Big Dreams for Iraqi Oil

Big Dreams for Iraqi Oil

[caption id="attachment_55234515" align="alignnone" width="620"] An Iraqi oil worker works at Al-Doura oil refinery [/caption]Iraq could become the second-largest oil exporter in the world by the 2030s, according to a study released on 9 October by the International Energy Agency (IEA).

Already the world’s third-largest oil exporter—it overtook Iran’s exports in in August—expansion in the country’s oil sector is expected to account for 45% of anticipated growth in world output over the current decade. If such growth were realized, Iraq could become the second most powerful member of OPEC and radically alter the balance of power in the region.

The country’s deputy prime minister for Energy, Hossein al-Shahristani, announced in a briefing on the report on 10 October that “the conclusion of our studies show that it’s feasible and desirable for Iraq to achieve a production of 9–10 million barrels per day by 2020.” He further promised that Iraq would seek to achieve that level of production, which corresponds with the predicted output levels in the report’s most optimistic scenario. The IEA’s more modest predictions put 2020 output between 5 and 6 million bpd. (Current production is 3.4 million bpd.)

The IEA outlines a number of obstacles to achieving an output of 9–10 million bpd by 2020. Most importantly, Iraq must more than triple its annual investment in the oil sector almost immediately, from US$7 billion in 2011 to US$26 billion per year. (If investment remains around 2011 levels or grows more slowly than anticipated, the study predicts that oil output would be only 4 million bpd by 2020.) It must invest a further US$6 billion in the power sector each year to 2035, to ensure first that peak grid capacity matches peak demand, and then to build a capacity buffer to prevent power outages. It must ensure that there is sufficient water supply for the extraction process, without compromising fresh water supplies required by the population. It would need to build facilities to capture associated gas from existing oil fields instead of flaring it; the natural gas collected would mainly support the domestic power and industry/manufacturing sectors.

[inset_left]The IEA outlines a number of obstacles to achieving an output of 9–10 million bpd by 2020. [/inset_left]

Infrastructure across many sectors would have to be improved: amongst other things, the country needs new roads and rail networks, more refinery capacity, and manufacturing facilities to support the fledgling petrochemicals sector and diversify the economy. Even if Iraq does sustain high levels of investment in the oil sector, to become a key exporter it would need to develop new ways to deliver the oil to market. According to the IEA, the country would ideally have two major pipelines running north to the Mediterranean and/or Black seas, as well as increasing its capacity to transport oil internally, hold it before export, and load tankers at offshore facilities. Iraq currently exports the majority of its oil through the Straits of Hormuz, a politically contentious sea passage that is often mined by Iran (and the subject of repeated Iranian threats to close it entirely). A main pipeline, which runs from Kirkuk north to the Mediterranean port of Ceyhan in Turkey, has a nominal capacity of 1.6 million bpd; neglect and damage from years of conflict have brought its operating capacity to only 600,000 bpd. A further pipeline to carry natural gas from Iraq to Europe via Turkey was planned—and would have been extremely useful, as it would have provided further revenue by exploiting this byproduct of oil production—but the project is likely to be scrapped this year due to changed economic circumstances in the EU.

As daunting as this may sound, it seems unlikely that the real impediment to such a major increase in production in Iraq will be in investment or infrastructure. Oil has been a source of extreme tension in Iraq for nearly a century; conflicts over it have been an inciting factor in (arguably) the three wars in the country since 1980. After the fall of Saddam Hussein in 2003, analysts had hoped that increased oil production would help repair the country’s tattered economy. This has hardly been the case: even if all the other obstacles to realizing the IEA’s predictions are disregarded or disposed with, it is impossible to ignore instability, corruption, and violence in Iraq.

While the 2005 constitution guarantees that “oil and gas are owned by all the people of Iraq in all the regions and governorates,” the government in Baghdad and the autonomous region of Kurdistan have been quarrelling over rights and access to substantial oil reserves located in the northern province. Baghdad’s refusal to enter into anything other than unattractive, low-paying service contracts with international oil companies (IOCs) has led several—notably Exxon and Chevron—to sign deals directly with Erbil. The region is offering significantly more favorable profit-sharing contracts, with a return of US$3–5 per barrel extracted compared to approximately US$1 in the south. Baghdad considers bilateral deals with Kurdistan to be illegal and unconstitutional, and has barred several IOCs that have contracts with Kurdistan (again notably Exxon) from bidding for contracts to develop oil production in the south. Due to this ongoing dispute, transport of oil via pipeline from Kurdistan has been halted in recent months, and the oil that does reach the markets is sold significantly below market value (US$60 per barrel, according to the New York Times). A new pipeline developed independently with Kurdistan is expected to be operational within two years, which should ameliorate the situation in that region somewhat. It will still take many years to resolve the political tensions between the two sides.

Baghdad’s dispute with Erbil highlights a major impediment to increases in oil output: the lack of a suitable hydrocarbons law to facilitate and regulate access to oil fields by the IOCs the country needs to help bring output in line with capacity. A controversial 2007 hydrocarbons bill was heavily contested by Iraqi citizens, largely because it sought to take control of oil away from the Iraqi government and award control to foreign (mainly Western) companies for 25 to 30 years in production-sharing deals. By 2009, the draft law had been all but scrapped and the government had tried to award eight service contracts to IOCs. Only one was taken up—by BP and CNPC (China)—although it was in the largest field at Rumailia. By failing to offer good profits on new concessions with IOCs, the country is also failing to balance the risk on doing business in a new, unstable country. Perhaps more alarming to the country is that, according to the IEA report, 95 percent of government revenue is derived from oil production. Thus delays in the hydrocarbons law in turn delay increased production and thus deprive the country of money needed to invest in infrastructure: a vicious circle.

The potential of Iraq’s oil sector is not limited by the size of its reserves, but by the country’s ability to organize, support, and fund its extraction and delivery to market. While Saudi Arabia currently has the largest proven oil reserves, Iraq is likely sitting on the largest oil reserves in the world: its resources have simply yet to be proven. Iraqi oil is also extremely inexpensive to extract. Three decades of conflict, dictatorship, and poor management have weakened the infrastructure needed to fully exploit that potential. Its citizens have much to gain: a well-managed expansion in oil production could relieve the high unemployment rate (16% in June 2012, according to the planning ministry), or even support direct cash payments to Iraqi citizens (as was proposed in a 2009 draft hydrocarbons law). But if Iraq is to realize its dreams, the government must act immediately and efficiently—and this, sadly, seems unlikely.
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