Market turmoil hits IS-captive Iraq
Spending constraints thanks to low oil prices and military expenditure are frustrating the federal government and the KRG
Under different circumstances the authorities in Baghdad and those in Erbil, the seat of the Kurdish Regional Government (KRG), would be sitting back to enjoy a golden year in 2016. Each is implementing ambitious plans to expand crude oil production and exports. Whether coordinated or developed separately these policies were designed to reinforce Iraq’s position as Opec’s second-largest producer behind Saudi Arabia and prepare it to defend the spot from an expected output hike from post-sanctions Iran.
Instead, both governments, amid worsening oil-price weakness and the ongoing military efforts to defeat IS, will struggle to meet the capex demands of their energy sectors. While both will seek to honour their commitments to international oil companies (IOCs), there is scant prospect of those firms being able to continue with development and expansion plans as they stand. As such federal and KRG oil production – and exports – are likely to plateau, at best, over the course of 2016.
Last year was characterised by political wrangling between the governments in Baghdad and Erbil, against the background of disruptions to normal oil operations in some parts of northern Iraq because of the IS insurgency. While the politicians bickered, the energy sectors in the two halves of the country concentrated on developing their own oil and gas resources.
The IS insurgency cut the pipeline linking the federal government’s northern fields, operated by the North Oil Company (NOC), to the Iraq Turkey Pipeline (ITP) to Ceyhan. Shortly afterwards the KRG seized the Avana Dome of the Kirkuk oil field and the Bai Hassan field. As a result, most of Baghdad’s efforts were concentrated on the south of the country, the predominantly Shia region, which has remained largely untouched by the Sunni-jihadist insurgency.
In licensing rounds in 2008 and 2009, IOCs were contracted to expand output at the major existing oil fields (Rumaila, West Qurna 1 and Zubair) and develop new ones (West Qurna 2, Majnoon, Halfaya and Garaf). These projects, despite occasional security disruptions and long bureaucratic delays in Baghdad, made solid progress. But the growth of oil production capacity was not matched by the debottlenecking and expansion of oil export infrastructure at Basra, Iraq’s main southern oil terminal at the northern end of the Gulf. At the beginning of 2014, for example, southern crude oil production capacity had increased to 2.75m b/d, but exports were stuck in the 2-2.5m b/d range, leaving around 200,000 b/d of held-up output capacity.
So no major investment plans will be carried out during 2016, and the likelihood is that production capacity will remain at the current level of around 3.5m b/d, with any expansion limited to just 100,000-200,000 b/d. Further delays to the implementation of key ventures like the Common Sea Water Supply Project, urgently needed for oil field water injection, will impact longer-term development plans.
It is tempting, therefore, to suggest that Iraq might be on course to meet its target of reaching southern export capacity of 6m-7m b/d by 2020. But this is where reality kicks in. IOCs in the south have been ordered to put oil field expansion plans on hold, while maintaining current output. Increased output would lift the volumes of oil owed to IOCs, thus fermenting further the fiscal pressures on Baghdad. But 2014 and 2015 witnessed a major turnaround in southern exports. The creation of a new grade of Basra crude oil (Basrah Heavy, alongside Basrah Light) and the introduction of dedicated pipeline, storage and loading facilities for it, increased export capacity. So too did the completion of extra oil storage tanks at Fao and the operation of new pumps. The effect was dramatic: by the second half of 2015, southern oil exports topped 3m b/d most months, reaching a record 3.36m b/d in November. This gave Iraq’s southern export sector new flexibility: it means that when there is a substantial build-up of stored crude oil, and assuming perfect weather conditions and no technical problems, southern exports could reach 3.5m-3.6m b/d.
No major investment plans will be carried out during 2016, and the likelihood is that the south's production capacity will remain at around 3.5m b/d
The economic crisis in federal Iraq also throws into doubt the government’s ability to deliver on its 2016 budget commitments, based on what today look like an unrealistic oil price of $45/b and exports of 3.6m b/d. In 2015, revenue from exports averaged out at $44.7/b – but in a year that had begun with the figure over $100/b.
Then, the budget’s export figure of 3.6m b/d assumes a rapprochement with the KRG, which would see both sides honour an agreement signed in December 2014 to pool exports through Ceyhan, to be marketed by Somo, in return for the Kurdish authorities receiving 17% of federal revenue. This deal was never fully implemented, and in June 2015 the KRG began independent exports (including the 150,000 b/d or so pumped into their export system by NOC).
Balance sheet expectations
All the signs are that the Kurdish authorities will continue this unilateral arrangement through 2016, despite the inclusion again of the 17% pledge in the federal budget for this year. The experience of 2015 has convinced the KRG that the Baghdad government will not be able to pay the full monthly amount it is due. Independent sales do not bring in sufficient revenue to cover running costs, never mind allowing for capex. Nevertheless, income from direct oil sales in the second half of last year far exceeded that received from Baghdad under the previous deal.
So, in contrast to the optimism of the early oil boom years in the Kurdish region of northern Iraq, 2016 – in economic terms – will be one of holding on for dear life.
It is estimated, for example, that the $510-$550m earned in December 2015 from oil exports will be enough simply to make regular partial pay-outs to IOCs (which are collectively still owed millions of dollars in back payments) and cover only a portion of public expenditure.
Civil servants and the Peshmerga, the front-line forces in the battles against IS, will remain with salaries in deficit.
The KRG’s grand plan had been for oil production capacity to reach 1m b/d by the end of 2015. The circumstances described above caused this target date to be put back to the end of this year. However, with the KRG facing dire economic problems, compounded by internal political unrest over the fate of the presidency and disputes among the major parties, the expectation is that Kurdish oil production will plateau at around 0.55m-0.6m b/d, which is close to the operational limit of the ITP.
Iraq remains, despite all the difficulties, one of the key players in the global oil industry.
But its golden year – its ascension to the league of mega-giant producers – remains hostage to a recovery of oil prices and a global victory in the war against IS.