day (mbd) in January, according to the IEA.

The disruption to Iraq’s oil supply occurred because of an outage of a critical pipeline that connects Iraq to Turkey’s Mediterranean coast in Ceyhan. Between February 17 and the middle of March, the 600,000 barrel-per-day pipeline was shut down. Confusion over the exact cause of the shutdown continued for a few weeks. Even Kurdistan’s Prime Minister was unsure of the reason for the closure more than 10 days after oil stopped flowing. Turkey blamed the disruption on damage from an attack by the Kurdistan Workers’ Party (PKK) in Turkey, although the PKK denies any involvement.

The inability to temporarily export oil devastated the finances of the Kurdish Regional Government in northern Iraq. Revenues plunged by half, dropping from $650 million in January to just $303 million in February. That has exacerbated the existing financial crisis that Kurdistan finds itself in, as low oil prices cut into revenues, the war against the Islamic State consumes scarce resources, and the political standoff with the Iraqi government in Baghdad has blocked access to the 17 percent of national revenues that the KRG is entitled to.

The pipeline was reportedly fixed and reopened in mid-March after three weeks offline, but then another snag interrupted oil flows. The Iraqi state-owned North Oil Company stopped oil exports on March 17, ostensibly over a technical issue. A more likely explanation was that Baghdad was trying to exert pressure on the KRG to resolve their dispute over revenue sharing and control over oil exports. The political dispute dates back to a December 2014 agreement between the Kurdish government and Baghdad, the details of which consist of the Kurds exporting oil under Iraqi government control in exchange for its portion of national revenue.

Reduced leverage for the Kurds means Baghdad now has the upper hand, and realizing that, the Iraqi government is no longer in a rush to seal a deal.

The deal was never really implemented successfully, with finger pointing from both sides. The Kurds are reportedly now so desperate for a new oil deal that they are even considering accepting 17 percent of actual oil revenues rather than 17 percent of the national budget. Of course, reduced leverage for the Kurds means Baghdad now has the upper hand, and realizing that, the Iraqi government is no longer in a rush to seal a deal.

Political and security issues across Iraq 

While the Kurds deal with a fiscal crisis, political turmoil swept into Baghdad in March, as weeks of protests from thousands of people over government corruption brought parts of the city to a standstill. Led by the influential Shiite cleric Muqtada al-Sadr, the protests forced Iraqi Prime Minister Haider al-Abadi to reshuffle his cabinet on March 31, putting technocrats at the top of several key ministries, including the oil ministry.

Meanwhile, Iraq faces yet another impending disaster. Reuters reported that U.S. Secretary of State John Kerry handed a confidential note personally written by President Barack Obama to Iraq’s Prime Minister when they met in Davos in January. The note laid out President Obama’s frustration with the Iraqi government’s inability to address the potential failure of the country’s largest dam near Mosul. Without repairs and maintenance, it is possible that the dam could break within the next few months, and if that were to occur, 500,000 to 1.47 million people “probably would not survive” if they are not evacuated in time, according to a U.S. government assessment. Everyone seems to agree that the disaster would be “biblical.” On March 2, Iraq inked a $296 million contract with Trevi Group, an Italian engineering firm, to repair the dam. However, it could take months before work can begin.

All of this bad news comes as the war against the Islamic State is finally making significant progress, a handful of high-profile attacks in Europe notwithstanding. ISIS has not pulled off a successful attack in Iraq since Ramadi in May 2015. ISIS offensives since then have been crushed, with the militant group suffering casualty rates of 60 percent or higher in some cases, according to the Brookings Institution. The group is losing territory, morale is low, and they regularly disperse when confronted. In 2014, U.S. intelligence said that ISIS was producing 70,000 to 80,000 barrels of oil per day. But the military campaign has cut that in half, and the group now only produces about 20,000 to 40,000 barrels per day, according to the latest and best estimates. Mosul is now within reach for Iraqi and coalition forces.

On the other hand, the corresponding political track is lacking. As Kenneth Pollack of the Brookings Institution puts it, “Even decisive military success against Da’esh is likely to prove ephemeral if there is no plan (nor any effort to implement such a plan) to create a political context where tactical military victories can be translated into enduring, political achievements.”

A quick retake of Mosul may only lead to chaos because there is no post-ISIS political plan for Mosul, or for the rest of Iraq.

Coalition forces are beating back ISIS, but there is a “danger of catastrophic success,” Pollack says, fresh back from a trip to Iraq. A quick retake of Mosul may only lead to chaos because there is no post-ISIS political plan for Mosul, or for the rest of Iraq. Without a political-economic program, or an attempt at sectarian reconciliation, the “liberation” of Mosul could result in “yet another American-Iraqi fiasco.” Unfortunately, military success followed by political failure has been an “American trademark” in Iraq dating back to 1991.

Iraq’s oil sector faces uncertain future

Southern Iraq, home to most of Iraq’s oil production, is also facing deteriorating security even though it is far from the battlefields of the Islamic State. Crumbling public services and high unemployment has fueled unrest, rattling the international oil companies operating there. Moreover, low oil prices and fiscal pressure on the Iraqi treasury have forced oil companies to cut investment in Iraq’s massive oil fields. Ultimately, that puts Iraq’s long-term production into doubt.

It was only a few years ago that Iraqi government predicted that it would triple its oil production to 9 mbd by 2020, an estimate that now looks absurd. Kenneth Pollack says that not only has Iraq’s oil production likely hit a wall this year at 4.2 mbd, but “many Iraqi government officials are concerned that oil production might even begin to decline in 2017.”