Having looked thoroughly into the implications of the latest U.S. Iran sanctions throughout the past few weeks, it is reasonable to ask who stands to benefit from such a set-up. Russia and Saudi Arabia are among the first that come to mind – having eliminated, at least partially, a relatively powerful competitor, they can now increase their market share and pump out more crude (unless market conditions force them to do another production cut). The United States, too, is already taking advantage of the sanctions – take condensate supply to South Korean refiners, where the U.S. is vehemently pushing Eagle Ford as a substitute for South Pars Condensate. Yet the biggest winner from US sanctions is a subtle pick, having been exempted from any limitations vis-à-vis Iran, the only nation to be allowed to do so. Yes, we are talking about Iraq.
The seven countries and one “jurisdiction” (read Taiwan) that received waivers last week saw their import possibilities curtailed to a fixed amount. Even though Iraq, too, received a waiver, it did so without suffering any restrictions (the only constraining moment was the 45-day period for which the waiver was granted, however, Iraqi officials have repeatedly asserted that it will take years to create their own energy infrastructure, hence dealing with Iran is a necessity). Whilst it is completely true that Iraq has no need for any additional volumes of oil, of which it has more than enough, the possibility to import gas and electricity…
Having looked thoroughly into the implications of the latest U.S. Iran sanctions throughout the past few weeks, it is reasonable to ask who stands to benefit from such a set-up. Russia and Saudi Arabia are among the first that come to mind – having eliminated, at least partially, a relatively powerful competitor, they can now increase their market share and pump out more crude (unless market conditions force them to do another production cut). The United States, too, is already taking advantage of the sanctions – take condensate supply to South Korean refiners, where the U.S. is vehemently pushing Eagle Ford as a substitute for South Pars Condensate. Yet the biggest winner from US sanctions is a subtle pick, having been exempted from any limitations vis-à-vis Iran, the only nation to be allowed to do so. Yes, we are talking about Iraq.
The seven countries and one “jurisdiction” (read Taiwan) that received waivers last week saw their import possibilities curtailed to a fixed amount. Even though Iraq, too, received a waiver, it did so without suffering any restrictions (the only constraining moment was the 45-day period for which the waiver was granted, however, Iraqi officials have repeatedly asserted that it will take years to create their own energy infrastructure, hence dealing with Iran is a necessity). Whilst it is completely true that Iraq has no need for any additional volumes of oil, of which it has more than enough, the possibility to import gas and electricity might become a little salvation for Iran. Even before the Islamic State made a bonfire of the country, electricity generation was a constant headache for Iraq, always lagging behind the populace’s genuine needs. At the height of the battle against the Islamic State, the electricity supply/demand gap rose to an unprecedented 45 percent instead of the usual 10-15 percent.
Everyone in Iraq understands that with generation capacities worth 25 TWh offstream after the carnage, the situation has to change. On average, electricity demand rose by some 6 percent in the last couple of years, effectively requiring the country to double its current generation capacity by 2023. To highlight the difficulty of coping with an issue as pertinent as electricity supply, it is estimated that $100 billion are needed to normalize Iraq’s electricity generation infrastructure. In a country as rich in hydrocarbons as Iraq, Baghdadi people receive (even during the hottest summer months) only 3-4 hours of electricity a day. Against such a background, Iran started supplying electricity to Iraq from July 2017 – until Teheran cut supplies a year later, citing a $1.5 billion unpaid bill as the reason.
Despite the non-payment issue (and alleged U.S. machinations to see that the Iraqi government did not pay Iran), importing electricity from Iran is a coveted development for both Baghdad and Teheran. For Baghdad, the advantage is fairly evident – thus it could save billions of dollars, were the imports to continue. The price formula, under which Iraq should have paid Iran is a relatively simple one: Price (in USD) = 0,1088*Brent Price (in USD/bbl)+0,08. It takes a couple of calculations to realize that by importing Iranian electricity, it can save 15-20 USD on every single barrel it decides not to use in domestic electricity generation and to sell instead. According to Iraqi Energy Ministry estimates, the country uses 194 kbpd crude oil for electricity generation – just one day would save Baghdad around 2-4 million USD.
Of course, politics can anytime interfere with business interests. However, there are reasonable grounds to believe that Iraq would not succumb to external pressure once again and would seek to renew the Iran deal. It has a powerful claim to back it up – namely, the Basrah protests this July which erupted after Iran has stopped supplying Iraq’s southern regions with electricity. Despite the fact that it was Iran who made a brisk move and the Iranian consulate being torched, the popular sentiment was very anti-American, as many believe Washington uses Baghdad to promote its geopolitical interests without any consideration for the interests of common Iraqis. The Basrah protests continued for almost three months (the U.S. Consulate there has closed), triggered by the dreadful state of public services.
The risk in having Basrah riots is that the protests might spill over to Iraq’s key export infrastructure – the oil terminal (ABOT), from which every day roughly 3.4 million barrels are pumped out onto the global markets. Not only would any damage to the Basrah terminal upend prices, it would also jeopardize the crude supply of the United States, as statistically 13 percent of Basrah volumes go to the U.S. To summarize all trends stated below, it is very likely that Iran will do its utmost to carve out a deal with Iraq, even if it comes with some additional concessions. For Iran, exporting gas or electricity is one of the few remaining lifelines to find a market outlet for its hydrocarbon riches (even if it is not crude), for Iraq it might not only solve some current operational problems, but also save further money.
Moreover, the Iran-Iraq ramifications do not end with the transborder gas/electricity deal. Iraq, perhaps reluctantly by the U.S. Administration, has become a key partner in replacing Iranian volumes.
Just to name a self-explanatory example, significant diplomatic efforts were undertaken to bridge the differences between Baghdad and the Kurdistan Regional Government (KRG) because this would unfreeze some 300kbpd of Kirkuk exports. These were derailed after the October 2017 takeover of Kirkuk by the federal Iraqi army (after the Peshmerga have freed it of the Islamic State’s yoke it remained temporarily under Kurdish control) – the pipeline connection to the Turkish port of Ceyhan is effectively under the KRG’s aegis and absent a deal the crude was simply not exported.
Graph 1. Iraq’s Oil Production vs Basrah Exports.
(Click to enlarge)
Source: OilPrice data.
Both the U.S. and Russia (the Russian NOC Rosneft bought the Kurdish section of the pipeline, hence no grand vision, pure profit-seeking) pressurized the conflicting sides to negotiate and voilà, just two weeks after the tightening of Iran sanctions, an agreement was reached. All this leaves Iraq in a position where the longer the current status quo remains, the better for Baghdad and the Iraqi oil sector. Iraq is in a privileged position, it enjoys political support from both the U.S., Russia and Saudi Arabia despite having a government that remains largely pro-Iranian. Hence, Iraq can dream big - now that Thamer Ghadhban has become head of the Oil Ministry, the construction of the 1mbpd Basrah-Aqaba pipeline to Jordan has returned to the government’s agenda.
Coupled with the restart and maximization of the Kirkuk-Ceyhan exports (1 mbpd) and the expansion of the Basrah terminal (Mitsubishi-led berth upgrading, Leighton-Offshore-led construction of SPMs and pipelines around them, Boskalis-led construction of a new floating oil island off the al-Faw peninsula), Iraq’s nameplate export capacity could very realistically reach 8 mbpd. Its factual production would be nowhere near that, even the generally quite upbeat Iraqi forecasts estimate 6.5 mbpd as a 2022 target. Iraq would be wise to invest heavily in oil infrastructure and less so in electricity generation (excluding transmission and distribution lines which are ramshackle) – under current circumstances, Iran can provide electricity on the cheap. Yet behind an ambitious façade, the inner stability of Iraq is brittle.
Lest not forget that the Islamic Dawa party currently at the helm of state did not win the September parliamentary elections – Muqtada al-Sadr’s coalition with Communists did, whilst Fatah came second. The nepotistic character of Iraqi politics, constant infighting, poor public services and endemic corruption might lead the populace to stage further rounds of protests, which would fit the Sadrists’ plans, having publicly advocated measures to increase transparency and break up patronage networks for some time already. Any strengthening of al-Sadr would force the U.S. to treat Iraq differently, upending the fine and highly delicate line Baghdad has outlined for its own future.
