The Call

Iraqi oil and its future

Iraqi oil and its future

By David Bender

Remember when Iraq was all about the oil?

Bush administration officials predicted that a post-war spike in Iraq’s oil production would pay for both the conflict and ease the country’s transition to democracy. Anti-war protesters countered that the war itself was little more than an oil grab. Now that the American combat mission is officially over, where is all that oil, and how will it change Iraq and the world?  

It seemed for years that violent chaos inside Iraq made a big increase in oil production entirely unrealistic; but now there are growing signs that oil project work could begin on several fields in the south over the next six months. If these projects move ahead, over the next decade, Iraq could begin to contribute enough production to significantly influence the global oil market, providing enough supply to undermine assumptions that energy demand from emerging Asia and increasing production costs will squeeze energy markets and add serious upward pressure on prices in the mid 2010s.

Iraq is now producing about 2.4 million barrels per day. The 12 contracts signed with some of the world’s largest oil companies fuel hopes that Iraq can increase production nearly fivefold by 2020. That target is unrealistic, but even the likelier tripling of production levels will have important implications for the global economy and raise interesting questions about regional political dynamics. For the moment, Saudi Arabia is the only producer with enough spare capacity to single-handedly move prices. How will the Saudis respond if Iraq can produce enough oil to usurp some of that market power? How will Iran react if a surge in Iraqi production drives down oil prices, depriving Tehran of badly needed revenue? Globally, will Iraqi oil power Chinese and Indian growth? Will it kill the electric car? Iraqi oil production increases will have widespread effects-if they happen.

But Iraq will be a politically volatile and potentially unstable place to do business for the foreseeable future, and a spike in the country’s oil production is anything but a sure thing. Nearly six months after parliamentary elections, U.S. combat troops leave behind a country without a government. Vote winner Iyad Allawi, incumbent Prime Minister Nouri al Maliki, an array of Shia sectarian leaders (including firebrand cleric Muqtada al Sadr), and the Kurds remain locked in a seemingly endless battle of diplomatic nerves, holding fruitless rounds of negotiations, forming and breaking alliances, and making declarations of principle with little bearing on political realities.

When (if?) a government is formed, it will likely be the result of an awkward political compromise meant to maintain sectarian peace, one ill-equipped to craft coherent policy or address the corruption and official incompetence that are more likely than a return to violence to weigh on Iraq’s productive potential.

That’s too bad, and not just for oil-thirsty outsiders. Oil may not have paid for the war, but it will be needed to pay for the reconstruction of the country. Virtually all of the next government’s revenue, the lifeblood of Iraqi development, will have to come from oil production.

Without a working government, vital political business is on hold. Iraq remains without an oil law that would create a legal structure for the contracts the government signs with foreign oil companies, a bureaucratic organization of the energy sector, or an equitable division of oil revenues among the country’s competing factions. Disputes continue over the legality of moves by the Kurdistan Regional Government (KRG) to unilaterally award oil blocs located within its jurisdiction to foreign companies. But the most dangerous unresolved problem concerns the conflict between Baghdad and the KRG over the question of whether and when to hold a constitutionally mandated referendum on the status of the ethnically divided (and oil-rich) city of Kirkuk. Terrorist groups are using this moment of political uncertainty to stage increasingly bold and frequent attacks around the country, testing the capacity of Iraqi security forces.

Little wonder that foreign oil companies are hesitant to begin project work, but there’s good cause for measured optimism that oil development in Iraq’s southern provinces, home to two-thirds of current production and the country’s only port, can move forward. A return to the nationwide violence of 2004-2006 is unlikely. A surge of ethnic bloodshed in Kirkuk and continued terrorist violence in the central and northern cities of Baghdad, Diyala, and Mosul could stunt the country’s political growth but won’t necessarily destabilize the relatively more secure and overwhelmingly Shia south. Government incompetence in Baghdad will slow things down, but government ministers have no interest in slaughtering the country’s only reliable cash cow.

Iraq isn’t on the verge of becoming Switzerland or Somalia. For the foreseeable future, its most ambitious leaders will be coping day to day with seemingly insoluble political problems. But over time, the country’s contribution to the world’s oil production will begin to grow, raising the next generation of questions for the political balance of power in the world’s most dangerous neighborhood.

David Bender is an analyst in Eurasia Group’s Middle East practice.