Iraq’s flood of ‘cheap oil’ could rock world markets

The U.S. is not the only nation experiencing a renaissance in oil  production.

Sidelined for two decades by war, sanctions and political instability, Iraq passed a critical milestone last year by producing  3 million barrels a day of crude oil for the first time since 1990, before the  Persian Gulf War, reaching 3.4 million barrels a day by December. Given its  access to vast reserves at low costs, Baghdad is poised to play a pivotal role  in determining whether the world’s growing thirst for oil drives up fuel prices  to debilitating levels in coming years.

Iraq has a potential as a game-changer” in the  volatile global oil market, said Maria  van der Hoeven, executive director of the Paris-based International  Energy Agency (IEA). Already, she noted, Iraq  has moved up to be the world’s third-largest oil exporter and is now on a path  to be much more, becoming a “strategic source of world oil supply” in the years  ahead. Iraq even has hopes of supplanting Saudi  Arabia as the globe’s biggest oil producer.

Iraq is perhaps the only country left in the  world that has huge stores of what insiders call “cheap oil” — untapped reserves  that can be extracted through relatively inexpensive, traditional drilling  techniques rather than having to employ costly technologies such as hydraulic  fracturing and deep-sea exploration — as in the U.S. — to tap reserves of oil  found offshore or in deep underground shale formations.

The boon of cheap oil is the ironic result of Iraq’s many years outside the economic mainstream, when  ongoing wars and an international oil embargo enforced by the United  Nations ensured that the nation’s oil treasures were left mostly untouched  in the ground.

The gusher of oil starting to flow from Iraqi wells couldn’t come at a better  time. Demand for oil is escalating in quickly emerging markets such as China  and India, where the use of cars is surging, and  other major oil exporters such as Russia and Saudi Arabia appear to be reaching limits of  their abilities to ratchet up production in major ways.

In fact, the IEA is  projecting that most of Iraq’s oil production — which Iraq’s leaders hope will top Saudi  Arabia’s 11 million barrels a day at 13.5 million barrels eventually — will  be funneled to China and other expanding Asian  markets rather than its traditional markets in the U.S. and Europe, filling a  critical gap in world oil supplies that should alleviate pressure on prices in  the years ahead.

Surging demand

Even using conservative estimates, the IEA  expects Iraq to more than double its current  production to 6.1 million barrels a day by 2020 and 8.3 million by 2030,  enabling the country to supply 45 percent of the increase in global oil demand  by 2035. Within two decades, IEA analysts expect Iraq  to surpass Russia to become the second-largest oil  exporter.

Iraq is coming back on the scene just when demand  for oil was poised to surge in a way that threatens to drive up oil and gasoline  prices to destabilizing levels. The world got a glimpse of what surging demand  in emerging markets can do to oil prices when the price of premium crude shot up  to an unprecedented $145 a barrel in July 2008 — the last time the world economy  was experiencing robust growth. Economists say the 2008 spike in oil prices  played a role in sending the U.S. economy into recession even before the global  financial crisis hit months later.

The global economy has been too weak since 2008 to stoke such high prices,  with demand for oil in the U.S., Europe and Japan — still the biggest consuming blocs — stable or in decline. Still, even in a weak  economy, premium crude on the London exchange has been trading well above $100  for several years.

The IEA said Iraq  will need to boost production to prevent another destabilizing spike in prices  the next time the world economy is firing on all cylinders. It estimates that if  things go well and Iraq is able to make the hefty  $530 billion of investments needed to triple production in coming years, world  oil prices still will rise gradually to $215 a barrel by 2030 because of  fast-growing demand in emerging countries.

But it could be much worse. Should Iraq fail to  realize its potential, the world could face a future punctuated by oil crises,  with prices skyrocketing as new sources of supply are unable to keep up with  robustly growing demand.

“Success is not assured, and failure to achieve the anticipated increase in Iraq’s oil supply would put global oil markets on  course for troubled waters,” said Fatih  Birol, the agency’s chief economist, adding that the “health of the global  economy” is at stake.

Obstacles to overcome

But it will not be easy for Iraq to scrape up the  mountain of cash needed to upgrade its tattered oil-producing facilities and  overcome a legacy of instability and violence that has hindered production in  the past. Years of war and neglect have left Iraqi oil fields with considerable  damage that will require major efforts to reverse. Iraq also will have to make large investments in its  electrical, natural gas and water systems as well as in better oil transport,  storage and drilling facilities.

Iraq will have to make some hard choices to come  up with the cash to make these major upgrades. Iraq’s $115 billion of yearly revenues from oil exports  provides nearly three-quarters of the income that the government and the  nation’s citizens depend on for basic needs and services. The nation would have  to devote a significant share of those revenues — about 10 percent — in the next  decade to improving its oil fields and facilities.

But Mr. Birol noted that the payoff is  enormous if Iraq makes the required investments: a  near doubling of its oil revenues to $5 trillion in the next decade. He said Iraq also could become a major exporter of natural gas  if it makes needed investments.

But perhaps the most nettlesome problems the nation will have to overcome are  political. In particular, it must resolve a festering dispute between the  government in Baghdad and the Kurdish regional government over control of the  nation’s northern oil fields in Kurdish territory.

Authorities in the semiautonomous Kurdish region defied Baghdad’s wishes in  recent years and negotiated contracts with major oil companies such as Exxon  Mobil Corp. to develop the fields — a move made possible by the lack of a  national law or consensus governing who controls the oil fields and how the  revenues that come from them are to be divided among the regions.

The conflict recently boiled over into armed clashes, with tensions in  particular centered on a plan by Exxon  Mobile to drill in an area of disputed territory claimed by Baghdad. The  national government threatened to send in the army, if necessary, to prevent the  drilling, and raised the threat of a wider war with Iraqi Kurds if the company  did not back off.

Much intrigue has swirled around Exxon  Mobil because of its conflict with the Baghdad government, including reports  that the oil giant might sell its stake in the mammoth West Qurna oil field in  the south to the China National Petroleum Corp. for $50 billion.

Baghdad also has showed its displeasure with other oil companies doing  business with the Kurds by refusing to include them in deals to develop Iraq’s  super-giant southern oil fields around Basra, which contain the largest reserves  of oil.

“Chevron was recently told it was not qualified to do business with Iraq  because of deals with Kurdistan,” Ben Lando,  editor of the Iraq Oil Report, said on Platt’s TV. The territorial dispute has  put global oil companies in a difficult position, he said. The Kurdish  authorities offer more lucrative production-sharing agreements, but the most  plentiful oil reserves are in the south, where the Baghdad government is  offering them skimpy fees for assistance in exploiting the oil.

“They have to decide whether to invest in Kurdistan or the rest of Iraq,” Mr. Lando said. “It’s really a political issue  more than anything else.”

Violence hampers drillingOil companies for years avoided working in Iraq  because of the threat of violence against company personnel and facilities. That  is still a concern, although the level of violence is down from the peak during  the U.S.-led military mission in 2006, Mr.  Lando said.

“Violence continues to be horrible for Iraqis,” but “it hasn’t really gone  into the oil sector that much. You haven’t seen attacks on refineries,” he said.  A recent kidnapping of foreign oil company workers was tribal-related rather  than the work of the al Qaeda terrorist network, he said.

The global standoff with Iran that has raised fears about disruptions of oil  traffic in the Strait of Hormuz, the shipping lane for most of Iraq’s  oil, is also not much of a concern in Baghdad, he said. Iran frequently  threatens to shut down the strait in retaliation for the West’s sanctions over  nuclear activities, but the Iraqis “don’t think it’s going to happen,” he  said.

Regardless of the violence and political feuds, Iraq represents one of the last and most promising  unexplored territories on Earth for oil companies at a time when conventional  oil production is declining in most other nations, he said.