The Fuse

Numerous Signs Point to Iraq Detracting from OPEC Cuts

by Pi Praveen | @PiPraveen503 | January 13, 2017

Iraq announced this week that, per commitments made to OPEC at the cartel’s November 30 meeting, it will reach the required 210,000 barrels per day (b/d) cut by the end of January. This is the first time that OPEC has held the country to a quota since the early 1990’s, and Iraq, along with Iran, was considered the most likely defector leading into November’s talks. The Iraqi Federal Government (IFG) had argued for an exemption due to its need for oil revenues to fund its campaign against Islamic State (IS). Iraq only reluctantly agreed first to freeze at 4.56 million barrels per day (mbd) before later agreeing to a cut.

There are a number of signs suggesting that Iraq will not follow through on its commitments to the cartel despite leadership’s continued show of compliance, in particular the expectations that exports are set to rise.

There are a number of signs suggesting that Iraq will not follow through on its commitments to the cartel despite leadership’s continued show of compliance, in particular the expectations that exports are set to rise. The State Organization for the Marketing of Oil (SOMO) announced southern exports of 3.41 mbd in November, 3.51 mbd in December, and a planned 3.64 mbd in February. These numbers exclude Kurdistan Regional Government (KRG) and Kirkuk production, with the former’s export numbers fluctuating near 600,000 b/d. In the days after the final agreement (which brought together OPEC and non-OPEC countries), the Wall Street Journal reported on a leaked document showing that SOMO had plans to increase shipments by 390,000 b/d from December’s numbers. Though SOMO is now releasing “official” production numbers, the KRG reports production and exports independently of Iraq’s Oil Ministry, and security and infrastructure risks regularly take fields temporarily offline. Against this backdrop, it is difficult for OPEC and Western watchdogs to corroborate exact data even before cuts were agreed upon.

The KRG, which also asserts claim over Kirkuk’s production, will likely not comply with any curtailment.

The KRG, which also asserts claim over Kirkuk’s production, will likely not comply with any curtailment. Top Kurdish officials have disputed Iraqi Oil Minister Jabbar al-Luaibi’s December 22 statement that the KRG will take part in cuts. Moreover, the Iraqi Prime Minister Haidar al-Abadi said that the KRG is exporting more crude oil than the 550,000 b/d permitted under the federal budget for 2017 passed on December 7, 2016. The KRG disavowed the budget after the Kurdistan Democratic Party (KDP) withdrew from parliament’s session to protest the exclusion of its wishes regarding the independent sale of Kurdish oil.

This controversy is the latest in the long-running conflict between Iraq’s Arabs and semi-autonomous Kurds, with the latter pushing for independence from Baghdad for years. Last year, a fragile oil deal between the two sides to limit the KRG to the same 550,000 b/d export level collapsed, and Kurdistan began to independently move its oil through the Kirkuk-Ceyhan pipeline rather than grant final authority to SOMO.

In an August 2016 letter, al-Luaibi instructed the eleven international oil companies (IOCs) operating in southern fields to draw up plans for expanding oil and gas production. Despite the agreement to cut output, he has yet to officially instruct them to halt any such plans. With the International Monetary Fund having recently bailed Iraq out to the tune of $5.34 billion under condition of Iraq fulfilling its arrears payments to IOCs, Iraq will find it difficult to renege on barrels committed to making these payments—and fees per barrel guaranteed under Long-Term Service Contracts (LTSCs)—while asking companies that are barely afloat while operating at or near capacity to slash production. If global oil prices continue their gradual rise in January, it will likely encourage Iraq to carry on business-as-usual in the hope of writing off its debts. Like the IFG, the KRG is saddled with debt and will be incentivized to sustain production to the best of its efforts.

Helping Iraq in this endeavor to pay off massive debts is its hold over the world’s fifth-largest proved crude oil reserves and its remarkable resilience in growing production levels at a rapid pace despite the protracted campaign against IS over the past two years.

Helping Iraq in this endeavor to pay off massive debts is its hold over the world’s fifth-largest proved crude oil reserves and its remarkable resilience in growing production levels at a rapid pace despite the protracted campaign against IS over the past two years. In mid-2015, Iraq’s new grade of heavy crude, Basra Heavy, came onto the market at an artificial sharp discount set by SOMO. The new crude grade has played a part in contributing to Iraq’s two-thirds share of OPEC’s production growth during the global supply glut over the past two and a half years. Despite Iraq’s domestic crude consumption remaining fairly flat, refiners across the country plan to boost capacity, with the bulk of growth channeled toward meeting demand in the global oil market.

Exports to the U.S. jump

The outlook is rosy for Iraqis on the global demand side. Though American refiners have said they have little appetite for the new grade of Basra, Iraq’s crude exports to the U.S. have still risen nearly 80 percent year-over-year between the latter halves of 2015 and 2016 as shown in Figure 1. Iraqi exports have ramped up in the same time period that Venezuela’s volumes to the U.S., traditionally the second-largest OPEC supplier to the U.S. after Saudi Arabia, have slowed. Saudi Arabia has also declared that it will decrease exports to the United States and Europe in favor of securing market share in Asia. The EIA puts preliminary numbers of Iraqi barrels to the U.S. for the first week of January 2017 at 955,000 b/d, a colossal jump from the 200,000 b/d to 500,000 b/d seen in 2016. The spike at the beginning of this year is likely a statistical blip, the result of U.S. refiners wanting to trim inventories at the end of the year for tax reasons, but it’s clear that Iraqi exports to the U.S. are at robust levels.

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Iraq’s neighbors in the Middle East and Asia are increasingly eyeing the country’s oil. Gazprom Neft is hoping to reach maximum production at its Badra field by 2018. A planned Basra-Aqaba pipeline to Jordan has a 2,250,000 b/d capacity, and a proposed Koysinjaq-Kermanshah pipeline would bring an additional 250,000 b/d online to Iran. Norway’s DNO and Britain’s Genel Energy just struck oil in their Peshkabir-2 well in the Tawke field. They are considering expanding exploration in the area just as rumblings begin of Kurdish crude slowly but surely becoming a baseload in Europe.

Chinese state oil company Sinopec’s trading arm Unipec, also Iraq’s top client, is increasing its purchases of Basra by three percent—around 40 to 60 million barrels per quarter—in 2017. China and India’s demand for Iraqi oil remains robust, with the two developing nations delivering the lion’s share of a recent 450,000 b/d increase in refining capacity across Asia. Reuters reported this week that three Asian and European refiners are on track to receive full supply allocations from Iraq come February. It is in Iraq’s interest to continue competing with Saudi Arabia and Iran to capture this market.

Possible supply disruptions in Iraq?

There are three plausible scenarios for supply disruptions to occur in Iraq in the coming months. First, IS, only recently relieved of its hostile control over northern oil fields, or Iranian-sponsored Shia militants could mount attacks on weak infrastructure and supply chains. Second, the Kurdistan Workers’ Party (PKK), angered by renewed cooperation between the KRG and President Recep Tayyip Erdogan’s regime, could attack the Kirkuk-Ceyhan pipeline and take up to 600,000 b/d offline, as it did early in 2016. And third, the KRG and IFG could once again reach an impasse on the oil deal included in 2017’s federal budget, one that would likely be precipitated by disagreements over KRG’s role in Iraq’s commitments to OPEC. All three of these scenarios would disproportionately cut into Kurdistan’s exports, likely leaving the federal government’s production levels intact.

As shown in Figure 1, Iraqi oil production has weathered IS’s siege of Iraq’s northern regions and intermittent disruptions stemming from Baghdad and Erbil’s simmering tensions, suggesting that it may continue to weather projected risks to supply more effectively than expected in 2017.

Above-ground risks are deterring some investors in Iraq, but not all.

Accordingly, the risks are deterring some investors, but not all. Late in Q4 2016, Exxon Mobil announced withdrawal from three of its six exploration blocks in Kurdistan, following Chevron’s lead from the year before and bringing the total number of cancelled blocks up to nineteen. However, the KRG’s Production Sharing Contracts (PSCs) are more attractive vehicles for hydrocarbons investment than the IFG’s LTSC set up and the KRG is still planning for an early 2017 tender of oil and gas blocks. Independent trader Glencore, along with rivals such as Vitol and Petraco, is betting big on Kurdish oil despite prospective setbacks. Glencore will follow up a $300 million loan to the KRG with another of up to $550 million, to be partly paid back by oil cargoes. The Oil Ministry will open bidding on 12 oilfields later this year. It has also proposed a move away from the less popular LTSC for the 19 bidders who have pre-qualified.

Oil Minister al-Luaibi’s signaling—and accordingly bullish headlines—aside, Iraq and the KRG have shown their ability and potential to expand production and exports against significant odds. With Iraqi socio-economic, military, and capital expenditures almost entirely dependent upon oil revenues and global benchmark prices ticking up as a result of OPEC cuts, it would not be surprising to see Iraq continue to keep pumping away.

 

 

 

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