The Fuse

Dramatic Increase in Iraq Oil Production Likely to Plateau

by Nick Cunningham | February 03, 2016

From an oil production standpoint, Iraq has been a remarkable success story over the past 18 months. Despite a once-in-a-generation crash in oil prices, plus a shocking blitz from ISIS and a subsequent drawn out war with the militant group, Iraq has somehow succeeded in executing a dramatic increase in oil production.

Iraq produced 4.13 million barrels of oil per day (mbd) in December 2015. That’s 774,000 barrels more every day than it produced in December 2014, although it’s unclear whether or not Kurdish oil production is reflected in the data.

The country’s accomplishment in rapidly increasing output over the past 14 months has been impressive, serving as the principle reason for the increase in OPEC’s total oil production since the group decided to leave output unchanged in November 2014. If you trust their numbers, Iraq accounted for about two-thirds of the roughly 1.5 mbd in production growth (excluding Indonesia’s recent inclusion into the group) that the oil cartel posted since their decision not to cut production in November 2014.

iraq ramp up

However, Iraq’s run of success might have run its course. Low oil prices are bleeding the government of much needed revenue. As a result, it is left with insufficient funds to finance its war against ISIS while paying public sector salaries, let alone ratcheting up investment to enable further growth in oil production.

The noose of low oil prices

For a country that depends on oil for 90 percent of its revenue, crude prices at $30 per barrel are presenting Iraq with a fiscal crisis. Iraq’s oil sells for a discount below international benchmarks because of the presence of sulfur. Iraqi crude averaged $22.21 in January, a level that is less than half of what the government assumed for its 2016 budget.

The drop in oil prices from December to January led to an estimated $650 million in lost revenues for the state, with receipts totaling just $2.26 billion. For context, that stands in contrast to the $4 billion that the government pays in just public sector salaries each month.

Iraq’s finance minister Hoshyar Zebari said that 2016 “will be a difficult and harsh year,” and that “projections indicate a continued collapse of oil prices.”

“Eighteen months ago, Daesh was the existential threat to Iraq,” Iraqi Member of Parliament, Mouwafak al-Rubaie, told The New York Times. “I think we managed to contain it and push it back. Now the existential threat is financial bankruptcy.” Iraqi officials fear social unrest if the government becomes unable to pay salaries. The government is turning to the $40 billion that it has in cash reserves to hold everything together.

The United States government has too much on the line to let Iraq fall apart.

To be sure, it is unlikely that Iraq would actually get pushed over the financial precipice. The United States government has too much on the line to let Iraq fall apart. It has already extended loans to the Iraqi government in the fight against ISIS and it would likely expand assistance if unrest threatened to destabilize the country further. Additionally, the International Monetary Fund could extend billions of dollars in loans to keep Iraq afloat. At the recent World Economic Forum in Davos, Prime Minister Haider al-Abadi said that he is looking to secure $6 to $7 billion in loans from the IMF.

Why Iraq’s financial mess matters for oil

The fiscal crisis in Iraq does threaten the long-term health of the oil sector, however. In Iraq oil companies are paid a fixed fee by the government for oil production. Many large companies, including BP, Royal Dutch Shell, ExxonMobil, Eni, and Lukoil, operate Iraq’s oil fields near Basra in the South, which account for the bulk of the country’s oil production.

The Iraqi oil ministry sent requests to oil companies last year to slash their development budgets because the government is running low on funds. BP, for example, agreed last year to spend only $2.5 billion in 2015 on developing the supergiant Rumaila oilfield, down from the original plan of $3.5 billion. At 1.35 mbd, Rumaila accounts for roughly one-third of Iraq’s total output.

Lower reimbursements from the Iraqi government will likely mean that Iraq’s success at ramping up production is probably near its limits. “Nobody can invest if they are not paying. At the moment the way things are looking, production in the second half of 2016 is going to start falling,” one oil executive told Reuters in September 2015.

Kurdish finances are no better

Another layer of Iraq’s complicated energy situation is the fact that the semi-autonomous region of Kurdistan has cut out the Iraqi central government in its quest to export oil. Kurdistan is producing and exporting oil, and it too is suffering from the crushing weight of low oil prices.

The Kurdish Regional Government (KRG) originally hammered out a deal with the government in Baghdad in December 2014 in which Kurdistan would export 550,000 barrels of oil per day under the auspices of Iraq’s State Oil Marketing Organization (SOMO). In exchange, Baghdad would send the 17 percent of the national budget that Erbil is entitled to. The deal only lasted a few months, at which point the KRG ventured out on its own to export oil through the Turkish port of Ceyhan without the consent of the Iraqi government. Kurdistan has exported about 600,000 barrels of oil per day, on its own, since September 2015.

Just as the government in Baghdad is hurting badly from low oil prices, so too is the government in Erbil. The KRG has $14 billion in outstanding debt, with an estimated $4 billion of that owed to oil companies, according to Stratfor. Kurdistan has a large public payroll, with 1 in 6 people employed by the Kurdish government, costing the public treasury $1 to $1.1 billion per month.

The slump in oil prices presents a tremendous predicament for Erbil. It has too many funding priorities and not enough revenue. Monthly earnings from oil exports have dropped to just $361 to $406 million per month, according to Stratfor. That is not enough to cover the salaries of its security forces (the Peshmerga), payments owed to the private oil companies operating in Kurdistan, and the salaries of public workers.

The Peshmerga has been fighting ISIS for the past year and a half, and the KRG is keen to keep those salaries untouched, but fighters have at times gone unpaid. Public workers have also seen their paychecks halted, and oil companies did not receive payments for the first half of 2015.

One thing working in Kurdistan’s favor is that their reserves hold some of the cheapest oil on earth.

But the KRG is now in a conundrum. In order to increase revenues, oil production needs to rise, or at a minimum, maintained at current levels. Ramping up oil production, however, will require upstream investment from companies such as Gulf Keystone Petroleum, DNO and Genel Energy, three oil drillers in Kurdistan that make up most of the region’s production. One thing working in Kurdistan’s favor is that their reserves hold some of the cheapest oil on earth. Genel Energy puts its production costs in Kurdistan as low as $2 per barrel. However, these companies won’t pour more money into Kurdistan unless they receive reliable and consistent payment. Already the companies have reduced investment, which has brought production growth to a halt.

The Kurdish Regional Government recently announced that it would prioritize regular and consistent payments to oil producers within its borders in order to restore confidence and ensure the industry can continue to maintain production. That bodes well for Kurdistan’s oil sector, but it remains to be seen if the KRG can follow through on its commitments.

krg exports

Increasing willingness to participate in production cuts

What Iraq needs most is a near-term rebound in oil prices.

This was a departure from the country’s previous resistance to participate in joint cuts, and reflects the country’s increasingly dire fiscal situation.

Iraq’s oil minister played a role in the oil price rally in late January when he gave credence to the growing speculation of cooperation between OPEC and Russia on a production cut, in response to a plea from Venezuela for an emergency meeting. “We have seen some flexibility from the brothers in Saudi and a change in tone from Russia,” Iraq’s oil minister Adel Abdul Mahdi told reporters at an oil conference in Kuwait on January 26. This was a departure from the country’s previous resistance to participate in joint cuts, and reflects the country’s increasingly dire fiscal situation.

Along with Iraq, Russia’s potential newfound willingness to engage with OPEC on possible production cuts, and the subsequent dismissal of such rumors by officials from both Russia and OPEC, contributed to several days of heightened oil price volatility. Brent rallied more than 10 percent in the days following the widespread speculation that a meeting might be scheduled for February.

Coordinated production cuts remain a remote possibility, for a variety of reasons, not the least of which is Russia’s questionable ability to follow through on any pledges. Nevertheless, Iraq’s finance minister suggested that Iraq would be willing to participate in a meeting to discuss possible coordinated action in order to stabilize oil prices.

“Iraq is a founding member of OPEC, so we will definitely take part, and the idea would be to reduce production actually to impact the oil price,” finance minister Hoshiyar Zebari said, according to Reuters. “Not sure we will say yes to Venezuela because we need to produce more, because of the challenges we have, but if we believe there would be a consensus, a collective decision then we might go with it,” he added.

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