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The Islamic State's territory is shrinking, taking a major bite out of its financing

An Iraqi soldier holds an Islamic State flag during a battle with Islamic State militants, north of Mosul, Iraq.
Ari Jalal | Reuters
An Iraqi soldier holds an Islamic State flag during a battle with Islamic State militants, north of Mosul, Iraq.

The Islamic State has lost nearly two-thirds of the land it once controlled, leveling a major blow to several critical funding streams including oil and gas revenue, taxation and extortion.

The organization, which took over vast swaths of Syria and Iraq in 2014, is one of the best-funded terror groups in history, according to an assessment by the Foundation for Defense of Democracies' Center on Sanctions and Illicit Finance. But a new report from the nonpartisan research institute, based on a review of nearly 200 sources, shows IS fortunes dwindling.

The setbacks come after coalition forces backed by U.S. airstrikes and advisors took back Fallujah, Iraq, and wrested control of much of the IS stronghold in Mosul, also in Iraq. They threaten to force a significant in change how the Islamic State raises funds.

Islamic State territory changes, source: U.S. military

"Going forward, IS is likely to shift its funding composition towards a more 'traditional' model of terror financing, relying more on external donors and extortive practices such as kidnapping for ransom," the report authors concluded.

Oil and gas running dry

In the course of capturing its territory, the Islamic State has taken control of oil supplies that it refines into fuel, which it uses internally and smuggles for profit.

Estimates for IS oil and natural gas revenue for 2015 vary considerably, but sit at about $500 million. The U.S. military projects airstrikes roughly halved those sales to $180 million to $250 million by mid-2016.

While this is a clear win, the report authors note that the Islamic State "has proven adaptable, shifting how it operates its oil market and even where it directs its smuggling."

Most of that oil is traded within Syria, including with the Syrian regime led by Bashar Assad, whose six-year war with militants created an opening for the Islamic State to occupy much of the country's eastern and central territory.

Sales to the Assad regime, which depends on IS-held oil and gas supplies to power the country, are the Islamic State's biggest funding stream, U.S. officials said in January.

The report authors see the reliance on Assad as a strategic vulnerability because IS revenues could plummet further if the Syrian ruler secures oil supplies from another source.

Tax and extortion pool shrinks

As the Islamic State loses land, the population it can extort and levy taxes against also shrinks. That's another significant blow: In 2014, taxes and extortion filled its coffers to the tune of an estimated $600 million.

The terror group is "adept at squeezing multiple revenue streams out of the people it controls," in the Center on Sanctions and Illicit Finance's estimation. But again, there are strategic vulnerabilities embedded in this funding stream.

IS revenue fell 30 percent from mid-2015 to April 2016, according to research firm IHS. In response, the Islamic State has cut back on governance and salaries, its two biggest expenses.

"The need to further squeeze locals and cut salaries as IS loses territory could provoke civilian resistance," the report authors wrote.

Still, the fact that most IS revenues come from external sources makes it difficult for the United States and other nations to disrupt funding without committing to military action.

The Islamic State is also sitting on a pile of looted cash from Syrian and Iraqi banks and has a web of other revenue sources, including factories and farms seized since 2014, donations from sympathetic foreigners, smuggling and trafficking.

New threat

The Center on Sanctions and Illicit Finance expects that as the Islamic State grows more desperate, it will increasingly pull one of its most sinister levers: kidnapping. The group can carry out abductions beyond its territory and has consistently generated tens of millions from this activity, the center said.

As such, loss of territory will not mark the end of the threat the Islamic State currently poses, but the beginning of a new one as seasoned fighters spread to other nations, the authors write.

"Indeed, Islamic State will almost certainly evolve into a diffuse and transnational terrorist group, not unlike al-Qaeda, after it loses its safe haven," they concluded.

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