Iraqi Oil Production and Exports to Continue Declining Without Infrastructure Overhaul

The escalating conflict in Syria and OPEC crude oil supply disruptions appear to have sent a mild panic to the oil markets. While Syria may not be a defining factor of price jumps, oil production cuts from Iraq and Libya by 170,000 barrels per day (bpd), in spite of increased output in Saudi Arabia, play a larger role. Worker protests in Libya brought the production down to 400,000 bpd in early August. Meantime, the second largest oil producer in OPEC with oil output exceeding 3 million bpd (mbpd) in 2012 and 2.4 mbpd going to exports, Iraq’s oil sales in 2013 have fallen below last year’s average, with July 2013 exports hovering at 2.25 million bpd. With Iraq’s increasingly important role as an oil exporter in the years to come, it is worth examining why its oil exports are on the decline and are unlikely to make a big jump without fixing the security and infrastructure problems.

This year’s decline in Iraq’s oil exports was largely due to the repeated insurgent attacks on the Kirkuk-Ceyhan (Iraq-Turkey) oil pipeline as well as other infrastructure failures. According to Iraqi officials, production disruptions due to repairs of de-gassing stations at the country’s oldest and largest Rumaila oilfield contributed to the recent cutbacks. Iraq plans to increase production by 360,000 bpd by the end of 2013 or early next year from new oil fields Majnoon, West Qurna-2 and Garraf and install three new single point mooring platforms in the Persian Gulf for additional export capacity.

But it is unlikely that the exports will increase further with a planned maintenance of Iraq’s major export terminal in the south – al-Basra Oil Terminal and Khor al-Amaya Oil terminal – which could cut output by 500,000 bpd for four to six months from September, despite assurances of Iraqi oil officials that disruptions would be minimal. Besides, the increase in export capacity is subject to tanker traffic in the Gulf, weather challenges, and the current export infrastructure taking turns between a shut-down and slow re-starts. At the end of the day, Iraq’s antiquated and neglected energy infrastructure is a critical obstacle to oil production and exports. This August, Iraqi officials chided Royal Dutch Shell for delayed start-up and for the inability to meet production goals of 175,000 bpd from the giant Majoon oilfield in the south. The row points to the infrastructure challenges confronting international oil firms operating in Iraq. Shell attributed delays to health and safety concerns, stressing that additional work was required to safeguard existing facilities. Similar problems exist in every part of the country’s energy value chain. Thus, Iraq’s new ambitious production figures of 9 mbpd by 2020 and exports of 4.5 mbpd in 2014 will be further curtailed with recurring infrastructure failures that beg for a complete renewal of the infrastructure, and inevitably cause disruptions while renovations take place. Constant terrorist attacks on the Kirkuk-Ceyhan export pipeline will not help the increase of exports either.

New Verse to a Refrain on U.S. Energy Independence

There is a lot of euphoria that America maybe moving towards energy independence with the boost of shale oil production. Latest news headlines say that the U.S. oil boom will render OPEC irrelevant and OPEC loses power as U.S. shale boom keeps prices down. Some observers argue that the U.S. could stop importing energy, particularly from politically unstable countries of the Middle East and Africa, thereby reducing its involvement in these regions.

Taking a longer view, it is not a fact yet that shale oil boom will not meet hurdles along the way. It is a fact that both shale gas and oil wells decline much faster than their conventional counterparts. Drilling new wells will be the only way to keep the anticipated high level of shale oil production. Further, even with the rising domestic oil production and a drop in overall U.S. crude imports, oil supplies from Canada, Saudi Arabia and Iraq increased to a 15-year peak in 2012. These three countries plus Venezuela remain top exporters of oil to the U.S.

Greater energy self-sufficiency is a possibility for the U.S., but the real questions are whether absolute energy independence is ever possible for America given rapid peaks and declines in unconventional oil wells and the nearly bygone era of its conventional oil production; the relatively expensive development of unconventional sources of energy compared to conventional oil and gas; whether the country's transportation sector, which accounts for close to 93% of all petroleum consumption, is able to reduce its addiction to oil; and whether it is ever possible to be immune to fluctuations of global energy prices given the increased financial and physical interconnectedness of major global energy markets. 

Key Issues to Understanding the Flawed Oil Pricing System

Following the news earlier this month that some of the world's major oil companies may have manipulated the Brent oil prices, some energy observers noted that it was a bomb that was waiting to explode. On May 14, 2013, the European Commission launched an investigation on BP, Statoil and Shell on suspicion of their involvement in manipulating oil prices since 2002. A U.S. commodity trading house, Prime International, filed a class-action lawsuit in New York against these companies on May 24, 2013. The scandal also involves one of the major independent oil price reporting agencies (PRAs), Platts, which collects and reports key international benchmarks on a regular basis. The prices that Platts reports provide grounds for long-term contracts, futures contracts, and derivatives and spot market transactions. Information that Platts provides to its subscribers, which range from oil companies to traders to banks to futures exchanges and governments, is used to help set prices for derivatives contracts and physical delivery of oil worth billions of dollars. According to the French oil company Total, “as much as 80 percent of all crude and oil-product deals are linked to reference prices including those published by Platts.” Even a minor mistake in price reporting carries significant implications on the energy markets. Several issues should be pointed out about PRAs and the energy market that may help understand the current mess.

First, some reporters immediately drew parallels between PRA oil pricing and the Libor-rigging scandal of last year. Libor, which stands for London Interbank Offered Rate, is a collection of rates designed to gauge the cost of borrowing between banks. Libor rates are used as benchmarks for nearly $10 trillion in loans and close to $350 trillion in derivatives. But comparing Libor-rigging to the oil price scandal is wrong. PRAs compete with each other for accuracy of price reporting, which is their bread and butter. Loss of credibility and reputational damage to their reporting would put them out of business. Unlike banks, they are not tied to energy trading apart from reporting about it. The key point on PRAs is they receive pricing information, everything from offers, bid and transactions, from energy market participants (i.e. buyers and sellers) purely on a voluntary basis. In other words, market participants are not required to share their trading data, but if and when they do so via PRAs, the latter must verify the accuracy and correctness of the data they receive.

Second, a lingering criticism of Platts has been its use of a market-on-close (MOC) methodology. Under the MOC mechanism, Platts establishes a time window and only trades transacted within this window are utilized to assessing the price of oil. According to Bassam Fattouh's seminal study of the oil pricing system, “the main criticism of the MOC methodology is that the Platts window often lacks sufficient liquidity and may be dominated by few players which may hamper the price discovery process.” Critics also point out the paucity of volumes traded within the Platts window, which is arguably not representative of the larger volume of trade taking place outside the window. As Fattouh argues, Platts favored the MOC methodology over what it previously used – the volume-weighted average of oil prices– believing that MOC most accurately reflected time sensitivity of assessed prices. However, there is no regulatory authority to oversee the behavior of PRAs or to address any dispute over PRA price assessments.

Third, given the varying levels of transparency between and within various layers of oil benchmarks, whether it is Brent, WTI or others, the current system of oil price discovery is quite imperfect. It will be interesting to see whether allegations of collusion among suspected oil companies to manipulate the Brent oil prices will bear evidence. A proof of such allegations is likely to result in evaluations of potential regulatory measures against market manipulation and a review of current methodologies used by PRAs to discover prices as well as transparency and accuracy of their assessment of energy prices.

Lastly, the current market-based system of oil pricing has existed since the 1980s, with oil prices set by the “market” and PRA reporting on prices based on their assessment of physical and financial transactions. Despite the known imperfections of the existing system, market participants (oil producers, oil companies, traders, refiners, financial actors, etc.) and governments have been hesitant to change it. It is highly unlikely that this system will be replaced with something else. But changes to PRA reporting methodology and transparency, which have come under increased scrutiny in recent years, might occur over the long term.