ANALYSIS: Loathe to cut oil production from the start, Iraq draws OPEC+ fire for its quota busting

London — Ever since OPEC teamed with Russia and other allies in late 2016 to tackle a global oil glut through production cuts, Iraq has been a reluctant participant, repeatedly flouting its quota.

But Iraq's serial overproduction has escalated from mere irritant to a head-on confrontation with OPEC+ kingpins Saudi Arabia and Russia.

A deal to extend the alliance's hefty 9.7 million b/d production cut agreement through at least July hangs in the balance, as Saudi Arabia and Russia seek guarantees from Iraq and other pump-happy members, such as Nigeria and Kazakhstan, that they will not only adhere to their quotas, but compensate for their overproduction with deeper cuts in the coming weeks.

Ministers had hoped to finalize the extension at a June 4 meeting, but that has been delayed amid the impasse.

"Conducting the meeting is subject to full compliance," one OPEC+ source said, asking not to be named because of the sensitive nature of the talks.

Analysts, however, doubt Iraq will be able to achieve full conformity. Iraq's budget is stretched thin, challenging a new cabinet that just took office in May, and contracts with international oil company partners in Iraq's upstream operations mean the government faces financial penalties if it forces output to be shut in.

It also has yet to reach an accord with the semiautonomous Kurdistan Regional Government on oil revenue sharing.

Iraqi oil ministry officials did not respond to requests for comment.

Since each country's oil production is a sovereign right, OPEC has no enforcement mechanism to force obedience on quotas beyond peer pressure and an appeal for responsible market management.

Holding up the deal – or even torpedoing it – is the only leverage members have, though analysts say the stakes are too high to imagine the deal falling apart, given April's devastating oil market collapse from the COVID-19 pandemic and a brief price war when no OPEC+ cuts were in effect. Delegates said a meeting could still happen in the next few days if the compliance issue is resolved.

"It appears Russia and Saudi Arabia will no longer accept lip service and are looking for deeper commitments. It's just not clear how they enforce that," said Mohammad Darwazah, an analyst with Medley Global Advisors. "We still believe a compromise is likely, but not before the Saudis extract their pound of flesh."

DATA DISPUTE

Iraq is a founding member of OPEC and the bloc's second largest producer. It is also the least compliant member, routinely exceeding its quota more than any other countries.

From January through March, Iraq pumped an average of 4.63 million b/d — about 170,000 b/d above its cap, for a compliance rate of 10.5%, according to S&P Global Platts calculations based on its monthly survey of OPEC production.

In 2019, it produced 203,000 b/d above its quota.

The historic 9.7 million b/d production cut agreement that went into force in May to combat the COVID-19 market rout calls on the 23-member OPEC+ alliance to rein in output far greater than ever before.

Iraq's current quota is 3.59 million b/d. But the oil ministry reported June 1 that the country's May exports averaged 3.58 million b/d, making it almost certainly in violation of its production cap, as Platts estimates that the country's internal consumption for refinery runs and power generation totaled about 550,000 b/d in the month.

Full OPEC+ compliance data will not be available until mid-June, after the six secondary sources used by the alliance to monitor production, including Platts, submit their figures.

Iraq, which unsuccessfully sought an exemption as the OPEC+ cuts were being negotiated in 2016, has disputed the secondary source assessments, consistently self-reporting production figures that are much lower, though analysts have cast doubt on Iraq's numbers.

"Iraqi official production data has long had a credibility issue," Darwazah said. "Official figures are generally unreliable, and usually underestimate actual levels."

Officials have also previously falsely claimed that its quota only applies to its crude exports instead of production. Behind closed doors at OPEC+ meetings, they have appealed for sympathy due to Iraq's desperate need for oil revenues after years of fighting the Islamic State terrorist group, according to people familiar the talks.

Most recently, with its May production shaping up to another gross violation of its cap, interim oil minister Ali Allawi on June 2 gamely blamed unspecified "technical issues" for its non-compliance.

HARD-PRESSED TO CUT

Its recalcitrance has caused tensions with other OPEC+ countries, culminating with the current standoff.

Overcompliance by Saudi Arabia has papered over the excess production of Iraq and others, but Saudi energy minister Prince Abdulaziz bin Salman, who assumed his post last September, has taken a hard line on free-riders.

Saudi Arabia, the UAE and Kuwait had committed to cutting an additional 2 million b/d beyond their quotas for June but have said they do not intend to continue those further cuts into July.

Without that extra restraint, OPEC+ compliance figures to fall, unless Iraq and other laggards improve their performance.

Helima Croft, head of global commodities strategy for RBC Capital Markets, said Saudi Arabia and Russia will have to provide Iraq with "some timeline flexibility" to implement what deeper cuts that it can.

But all sides are sufficiently motivated to avoid another major price crash and come to some kind of accommodation, she said.

"Iraq and Nigeria are both facing heavy pressure to honor their cut commitments, but we believe that Saudi Arabia and Russia will likely allow these cash-strapped producers some timeline flexibility in order to secure an agreement," she said.