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Fragility in Iraqi oil

Iraq is heading towards 2017 overwhelmed by security, political and economic uncertainties, any of which could negatively affect the oil sector

As Opec's ministers met in Algiers in late September, Iraq offered a rare discordant note. The group struck a deal-but even before the markets had digested the news, Iraq's new oil minister Jabbar al-Luaibi had some quibbles. He rejects the third-party production data on which Opec relies to make its output calculations, insisting that they consistently underestimate Iraqi flows. Unless Opec fixed the problem, he said, "then we say we cannot accept this, and we will ask for alternatives".

Iraq's government says its total production-from fields in federal areas and those in the semi-autonomous Kurdish region-is 4.7m barrels a day, with the potential to rise to 5m b/d. Independent estimates put the figure somewhere between 4.3m and 4.5m b/d. Southern Iraq's output numbers aren't in doubt: production and exports have been averaging 3.4m b/d and 3.2m b/d, respectively. The problems come with assessments of northern and Kurdish regional output.

Nothing is straightforward either in the whole relationship between the federal government in Baghdad and the Kurdish Regional Government (KRG) in Erbil. After months during which no oil produced by federal Iraq's North Oil Company (NOC) was exported through the Iraq Turkey Pipeline (ITP) to Ceyhan, via the KRG export infrastructure, in August the two sides reached a partial agreement. This specified that until the end of 2016 Baghdad and Erbil would share revenue from Kirkuk production-usually totalling 150,000 b/d, but presently about 90,000 b/d. The hope then is that in 2017 they will agree to return to an arrangement under which Iraq's state marketer Somo would handle all Ceyhan exports and the KRG receive 17% of federal spending, in line with Iraq's constitution.

Borrowed time

The decision by the two sides to seek an interim arrangement reflects the parlous state of the economy in both the federal and Kurdish regions of Iraq because of lower oil prices and the high cost of the war against Islamic State (IS). The KRG's public finances are close to collapse. The Erbil authorities struggle to pay civil servants' wages and owe billions of dollars in back payments to international oil companies (IOCs). The resumption of Kirkuk exports through the KRG's infrastructure gives it at least a 10% lift in revenue, with potentially 75,000 b/d of crude oil added to its existing exports of 480,000 b/d. For Baghdad, the August agreement gives them back an export outlet for NOC-produced Kirkuk oil.

The oil deal was a by-product of Kurdish support in the federal parliament for recent cabinet appointments by prime minister Haider al-Abadi, including that of Luaibi, who within hours of taking office ordered the restart of federal exports via the KRG. Whether the temporary arrangement can be translated into a long-term settlement, though, is doubtful. Baghdad has not dropped its stance that all oil produced on Iraqi soil belongs to the state and that independent KRG production and exports are illegal and unconstitutional. Overcoming these differences would need a comprehensive agreement covering a range of contentious issues. It's unimaginable under current circumstances.

Several obstacles stand in the way of any such accord. One takes the form of political tension within the KRG. The rivals of the ruling Kurdistan Democratic Party (KDP), the Patriotic Union of Kurdistan (PUK) and Gorran, an upstart third party, oppose the August deal with Baghdad and have been lobbying Abadi to scrap it. A measure of the PUK-KDP rivalry is that PUK members of the federal parliament in August voted with supporters of former Shia prime minister Nouri al-Maliki to oust finance minister Hoshyar Zebari, a Kurd and senior KDP figure, from his post on corruption charges.

On top of the Kurdish problem, political rivalry in Baghdad itself also looms over Iraq's oil sector

The dispute between Erbil-based KDP and Sulaimaniya-based PUK and Gorran encompasses several issues relating to oil. The latter two parties never endorsed the Peshmerga's capture in 2014, at the time of the IS surge, of two NOC assets, the Avana Dome of the Kirkuk oilfield and the nearby Bai Hassan field. While the PUK controls the Kirkuk council and is responsible for security in the area, it is unhappy at the KDP's monopoly on transportation of export crude oil to the ITP.

Furthermore, the PUK and Gorran, which enjoy good relations with Tehran, are proposing the construction of a cross-border pipeline to Iran. This would enable a swap deal involving KRG oil being supplied to Iran's northern refineries and an equivalent volume of oil exported from Iranian terminals on the Gulf on the KRG's behalf.

Aside from internal KRG difficulties, the liberation of Mosul from IS control-when it happens-will pose questions of sovereignty that further strain relations between Baghdad and Erbil. The federal government regards the KRG's unilateral seizure of territory disputed with Baghdad-notably Kirkuk-along with areas formerly controlled by IS, as illegal. Abadi has often insisted that oilfields in Kirkuk belong to the federal government, which will ultimately regain "full control" of them.

The joint Iraqi-Kurdish military campaign against IS has given Baghdad and Erbil little time to address their differences. But there are moments when progress seems possible. In late September, Masoud Barzani, president of the Kurdish region and KDP leader, met Abadi in Baghdad and announced that they had agreed "to solve the disputes, especially economic and oil and gas, and seek a better solution for all of them". Details were scant, and the brief meeting appeared, as much as anything else, to be about consolidating relations between the KDP and the Abadi government, in the context of intra-KRG rivalry.

Political rivalry in Baghdad itself also looms over Iraq's oil sector. The persistent efforts of Maliki and his supporters to undermine the government of Abadi, a fellow member of the Shia Dawa party, is consuming much of the central authorities' energy. The pressure from Abadi's opponents has resulted in his ministers of interior, defence and finance being forced out of office. At the same time, Maliki has led moves to block Abadi's attempts to appoint technocrat ministers, rather than ones chosen on religious or sectarian lines, the pattern since the overthrow of Saddam Hussein.

A weakened federal government is facing not only the prospect of confronting the KRG on oil and sovereignty, but also worsening sectarian tension. The country's already marginalised Sunnis fear that the participation of Shia militias in the battles for Mosul will lead to further persecution. At the same time, the Abadi government is hearing fresh demands from the authorities in Basra for the predominantly Shia province to gain more income from oil exports through the south, a desire inflamed by the KRG's unique arrangement.

Upgrade time

Against this gloomy background, the southern oil sector provides a brighter picture. The region has not experienced the violence witnessed elsewhere, and exports via the Basra Oil Terminal have seldom been below 3.2m b/d in recent months, and rose to 3.36m b/d in April. So far so good. But if this level of exports is to be maintained or increased, then the government will need to release the brake on capital expenditure and provide fresh investment incentives for cash-strapped IOCs. Also southern oil transport and storage infrastructure need capacity expansion and upgrading. In a climate of persistent federal budget cuts and rising debts to IOCs, hope of such projects being approved is dim.

Above all, IOCs say their efforts to maintain production will be hampered if the long-promised common seawater supply project does not become a reality soon. Seawater is urgently needed for injection into oilfields to maintain pressure and boost output. The plans were drawn back seven years ago, in 2009, with the aim of providing 12m b/d of seawater to southern fields by 2013. Originally the work was to be carried out by ExxonMobil, but when the latter signed an upstream contract with the KRG the venture was put in the hands of the state-owned South Oil Company. A combination of budget paring and bureaucratic and political wrangling means the seawater won't arrive before 2020-21, at best.

Meanwhile, the federal government is looking ahead to 2017, presenting a budget based on an oil price of $42 a barrel for Iraqi crude oil-which reasonably assumes a Brent price of around $50/b. The $5.34bn IMF loan to the government agreed in July, if all the loose ends can be tied up, will provide a huge boost to the Baghdad authorities. But achieving this swiftly has been made more difficult by finance minister Zebari's dismissal-an example of how Iraqi domestic politics has a habit of getting in the way of urgent matters.

At the same time, a blend of domestic political rivalries, disputes over territory and chronic fiscal constraint risk denting Iraq's chances of remaining Opec's second-biggest producer and maintaining a loud and influential voice within the organisation.

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