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Iraq close to a deal?

The outlook for the energy sector is bright, but the post-elections political prospects remain cloudy

Two narratives dominate speculation in the aftermath of the parliamentary elections in May, and one should be cautious in giving them credibility, because there'll be much political 'horse trading' in the coming months.

The first narrative claims that the Sadrist populist movement, with strong support among Iraq's poorest Shia communities, won the election. This is misleading. The Sadrists, led by the unpredictable cleric, Moqtada al-Sadr, performed better than expected. His Sairoon bloc won 54 out of 329 seats, but its political clout is limited. For example, despite boycotting a parliamentary vote on an election recount, deputies voted it through.

How much influence the Sadrists will have on the energy sector, therefore, remains to be seen, although representatives have suggested "correcting" oil contracts, including those from the recent licensing rounds. What this means is unclear. But the fundamental point is that, on its own, Sairoon can't force through legislation in either the cabinet or parliament. Sadrists can play more of a kingmaker role than in the past, but they haven't won. In fact, the Sadr movement has long supported outgoing prime minister Haider al-Abadi and may even be key to his second term, if a compromise candidate can't be found.

The second narrative from the election has more validity. A low turnout reflected a rejection of the political process by many, and this, in itself, represents a new danger. Certainly, the 44% turnout should be a wake-up call to the political elite.

On the positive side, there are many new faces in parliament; and the strong showing of previously marginal parties, such as the communists, proves that Iraq's democracy still has life.

While one can't speculate on the allocation of ministries, the likelihood is that the political landscape will remain fragmented, with Abadi's side of the Dawa party, Ammar al-Hakim's al-Hikma bloc and Sadr's Sairoon the chief power brokers. They offer the path of least resistance to government. In the event that Iraqi Kurdish groups issue maximalist demands on energy as a condition for joining government, attention will turn to Fatih, Hadi-al Ameri's coalition and Nouri al-Maliki's smaller State of Law Coalition, both generally regarded as Iran-leaning.

King maker? Sadr's bloc won most votes, but not enough to for a government alone

However, many believe that the Shia parties will eventually regroup to form a large parliamentary bloc and invite other factions to join. This means a return to the quota system, based on power sharing among Sunnis, Shia and Kurds.

Baghdad-Erbil differences

With an Iraqi high court ruling on the legality of the Kurdish Regional Government's (KRG) oil contracts imminent, the Baghdad-Erbil energy dispute will feature prominently in the coming weeks. An immediate challenge is the KRG debt amassed from pre-financing deals and borrowing from Turkish banks. This was at one point as high as $21bn and will be a growing issue for the KRG, despite the recent increase of oil prices. Joint auditing, most likely with external monitoring and dispute resolution, will be vital to building trust for any forthcoming deal.

1m b/d—2018-2022 target rise in southern output

The next vital element in the KRG energy dispute is constitutionality. Baghdad will seek to cement its interpretation of Articles 111 and 112 of the constitution, overruling the Kurdish strategy on oil exports, which is based on Article 115. This gives priority to regional governments in disputes over competencies that aren't strictly federal.

Baghdad will argue that oil and gas isn't an area of shared competency, with the federal government empowered to make final decisions, provided that regions and governorates have some input and that policy isn't unilateral. Baghdad views Kurdish oil contracts as unilateral deals, at odds with the constitution's stipulation that policy must be formulated "with" the federal government. Article 112 says a region shall formulate "strategic policies" "together" with the federal government.

The KRG has some leverage because the current oil export pipeline to Turkey crosses its region, as does a planned gas pipeline to be developed with Rosneft. Recent Russian proclamations that Moscow's energy deals in the Kurdistan Region of Iraq (KRI) are "legal" may give the Kurds some false hope. In the long term, it's likely that a new grand bargain will be struck, increasing revenues for all and helping to stabilise northern Iraq, at least in the short term.

INOC delays

Despite the passing of a law establishing the Iraqi National Oil Company (INOC), the new government will still face challenges implementing it. This is because many overlapping authorities are involved. INOC as operator has to deal with various cabinet portfolios including the oil, planning and finance regulators. Therefore, the government may seek major revisions and amendments from the new parliament. International oil companies, for their part, will seek further amendments to the technical service contracts to make them more lucrative, against the background of Shell's decision to relinquish Majnoon.

National oil companies, like the Basra Oil Company, will struggle to secure enough funds to increase oil production from existing assets beyond 200,000 barrels a day. However, if INOC becomes an umbrella for all state-owned upstream operators, a national effort will receive a cash boost. This won't take place before 2020 in the best-case scenario. Moreover, the oil ministry may go ahead with a further bid to auction potential assets. In the short term, Basra and Dhi Qar oil companies have signed a capacity-building and training memorandum of understanding with Chevron.

Question marks

For now, this leaves Iraq's ambitions to surpass 4.3m b/d in exports and expand refining capacity beyond 600,000 b/d in doubt. However, Iraq still envisages raising oil production in 2018-22 by 1m b/d from the southern fields (above the current production plateau) in addition to at least 700,000 b/d from Kirkuk. This will challenge gas-flaring reduction targets, but the overall rise in utilisation of associated-gas capture is expected to reach 2bn cubic feet a day from the southern fields and an estimated 500m cf/d from the KRG at Khor Mor fields, which will go to local power generation.

IOCs will seek further amendments to technical service contracts to make them more lucrative

If realised, increasing use of gas will relieve pressure on the power sector by supplying the national grid with enough feedstock to meet local demand. This should calm some of the social unrest that's common in the hot summer months.

No progress is assured, however. A significant challenge facing oil-production growth is the long-delayed Common Seawater Supply Project. This was awarded to ExxonMobil in 2010, then cancelled, before Exxon returned to negotiations. Now, discussions on contract terms have stalled. This means Iraqi production could be curtailed somewhere in the 5m-b/d range if enhanced oil recovery isn't taken seriously before 2020.

Iran issues

Another challenge, regionally, is the risk that Iraq could become a casualty of the mounting US-Iran confrontation. Politically, Iraq has to be very careful not to be drawn into taking sides in this dispute; and it appears unlikely that a new government, formed of the major parties, would want to take risks.

At the same time, Iraq will come into increasing competition with Iran as market share in Asia becomes more valuable to a constrained Iranian energy sector. Iran may seek to intensify its economic activities in Iraq, and it will, therefore, be difficult for the new Iraqi administration to sustain commercial exchanges with Iran without incurring penalties from Washington. The Iraqi banking system will continue to support Iran (directly or indirectly) by supplying Tehran with dollars—action that the US will want to stop.

One thing certain in the election aftermath is that the coming year will continue to see great progress in the Iraqi energy sector—as the recent licensing rounds and the awarding of six of 11 fields-displayed. Beyond that, the picture is much less clear and there will be many weeks of difficult political negotiations ahead, perhaps until the autumn.

Luay al-Khatteeb is Fellow at the Center on Global Energy Policy (Columbia-SIPA) and Executive Director of Iraq Energy Institute

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