How Might an Iran Deal Worsen Iraq's Increasing Energy Chaos?

Just as Iraq is suddenly becoming a more unstable place for Western energy companies, the world's leaders will resume their negotiations with its neighbor Iran on Wednesday. The talks are intended to thrash out a lessening of the tension between the rogue country and most other nations, to reduce strict sanctions -- primarily banking- and energy-related -- that have been imposed on Tehran, and to at least slow the country's drive toward nuclear weapons capability.

But it seems that a key question for energy investors suddenly becomes how, should Iran be even somewhat liberated from its debilitating economic shackles, its influence in Iraq might be altered. That's recently become far more than an academic inquiry. Within just the past week, oil-field services giants Schlumberger (NYSE: SLB  ) and Baker Hughes (NYSE: BHI  ) at least temporarily halted their Iraqi operations in the face of sometimes violent erruptions in the country.

Disrespect to the imam?
Indeed, last week demonstrations erupted against Schlumberger as it worked on the giant Rumaila field, to the nation's south. Apparently, a British worker for the company had tried to remove flags honoring Imam Hussein, an iconic figure among Shiite Muslims. The Shiite community is currently celebrating Hussein's death 1,000 years ago.

Schlumberger's offices in the Basra province were badly damaged in the process. However, it was soon announced that the company's work at Rumaila, which had been briefly suspended, will be resumed. The huge field is being operated primarily by BP.

At about the same time that Schlumberger temporarily ceased its activities in Iraq, Baker Hughes announced that it, too, was halting its own work in Iraq. It seems possible that Baker's decision was tied to the attacks on its larger rival's compound, but that remains unclear. Late last week, a Baker Hughes spokeswoman would say only, "Right now our focus in on the security of our people."

Unprofitable and insecure operations
Iraq also has hardly resulted in a financial windfall for the companies. The largest of the integrated majors, ExxonMobil (NYSE: XOM  ) , is selling its interest in the West Qurna-1 field, also in Basra, and moving on.

In July, Weatherford International (NYSE: WFT  ) , another sizable services company, announced that it was abandoning its unprofitable operations in the country. Weatherford management had earlier made much of what it considered to be its bright prospects in Iraq. Earlier this month, the managing director of Royal Dutch Shell's (NYSE: RDS-B  ) Iraq operation observed, "Oil companies are certainly reassessing their calculations with respect to the targeting of work sites in Iraq, which is still witnessing security breaches in all sectors."

So, as we head for a potential deal with Iran, it's important to observe -- as I did in a Foolish piece a half-dozen years ago -- Iraq's vital location in the Middle East: Saudi Arabia sits to its south, Iran is at its east, and Syria to its northwest. Only Iraq and the Persian Gulf separate largely Shiite Iran from the primarily Sunni Saudi kingdom. The latter two countries have long been at loggerheads, and the balance between them could be affected by Iraq's Shiite majority.

And how would the increasing instability in Iraq potentially be affected by negations between the P5+1 countries (Britain, France, the U.S., Russia, and China, plus Germany) and Iran? And how should investors with an energy bent play the possibility that those talks could lead to removing the major countries' boots from Iran's neck?

Foolish conclusion
My feeling is that a reinvigorated Iran would be increasingly at liberty to insert itself into Iraq's already dicey affairs, and probably not in a good way. Indeed, that's a salient concern of other nations in the region, including the Saudis and the United Arab Emirates, which, like Israel, take a dim view of the talks' potential results.

For now, I'll limit my investment recommendation to the oil-field services sector. In doing so, I'll only note that I'm inclined to find even more favor in behemoth Schlumberger. Among other things, its industry-leading geographic spread could render heightened Middle East outbreaks less deleterious to it than to its peers.

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