FEATURE: Politically fractured Iraq's fiscal struggles strain its OPEC commitment

Dubai — Iraq may be the birthplace of OPEC and its second largest oil producer, but the bonds of its membership to the exporters group are likely to be tested again in 2021 as the volatile country faces its deepest economic crisis in decades, with fractious parliamentary elections looming in June.

Ever since OPEC teamed up with Russia and other allies in 2017 on a series of production cuts, Iraq has struggled to comply with its output quota, citing its desperate need for oil revenues to rebuild after years of war, as well as its long-standing dispute with the semi-autonomous Kurdistan region, which controls its own crude production.

Though the country has significantly reined in output in the wake of the coronavirus pandemic, it has not gone far enough to comply with the latest sweeping OPEC+ cut agreement.

Analysts say political realities make it unlikely Iraq will fully adhere to its quotas, even as it continues to proclaim loyalty to OPEC and endures private and public scoldings for its lack of production discipline.

"Iraq is facing its worst fiscal crisis since sanctions were imposed in the 1990s. The pressure is tremendous, and it needs all the revenue it can get, as short-term stabilization moves all require political and social pain, which the government is trying to avoid," said Raad Alkadiri, senior director at the BCG Center for Energy Impact. "So, some cheating on its OPEC quota appears likely."

Iraq produced 3.80 million b/d in November, according to the latest S&P Global Platts survey of OPEC output. That is right at its quota, but it still owes almost 600,000 b/d in additional "compensation cuts" for quota violations since May under the OPEC+ agreement.

Member quotas will ease slightly in January with the alliance lifting collective output by 500,000 b/d, which could help Iraq improve compliance going forward – if the government sticks to the deal.

Political wrangling

Then-Prime Minister Adel Abdul Mahdi took much flak from politicians in April when he signed on to the OPEC+ coalition's pandemic-driven pact to deepen cuts to unprecedented levels. As the caretaker leader of a temporary government, he had no authority to commit Iraq to such stark measures, critics said, even with oil prices crashing.

The successor administration of Prime Minister Mustafa al-Kadhimi that took office in May – an interim government – has kept Iraq in the agreement, though officials have openly questioned whether the deal remains in the country's best interest.

Kadhimi's government has a mandate to prepare for the parliamentary elections, which are shaping up to be a contentious event with various political parties jostling for power, while neighboring Iran and the US are still vying for influence.

Iraq leans on Iran for trade and, more essentially, energy imports. Despite having access to huge crude reserves, Iraq's electricity sector suffers from acute fuel shortages that cause power outages in the hot summer months, which often lead to deadly protests.

Meanwhile, the US, which has pushed Iraq to reduce its reliance on Iranian energy supplies, is withdrawing troops at a time when the resurgent Islamic State militant group has attacked foreign missions and even energy infrastructure.

Slow progress on budget talks between the federal government in Baghdad and the Kurdistan Regional Government in the north have not helped.

"Hydrocarbon assets in northern Iraq have remained vulnerable even as the Islamic State presence there has reduced," said Niamh McBurney, head of Middle East and North Africa for security consultancy Verisk Maplecroft. "This won't affect the southern provinces which produce the vast majority of Iraq's oil, but it is a concern for the power sector, which has struggled to recover and continues to be targeted by Islamic State."

The US' patience with Iraq is also wearing thin and as outgoing President Donald Trump ratchets up pressure on Iran, his administration has shortened the length of the sanctions waivers granted to Baghdad to continue importing energy from its neighbor.

Once President-elect Joe Biden takes office in January, the US may relax its stance on Iran, but Iraq's political and economic mayhem will remain, exacerbated by lower oil prices and the pandemic.

Iraq has sought financial aid and investments from Saudi Arabia and could continue to reach out to the kingdom and other Gulf states, as well as the US, for further assistance, but it "may not be a priority for those governments and packages may only provide relief for some weeks," said Nareeka Ahir, a geopolitical analyst with Platts Analytics.

Investments imperiled

Ties with international oil companies could be at stake.

In 2020, Iraq instructed IOCs to reduce capex, a trend expected to continue into 2021. Meanwhile, IOCs themselves are slashing budgets amid the low oil price environment and their energy transition goals.

Ahmed Mehdi, a research associate at the Oxford Institute for Energy Studies, said 2021 oil-related capex is projected to be about 38% lower than in 2015, the last time Iraq ordered IOCs to cut costs.

That could jeopardize Iraq's plans to boost production capacity to 7 million b/d by 2027 from 5 million b/d now – or even sustain current output levels, with IOCs paid a per barrel fee. Projects in the works are mostly complex, involving water injection or significant infrastructure upgrades.

"The reality is that the next phase of Iraqi production growth will be both more expensive and complex," Mehdi said.

Oil minister Ihsan Ismaael has acknowledged that some projects have been slowed, but blamed the current OPEC+ cuts and not its dealings with IOCs.

Iraq's payments to IOCs are not "as normal" but are "acceptable" to both sides, he said in October.

But a failure to invest now could very well leave Iraq in a tougher spot down the road.