Uncertainty for Iraq oil industry as troubles divide country
The Islamist-led Sunni surge leaves Iraq on the brink of collapse. Derek Brower assesses what it means for the country’s oil industry
In the space of a just few weeks, Iraq has gone from a troubled state to one on the verge of failure. Vast swathes of the country’s north are now in control of Sunni Islamists who have declared a caliphate stretching through Syria and Iraq - and wish to conquer Baghdad, too.
A re-ignition of the 2007-08 sectarian war may be unavoidable and Iraq’s partition grows likelier by the day. Even if a break-up of the country along sectarian lines can be avoided, the advance of the Islamic State (IS), the Islamist group formerly known as the Islamic State of Iraq and the Levant (ISIL), has changed the political calculus for the country, whose politicians haven’t yet even formed a government more than two months after April’s parliamentary elections.
Iraqi Kurdistan is on the verge of independence, with a referendum in the works and independent pipeline exports via Turkey established. Kirkuk and the disputed areas between Iraqi Kurdistan and the rest of Iraq are under the control of the peshmerga. It is difficult to imagine Baghdad ever regaining them. “Pre-Mosul Iraq has gone and there is a new reality,” Ashti Hawrami, Iraqi Kurdistan’s energy minister, told Reuters recently, referring to ISIS’s capture of the city in June.
What does the IS advance and the fracturing of Iraq mean for its oil sector and the world’s market? The ISIS-led Sunni surge has triggered some of the worst violence seen in Iraq since the civil war six years ago. The bloodshed may get worse. Some of Iraq’s oil infrastructure is under threat. Sabotage has shut the Iraq-Turkey Pipeline (ITP) since March. It passes through IS-controlled territory, so there is no prospect of fixing it. IS and Iraqi federal forces were battling for Baiji and its refineries as Petroleum Economist went to press (both sides claim to be control of the complex). The 310,000 barrel a day (b/d) Baiji complex, Iraq’s largest, supplies a third of the country’s petroleum products and would support IS efforts to build its own petro-state. Oil is crucial to IS ability to self-finance – it controls oilfields in Syria and has established tea-pot refining operations, even laying plastic pipelines to smuggle products to buyers in Turkey. Winning Baiji would boost the insurgency and damage Iraq: petroleum shortages have already emerged in areas depending on its products, including Kurdistan.
Elsewhere, Anbar province, in Iraq’s west, is wholly under IS control: Kogas, the South Korean firm developing the Akkas oil- and gasfield, has withdrawn all its workers. Federal forces have reportedly stopped guarding the facilities, too. However, the megaprojects in the Shia-dominated south, the bedrock of Iraqi oil production and exports, are largely immune to the unrest, so far. There have been rumours of IS sleeper cells and jihadists entering Iraq’s south to target its oil facilities; a recent car bomb in Basra shows that the region is not entirely insulated from the violence. But terrorists have been trying to hit the south’s oil infrastructure for years, with little impact.
International oil companies (IOCs) have beefed up security in the south, and some have removed non-essential workers. BP is understood to have withdrawn 20% of its staff in Rumaila; ExxonMobil’s American workforce has left; and Eni has offered staff the option of working from Dubai. That doesn’t mean Basra and the south are entirely safe. The Iraqi government pulled police and troops out of southern Iraq six to eight months ago to deploy them against ISIS in Anbar, points out Kenneth Pollack, of the Brookings Institution, a US think tank. Eleven of 17 army battalions, for example, were redeployed from Basra before ISIS’s Mosul offensive, leaving the south more vulnerable than before, implies Pollack. Should IS penetrate Baghdad, it could also threaten water and electricity supplies to the south, while wreaking havoc on the central government.
IS will not, though, gain any territory in Basra. Its swift advance in the north and west came in part from the support of Sunni tribes alienated by Nuri Al-Maliki, Iraq’s prime minister. The Shia of the south are by no means united in defending Iraq’s integrity or Maliki. But IS would have no support in a region now crawling with Shia militias spurred into action by their religious leaders.
Meanwhile, oil infrastructure continues to come on stream near Basra. Exports from the south hit 2.582 million b/d in May, the highest since 2003, but were back down to 2.423m b/d in June because of maintenance on two jetties, which were left idle for the whole month. A third single-point mooring buoy in Basra is now up and running. Oil minister Abdul Kareem al-Luaibi says IOCs are working normally in the country and exports will “surge” in the coming months. Officially, Iraq says oil exports will rise to 3.4m b/d by the end of the year, as the new loading infrastructure near Basra starts up.
Oil price predictions
Figure 1: Conflict in Iraq, as of 5th July 2014
The stability of southern Iraq has been reassuring to the oil market, which has defied some wilder forecasts that the IS advance would cause a spike in prices. After rising to around $115 a barrel in the days following the Islamists’ capture of Mosul, front-month prices have retreated back to around $111/b. But the longer-term impact of Iraq’s deterioration will be more troubling for both the country’s oil sector and the world’s markets. The International Energy Agency (IEA) said in 2012 that Iraq would account for 45% of global oil output growth until 2035, with production rising to 6.1m b/d in 2020 and 8.3m b/d 15 years later. Both targets have looked doubtful for some time. The political deterioration makes them unrealistic.
Problems like Iraq’s chronic red-tape and corruption will not improve while the government - assuming one acceptable to all parts of the country can be formed - is distracted by violent threats to the country’s very integrity. Baghdad lacked bureaucratic capacity to process basic paperwork in the energy sector before the insurgency.
The IEA predicted that Iraq would need more than $500bn of cumulative investment in its upstream by 2035. But given worsening security and the threat of war, the terms of the services contracts with the IOCs, already a source of discontent for investors, may now need to be revised if Baghdad is to draw in further investment. Either way, delays are inevitable.
The insurgency is also stymying Iraq’s export options. Although capacity through Basra is rising, the ITP has been shut since March. There is little prospect of it re-opening as long as IS controls the territory through which it passes. Nor is there hope, for now, of building a planned 2.25m b/d pipeline to Jordan: it would pass through Anbar, also under IS control.
Even if a political solution is reached, the long-term prospects for the oil sector are cloudy. Any settlement would certainly see Kurdistan gain greater autonomy. Other provinces, including the Sunni-majority ones in the north but also Basra, would demand similar concessions. Central control over the country and its oil sector could be devolved, adding layers to the bureaucracy and new authorities for investors to deal with.
Kurdish ambitions for independence from Iraq are now in plain view. The insurgency has given this political momentum, not least by allowing the peshmerga, the Kurdish army, to take full control of Kirkuk and disputed areas unopposed by the Iraqi federal army, which melted away in the face of the Islamist onslaught. A Kurdish referendum on independence may be held within months.
Rising Kurdish oil output and newly operational infrastructure have underpinned the Kurdistan Regional Government’s (KRG) plans for independent oil exports. A pipeline connecting the Taq Taq oilfield to Khurmala Dome, southwest of Erbil, and from there to Fish Khabur, on the Turkish border, where it connects to the Turkish section of the ITP, has been shipping oil to Turkey this year. Capacity, now 300,000 b/d, will eventually rise to 1m b/d, says the KRG. Exports through the line are now about 125,000 b/d. But KRG energy minister Hawrami said in London last month that exports would reach 200,000-250,000 b/d in July and 400,000 b/d by the end of the year. Rising output from the Taq Taq, Tawke and Shaikhan fields make this plausible, although Wood Mackenzie, a consultancy, predicts exports will reach just 200,000 b/d by the end of the year.
More importantly, the KRG, defying Baghdad, has now begun exporting the oil that has stockpiled for months in tanks in Ceyhan. Cargoes have been sold for about $101/b to unnamed traders in Turkey: four have loaded so far. A senior Kurdish oil official told Petroleum Economist that five had been sold. The US, which continues to oppose independent Kurdish exports, helped prevent some of those cargoes from reaching either Morocco or southern Europe. Israel has now emerged as a buyer and one cargo has unloaded south of a refinery in Ashkelon. The KRG denies it has struck a deal with Israel, aware of the political significance of such a buyer. (Israel’s foreign minister told the US that a Kurdish state is a “foregone conclusion” and that it would be swift to recognise it.)
KRG ministry sources say the oil is being sold on a freight-on-board basis, meaning Erbil is not responsible for the crude’s destination. Kurdish officials talk of establishing a precedent of sales to reassure future buyers that Baghdad could not intervene - “facts on the ground”, in Hawrami’s words. Once established, the KRG plans to ship one or two 1m barrel cargoes out of Ceyhan each week. Momentum is behind the Kurds’ oil plans, and so is desperation. In June, the Supreme Court in Baghdad ruled against the central government’s plea that recent Kurdish oil exports were illegal. The KRG heralded the ruling as “clear victory”.
Cash flow concerns
Meanwhile, the budget dispute between Erbil and Baghdad has left the KRG starved of cash. As long as the KRG could not export the 400,000 b/d required by the federal budget, it would not receive its 17% entitlement to the budget’s funds. Having received just $900m of $6bn it is owed, according to Hawrami, the KRG has borrowed $1bn from foreign lenders and $2bn domestically, secured against future oil exports. That looked a gamble given Baghdad’s opposition to the KRG’s independent oil-export strategy. But the insurgency has drained Baghdad’s political power. Any political or military solution to the insurgency would have to involve cooperation between Baghdad and Erbil, and concessions over oil. But a measure of the distance between the two sides came during a parliamentary session in Baghdad in July, when Kurdish members walked out, denying the meeting the quorum needed to begin discussions about forming a new central government.
Bigger questions remain over Kirkuk. “We won’t give up an inch of Kurdish land,” KRG president Massoud Barzani said in June. Hawrami says KRG oil exports, which once passed through the ITP, could now flow through Kurdistan to Turkey. A new pipeline linking Kirkuk’s oil with the new Kurdish export line has been completed, says the KRG (local sources say it is not ready). Kirkuk’s reserves of around 10bn barrels are almost double those in Kurdistan itself, though years of poor reservoir management and war have seen output dwindle from around 900,000 b/d to about 250,000 b/d.
For now, Hawrami insists the KRG could export Kirkuk’s oil on behalf of the rest of Iraq. Indeed, revenue from the Kurdish oil sold out of Ceyhan is being held in Turkey’s Halkbank and will be paid to the central government, once Baghdad agrees to disburse the 17% of the budget owed to Erbil. If Kurdistan gains independence, Kurdish officials say privately that Kirkuk’s oil revenue could be shared with Baghdad. Including the field’s output, Hawrami says Kurdish exports could reach 1m b/d next year.
But with peshmerga in control of disputed territories, including Kirkuk, and oil exports under way, a new oil state may emerge. At a minimum, Kurdish exports seem certain to grow more quickly than they would have while the older dispute with Baghdad lingered. It is now yesterday’s story. On oil, “there is no going back,” says one senior Kurdish official.