Will Iraq dictate world oil affairs?

Iraq is a sleeping oil giant. It holds the world’s third largest oil reserves after Saudi Arabia and Russia with 112.5 billion barrels of proven reserves and around 98 billion barrels of undiscovered oil. But until recently it was supplying just 2% of the world’s oil.

Although Iraqi oil installations sustained minor damage in the last war, oil production and exports have not yet resumed on any significant scale.

Reasons for this can be attributed to a lack of planning, organisation and understanding from the current occupation administration and poor security as highlighted by the media on a daily basis.

Attempts have recently been made to analyse and determine the future of Iraq’s oil industry exports, whilst developing a programme to attract essential foreign investment needed to increase Iraq’s oil production to pre-war levels. Unfortunately the assumptions made have been unrealistic and uninformed.

The Iraqi oil industry is in a shambles, unable to produce enough crude oil and refined products to satisfy domestic demand, let alone export to the world. Refineries are limping along, largely due to a shortage of electricity.

Iraq’s infrastructure problems are severe due to operating constraints and the previous regime’s erratic policies. Iraqi oil managers have resorted to sub-optimal techniques to sustain production. For example, the Basra refinery, Iraq’s second largest, is running at less than half capacity, due to a shortage of chemical additives.

Besides technical problems, persistent looting and resistance attacks have plagued the oil industry.

“The industry is in a state of dilapidation,” said one expert on oil affairs recently.

It is the most accurate description of the state of the Iraqi oil industry, overseen by the US Administration through Philip Carroll as Head of the Advisory Board of the Iraqi oil ministry (formerly headed Royal Dutch Shell in the US).

US appointed de facto oil minister in Iraq Thamir Ghadhban reinforced the above notion by stating it would take 18 months to restore the country’s giant oilfield’s to their pre-war production levels of 3 million barrels per day.

A further barrier to the development of the Iraqi oil industry, was highlighted again, when the Pentagon recently warned companies, hoping to operate in Iraq that they will have to provide their own security and that their movements would be restricted.

However, disregarding all these obstacles, the Bush administration ihas been optimistic about cranking up the flow quickly. Vice-President Cheney recently said: “We ought to be able to get their (Iraq) production back up in order of 2.5 to 3 million bpd hopefully by the end of the year”.

Why is Iraq’s oil so important?

Iraq not only has the potential to become the world’s largest oil producer but also can produce the oil more economically than most oil producing countries.

Favourable geology has given Iraq some of the world’s most prolific oil wells. In 1979 Iraqi wells produced an average of 13,700 bpd. By contrast each Saudi Arabian well averaged 10,200 barrels.

US wells, which are gradually drying up, averaged just 17 bpd. It would take more than 800 US wells to pump as much oil as a typical Iraqi well. Consequently, production costs in Iraq are much lower. The average cost of pumping a barrel of oil out of the ground in the US is about $10; in Iraq it is less than $1.

Most of Iraq’s known oil reserves are waiting to be developed. That’s why many countries have has cast a covetous eye on Iraq, and why each one of the world’s major powers and international groups has an agenda for Iraqi oil.

Swing producer

For now at least, US policymakers envision Iraq as a swing producer, i.e. a producer that can provide just enough oil to even out world supply, demand and prop up prices.

Iraq’s importance in reducing the price of oil was spelled out two years ago in an energy study issued by the Council on Foreign Relations and the James A Baker III institute for public policy.

The report said “tight oil markets have increased US and global vulnerability to disruption and provided adversaries undue potential influence over the price of oil. Iraq has become a key ‘swing’ producer posing a difficult situation for the US government.”

The US occupation of Iraq has reinforced its role as a swing producer. However, this presents a different set of problems.

If Iraq limits its production between 2.5 million and 3.5 million bpd per day it will fail to generate enough revenue to rebuild its infrastructure.

Iraq needs to pay off at least a portion of the $420 billion it owes in debt and war reparations, modernise existing oil fields, open new fields and raise the living standards of its people.

A US State Department–sponsored advisory group of Iraqi exiles has concluded that the country needs to double its output by the end of the decade to “invigorate Iraq’s economy and lift the Iraqi people out of a future of impoverishment”.

If Iraq succeeds many experts are inclined to believe that the growing demand for oil around the world would absorb the new supply as quickly as it came to market, thus keeping prices stable.

But others see Iraqi production pushing oil prices sharply downwards, creating instability elsewhere, especially in Saudi Arabia.

Restricted production in Iraq has become the norm. It has never come close to achieving its potential. Production peaked at 3.5 million bpd in 1979.

Prospects

The volume of production in the ‘New Iraq’ will depend on many variables: Firstly, whether a new government could encourage foreign oil companies with the technical expertise and financial capability to develop fields.

Secondly, will Iraq return to its status as a dutiful member of OPEC and abide by the cartel’s production quotas – or ignore them and produce volumes that benefit the Iraqi people?

As he set out a goal of transforming the country into free-market economy, Paul Bremer the American occupation’s chief administrator for Iraq said on 22 June that some of the profits from Iraqi oil sales could be distributed to its citizens as dividends.

Thirdly, much depends on whether Iraq can form alliances with Russia, France and China, amongst others, to manage production or whether American and British companies get all the action.

In the years leading up to the occupation of Iraq, the US bought about 600,000 bpd under the oil for food programme, although no American oil companies operated on its territory.

Quitting OPEC

It is clear that the amount of oil that Iraq will bring to the market will influence the Russian economy, the price Americans pay for gasoline, the stability of Saudi Arabia, Iran’s future and last but not least the strength and effectiveness of OPEC.

Philip Carroll recently touched on the future relations between Iraq and OPEC, “They (Iraq) have from time to time, because of compelling national interest elected to opt out of the quota system and pursue their own path…they may elect to do that same thing. To me it’s a very important national question”

Iraq’s planned return as a key player in the world oil market after 13 years of UN sanctions has prompted concerns within OPEC, with some analysts warning that Iraq could kill off OPEC countries if it decides to leave the cartel in a bid to produce as much oil as it can outside the quota system.

As a founding member of OPEC, Iraq will experience a strong historical pull to remain within the organisation. An important factor is the knowledge that producing outside an OPEC quota will not necessarily bring increased resources.

Every producer must balance between restraining output to maintain higher international oil prices and expanding individual production capacity to seek higher revenue through rising market share but at lower international price levels.

Operating outside OPEC will not necessarily mean increased profits, as Iraq oil decision-makers are also aware of the fact that Saudi Arabia may punish Iraq by flooding the market if Iraq chooses to quit OPEC.

In this scenario, Saudi Arabia and other OPEC members will likely lobby Iraq to accept an oil production quota equal to Iran, which is 3.18 million bpd and is in line with historical precedent. As Iraq’s success relies on good neighbourly relations, there are reasons for it to be part of OPEC that are not as compelling to countries outside the cartel such as Russia.

Saudi Arabia, the world’s largest oil exporter and OPEC heavyweight has already moved to play down the prospect of Iraq leaving OPEC.

It believes that the notion that Iraq will undermine the cartel’s market power is based on false political assumptions and ignorance.

Saudi Arabia has every reason to be concerned. Although it is viewed as a country synonymous with wealth, it is however deep in debt. In a few years when Iraq begins to produce serious quantities of oil for export it may be just enough to send the price down and send the Saudi economy into even an deeper decline.

Israel

An important issue often overlooked when discussing Iraq’s oil, is the role Israel will play further to the occupation of Iraq. An Israeli Minister recently said he wants to reopen a pipeline, which has been closed for more than 50 years to bring Iraqi oil through Jordan to Israel.

This move would cut fuel costs in Israel and help regenerate the port city of Haifa. Israeli Finance Minister Benjamin Netanyahu moved further to raise this issue as he also expects an oil pipeline from Iraq to Israel to be reopened in the near future. “It wont be long when you will see Iraqi oil flowing to Haifa”.

It is obvious that any decision on how Iraq will operate in the oil industry will be tied to American interests in Iraq, in particular, its influence as a regional power and its potential role as a major oil producer.

A massive expansion of infrastructure and investment, as well as a stable political environment, will be required to increase Iraq’s oil production capacity.

It is not a question of if, but when Iraq will dictate the state of world oil affairs. The gradual return to normality of the Iraqi oil industry will be monitored closely by the world oil industry, as it attempts to plan for the uncertainties it will bring.

Go back: Special Report