At the beginning of the month, Iraq stunned the world oil market by refusing to export oil under the so-called U.N. oil-for-food program. According to the terms of that program, Iraq is allowed to sell unlimited quantity of crude oil on the world market for payments to U.N.-controlled bank accounts.
The proceeds are generally used for the purchase of humanitarian supplies, which are distributed in Iraq under U.N. supervision. Some money is spent to pay compensation for Gulf War victims, pipeline transit fees for Turkey and funding for U.N. weapons-monitoring activities. Every six months, the program is reviewed by the United Nations.
On Feb. 26, U.S. Secretary of State Colin Powell proposed a modification to the sanctions on Iraq, so that they would be more carefully targeted toward military items sought by the Iraqi government. In turn, this would allow freer movement of non-military goods.
Iraq opposes the plan strongly. A discussion is underway over the plan, but the parties reached no decision at the beginning of June, when the oil-for-food program was set to be rolled over for another six months.
In order to continue the discussions, without creating disruption in Iraq's oil exports, the U.N. Security Council voted to extend the program for a month only. Surprisingly, Iraq refused to accept this decision, and halted export to all buyers except for neighboring countries, insisting on a regular six-month extension. That news made oil prices jump.
However, this is not the first time Iraq has cut its oil exports. On Nov. 16, Iraq's State Oil Marketing Organization (SOMO) demanded that companies lifting cargoes of Iraqi crude begin paying a 50 cent per barrel surcharge directly to the Iraqi government (in violation of U.N. sanctions) starting Dec. 1, 2000. On Dec. 13, Iraq resumed exports of crude after a disruption of 12 days due to a dispute over this issue.
Iraq contains 112 billion barrels of proven oil reserves, the second-largest in the world (behind Saudi Arabia), along with roughly 215 billion barrels of probable and possible resources. Following Iraq's invasion of Kuwait and the embargo on Iraqi oil exports, Iraqi oil production fell to around 0.3 MMBD (million barrels per day), down from 3.5 MMBD in July 1990.
Iraq resumed its oil exports after it was legally allowed by U.N. Resolution 986, passed in April 1995. Last year, Iraq averaged net oil exports of around 2 MMBD. Iraqi oil was sold initially to Russian firms (i.e., Machinoimport, Sidanco, Slav-neft and Zarubzhneft), with other large purchasers including Italian (Italtech), Malaysian (Mastek), French and Chinese companies.
The oil is then resold to a variety of oil companies, including over 0.6 MMBD to the United States through third parties. I suppose it's unprecedented that at the same time American warplanes were destroying targets in Iraq earlier this year, they were probably fueled by jet kerosene made of Iraqi oil.
In addition to U.N.-sanctioned oil exports, there have been periodic reports that Iraq has smuggled up to 0.45 MMBD of crude oil and products via a number of routes. Reports also have estimated that these illegal shipments may be providing Iraq with as much as $600 million to $2 billion per year in illegal revenues.
In April 2000, the U.S. Navy stopped a Russian tanker, the Akademik Pustovoit, which it suspected of smuggling Iraqi oil. The United Nations later determined that around 20 percent of the vessel's gas-oil cargo was of Iraqi origin.
As a general practice, Iraq is awarding oil and gas contracts to companies from countries supporting the lifting of sanctions. Russia is one of its closest partners. In April 2001, Iraqi Vice President Taha Hussein Ramadan met Russian President Vladimir Putin, the highest-level Iraqi-Russian contact in several years.
Following the lifting of U.N. sanctions, Iraq hopes to increase its oil production capacity to over 6 MMBD, which would probably be a disaster for the oil market. Production costs are very low in the country, just several dollars per barrel, so it would always be profitable to export oil, no matter how low the price drops.
Iraq has signed several multibillion-dollar deals with foreign oil companies, mainly from Russia, France, and China. Iraq owes Russia several billion dollars for past arms deliveries, and has a $3.5 billion, 23-year deal with Iraq to rehabilitate Iraqi oilfields, particularly the 15-billion-barrel West Qurna field.
Since a deal was signed in March 1997, Russia's LUKoil (heading a Russian consortium plus an Iraqi company to be selected by the Iraqi government) has prepared a plan to install equipment with capacity to produce 0.1 MMBD from West Qurna's Mishrif formation.
Iraq insists that the work should begin immediately, and if there is a significant delay, LUKoil could lose its contract (and possibly be replaced by another Russian company). LUKoil has been restrained from doing so by U.N. sanctions
In April 2001, a joint Russian-Belarusian oil company, Slavneft, was reported to be in talks with Iraqi officials on the billion-barrel; Suba-Luhais field in southern Iraq, and expected to sign a service contract to begin drilling later this summer. Full development of Suba-Luhais could result in production of 0.1 MMBD at a cost of $300 million over three years.
The Saddam field contains 3 billion barrels of oil and 5 trillion cubic feet (Tcf) of associated gas. Iraq is seeking foreign assistance for its development. Russia's Tatneft and Zarubezhneft reportedly have received U.N. approval to drill 33 wells in the Saddam field. Zarubezhneft also has a contract to drill approximately 100 wells in the North Rumaila field.
So the main problem for Iraq now is U.N.-imposed sanctions. After the sanctions are lifted, there could be a boom in the country's oil and gas industry. The companies that are going to benefit from it are primarily Russians one.
Profits from Iraq will be partially offset by the lost revenues from exporting Russian oil, as Iraq's full return to the world market would inevitably be accompanied by a drop in oil prices. Moreover, Iraq's main export oil brand, Kirkuk, is similar in its composition to Russian brand URALS. Accordingly, the main consumers of Russian and Iraqi oil are the same high sulfur-oil oriented European refineries. The more Iraqi oil is at the market, the cheaper Russian URALS becomes due to competition.
Currently Iraq's oil export halt is providing strong support to the market. OPEC promised to compensate for all oil lost due to the halt, but it will take some time before it switches from words to action. Now, OPEC will just wait for Iraq to resume oil export.
If nothing changes until the next OPEC meeting scheduled for July 3, the cartel is quite likely to raise output. The most influential OPEC country, Saudi Arabia, has tense relations with Iraq and recently seized control of an Iraqi pipeline on its territory. Personally, I think, to prevent losing its market share in favor of OPEC, Iraq will be forced to find some compromise with the U.N. and resume export soon.
(The author is analyst with the Financial Intermarket Brokerage Online Group Inc. (FIBO)