Iraq's Oil-Fueled Comeback Story Threatened by Anbar Violence

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Published January 08, 2014

| FOXBusiness

The violent uprising that has erupted in Iraq’s Anbar province in recent weeks is a scary reminder of the high risk of investing in a volatile country that is banking on improved security to drive economic growth.

As the U.S. steps up much-needed support for the Maliki government in Baghdad, the latest instability could scuttle Iraq’s attempt to build out oil exports, the centerpiece of any economic expansion.

The evolving situation also threatens to drive up energy prices around the world and create new geopolitical headaches for the U.S.

“Iraq has not only a weak economy, but a fracturing political system and social fabric,” said Paul Christopher, chief international strategist at Wells Fargo Advisors (WFC).

Iraq’s economy had been showing signs of stability and prospects for increased oil production in 2014.

In fact, a special report issued by the International Energy Agency in late 2012 predicted Iraq would more than double its oil production of three million barrels per day by 2020 and reach over eight million barrels by 2035, overtaking Russia as the world’s No. 2 oil exporter. 

The IEA forecasted such growth would translate to nearly $5 trillion in oil export revenue through 2035, funds Iraq could use to transform itself following decades of hardship.

Hopes for oil-fueled growth have tantalized Western investors, some of whom have gobbled up shares in its less-than-liquid stock market and risky currency, the dinar.

“If they could get the political and security situation under control, Iraq could have tremendous upside advantage for investors. It would be a fantastic growth story,” said Helima Croft, senior geopolitical strategist at Barclays (BCS). “Oil is the main lifeline for this country. If you have anything that disrupts the oil story, it’s going to have huge effects for the rest of the economy.”

Civil War Fears Resurface

That’s why all eyes are now on Anbar province, where last week Al Qaeda-affiliated groups seized control of the pivotal cities of Fallujah and Ramadi -- representing the first time these groups had captured Iraqi territory since U.S. troops withdrew in 2011.

“The political schism has never gone away. It’s always been there,” said Christopher.

While Iraqi troops have recaptured Ramadi, they are still planning an offensive to take back Fallujah, where U.S. military personnel were involved in some of the fiercest fighting during the Iraq War.

“The Maliki government is now facing an resurgent insurgency without the help of the U.S. The last time we saw this you had 100,000 U.S. troops there,” said Croft. “Is the Iraqi military capable of handling a revitalized Sunni-Al Qaeda insurgency?”

The U.S. has ruled out sending troops to help root out the insurgency in Anbar, but Washington does plan to provide support in the form of military hardware like Hellfire missiles and low-tech surveillance drones.

The worst-case scenario is that the delicate situation in Anbar spirals out of control and turns into an all-out civil war.

The United Nations estimates 8,868 people were killed in attacks in Iraq in 2013, making it the deadliest year since the end of the civil war in 2008. Almost 8,000 of the deaths were civilian, more than doubling the level of 2012.

In a research note, Croft wrote that a key indicator to watch over the coming months is whether Iraq’s Shiite militias carry out retaliatory attacks on Sunni civilians on a “significant scale and push the country to the brink of civil war.”

Pivotal Oil Build-Out at Risk

Even if Iraq avoids a civil war, the deteriorating security situation is likely to further slow the expansion of the country’s energy infrastructure.

Hurt by bad weather and contractor delays caused by infrastructure and payment issues, Iraq’s southern region has exported a weaker-than-expected 2.1 million barrels per day of oil over the past three months.

Now that situation could be worsened by the need to focus attention and, more importantly, resources on Anbar. The IEA report estimated Iraq will need $530 billion of energy investment through 2035 to meet its anticipated levels of oil, gas and power supply.

It’s also possible that oil facilities in southern Iraq will be hit by an attack that spooks Western contractors and drives up energy prices.

“You just have to be lucky once with a southern oil facility. The market will be shocked if you have (an attack) down there,” said Croft.

Energy contractors have not forgotten the deadly siege by terrorists on a remote gas field in Algeria owned by BP (BP) almost exactly a year ago. The hostage crisis resulted in the deaths of at least 67 people, including 29 militants.

“Algeria was a wake-up call,” said Croft. “People will always be able to take risks in frontier economies, but if we are slipping back into a civil war situation, a lot of companies will say, ‘I’m not willing to put my workers at risk.’”

Oil Firms, China Watch Closely

There are a number of Western oil companies that have a stake in Iraq’s future, including U.S. heavyweight ExxonMobil (XOM), which owns 25% of a major oil project near Basra.

Exxon recently agreed to sell major stakes in the project, West Qurna-1, to a group of investors that includes PetroChina. The $50 billion project produces about 510,000 barrels of crude per day and one day could churn out three million barrels a day.

Chevron (CVX) has signed at least three deals in Iraq’s autonomous Kurdistan region, angering the central government in Baghdad, which has banned the U.S. company in other parts of the country.

While U.S. companies struggle to deal with the Maliki government and grapple with security concerns, China has made little secret of its interest in getting a piece of Iraq’s 141.4 billion barrels of proved reserves.

Despite the fact that it was the U.S.-led coalition that toppled Saddam Hussein, China has been the biggest foreign winner of the opening up of Iraq’s oil markets.

Needing to feed its fast-growing economy, China recently indicated it wants to boost its purchases of Iraqi oil by more than two-thirds to 850,000 barrels per day in 2014. 

The IEA projected that by 2020, 80% of Iraq’s oil will be shipped to Asia, including 1.5 million barrels per day to China, which could eventually import two million barrels per day by 2035.

Iraqi Dinar: Still the Wild West of Currencies

The developments in Anbar province are likely to alarm bold investors who have scooped up Iraqi assets in hopes the country would be able to capitalize on its immense oil reserves.  

“They don’t have the security or even the political consensus to develop an Iraqi oil industry. It looks like it’s going to devolve into the Kurds, Shiites and Sunnis taking what they can,” said Christopher.

Some investors have bought up the Iraqi dinar, betting an economic resurgence would lead to a revaluation of the currency, which currently trades at 1,165 dinar per U.S. dollar and is still shunned by most U.S. banks.

“This is a very significant blow to the hopes of a revaluation,” said Christopher, who said Wells Fargo “strongly advises” investors against investing in the Iraqi currency. 

Countries typically revalue their currencies only after their economies are strong enough to tolerate the resulting hit to exports.

“Iraq is not at that point. In fact, Iraq is the diametric opposite spectrum. The people who bought the dinar have made a huge mistake,” said Christopher.

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