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Oil and trends toward de facto statehood in the Levant

Oil and trends toward de facto statehood in the Levant

Map 5. Iraq’s oil and gas infrastructure and IS- and KRG-controlled territory (Kirkuk field seizure highlighted).
Map 5. Iraq’s oil and gas infrastructure and IS- and KRG-controlled territory (Kirkuk field seizure highlighted). Click to enlarge.

The future of the Iraqi state is intricately entwined with its oil wealth. With a war being fought against IS on what is effectively two oil-rich fronts – one controlled by a semi-autonomous Kurdish population in the north and the other by a largely Shiite population in the south – the former business-as-usual bickering over oil revenues is rendered of secondary importance. Much more pressing is resolving the situation on the ground, by continuing the fight against IS and financially sustaining the military resistance as well as supporting the fiscal plans of the respective regions.

In the case of Baghdad, this means addressing the grievances of the marginalized Sunni population currently exposed to IS in Iraq’s western provinces or risk losing it. The manner in which these two challenges are addressed will determine the fate of the Iraqi state. It remains to be seen whether Iraq will continue the de facto fragmentation into a Kurdish northern state (incorporating Syrian Kurds on Iraq’s north-west border as Syria also fragments; see Country Report: Syria) and a predominantly Shiite state with the Iraqi Security Forces (ISF) as a sectarian instrument alongside the militias or whether the unity government elected in April 2014 will bring Iraq together against IS.

As the Kurds fight IS in the north, the incentive to break away from Baghdad is not trivial. With a limited ISF presence in the north, the Peshmerga (Kurdish military) have seized Kirkuk and the super-giant Kirkuk oilfield (see Map 5).

Kirkuk’s truck export route to Jordan through Anbar (typically moving 10,000bpd) has been cut due to the presence of IS, but some 15,000bpd of condensate and 20,000bpd of crude oil are being exported to Turkey by truck. Furthermore, the KRG is also looking to build its own pipelines to export crude oil directly via Turkey, bypassing the national export pipeline system. Although Turkey has not officially agreed to this plan, the Anglo-Turkish company Genel Energy plans to build the 420,000bpd Kurdistan Iraq Crude Export (KICE) pipeline that will connect its fields in the Kurdish regions in northern Iraq to the Turkish border. The KRG has also explored the possibility of supplying natural gas to Turkey.

Agreement between Baghdad and KRG

Map 6. Oilfields under IS control.
Map 6. Oilfields under IS control. Click to enlarge.

In the second half of 2014, however, the heated environment spurring the Kurds towards secession from Iraq cooled, simply because the Kurds face a difficult choice: leaving Iraq means losing revenues from the central government. This loss would be disastrous in the near term, as an independent Kurdistan would make under $7 billion per year, almost a third less than they received from just 12% of Iraq’s total oil revenues.

This is not economically sustainable, especially at a time when Prime Minister Nechirvan Barzani’s government faces the additional financial strain of aiding beleaguered Syrian Kurds and the Kurdistan region becomes a dumping ground for the rest of Iraq’s problems. With nearly two million internally displaced persons now in Iraq, the majority in Kurdish territories, the KRG is facing a fiscal burden of almost $300 million per month, and the recent decline in oil prices means the Kurds will need to produce up to twice as many barrels per day to break even, even selling at market prices – the KRG has so far sold oil at great discounts, mainly because traders view the purchase of KRG oil as a risk in the face of legal objections from Baghdad.

In Arbil, the lack of petrodollars coming from Baghdad – and too few coming from the sale of Kurdish oil – has left a multitude of civil servants, including 180,000 Peshmerga fighters – without salaries for months. Perhaps triggered by this situation, the government of Iraq and KRG signed an agreement in November 2014 to ease tensions over Kurdish oil exports and civil-service payments from Baghdad.

Hoshyar Zebari, Iraq’s deputy prime minister and finance minister, said the central government had agreed, for the time being, to resume payments from the federal budget for Kurdish civil servants’ salaries. Zebari, a Kurd, described the step as a “major breakthrough” that would reduce friction between the KRG and Baghdad. He said the payments would cover October (previously outstanding and a major source of contention) and then November.

Under the agreement, Iraqi Kurdistan will commit to the federal budget 150,000bpd of oil exports, equal to about half of its overall shipments. The KRG is apparently taking advantage of Iraq’s new unity cabinet, which includes Shiites, Sunnis and Kurds. Perhaps the legacy of Iraq’s former oil minister, Hussain al-Shahristani, who pursued an aggressive centralized oil policy disliked by the Kurds, is fading. The appointment of Adel Abdul Mehdi as the new oil minister has helped to sway the Kurds, as he enjoys close relations with Barzani’s party. Finally, 17% of Iraq’s oil and gas revenues are slated to be sent to Arbil, if a longer-term agreement can be reached. In light of the development plans for the fields in Basra, this is a slice of a large pie.

Unsurprisingly, energy also figures prominently in the activities of IS. Territory currently controlled by IS in Iraq is predominantly in the western Anbar province, which, in terms of hydrocarbon reserves, pales in comparison to the Kurdish-controlled north and predominantly Shia-controlled south. However, there is oil to be found in territories controlled by IS in both Iraq and Syria.

Maplecroft, the risk management firm, estimates that IS now controls six out of ten of Syria’s oilfields, including the big Omar facility, and at least four small fields in Iraq, including those at Ajeel and Hamreen. Revenue streams associated with illicit production are aided by the long-standing networks of black-market oil sales and smuggling in the Levant. The imposition of UN energy sanctions on Iraq in the 1990s resulted in a robust network of smugglers, traders and bootleg refineries.

“The fact that Iraq was under sanctions for so long led Kurdish and Iraqi businessmen to fill a vacuum and create smuggling networks for Iraqi oil,” says Valerie Marcel, a Middle East and Africa energy specialist at Chatham House. “Turkish, Iranian, Syrian, Iraqi networks have grown because of decades of bans on exports.” The Energy Information Administration (EIA) and the Iraq Energy Institute have estimated IS production at 50kbpd in Iraq and 30kbpd in Syria, implying earnings of $3.2 million per day when sold at the black-market price of $40 per barrel. As such, these oil installations have been prime targets for the US-led airstrikes initiated in August 2014.

Implications for foreign operators

It is unlikely that the IS militants will be able to overwhelm key Shiite territories or the Kurdish federal region militarily, especially with the initiation of coalition airstrikes against IS. But there is still the risk of one-off acts of terror that may include sabotage, kidnapping and other threats to Iraqi energy installations and personnel. This is not to deny that oil projects in Iraq are among the technically more straightforward and lowest cost in the world, in terms of the capital cost per unit of new production capacity and operating expense. Many companies will remain interested in the prospect of high volumes, in the knowledge that Iraq’s fields are of such size and quality that there is relatively little technical, price or exploration risk.

That said, it is likely that capital that would otherwise have been allocated to investment may now be diverted to combat IS. Adding security, as is likely to be necessary, will raise the operating costs and lower the profitability for the operators and the people of Iraq.

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