On 20 June Iraq Energy Institute held a webinar on the current crisis; Iraq: Lagging OPEC+ Compliance, Struggling Oil Revenues, And an Economic Crisis in A Scorching Summer. This webinar was jointly organised by Iraq Energy Institute (IEI) and Energy Intelligence.
The event was deftly moderated by Simon Martelli, Energy Intelligence’s Senior Middle East Correspondent, and featured presentations from Abhi Rajendran, Director of Research and Advisory at Energy Intelligence, Yesar Al-Maleki, Iraq Energy Institute (IEI)’s Managing Director and Robin Mills, Senior Iraq Energy Institute Fellow, and CEO of Dubai based Qamar Energy.
The event has been recorded in video format below and will soon be available on our YouTube channel here. Also, the following is a summary of the key information presented by each panellist.
Mr. Rajendran outlined his organisation’s perspective on the current crisis, framing the question “what is the path forward given the challenges in the past several months? Noting how May witnessed a price rebound and stabilisation around the $40 level, Mr. Rajendran’s analysis sought to answer a question on the minds of energy analysts everywhere: “Is the worst behind us?”
Outlining the Energy Intelligence house view, he noted that through H1 2020 “there was a build-up of a significant amount of inventory, not just from an oil market perspective but from a refined market perspective. That will be an overhang for the market to deal with, but that said, we do think that despite how much demand fell, supply has pulled back quite a bit, led by the OPEC+ group.”
He continued, “Compliance was quite high in May and going into June but we’ve also seen some pretty deep supply cuts from non-OPEC countries. And if you combine those factors, the supply level is below where demand is. That’s important to keep in mind because it puts some level of support for prices.”
Looking to H2 2020, he remarked how, “prices move higher, cautiously. Again, there is the inventory and stock overhang and macro demand questions are lingering. But all that factored in, the price environment moves comfortably into the $40 range and we would not be surprised if, in the second half of this year prices touch $50. We are now at a point where we are drawing inventories and the cuts are a critical component of that. The supply side must continue to stabilise and we will be watching how OPEC+ evolves.”
“Compliance is a major area of focus. Every month we spend a lot of time looking country by country on how compliance looks, from NOCs and partner companies. In May Saudi Arabia, the UAE, Kuwait and Russia showed very high levels of compliance, including Algeria and Oman. Some countries were slower implementing the cuts. With regard to Iraq, we saw roughly 50% compliance, so slowly moving towards their quota.”
Remarking how the market was rebalancing through the OPEC+ initiative, he explained, “We do expect a catch up from Iraq and Nigeria in June-July. It’s unrealistic of course to expect 100% compliance in July but as a group, we’d be looking at 80-90% compliance in aggregate. In our view, the extent of ultra-deep cuts will depend on prices.”
“The current price environment suggests deeper cuts could be extended to August, although that’s not our base case at the moment. And secondly, it will depend on compliance, if there are weaker prices and weaker compliance, we may see deeper cuts. To conclude, we’ll look at the fiscal constraints of all the different OPEC+ countries. A key part of our work is really looking at the budgets and economic factors influencing broader policy and from an oil policy perspective that means conducting our own breakeven analysis.
Looking at this indicator, Mr. Rajendran noted that, “As a group, the external breakeven price is comfortably in the 70s, but there is a wide spectrum of where that price stands. At the lower end, you have Russia, closer to $50 while other countries like Saudi Arabia are in the 60s and the UAE is on the lower end of that. Iraq is around $70. From an economic health perspective, of course, Iraq would want to be in that $70 range. It won’t be a quick rebound this year but next year $50- $60s ranges are realistic and by 2022, 2023, our base case is that $70 plus is where we can expect the oil price.”
Mr. Al-Maleki presented a rundown of the major challenges Iraq had faced in terms of regional crises and geopolitics in the past nine months, as well as domestic turmoil, a narrowly avoided conflict between the U.S. and Iran and the emergence of the global pandemic.
The dust is now settling on this period after “a void where Iraq was without a government and for one critical month, no Minister of Oil and with debates focusing on a potential minister from Basra.”
Mr. Al-Maleki noted that the stage was now set to move forward, stating, “There is a new Oil Minister, Basra Oil Company head Ihsan Ismaael, while U.S.-Iraq strategic dialogue is ongoing and the world economy is opening up again. But Iraq is facing a triple shock of a COVID-19 surge in cases, declining oil revenues and an economic crisis.”
As the new government solidified, Mr. Al-Maleki noted that COVID-19 had led to a peak “27 million barrel per day of demand destruction” in the first quarter of this year while Iraq “pledged cuts of 1.6 million barrels per day of production” as part of the OPEC+ market supply stabilisation agreement.
Moving forward, he stressed, “we need to look at deeper problems in Iraq’s economy.”
Firstly, Iraq has one of the most under diversified revenue bases in MENA oil-producing countries, where oil makes up 93% of fiscal revenue, 99% of exports and 60% of GDP. The key message here is that there is poor long-term fiscal planning. This is usually short term and lacks policies to build fiscal buffers. Planned and actual revenues and expenditures are usually mismatched since policymakers usually think on an annual cycle rather than multi-year budgets. At the same time, 75-80% of the budget is operating expenditures, leaving very little room for investment.”
A second point Mr. Al-Maleki highlighted was the sensitivity to oil prices. Volatility poses significant challenges and no fiscal breakeven price floor can be set for a multi-year government budget. Usually, the price is set on a poorly planned basis every year.”
Thirdly, he highlighted how “Iraq’s main fiscal buffer today is its foreign exchange reserves. With no other buffers available such as a Sovereign Wealth Fund, the government tends to borrow from state-owned banks and foreign exchange reserves. This policy places the stability of the Iraqi Dinar at risk as well as causing a fluctuation of Central Bank of Iraq assets, with oil shocks and rebounds.”
Finally, he remarked that “Iraq’s only way on the short-term out of this crisis is borrowing, either domestically or internationally until the oil price rebounds to higher levels. Parliament is working on draft legislation to allow borrowing even for operating expenditures, which the IMF and World Bank warn against.”
Mr. Al-Maleki then ran through some of the technical, financial, political and legal challenges Iraq’s oil industry face. On the technical side, he noted how “Iraq has limited additional flexibility to reduce production from nationally operated fields. Iraq needed to prioritise production of the more marketable and higher value Basra light by reducing production from heavy oil fields, but one challenge here is that further cuts, across the board, will impact associated gas capture and therefore, the domestic electricity sector.”
On the financial side, “Iraq would need to consider the impact on International Oil Companies (IOC) long term spending, which includes the aforementioned challenge of the government’s ability to set multi-year spending schedules for spending on energy infrastructure projects.” He noted that “Iraq needs to consider the challenge of balancing payments in kind and highly needed sate petrodollar inflows.”
On the political side, he emphasised the need to “ensure Kurdistan Regional Government (KRG) compliance with reduction targets and consider the effect this will have on budget talks. At the national level, a considerable issue is the importance of isolating Ministry of Oil (MoO)’s decision making from popular and political interference in the upcoming months. Iraq would also face regional pressure to ensure increased OPEC+ deal compliance.”
From the legal perspective, Mr. Al-Maleki noted that a critical issue will be guaranteed payments for IOCs for unused production in case of government-ordered curtailment, as per Technical Service Contract (TSC) agreements. This brings into play the prospects of contract renegotiation and the notion that the 5th licensing round contracts could provide an alternative, more flexible and sustainable model for both parties.
Additionally, Mr. Al-Maleki highlighted the issue of KRG independent Production Sharing Contract (PSC) agreements with IOCs and the imperative of the KRG to honour these contracts despite extreme financial pressure and how that may complicate expected budget talks between Baghdad and Erbil.
Lastly, Mr. Al-Maleki provided IEI’s projections of Iraq’s oil production for June where further production reductions are predicted from nationally operated fields and MoO imposed cuts kicking in mid-month at fields operated by IOCs. The country’s compliance with the OPEC+ deal is expected to pass the 60% mark. For the months to come, certain domestic and global market conditions will have to materialise for Iraq to achieve higher deal compliance. However, the build-up of previously unreduced volumes may render the latest OPEC meeting communique of full compliance by September an impossibility.
Our final speaker was Robin Mills who highlighted that Iraq’s production capacity growth was already levelling off after 2020, explaining that, “A lot of the major Iraqi projects were reaching completion, so there was not a lot of production growth on the horizon without more projects.”
In terms of OPEC+, he noted that “Iraq has cut production from state-operated fields as much as it can, they do however need a minimum level of production for feeding local refineries and producing associated gas. So, Iraq has to make significant cuts at the IOC fields to reach the required OPEC+ level. And of course, they have already agreed on some cuts to fields such as Rumaila. But as Yesar outlines, it will be difficult for Iraq to reach full compliance because that would imply much steeper cuts in the IOC fields.”
This would require ongoing political engagement between Baghdad and the Kurdish Region of Iraq (KRI). Mr. Mills explained, “The KRI region has never been included in OPEC+ cuts before and now it is meant to be. Baghdad has some leverage here due to the issue of budget transfers. In any case, production has been declining in the KRI due to a lack of investment in new drilling, even a shut-in of some production in some cases because of the very low realised prices that these fields are getting, in some cases zero realised price, nowhere near covering their costs.”
He continued, “When you consider all of the current factors, OPEC+ and budget cuts, it’s clear many projects will be delayed and cut back as far as possible. Production growth will move out to 2021, 2022, when investment resumes.”
“However, if we look a little bit further ahead to new production and offsetting declines in more mature fields, Iraq cannot hit targets in the south without progressing on water injection. Treated and industrial water is almost at 2018-19 requirement levels, but it’s not enough to reach the re-injection needs and pressure maintenance for higher production levels.”
“In 2025, the Common Seawater Supply Project (CSSP), or Southern Iraq Integrated Project (SIIP), could be coming in, a date that was optimistic last year and even more optimistic now. Now it will be delayed, but also the production is lower. Iraq will need this very large and very expensive water injection project or lots of smaller projects that amount to the same thing.”
Turning to gas utilisation in the power sector, Mr. Mills remarked how “gas demand in the power sector will grow even if we allow for a slowdown in power projects,” something vital for pushing Iraq beyond the 20 GW maximum generation capacity (up to 7 GW below peak summer demand) and narrowing the demand gap (but not closing it) before 2025.
In terms of supply, Mr. Mills noted how Iraq has “worked hard particularly under the Basra Gas Company to increase capture of flared gas, which has slowed somewhat due to some factors but there has been a significant increase in the amount of gas captured, enough to displace a lot of the crude burning in the power sector.”
The current situation remains positive in the near term, according to Mr. Mills: “In 2020 we expect a significant drop in associated gas production because of the OPEC+ cuts. Interestingly, that doesn’t really affect the amount of gas being captured, if the cuts are done well and carefully phased.”
“Because Iraq is constrained on gas processing capacity, if cuts are done well at particular fields and distributed between fields, associated gas production goes down but as long as processing capacity is still there, you can process what you are still producing so you can cut the flared gas more than you cut the captured gas. Ideally.”
“Of course, associated gas is not the only consideration when deciding which fields to cut, but if possible, you’d want to focus the cuts on fields that are flaring, so gas capture can be maintained. So, gas capture will go down a bit, but flared gas will go down significantly.”
“This could change if cuts continue next year. But overall, we see rising capture of gas as Ratawi Hub, Nasiriyah, the expansion of BGC, associated gas capture and longer-term non-associated gas and new gas fields, and there are of course question marks about how quickly those come in, but overall gas supply could increase. But flaring could remain a constant. All of this depends on continuing investment and progress in projects.”
Turning to the controversial subject of short-term Iraqi reliance on Iranian gas exports through pipelines into Diyala and Basra provinces, Mr. Mills noted how one potential solution is a previously discussed plan for additional gas from the KRI to replace or supplement Iranian gas and meet Iraq’s shortfall.
Mr. Mills noted the “obvious market” for gas from large fields in the KRI would be federal Iraq, noting how potential supply could come from “Khor Mor which is in production, Chemchemal which is being appraised and other fields, Miran and Bina bawi.”
“Conceptually, this supply could go to new power plants under construction in Baghdad, as well as plants in northern Iraq, while plants in southern Iraq can be supplied by associated gas there. So, this is a rare win-win in Iraqi politics, providing leverage for KRI, gas at a competitive price for federal Iraq and creating shared interests. Let’s hope these negotiations move ahead this year, given the urgency of the situation.”
Turning to Iraq’s untapped solar potential, Mr. Mills noted how in 2019 Iraq held a 755 MW solar tender, but it remains “currently on the back burner due to concerns over costs coming over USc 6/kWh.” Mr. Mills noted that regionally, there had been record-setting solar PV costs in the UAE and Saudi Arabia at 1.5 cents per kWh.
“So, some people have asked, why would Iraq be so expensive? The answer is, you’re looking at the first projects, it’s a new country for large scale solar, a new model and Iraq is not creditworthy as those other (Gulf) countries, there are significant issues of logistics and security. So, put all that together and it’s not surprising the first few projects would be so expensive.”
“But the idea is to get these projects rolling and the costs will come down to a competitive level. But even 6 cents is a pretty good price, particularly compared to oil and even a modern combined cycle plant paying $6 for its gas is almost 8 cents kWh. So solar PV is a good deal on that basis.”
Summary by Robert Tollast, Iraq Energy Institute Editor
Videography by Fazl Al-Abodi, Creative Designs Consultant
Special thanks to Amena Bakr, Ahmed Eissa, Oliver Klaus and Kevin Kear from Energy Intelligence for supporting the organisation of this joint event.
Presentation Slides by Abhiram Rajendran
Presentation Slides by Yesar Al-Maleki
Presentation Slides by Robin Mills