OPEC's No.2 Goes Rogue: Plans 600,000 Bpd Oil Output Increase

Authored by Irina Slav via OilPrice.com,

Iraq has plans to boost its crude oil production by 600,000 bpd to 5 million bpd by the end of this year, regardless of its participation in OPEC’s production cut deal. Iraq is the cartel’s second-biggest exporter of crude and has been the most disinclined of all parties to the agreement since its inception, with a lot of observers expecting it to be the first one to cheat.

Iraq’s first problem is that as much as 95 percent of its budget revenues come from crude oil. There are no viable alternatives in sight for revenues at the moment. The second problem that the country has to contend with is its war with Islamic State, which makes these revenues more important than ever.

Amid the final push against IS in Mosul, Iraq is working hard to ensure the sustainable growth of its oil and gas industry—OPEC deal or no OPEC deal. Three months ago, Oil Minister Jabar al-Luaibi said that Baghdad is planning to build five new refineries on an investment basis, in addition to fixing and expanding existing refineries that were damaged in the war with IS.

While Al-Luaibi has repeatedly assured media - and indirectly, investors - that Iraq will stick to its OPEC commitment, Iraq is doing whatever it can to boost its returns from its only significant natural resource.

As part of these efforts, the government recently started a review of the contracts it has with foreign oil companies operating local fields in a bid to better match its interests to those of the operators. Currently, international oil companies in Iraq are working under the so-called technical service contracts, which a few years ago, forced them to reduce production from some of the country’s biggest fields because Baghdad had no money to pay them for operating the fields.

Baghdad is also cooperating with Tehran to make the most of the oil finds that the two neighbors share. Bilateral relations have been uneven historically but now that both Iraq and Iran are scrambling with their respective problems, a partnership has emerged as the mutually beneficial way to proceed. It is also strengthening its ties with other neighbors and farther countries such as Egypt, European Union members, and the U.S.

A 600,000-bpd production increase would be substantial, but Al-Luaibi did not disclose the source of this increase. Huge fields such as West Qurna, Rumaila, and Majnoon are nowhere near depletion, so Iraq could significantly boost production in these fields.

Then there is one more candidate for additional production: the Kirkuk field in the Kurdistan Autonomous Region. Kirkuk currently produces less than half a million barrels of crude daily, even though its can pump as much as 1 million bpd. The problem – yet another big one for Baghdad – is that the Kurdistan Regional Government is as eager as Baghdad to take full control of the field.

Tensions between the central government and the KRG have been simmering for a while now, and of course, it’s all about the oil, as both sides throw accusations at each other of overstepping its boundaries.

For now, Iraq’s plans to increase production seem to be vague, unless Al-Luaibi and the rest of the government just don’t want to go public with more specific plans. Given the price environment, however, and the growing likelihood that the production cut will be extended, Iraq’s output-boosting efforts have the potential of a major headwind for prices in the second half of the year.

Iraq: What You Haven't Been Told

By Chris at www.CapitalistExploits.at

When most of us think of Iraq we picture burning oil fields, sand, blown-up buildings, sand, machine gun-toting jihadists, sand, helicopter gunships, sand, Humvees, mosques, and well... sand.

We know that George and Tony told us the war is over and that was ages ago so it must be true.

In fact, things must be jolly peachy by now because by my calendar that was May 2003, some 14 years ago. Still, George and Tony - like many podium donuts before them - said a lot of things and so with much of what traditional media tells us oscillating between questionable and "hahaha, bullsh*t", it makes a whole lot of sense to source information directly from credible sources.

I"ve made a point of doing this personally and I can"t recommend it enough. In any event, long-term readers will recall my buddy Thomas Hugger from Asia Frontier Capital (I chatted to Thomas here).

Well, one of the funds under Thomas" umbrella is a relatively newly launched Iraqi fund, and so, since I wanted to get a better idea of what"s happening in the Middle East and Iraq in particular, what better person to bring me up to speed than the CIO of the AFC Iraq Fund, Ahmed Tabaqchali.

I hit record on the conversation so that you, too, could enjoy it:

(click on the image to listen to the podcast)

In addition as a follow up Ahmed followed up with a lot of data points (message below). This should be read in conjunction with the recorded call.

Dear Chris,

The correction in the equity market that was anticipated in last month’s update started in late January and extended into February with an overall decline of about -3%, as measured by the RSISUSD Index, which seems to have played its course and it looks like the market will end the month flat. The most likely scenario is for an extended consolidation with an upward bias in the next couple of months.

I, however seem to have been overly cautious in underestimating the strength of the rebound which is often the case in illiquid frontier markets in that observers always underestimate the strength of a rebound in the same way that extent of a decline exceeds observers’ expectations. 

This year’s market, so far, is playing out as the mirror image of last year that saw a relentless decline in the index with -13.7% in January, -4.4% in February, -10.75% in March, -6.6% in April, and -11.9% in May. Liquidity is the same driver with this year seeing an initial & gradual recovery in liquidity while last year it was the final draining of liquidity.

The revival in liquidity is mostly local with foreigners selling for the month, although at much smaller levels than last year (see chart below). While, this is an unwelcome development, never the less the flip side to it has been the ease at which locals have absorbed this selling especially considering that foreign selling in selected names has resulted in minor declines of -3% to -7% which has mostly been recovered as a result of local buying that seems to continue unabated.

Net Foreign activity index on the Iraq Stock Exchange (ISX) (green) vs. 10-day of average of net foreign activity (red):

Source: Iraq Stock Exchange (ISX), AFC

The same observations hold for the recovery of the market price of the Iraqi Dinar with the price action mirroring that of the equity market. Recall that last month it was observed that the market price of Iraqi Dinar (IQD) vs the USD has improved by about +1.8% for January lowering the premium over the official exchange rate to about 8% from just under 10% that devolved in 2016. The premium widened to 8.7% by mid-February but has recovered to about 7.2%.  This is still above the normal range of 2-4% leaving room for further narrowing of the premium (see chart below).

Official IQD/USD rate (grey), Market IQD/USD rate (red), Spread (green) RHS

Source: Central Bank of Iraq, AFC. The spikes in 2012, 2013 and 2015 were a result of CBI polices that aimed to control the demand for USD but were abandoned when they raised market prices.

However, the improvement in liquidity is still in the early phases, with overall liquidity still scarce as can been seen from average daily volumes that although are at the same elevated levels of the last few months but are meaningfully below those of the prior years when the market was much stronger. Given that the risks of the last two years are still present, liquidity in the economy is still scarce that the recovery will likely be in fits and starts and the opportunity continues to be to acquire attractive assets that have yet to discount a sustainable economic recovery.

Supporting liquidity improvements are the continued strength in oil prices at sustainably higher levels that those budgeted for by the government & the IMF and thus should give further impetus to the expansion in non-oil capital investment spending which is estimated to be up +192% yoy in 2017 after contractions of -68% in 2016 and -50% in 2015 (the importance of this investment spending for the economy was highlighted in December’s newsletter in the section for 2017 outlook which appears under the December 2016 review).

The last few days saw further acceleration in the Mosul offensive with the start of the campaign to liberate the western part of the city, which is coupled with increased US support and involvement as highlighted by the US defence secretary’s current visit to Iraq. Parallel developments against ISIS in Syria have been taking place which combined should accelerate the end of the ISIS occupation and end of conflict.Finally, the chart below continues to support the thesis that the market has a significant catching up to do in the long process of discounting the end of conflict and the subsequent recovery afterwards. The recent gains, as impressive as they are, only represent a 30% retracement of the -68% decline from 2014 peak to 2016 multi-year lows.

Rabee Securities’ RSISUSD Index (red), 200 day moving average (green)

Source: Iraq Stock Exchange (ISX), Rabee Securities, AFC

Regards,

Ahmed Tabaqchali, CIO AFC Iraq Fund

I find that every little extra data point and nuance is valuable to me, even if at the time I can"t see how it may have an impact on what I"m focussed on. Over time, it provides an incredible war chest of intellectual firepower in that 3 pounds of mushy stuff stored inside our skulls.

Since Iraq is a geographically strategic player in the Middle East, understanding what is happening there and with their neighbours could well be very valuable to us as investors and to those wishing to participate in the country. As is so often the case with postwar economies, the returns can be pretty phenomenal.

- Chris

I"ll leave you with some of the key quotes from the Chilcot report, because, after all, it"s worth knowing some things about the conflict, the aftermath of which Iraq is still grappling with:

"We"ve concluded that the UK chose to invade before the peaceful options for disarmament had been exhausted. Military action at that time was not a last resort."

"It is now clear that policy on Iraq was made on the basis of flawed intelligence and assessments. They were not challenged, and they should have been."

Tony Blair "overestimated his ability to influence US decisions on Iraq"

"The judgements about the severity of the threat posed by Iraq"s weapons of mass destruction - WMD - were presented with a certainty that was not justified."

"Despite explicit warnings, the consequences of the invasion were underestimated. The planning and preparations for Iraq after Saddam Hussein were wholly inadequate.?"

The legal basis on which military action was launched was "far from satisfactory".

"The Armed Forces fought a successful military campaign, which took Basra and helped to achieve the departure of Saddam Hussein and the fall of Baghdad in less than a month.?"

"The invasion and its aftermath led to the deaths of 150,000 Iraqi, most of them civilians."

"The Government"s preparations failed to take account of the magnitude of the task of stabilising, administering and reconstructing Iraq, and of the responsibilities which were likely to fall to the UK."

"Military action in Iraq might have been necessary at some point, but in March 2003 there was no imminent threat from Saddam Hussein."

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Despite OPEC Cuts, Iraq To Boost February Oil Exports To Record High

One month ago, we were surprised to report that while oil traders and analysts were expecting OPEC member nations to, at least initially, pretend to comply and affirm their adherence to the production cuts as per the the Vienna meeting (before eventually cheating on their quotas), a very aggressive Iraq was not only not cutting output, but according to Iraq’s national oil company, the State Organization for Marketing of Oil (SOMO), had disclosed plans as of December 8, nine days after agreeing to cut production, to increase deliveries of its Basra oil grades by about 7% to 3.53 million barrels a day compared with October levels. The unexpected news was first reported by the WSJ which obtained a detailed oil-shipment program: such oil shipments represent about 85% of Iraq’s exports.

To be sure, Iraq did come up with a convenient scapegoat when just days later it blamed the autonomous Kurdish region of exporting more than its allocated share of oil. As a reminder, as part of the deal, Iraq, OPEC"s second largest producer, agreed to reduce output by 210,000 bpd to 4.351 million bpd. However, it immediately accused Kurdistan, over whose oil production Iraq"s level of control is limited at best, of producing well more than its quota.

"The region is exporting more than its share, more than the 17 percent stated in the budget,” Iraq oil minister Haider al-Abadi said at the time.

Fast forward to this morning, when Reuters, looking at the same loading schedules, reported that Iraq plans to raise crude exports from its southern port of Basra to an all-time high in February, keeping exports high even as OPEC production cuts take effect this month.

Just like last month, the country"s State Oil Marketing Company (SOMO) announced plans to export 3.641 million barrels per day (bpd) of crude in February, according to trade sources and preliminary loading schedules obtained by Thomson Reuters on Tuesday, beating a record of 3.51 million bpd set in December. The February volume includes 2.748 million bpd of Basra Light and 893,000 bpd of Basra Heavy, the documents showed.

Reuters adds that for January, SOMO had planned to export 2.627 million bpd of Basra Light and 903,000 bpd of Basra Heavy. Basra crude accounts for the bulk of oil exports from Iraq.

Surprisingly, despite the jump in exports, Iraq"s oil ministry said on Tuesday it has cut oil production by 160,000 bpd since the beginning of January in line with the OPEC decision.

While it is unknown if Iraq will again blame the Kurds on its seeming non-compliance, when despite allegedly cutting production it continues to capture market share by expoerting more, oil has slid and at least in early trading was down to session lows, and was approaching a critical support level.