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How OPEC Could be Threatened by Iraq’s Re-Emergence as a Major Oil Producer
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How OPEC Could be Threatened by Iraq’s Re-Emergence as a Major Oil Producer

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How OPEC Could be Threatened by Iraq’s Re-Emergence as a Major Oil Producer

Iraq is returning to an energy market which is radically different than the one it was forced to leave years ago, and its OPEC partners now also have a different view on Iraq’s participation. A new paper by Sammy Six and Lucia van Geuns of the Clingendael International Energy Programme (CIEP) assesses how current market developments impact the strategic position of Iraq – and vice versa: how Iraq is likely to impact the global oil market. The authors conclude that although Iraq will help to ease the oil market in the short term, many tensions and uncertainties remain. One thing is clear: OPEC is in for a rough ride.

After decades of wars and sanctions, Iraq has firmly re-established itself among the world’s top oil producers. Sound investments in the energy sector have boosted Iraq’s oil production to well over 3 million barrels per day as of the end of 2013. Further expansion of the hydrocarbon sector should provide the Iraqi government with the means to rebuild public infrastructure and bolster the economy. Baghdad has negotiated service contracts with a host of foreign oil companies. These efforts have been so successful that they could put Iraq on track toward producing 9 million barrels per day by 2020, close to what Saudi Arabia or Russia currently produce. This is much more than what the International Energy Agency (IEA) expects. IEA foresees only a doubling of current production levels, to about 6 million barrels per day by the end of the decade, due to numerous political, infrastructural and security issues that severely constrain further production growth.

Iraq’s oil potential is based on the country’s vast proven reserves that are relatively untapped and inexpensive to extract, unlike other sources of incremental oil. Because of its favourable geology, Iraq has been forecasted to account for almost half of global supply growth over the current decade.

Unconventional resources

For some years now Iraqi production growth has been associated with matching the ever-growing demand for oil from emerging countries outside the OECD. Oil markets, however, have undergone fundamental changes in recent years. Rising prices and technological advances have significantly enlarged the supply pool, while economic expansion in Asia seems now to be developing more slowly which in the medium term could mean an easing of oil market fundamentals. Since 2010 the oil market has also been profoundly affected by the transformation of the US into perhaps the world’s largest oil producer within a period of a few years. This represents a development unimaginable even in the minds of the many politicians who in the past have rallied for an energy-independent North America.

Yet it would be premature to conclude that all tensions in the oil market have been resolved. Many uncertainties remain. Hopes for growth in conventional supply are almost exclusively pinned on Iraq, a country with enormous oil reserves but which also faces many infrastructural and institutional challenges. At the same time, energy from unconventional resources is rapidly driving up upstream costs and only shows potential outside North America beyond the medium-term outlook. Moreover, the many production outages in key countries in Africa and the Middle East highlight the continuous fragility of energy markets, even in the age of shale.

On the demand side, the exact trajectory of oil demand growth in emerging markets, and the magnitude of the decline in demand in OECD countries, are other uncertainties which remain difficult to assess. Based upon this ambivalence concerning supply and demand, we should remain cautious when talking about the beginning of the end of the current commodities ‘super cycle’.

Squeeze into the market

What is clear, however, is that over the next few years OPEC will see its position challenged. Non-OPEC supply is expected to keep pace with demand growth until the end of the decade and reduce the call on OPEC by more than a million barrels per day. Beyond 2020, however, market power is predicted to shift back to OPEC due to the inherent limitations of the North American resource base. Furthermore, we are unlikely to see similar volumes of unconventional production arise outside North America in the period up to 2030. This means that in order to reach required levels of production to meet demand after 2020, Iraq will be vital to OPEC, as production capacity prospects in other member countries, aside from Iran, appear to be limited.

At the same time, Iraq will have to find ways to squeeze into the market without antagonising other OPEC members too much. So far it has tried to gain market share by (1) discounting its crude compared to rival grades, (2) offering more competitive contract provisions compared to other Gulf exporters and (3) further cementing political and commercial relations with key customers in Asia.

The growing strength of Iraq could lead to a deep rift over the country’s allowed production quota within OPEC. It even has the potential to induce a trade war between OPEC members, especially between Saudi Arabia, Iraq and Iran. Asian customers would be the main beneficiaries of such an export battle. Europe, to a certain degree, also stands to benefit from a changing oil trade map: with the US increasingly supplying its own demand, West African barrels of sweet light oil, often already sold at a discount as a result of growing US oil production, become available for the European market.

Famous dilemma

In this environment OPEC will continue to struggle with its famous “dilemma”: it needs high oil prices in order to support growing public expenditures, but this in turn will unlock even more unconventional production and lead to further demand destruction. In the coming months and years the search for a proper balance will again fall to Saudi Arabia, as the country is the only player holding a significant spare capacity. However, Riyadh is already feeling the hot breath of its ambitious Northern neighbour. Even though Iraq does not seem willing to invest in upholding its own spare capacity, it can and probably will challenge Saudi Arabia’s leadership by upsetting the traditional balance of power within OPEC. The rise of Iraq will thus further challenge OPEC cohesion. Some may consider this good news, but it does represent yet another key uncertainty in the oil market.

How OPEC Could be Threatened by Iraq?s Re-Emergence as a Major Oil Producer

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