Iraqi Oil Is a Dream Deferred

Increasing levels of violence, chronic instability, and government ineptitude may devastate Iraqi oil production.

Jun 15, 2014 at 4:26PM

Last week, I wrote that Libya is a losing gamble for multinational oil and gas companies.

We are quickly approaching a similar stage in Iraq, if we aren't there already.

On June 10, the Islamic State of Iraq and Syria surprised and overwhelmed Iraqi security forces in Mosul, the country's second-largest city. ISIS drove out the security forces and government buildings were taken over. The situation prompted Prime Minister Nouri Al-Maliki to declare a nationwide state of emergency.

Thousands of families are fleeing Mosul, and most are headed northward to predominantly Kurdish areas. This flood of internal refugees will strain resources in northern Iraq and possibly exacerbate tensions in the area because of the large number of Syrian refugees who fled there as the Syrian situation deteriorated since 2011. Over 200,000 Syrian refugees reside in Iraqi Kurdistan.

It is worrisome that Mosul does not mark the first time this has happened, nor is it today's only case of ISIS controlling a major Iraqi city.

Aqi Map Political Influence

Source: Business Insider

In January, ISIS captured captured Fallujah. In this case, too, government forces were driven out by ISIS. The city is a mere 45 miles from Baghdad, the capital of Iraq. Iraqi forces still have not reestablished control of Fallujah. As the map above shows, ISIS -- which developed from Al-Qaeda in Iraq in April 2013 and is also highly active in Syria -- has a strong presence throughout western Iraq and around Baghdad, and is creeping up on Basra. With wide swaths of Iraqi territory under ISIS control or influence, we can expect Iraqi instability to persist for the foreseeable future.

What impact will these and related events have on oil production?

Iraq Oil Infrastructure

Source: Platts.com

Mosul and the Kurdish Autonomous Region are located near a significant number of oil fields, including the supergiant Kirkuk oil field. The Kirkuk field is among the country's most important and is estimated to contain up to 9 billion barrels of reserves. ISIS is very active to the west, east, and south of this oil-producing area. Fighting in and around Mosul has halted repairs to the Kirkuk-Ceyhan Oil Pipeline, which can carry approximately 600,000 bbl/d of crude. This level of uncertainty and risk will undoubtedly reduce foreign investment and endanger Iraq's stated goal of tripling its oil production by 2020.

Kurdish authorities and the Iraqi central government have already butted heads over control of the Kirkuk and nearby fields. The struggle between provincial and central power has affected all multinational firms operating in Iraq.

Last September, the Iraqi central government reached an agreement with BP (NYSE:BP) to help boost production of the Kirkuk field to 500,000 bbl/d. The Kurdistan Regional Government flatly rejected the deal. In reversed situations, Chevron Corporation (NYSE:CVX) and ExxonMobil (NYSE:XOM) reached deals and signed contracts with the KRG. Central authorities banned both companies from signing deals with the Iraqi government for projects in the rest of the country.

With ISIS lurching toward Basra, oil fields in southern Iraq are not safe either. Southern Iraq is the country's hydrocarbon breadbasket, holding 75% of Iraq's proven oil reserves. Around Basra are the three major fields of Majnoon, West Qurna, and Rumaila.

Royal Dutch Shell (NYSE: RDS-B) is a major stakeholder and operator of the supergiant Majnoon field. It is also a secondary partner in Phase 1 of the West Qurna field, where Exxon sold a quarter of its stake last year to PetroChina (NYSE: PTR). In Phase 2 of the West Qurna field, Lukoil holds the majority interest and Statoil (NYSE:STO) is a secondary partner. BP holds the largest position in Rumaila. Rumaila yielded 1.4 million bbl/d in 2013 and is estimated to contain reserves of 17 billion barrels.

What's the Foolish conclusion?
ISIS and political conflicts between provincial and central governments are making it increasingly difficult to do business in Iraq. Even though the presence of ISIS is weaker in southern Iraq, it still presents a major cause for concern. All it takes is one glance at the preceding paragraph and seeing names such as Shell, PetroChina, BP, and ExxonMobil, to realize how conflict in southern Iraq can disrupt the operations of the largest firms and destabilize the global oil market. At any rate, the 25% of national oil production in northern Iraq is under great threat, as that is where ISIS control and influence and province-center disputes are most pronounced.

As in Libya, there are no easy solutions to these problems. Especially in the case of the KRG and the central government, these problems have long histories. They are caught up in, and exacerbated by, the political economy of resources and regional dynamics. Although Iraq's oil production has been a series of starts, stops, and drops since 2003, it has not been as bad as Libya has been since 2011. Iraq is not a losing gamble for oil companies, but every now and then it will be on the brink of being so. Companies in Iraq and their investors must be prepared for that reality.

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Dajahi Wiley has no position in any stocks mentioned. The Motley Fool recommends Chevron and Statoil (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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