Atlantic Council GLOBAL ENERGY CENTER SHAPING IRAQ’S OIL AND GAS FUTURE Ellen Scholl SHAPING IRAQ’S OIL AND GAS FUTURE Ellen Scholl ISBN: 978-1-61977-482-7. Cover photo: Oil tankers load crude from the port of Basra in Iraq, one of the most import oil export points in the country, in 2012. Essam Al-Sudani ([email protected]). This report is written and published in accordance with the Atlantic Council Policy on Intellectual Independence. The authors are solely responsible for its analysis and recommendations. The Atlantic Council and its donors do not determine, nor do they necessarily endorse or advocate for, any of this report’s conclusions. January 2018 CONTENTS Executive Summary 1 Introduction 2 The Politics of Energy in Iraq 4 All Politics Are Regional 10 Oil Development and Importance in Iraq 14 Energy Landscape: Oil Markets in Transition 16 Challenges and Recommendations 18 Gas Development Key to Iraq’s Future 22 State of Play: Iraq as a Nascent Gas Producer 25 Challenges and Recommendations 28 Conclusion 30 About the Author 31 EXECUTIVE SUMMARY nergy has and will continue to be an integral In addition to removing obstacles to increased part of the Iraqi economy for years to production and export growth, perhaps the biggest come. Oil revenue provides the bulk of the challenge for Iraq is sustainably managing the Iraqi national budget, as well as the budget resulting resource revenue in a way that serves Ein the Kurdistan Region of Iraq (KRI), providing a the country’s long-term development interests key source of revenue and funds for recovery and and improves the living conditions for all Iraqis. development. Iraq also boasts substantial gas Sustainable management of resource revenue, along resources, still in the early stages of development, with creating the foundation for a more diversified which could serve as a key source of energy for economy, is critically important both for Iraq more domestic power generation, the basis for value- broadly and the KRI. added industries, and eventually a source of trade and export revenue. Gas has the potential to play a crucial and growing role in Iraq’s economic future, which political leaders Despite the serious challenges Iraq has faced in both in Baghdad and Erbil should work to utilize. recent years, including the impact of the fight To improve gas resource development, the report against the Islamic State of Iraq and al-Sham (ISIS) makes the following recommendations. and less favorable oil market conditions since 2014, Iraq has made substantial progress in incentivizing 1 Baghdad and Erbil must get the incentive energy sector investment and increasing oil structure right. production and exports. That said, political and 2 Part of the incentive structure should include economic challenges still loom large, and the supportive gas pricing. events of late 2017 sparked by the September independence referendum held by the Kurdistan 3 Institutions should mirror ambition. Regional Government (KRG) underscore the degree to which oil development can be impacted, and even 4 Baghdad and Erbil should take a comprehensive 1 hampered, by Iraq’s long-standing ethnic, sectarian, approach to developing and integrating and political divisions. This is seen most clearly by infrastructure throughout the supply chain, Baghdad’s retaking of the Kirkuk oil fields, which including mid- and downstream infrastructure. had been under KRG control since 2014, and the With the chain of events that followed the fall renewed debate over resource management and 2017 referendum, and as 2018 elections in Iraq and revenue sharing. the KRI approach, the potential new leadership in Despite enormous progress in increasing oil Baghdad and Erbil should prioritize addressing production and smaller but equally meaningful gains these obstacles to incentivize long-term oil and gas in gas development, particularly in the KRI since the development and sustainably manage resources fall of Saddam Hussein, obstacles to Iraq reaching and the resulting revenue. This will require its production potential remain. To continue to addressing the still-unresolved political issues capitalize on Iraq’s oil resources and increasingly between Baghdad and Erbil, which remain a key utilize its significant gas resources, there are several source of uncertainty. With oil prices remaining low, challenges to be overcome, and improvements to and global and regional gas demand set to grow, be made. Baghdad and Erbil should recognize this is both a crucial moment for energy sector investment and For oil, the following issues must be addressed, a key window of opportunity for gas development. both by the Iraqi government in Baghdad and by the KRG in Erbil. Gas, less politically fraught than oil, has the potential to serve as a key area of cooperation between 1 Improve the fiscal terms for companies, provide Baghdad and Erbil and could help improve the stable investment conditions, and above all reliability of electricity supply. In the early stages of guarantee business certainty—and payment. development, and as KRI gas production increases, the potential to supply Iraq with gas should be seen 2 Alleviate uncertainty and maximize production as an avenue of cooperation and a way to relieve by addressing the issue of revenue management the country’s need for electricity and gas imports and providing a durable and workable agreement from Iran and as an important step for cooperation on exports. and leveraging resources for the benefit of all Iraqis. 3 Formulate a robust infrastructure development framework that matches Iraq’s ambitions. ATLANTIC COUNCIL INTRODUCTION investment, and strategic thinking and could serve “While continued oil as an impetus for reform and an area of cooperation development is critical, gas between both Baghdad and Erbil and between Iraq and its neighbors. Less controversial than oil, has the potential to play a and perhaps even more integral to broad-based economic development, gas is an opportunity crucial role in Iraq’s economic for Iraq to forge a resource development model future.” predicated on cooperation and mutual benefit. Gas development would not only enable Iraq to meet its domestic needs, but also to position itself as a il and gas development is crucial to Iraq’s potential exporter in a region that could account future as a primary source of revenue for up to a fifth of global demand growth looking and a driver of the Iraqi economy. While out to 2040.1 oil and gas production cannot single- Ohandedly ensure Iraq’s recovery, such a recovery While energy development has the potential to will prove elusive, if not impossible, without it. Oil serve as an avenue of cooperation, it is impacted, production provides much-needed revenue and and often hampered, by Iraq’s long-standing ethnic, economic development and underwrites the Iraqi sectarian, and political divisions. Historically, federal budget, while gas development could play energy development in Iraq was largely confined a key role in Iraq’s future by fostering broad-based to areas that are currently under the direct economic development, improving electric service authority of the federal government in Baghdad, provision, and fostering value-added industries. established in the wake of the 2003 overthrow of Additionally, increasing production could provide the Baath regime. The new constitution, adopted the basis for cooperation with neighboring in 2005, legally established the Kurdistan Region of Iraq (KRI), with its own autonomous, regional 2 countries and undergird regional economic development and trade. government. That same constitution also left key questions about the primacy of authority for oil and This is far from guaranteed, however, and oil and gas, gas development between the federal government respectively, are in dramatically different stages of and regional governments unresolved. exploration, development, and production—and they serve different interests and outcomes. Oil Iraqi energy development still reflects this production, currently more advanced, is essential situation. The federal government in Baghdad is for cash flow and at the heart of issues between in charge of the bulk of the country’s resources the Iraqi central government in Baghdad and the and has pursued energy development along autonomous Kurdistan Regional Government traditional state-run lines, which reject the concept (KRG) in Erbil. Oil is politically fraught due to of international companies taking a direct stake in the country’s history with oil production; the the ownership of oil and gas resources. However, in geographic distribution of oil fields, the majority the areas controlled by the KRG—where, with the of which lie in the south, while 17 percent are found key exception of the supergiant Kirkuk field that in the north; the unresolved interpretation of the the KRG still partially controls, there was virtually 2005 Iraqi constitution; and ongoing disputes over no exploration prior to 2003. The KRG’s decision revenue sharing. Changing oil market dynamics to allow international companies to take direct due to the rise of US shale production and policy stakes in oil and gas fields resulted in a major changes from Saudi Arabia and the Organization transformation, as multiple discoveries turned the of the Petroleum Exporting Countries (OPEC) also Kurdistan region into a significant energy province impact the future of oil in Iraq. in its own right, with both oil and gas development underway. While continued oil development is critical, gas has the potential to play a crucial role in Iraq’s Sandwiched between the areas controlled by the economic future. Relatively ignored, undervalued, federal government and those run by the KRG and under-explored, gas could provide an are the historic oilfields of Kirkuk. The backbone opportunity to develop largely untouched of Iraq’s initial oil development, these fields now resources and address domestic power needs. straddle the political boundaries and effective Gas development will require long-term planning, zones of control of the federal government and 1 The International Energy Agency, 2017 World Energy Outlook, 2017, 341.