Changing fortunes for Iraq in 2019
A new federal government has a powerful engine in terms of rising crude output and export capacity, but also faces huge
Iraq is setting off on the right foot. Record crude output (4.6mn b/d) and exports (3.58mn b/d) in August 2018 supported Iraq's fiscal outlook, allowing Baghdad to secure an estimated budget surplus of $23bn—a turnaround from its planned deficit of $10.6bn. Iraq was also set to exit 2018 with a new government, spearheaded by former oil minister Adel Abdul-Mahdi. For investors, key questions arise for Iraq's petroleum sector in 2019: by how much will crude production and exports increase? And will the summer of 2019 signal fresh protests as temperatures soar and electricity shortfalls re-emerge?
Abdul-Mahdi, a respected economist, achieved several feats during his former roles as oil and finance ministers: he oversaw Iraq's efforts to recapture Baiji refinery from Islamic State (IS) group militants in 2015-16; he was instrumental—along with SOMO—in segregating Iraq's crude grades, launching Basrah Heavy in 2015; and, finally, he supported Iraq's push to international capital markets and more effective debt management.
Politically, Abdul-Mahdi, having abandoned his former party (the Islamic Supreme Council of Iraq) is the first independent premier in Iraq's post-2003 history. Having been chosen as a compromise candidate, he has made public his frustrations with Iraq's political system, not least party interference and the use of ministries as tools for political cronyism. With no real power base in Iraq's parliament, his authority stems from the backing of two prominent Shia figures set to dominate the political landscape in 2019: Moqtada al-Sadr (head of Sairoun) and Hadi al-Ameri (head of the al-Fatah Alliance).
Abdul-Mahdi knows that Iraq's energy sector is on trial. Some positive developments have been notched up since assuming power—particularly a new deal with the Kurdish Regional Government (KRG) to resume Kirkuk exports via Turkey. But this was more a result of US pressure, seeking to replace Iranian exports.
Iraq in 2019 will largely ignore Opec output policy. Compliance with any deal will be low
Protests in oil-rich Basra in the summer of 2018 exposed the supply-demand gap balance in Iraq's electricity sector (approximately 7.5GW); likewise, areas liberated from IS have increased the call on refined product imports. The challenge of pushing through difficult reforms—subsidy reform, tariff collection and reducing public sector payrolls—will likely continue throughout 2019.
Iraq's proposed 2019 budget signals this. The Popular Mobilisation Forces—an umbrella group of mostly-Shia militias supported by Ameri and Iran—will also put a new drag on government finances. Provinces still reeling from the damage sustained by IS and consumed by water and electricity shortages have already started protesting their lack of funds from the federal budget. Further protests from these constituencies are likely in 2019, particularly in Nineveh and Anbar provinces, where security risks remain due to the ongoing war in Syria.
Despite these political headwinds, Iraq is set to increase crude output in 2019. With approximately $11bn earmarked by the Ministry of Oil (MoO) to enable IOCs to recover their costs for operations under technical service contracts, Iraq's production capacity in 2019 will average approximately 5mn bl/d.
Incremental gains next year will be driven by production from PetroChina-operated Halfaya field, North Oil Company fields in Kirkuk, and additional volumes from state-operated fields.
For Kirkuk, crude output will increasingly be directed to refineries (particularly Baiji) and via the KRG-operated pipeline through Turkey. Iraq's southern export capacity—which includes the 1.6mn-bl/d Basra Oil Terminal, the non-operational 350,000-bl/d Khor al-Amaya terminal and four single-point moorings (SPMs) with capacity of 900,000 bl/d each—will increase marginally. Plans to increase onshore storage and deliver a new 120km (75-mile) sub-sea pipeline connecting onshore storage at Fao with SPM-4 will also help export volumes in 2019.
For legacy brownfields, 2019 will prove challenging: Rumaila Operating Organisation, operated by BP, will focus upstream capital expenditure on North Rumaila, tapping into the heavier Mishrif Reservoir (average API of 34°) and defined by weak aquifer support—a microcosm of Iraq's wider water challenges. Similarly, production increases from West Qurna-2 will be dependent on a newly proposed Tuba-Fao pipeline (which Lukoil will build), designed to feed volumes from West Qurna-2, Ahdab, and Tuba to Fao.
Despite the exit of Shell from Majnoon, it is unlikely 2019 will see any other IOCs pull out of Iraq's upstream. On the contrary, the MoO, aware of IOCs repositioning their global upstream investments in a more competitive industry, may seek to provide better terms for new entrants, especially in support of state-operated fields. In particular, ExxonMobil—currently engaged in talks over the South Integrated Project—may increase its involvement at Luhais and Ratawi in return for increased investment in the midstream pipeline network and export infrastructure.
Iraq's upstream boost in 2019 will be matched by the MoO's attempt to play catch-up in its downstream sector. Federal Iraq's refining capacity stands at approximately 650,000 bl/d, with refining runs of 550,000-600,000 bl/d. This capacity can meet domestic demand; but the mismatch between product demand and output has geared the MoO to upgrade existing refineries in order to reduce the product import bill ($2.5bn per year). In 2019, incremental refining gains will be made at the 15,000-bl/d Qayarrah refinery (which will receive increased volumes from the Qayarrah field). The Daura refinery is also set to increase runs in early 2019, following the opening of a new 40,000-bl/d pipeline from Kirkuk to Daura (via Baiji).
5mn bl/d—Iraq's 2019 production capacity
The restart in September 2018 of the war-damaged Salahuddin-2 unit (Baiji refinery) will help increase output from Kirkuk and meet product shortages in 2019. Whilst current runs are low at around 10,000 bl/d, this is set to increase in the coming year. The Salahaddin-1 unit (70,000 bl/d capacity) is non-operational, with plans for its restart in 2019—which will assist increased output from the Avana Dome and Bai Hassan fields. Additional refining capacity gains are also set to come from upgrading the Basra refinery (by 70,000 bl/d). Despite these refining gains, Iraq will continue to import light products, particularly gasoline and diesel.
The second half of 2018 highlighted a major imbalance in physical oil markets: a glut of light-sweet grades (particularly from the US) and increased tightness in medium-heavy grades. Iraq in 2019 will largely ignore Opec output policy. Compliance with any deal will be low. Iraq is likely, however, to follow Saudi Arabia and Kuwait in reducing exports to the US in 2019 to address rising inventories. Both Opec restraint and demand by Asian refiners for medium-heavy grades in 2019 will support SOMO's ability to market its crude. While oil price volatility will dominate the market in 2019, Iraq's budget price assumption of $56/bl is conservative.
Other market factors provide an additional fillip to Iraq in 2019: both the likelihood of US policy towards Iran tightening from May 2019 (as sanctions waivers expire) and soaring middle distillate demand (particularly diesel) driven by IMO 2020 will keep Iraqi crude grades competitive, particularly among complex refiners in India and China. SOMO will also make new advances into the Chinese independent refining market, following the signing of new JVs with Chinese companies in 2018. Iraq will also accelerate market share in Mediterranean markets; having inked a deal with Erbil to resume exports via the KRG pipeline toward the end of 2018, increased output from Kirkuk will support exports to Italy, Greece and the EU via Turkey, particularly as Mediterranean refiners grapple with reduced purchases from similar-quality Iranian grades and ongoing volatility of Libyan cargoes.
As oil production increases in 2019, the call on Basra Gas Company (BGC) to process associated gas from Licensing Round 1 fields will increase. With BGC set to handle approximately 1.2bn cf/d in 2019, Iraq will continue to flare gas in the coming year, at a cost of $50 per second. Increased MoO attention on gas handling at IOC fields will also dominate the agenda.
Ahmed Mehdi is Energy Strategist, Livingstone Partners. Previously PwC Deals Advisory unit, London