Between a Rock and a Hard Place: Iraq’s Pledge to Cut Oil Production

This is a guest post by Jareer Elass, an energy analyst who has covered Middle East state-run oil industries and OPEC developments for over two decades for a variety of Middle East newspapers and publications. 

Iraq faces an uphill battle in meeting its obligations to the historic production cut agreement reached by the Organization of Petroleum Exporting Countries (OPEC) and other major producers such as Russia. The production cuts are due to begin today. Not only is Baghdad mired in deep economic and political crises that show little signs of abating but Iraq’s complex service agreements with international oil companies (IOCs) operating its southern fields means that the Gulf producer would actually have to pay more money to the foreign firms working in its oil sector in excess of existing service fees if it demands the IOCS rein in output to help Iraq meet its targeted quotas. The supplemental fees, which could be millions of dollars, are stipulated in the oil field service contracts that Iraq holds with foreign oil companies that have been assisting with its oil production capacity expansion program over the last several years. The payments structure for Iraq’s service contracts means that output cuts put an added financial strain on the ability of OPEC’s second largest oil producer to comply fully with its pledged one million b/d plus output reductions in the coming months.  

The mid-April OPEC+ oil producer agreement to slash global oil output by 9.7 million barrels a day (b/d) as of May 1, 2020 required sign-offs by major producers including OPEC kingpin Saudi Arabia, non-OPEC producer Russia and Iraq. The groundbreaking pact called on the participants to make their biggest output cuts for May and June, followed by an easing of those reductions from July through December and a further adjustment between January 2021 and April 2022. The OPEC+ agreement dictated that most participating governments initially pare their output by 23 percent from an October 2018 baseline. Additional reductions are also being undertaken by countries outside of the original OPEC arrangement, such as, Canada, Norway, and Brazil.  

As part of that historic deal, Baghdad agreed to reduce its production by 1.06 million b/d for May and June from 4.653 million b/d to 3.592 million b/d. For the second half of 2020, Iraq agreed to keep its output at 3.804 million b/d – reflecting an 849,000 b/d cut from the October 2018 baseline – and from January 2021 through April 2022, Baghdad’s mandated production quota will be 4.016 million b/d, a 637,000 b/d reduction from the baseline. 

Iraq’s oil production has been crippled for decades by war and sanctions. Since 2014, the country has made headway boosting its output, which reached a record high of 4.88 million b/d last August, up from under 3 million b/d in the early 2010s. Iraq’s oil industry revival gained momentum after the Islamic State was driven out from most of its territory in late 2017. The country has benefited from enhanced technical services provided by IOCs at its southern fields. Prior to the COVID-crisis, the International Energy Agency (IEA) had forecast that Iraq’s crude production could reach nearly 6 million b/d by 2030. 

Over the years, Baghdad has tried to make up for low prices by raising crude production and has in past years sought an exemption from OPEC production cuts, arguing it should be allowed to compensate for years of turmoil that held its exports down. Iraq’s economy -- which is 95 percent dependent upon oil revenues -- is less diversified than its other Gulf neighbors. Iraq has a very limited private sector, and the International Monetary Fund (IMF) has suggested that Iraq’s financial reserves of $62 billion are insufficient relative to its ongoing expenses and current debt load. Baghdad is currently running a $2 billion monthly deficit for state expenditures.  

Iraq is also in the midst of a political crisis, with its newly selected prime minister-designate Mustafa al-Kadhimi struggling to form a new government. He is the third designate for that post since the resignation in November of Prime Minister Adel Abdul Mahdi. Abdul Mahdi remains as prime minister of the caretaker government while Kadhimi faces a May 9 deadline to secure a vote of confidence from the Iraqi parliament.  

A 2020 draft budget was rejected by the parliament and is already outdated as it was predicated on an average oil price of $56 a barrel, some $30-$40 a barrel lower than current oil prices. Iraqi officials have warned that Baghdad will have to postpone most development and energy projects and turn to foreign borrowing should oil prices not rebound. The country will find it increasingly difficult to borrow from international agencies without an approved 2020 budget and a quick resolution to its government crisis. 

In March 2020, the Iraqi oil ministry asked its IOC partners that mostly operate the country’s southern oil fields to cut their capital expenditures by 30 percent while also deferring ministry payments to the firms. Even without any new production cuts, Baghdad has been unable to repay fully the IOCs as part of their technical service contracts, in which the foreign firms get compensated quarterly with a fixed fee per barrel that is linked to production. 

The IOC contracts require the Iraqi government compensate the IOCs when production cuts lower the service fees that are linked to planned higher production rates. The arrangements would make it extremely expensive for Baghdad to curtail its output by 1.06 million b/d in May and June. The Iraqi oil ministry is expected to begin by trimming production from its fully state-operated fields, that do not require a payout to IOC operators. Such cuts could amount to around 400,000 b/d.  

Organizing IOC cooperation for additional cuts could require contract renegotiations unless Baghdad can figure out a way to allocate more funds to pay out the firms under existing contract stipulations. Baghdad was forced to shut down production at the 90,000 b/d Gharraf field operated by Petronas after the IOC abruptly evacuated staff over coronavirus concerns in mid-March. 

The semi-autonomous Kurdish Regional Government (KRG) has agreed to contribute production cutbacks, following discussions between central government and KRG officials in Baghdad on April 19. According to KRG Finance Minister Awat Sheikh Janab, “We agreed to reduce the production of oil based on the OPEC agreement,” though the minister did not specify how much the KRG would contribute in cut output.  

Still, that KRG cooperation with Baghdad could fail to materialize, given that the Iraqi central government in mid-April called on its finance ministry to halt budget transfers to the KRG and to take back all transfers made to the regional government since January over an ongoing budget share dispute between Baghdad and Erbil.  

So far, Iraq has been able to export substantial volumes to China, whose oil firms are due oil for repayment for work in Iraqi oil fields. Iraq shipped over 1.3 million b/d to China in February and March, up 45 percent from a year earlier. However, mounting global inventories of crude oil amid sluggish demand could make it more difficult for Iraq to continue to sell all of its exports in the coming weeks, creating logistical problems for the country’s oil sector.