Instability threatens Iraq’s oil production

While for much of 2015 oil traders were fixated on the United States shale oil producers, Chinese energy consumption and the actions of Saudi Arabian oil minister Ali al-Naimi, this summer they are also likely to be keeping a close eye on OPEC’s second-largest producer, Iraq, where instability could curtail the nation’s oil production and move global crude markets.

Over the past 18 months the south of Iraq has seen a surge in crime, including murders, kidnapping, armed robberies, extortion and drug trafficking.

High-profile incidents included the shooting of an Italian oil worker in August 2015 in Basra, the murder of two oilfield engineers who were working on the Az-Zubair field in November, and the kidnapping of 26 Qatari hunters in Muthanna province in December.

Tribal violence has also increased as state control has receded and tribes have filled the vacuum, playing a greater part in dealing out justice and resolving regional disputes.

Since the beginning of 2015 tribal conflicts have left dozens dead, including women and children. These deaths have sparked mass protests demanding better state-provided security and prompted Iraq’s top Shia cleric, Grand Ayatollah Ali al-Sistani, to call for an end to the clashes.

Disarming militants

In early 2016 Baghdad moved to try to clamp down on criminal and tribal violence in the south, sending federal forces armed with heavy weapons and tanks into Basra to try to confiscate weapons from militant groups in the region.

On January 15, the government announced that more than 30 people had been detained in the operation and weapons including rocket-propelled grenades and mortars had been seized during raids on houses.

The failure of the central government to disarm renegade militants and sooth tribal tensions at the beginning of the year has underlined the limits of Baghdad's influence in the region.

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However, the operation’s success was short-lived and what was originally intended as a show of force quickly turned into an embarrassing demonstration of the central government’s declining influence in Iraq’s south.

According to security sources, most of the additional forces that were sent into Basra in January were withdrawn after just over a week following reports of disagreements with powerful Shia militia members over weapon confiscations.

Stability in Iraq’s south is expected to further deteriorate over 2016 as budget problems in Baghdad limit the government’s ability to provide basic necessities to citizens.

In 2015 Baghdad has seen its budget deficit expand rapidly owing to extra spending on the ongoing war against the Islamic State in Iraq and the Levant (ISIL) and the collapse in oil prices, which have fallen by two thirds since June 2014 due to increased production in the US, OPEC’s decision not to reduce production, and slowing growth in China.

In October, Iraq’s government forecast a deficit worth 11.9 percent of gross domestic product for 2016. That figure is now expected to be even higher owing to further declines in the price of oil.

Baghdad’s financial crisis has frozen activity on thousands of important infrastructure projects across the country – something that could prove especially significant in the south, which regularly sees disruptive protests during the summer months because of electricity blackouts, high pollution levels, and inadequate supplies of fresh water.

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In the past year, almost nothing has been done to improve power and water infrastructure around Basra – and the budget crisis has created new problems, including job losses and delayed salary payments.

Owing to the government’s failure to address the grievances of communities in Basra, Iraqi officials are expecting the summer of 2016 to be the most disruptive season of protests on record, and some fear it could potentially affect the region’s oil exports.

Economic impact

Over the past three years Iraqi oil exports have shown incredible resilience, hitting new highs despite ISIL taking control of large swaths of the country in June 2014.

One of the key factors behind Iraq’s success in increasing oil output amid political turmoil is geographical.

More than three quarters of the country’s oil is produced and exported from Basra and neighbouring provinces in the south, which lie more than 500km from the fighting with ISIL.

In January Iraq exported an average of 3.88 million barrels a day, including exports from Iraqi Kurdistan.

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This is 660,000 barrels a day more than it was exporting before ISIL’s advance across the country in the summer of 2014, which saw the group secure around a third of the country’s territory.

Just how long this impressive export growth can be sustained remains to be seen, and 2016 could well prove to be a key test for oil companies active in Basra.

Though the region’s oilfields and related facilities are well-fortified and international oil companies can rely on several layers of security, including government-provided oilfield protection forces and private contractors, the environment in which oil companies are operating is almost certainly going to get more difficult.

The failure of the central government to disarm renegade militants and soothe tribal tensions at the beginning of the year has underlined the limits of Baghdad’s influence in the region.

Additionally, failure to provide adequate power and water infrastructure is likely to fuel public anger and separatist sentiment, which could potentially be channelled by political groups looking to further undermine the central government.

All this has ramped up risk for oil companies operating around Basra, which could potentially become targets for the region’s well-armed militant groups that are increasingly acting with impunity.

As Basra’s oil exports are the biggest single source of income for Iraq’s government, any kind of sustained period of disruption to operations would be devastating for the country’s already fragile economy and would significantly affect its efforts to fight ISIL in the north.

Additionally, an unexpected cut in Iraqi oil production would deliver a shock beyond the country’s borders, applying upward pressure to global crude prices and making Iraq a key market to observe for oil traders in 2016 along with the US, Saudi Arabia, and Iran.

Wil Crisp is an energy and industry reporter for Middle East Economic Digest.