Middle East Turmoil

Iraq's oil industry faces setback to revival

Clifford Krauss

After a long history of wars and sanctions, Iraq re-emerged as a critical source of oil in recent years. Mounting Iraqi production helped to ease world oil prices despite the tightening restrictions on Iran and tanking exports from Libya. And Western and Chinese oil companies rushed back, revitalizing long-neglected oil fields in the north and south.

Now suddenly all that progress has been put in jeopardy with the intense military offensive by extremist insurgents.

Kurdish Peshmerga forces and Iraqi special forces deploy their troops and armoured vehicles outside of the oil-rich city of Kirkuk, Iraq
Anadolu Agency / Contributor | Getty Images

The stakes for the oil markets are high as the Iraqi government tries to gain control over the situation. An eventual decline in Iraqi exports would put pressure on China and India to increase their imports of Iranian oil again, weakening the United States government's position in negotiations with Tehran over nuclear policies. Russian oil exports would become more crucial for global markets, potentially strengthening the Kremlin's hand in Ukraine. And a major spike in global oil prices could help unfriendly regimes like Venezuela.

"The collapse of Iraq would bring an international oil crisis," said Dragan Vuckovic, president of Mediterranean International, an oil service company that supplies state oil companies in Iraq. "It would mean crude oil would go up to $150 a barrel. It could spread unrest to Saudi Arabia and Kuwait."

So far, the oil markets are taking the growing unrest in stride.

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American drivers are likely to see gasoline prices go up 5 to 10 cents a gallon in the coming days because of the Iraqi violence. But oil prices have been rising modestly compared with what would be expected from a major crisis in the Middle East. At $113 a barrel, global prices remain well below levels that could significantly slow the world economy.

The stock markets, too, have been relatively calm. And while the yields are rising on Iraqi bonds, they are still below the average over the last year.

The relatively muted response reflects the supply situation. No Iraqi oil production or export installations have been damaged yet and the unrest may strengthen the hands of Kurdish political leaders in northern Iraq who would like to have a free hand in exporting oil from their province without Baghdad's interference. And growing oil production in the United States and Canada has helped cut American oil imports, helping to keep global supplies hardy.

Oil prices climb as Iraq intensifies

Still, Iraq plays an important role for market stability. With current production of 3.3 million barrels of oil a day, Iraq is the second-largest producer in the OPEC cartel, and it has the potential to become a far larger player on the world stage. Current predictions by the International Energy Agency show Iraqi production growing to 4.4 million barrels a day in 2015 and to nearly 6 million barrels a day by 2020.

That kind of growth will require large amounts of foreign investment to resuscitate Iraqi oil fields that were poorly maintained for decades under the Saddam Hussein regime. The Western oil giants ExxonMobil, BP, Royal Dutch Shell, Occidental Petroleum and Chevron have plowed significant resources in the southern Iraqi fields and the Kurdistan region of northern Iraq. They also have the skilled talent and expertise that Iraq needs and cannot always get from Chinese and other non-Western oil companies investing in the area.

"All the oil companies are on alert," said Daniel Yergin, the oil historian. "They are going to worry about the security of their people and installations. Obviously, no one is going to do anything new. Confidence about the growth of Iraqi oil output becoming a key element of stability in the world oil market is now in question."

Already, insurgents in recent months attacked and crippled an important northern Iraqi oil export pipeline, meaning a loss of $20 million in daily revenue for the central government in Baghdad. The new attacks will at least delay repairs of the pipeline. This week the insurgents surrounded the Baiji oil refinery, a major source of gasoline and diesel to central Iraq and to a vital power station that supplies Baghdad. Despite conflicting local reports, it seems that the insurgents have taken effective control of the plant, though they are allowing it to continue to operate for the moment.

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As grim as the worst-case situations may be, most analysts still say there is no immediate threat to Iraq's southern oil fields, which account for approximately 90 percent of the country's production and oil export. Basra, the heart of Iraq's oil economy, is situated in an area strongly dominated by Shiites who generally support the central government and are implacable enemies of the Sunni forces on the march in the north.

Badr H. Jafar, chairman of Pearl Petroleum, a consortium that operates in Iraqi Kurdistan, said it was "highly unlikely" that terrorists could disrupt production and operations in southern Iraq. But he predicted that the disruption at the Baiji refinery "is likely to affect the electricity supply to Baghdad."

Sadad Ibrahim Al-Husseini, former head of exploration and development at Saudi Aramco, said the new terrorist attacks would mean "higher prices for sure and delayed investments in the south." But he added that they had also created "three fundamental new realities in Iraq" — some of which could be helpful for global markets, at least in the short term.

The Saudi oil man said heavily armed Kurdish militias would now "fill the power vacuum in northern Iraq and take over the disputed giant Kirkuk oil field and other fields around it." Second, the central Iraqi government will be forced to redirect exports of southern Iraqi oil that once went through Turkey to leave from the gulf. And finally, he said, "the Turkish government will now have no choice but to commit itself to supporting the Iraqi Kurds" in order to maintain security on its southern border and protect Kurdish oil supplies that go through Turkey.

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World oil supplies are relatively robust at the moment, which explains why oil price increases have not been significant. Global supplies are up a million barrels a day from a year ago, mostly because of North American production. And OPEC supplies moderately increased in May, as increased Saudi Arabian production compensated for declines in Libyan exports throttled by militia unrest. China has stockpiled large amounts of oil in recent weeks, making a global shortage less likely.

Still, many oil experts expressed concern about the prospects for Iraqi oil production stability and its meaning for world markets. Since oil meets 90 percent of the country's energy needs and is the main source of the government's funding, oil infrastructure is a tempting target for any group that wants to destabilize the country. As such, analysts worry that even the Shiite-controlled southern area could be in jeopardy.

Experts note that there have been periodic suicide bombings, albeit of mostly civilian targets, over the last year in southern Iraq, including a truck bombing in a Basra port last August. And just over a month later there was a bombing at the large Daura refinery complex in Baghdad, although the principal target was the mosque inside, and equipment did not suffer serious damage.

"This was a heavily fortified facility," noted Helima Croft, senior geopolitical analyst at Barclays, "and he got in there."