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Iraq is balking at OPEC's oil output deal, and Baghdad could get away with it

Iraq's insistence that it should be exempt from a proposed deal to limit oil output may sound audacious coming from OPEC's second largest producer, but analysts say it's entirely possible that top exporter Saudi Arabia will give Baghdad a pass.

Iraqi Oil Minister Jabar Ali al-Luaibi dropped the bombshell on Sunday, doubling down after Iraq had already kicked up a fuss over how OPEC plans to set quotas when it meets next month in Vienna. He argued that his country can't cut production because it badly needs oil revenue to fight the Islamic State, which Iraqi forces are now fighting to dislodge from Mosul, Iraq's second-largest city and ISIS's last stronghold in Iraq.

Crude output from Iraq has risen steadily as OPEC members battle for market share amid a two-year oil price rout. Iraq pumped at 4.45 million barrels per day in September, according to secondary sources.

To be sure, Iraq has traditionally been exempt from OPEC quotas, on the grounds that its economy has labored beneath the weight of war in recent years and sanctions before that. Still, Iraq's call to be exempt has helped to send oil prices below $50 a barrel this week and overshadowed supportive comments from Iranian and Russian officials regarding efforts to secure cuts from non-OPEC producers.

Iraq is "absolutely" stuck between a rock and hard place, said Bilal Wahab, a fellow at the Washington Institute for Near East Policy. Its economic situation is so bad, it cannot afford to cut oil production, but it is also desperate for the relief that higher oil prices would likely bring.

For that reason, the Iraqi oil minister's comments should not be taken as a mere bluff ahead of a high stakes meeting, say analysts.

"I think the argument is serious. It's not just saber-rattling. The Iraqi economy is in shambles, as is the Kurdish economy, and the war effort adds to the burden," said Wahab, referring to the semi-autonomous area known as Iraqi Kurdistan.

This summer, the International Monetary Fund floated Iraq a $5.3 billion loan to help Baghdad weather reforms aimed at tackling oil's prolonged price slump and an ISIS insurgency that has displaced 4 million people. At the time, the IMF said Iraq's government, which relies on oil for roughly 90 percent of its revenue, faced a $18 billion funding gap.

That deficit threatens to further undermine an already unstable nation by making it difficult for Baghdad and the Kurdish capital of Erbil to deliver basic services, pay public workers, and compensate international oil companies.

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It's not only state finances standing in the way of Iraqi participation in an OPEC cut, but also the often contentious relationship between the central government in Baghdad and the Kurdish leadership in Iraq's northeast. In doing a deal with OPEC, Baghdad runs the risk that the Kurds would just refuse to go along with their own oil fields, leaving the Shiite Muslim south to bear the financial burden of production caps and potentially inflaming already deep divisions over revenue-sharing, according to Wahab.

A production cut would be a hard sell to the Kurds, who have long sought an independent homeland carved out of parts of Iraq, Turkey and Syria, and who are fiercely protective of their autonomy within Iraq.

"The Kurdish government has been really working hard and ... at huge cost to maintain this level of oil independence, and one of the challenges of saying yes to Baghdad is losing that independence they have achieved," he said.

Amid the call to be exempt, the Iraqi oil ministry also launched an effort to attract foreign companies to develop a dozen small and mid-sized oil fields.

Saudi Arabia has already signaled it may exempt Libya, Nigeria and Iran from production quotas because those countries are restoring sidelined capacity. Libya and Nigeria's output has tanked due to internal conflicts, while Iran is clawing back market share after sanctions on Tehran were lifted this year.


Unlike Iran, which has a more diverse economy than Iraq and enjoys relative domestic stability, the Iraqis simply need higher oil prices, said Helima Croft, head of commodity strategy at RBC Capital Markets.

"Here's the problem for Iraq, and this is where they could push it too far," she told CNBC. "The Iranians are in a financial position to walk away. The Iraqis don't have a major slug of product coming on."

"It would be one thing if the Iraqis had 500,000 barrels up their sleeve that they could put on the market," she added.

But the fact that Iraq does not have hundreds of thousands of barrels a day it can suddenly bring online could serve as a weapon as much as it presents a weakness. Since Saudi Arabia doesn't fear Iraq will suddenly ramp up production while others are cutting, Riyadh could be willing to extend some sort of special treatment to Baghdad, Croft said.

"They would prefer Iraq to stay in the tent of doing something. This is where it's going to be a bit of a push and pull, but I don't think anyone is incentivized to have this thing blow up," she said.

How to measure baseline production?

Riyadh is aiming to sell a stake in state oil giant Saudi Aramco in order to fund a $2 trillion sovereign wealth fund designed to diversify the Saudi economy. A rising oil price would make the IPO more attractive to investors.

Still, the OPEC deal simply won't work if Iraq does not participate in some form, said Richard Mallinson, geopolitical analyst at research firm Energy Aspects. In his view, no one is expecting Iraq to make big cuts, but Baghdad and its OPEC peers must at least address the dispute over how the cartel measures baseline production.

Immediately after the OPEC deal was announced last month, Iraq insisted the quotas should be based on current production figures supplied by Baghdad, rather than secondary sources that reflect lower Iraqi output. Striking an agreement could be tricky, with most of OPEC united around output levels provided by secondary sources, but with Iraq insisting cuts be measured against its own, higher figures, Mallinson said.

"Nobody in the market really agrees with those numbers that Baghdad is putting out, and so I think there's going to be some difficult diplomacy behind the scenes between now and the 30th of November to try and get Baghdad singing from the same sheet as the other producers," Maillinson told CNBC's "Street Signs" on Monday.