Iraq Looms Large as Oil Grows Scarce

10/15/2012 9:15 am EST

Focus: COMMODITIES

Long neglected by war and poor investment, Iraq's huge untapped fields could ease a future supply crisis. But developing those fields will come at a price, writes Florian Neuhof of The National.

Gone are the heady days of the early oil booms, when wildcatters would stumble on rich reserves conveniently located a few meters underground.

Rapidly developed oilfields on the American plains no longer flood the market with kerosene, and it has been a while since the wells around Baku quickly pumped enough oil to satiate most of Europe's demand. In today's world, increases in production are incremental, and a cause for anxiety over whether they will meet projected increases in demand.

But there is one country that has the potential to recreate the oil bonanzas of old. After being diminished by years of conflict and long periods of underinvestment, Iraq's oil output is now predicted to almost triple in the coming decades.

This week, the International Energy Agency (IEA), the body representing the Western importers of hydrocarbons, added its own assessment. In Iraq, the agency has forecast in a probable increase in production from just over 3 million barrels per day (bpd) to 6.1 million bpd in 2020, rising further to 8.3 million bpd by 2035.

Projections for future Iraqi production are subject to much debate, not least in Baghdad's hallways of power—and the IEA is less optimistic than the Iraqis themselves. Thamir Ghadhban, the top energy advisor to the prime minister and a former oil minister, said last week that the government would probably adopt a target of producing 9.5 million bpd by 2020.

But even a smaller increase would make Iraq crucial to the global oil market.

"[Our] study confirms the increasing importance of Iraq to the global energy system, highlighting the key role it is expected to play in meeting growing energy needs and the responsibilities it will assume as a strategic source of world oil supply," says Maria van der Hoeven, the IEA chief. "We all have an interest in Iraq realizing its potential and revitalizing its economy."

Determining future supply and demand is tricky, but few disagree that demand will increase significantly, driven by growing Asian economies. There is less consensus, however, on supply.

Some argue that tapping unconventional sources—shale gas, oil sands, and deep offshore—will help to meet increases in consumption. Others point out that the added unconventional supply will be offset by a decline in production at existing fields.

But one thing is clear: Iraq's mega-fields in the south and its sizable reserves in the north are easily exploited, and are the lowest-hanging fruit in the race to stave off a supply shortage.

If Iraq were to miss the IEA's forecast, it would add $15 to the price of a barrel in 2035, says the agency, as well as costing the country $3 trillion (Dh11.01tn) in lost revenue.

"Oil global demand forecasts indicate that the world will need two new Saudi Arabias by 2035 in terms of production levels. If this is the case, then the only promising candidate for conventional oil production is Iraq," says Luay Al Khatteeb, the executive director at the Iraq Energy Institute.

Saudi Arabia currently produces about 10 million bpd in an effort to meet global demand and keep oil prices stable. While this is approximately the amount pumped by Russia, the kingdom is the only country with significant surplus capacity that can be tapped at short notice.

Saudi Arabia is making use of this spare capacity to good effect, calming a market jittery over reduced Iranian exports. But its production muscle may no longer be sufficient to fend off all risks.

"After the fast-moving drama of Arab Spring, with all the geopolitical dynamics, OPEC member states can no longer be sustained by one swing producer," says Al Khatteeb.

As such, Baghdad is currently deliberating whether to invest in spare capacity, says Ghadhban.

Developing Iraq's oil industry requires gargantuan investment. The IEA estimates that $530 billion is needed if its production forecasts are to be met, and that 90% of those funds will have to come from government coffers.

This is only about 10% of projected revenues through 2035, but that requires an increase in annual spending from $9 billion last year to $25 billion.

Investment and production in Iraq are hampered by bureaucratic bottlenecks and unfavorable terms offered to international oil companies (IOCs). A standoff over oil rights between the regional government in Kurdistan and Baghdad and an unstable security situation also need addressing.

There are also other issues to consider. The IEA report voices concerns that government spending will fail to address crucial issues, such as providing employment for Iraq's young workforce.

"If there is not a synergistic effort between the IOCs and the government, job creation in the oil and gas sector won't provide sufficient opportunities to locals, and it will prove a vicious cycle," said Laith Allawi, the general manager at Saracen Ventures, and nephew of the Iraqi opposition leader Ayad Allawi.

The government's rush to establish Iraq as an oil superpower also comes at the expense of a diversified economy. "The monetary value of increasing capacity to 10 million bpd will involve the opportunity cost of those funds being deployed to other areas of the economy that require ample financing, especially in power, health care, education, and agriculture," says Allawi.

While Iraq's government is keen to enhance the country's prestige internationally, it would do well not to forget its problems at home.

Read more from The National here...

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