There may come a day when Iraq is not a wild card in oil market scenarios, but that day is not at hand yet.
Oil prices have remained buoyant in recent weeks for a number of reasons, a strike by Nigerian oil workers and persistently low crude stocks among them. But the major factor underpinning a bullish price outlook for the oil market in the next few months has been the market's surprise that Iraq's presumed resurgent production would undermine efforts by the Organization of Petroleum Exporting Countries to defend prices. Looking even further out, some have speculated that a rapid buildup of production in Iraq would bring OPEC to its knees and perhaps cause the group's demise.
But there has been ample evidence that Iraq's return to prewar production levels would take longer than many surmised; the more realistic early scenarios called for late fall. Now that a campaign of harassment and sabotage by pro-Saddam forces within Iraq has begun to take its toll, even the Iraqi oil officials' optimistic scenario for a return to prewar output levels is yearend. And there is reason to believe that Iraq will find it in its own best interest to stay within the OPEC fold and support current efforts to sustain a price path along the lines of its current target of $22-28/bbl (for an OPEC crude basket).
Iraq's return
Two highly respected oil analysis groups have produced reports recently that speculate about Iraq's future role within OPEC and arrive at roughly the same conclusion: Iraq would be best served by remaining within OPEC, securing a quota commensurate with its enormous potential, and adhering to that quota in support of the group's targeted price band.
These reports followed one that London think tank Centre for Global Energy Studies released early this year, before the war, that Iraq would adopt a policy of accelerated oil development and production following a change of regime. CGES estimated that Iraq could attain its pre-Kuwait-invasion productive capacity of 3.5 million b/d in 2-3 years at a cost of $5 billion. It could boost that capacity further by an additional 4.5 million b/d over 9 years at a cost of $30 billion.
"Iraq is unlikely to ask for an OPEC quota increase as long as its production is compatible with its historical share of 14.5% of total OPEC production," CGES said in a January report. "However, once this share is exceed at some stage down the road, it would be up to OPEC to keep Iraq within in the organization by granting it an appropriately higher quota. In the absence of a favorable response from OPEC, Iraq may well opt to leave the organization."
Reasons to stay
July reports by FACTS Inc., a Honolulu consulting group headed by Fereidun Fesharaki, and by Wood Mackenzie Ltd., Edinburgh, suggest that Iraq would be better served by staying within OPEC.
FACTS first assumes that OPEC will be producing 33.85 million b/d in 2010 and will maintain its current 37% share of the world oil market. FACTS also projects world oil consumption will grow 2%/year. In their report, Fesharaki and Hassaan Vahidy contend that a 37% market share represents the highest payoff path for OPEC. While Iraqi production was 8-9% of the OPEC total during the 1970s, "given the country's potential and declining or stable output from some of the other OPEC members, a share of 11% or even 13% for Iraq seems plausible." The FACTS report authors conclude that Iraqi output near 4.4 million b/d in 2010, consistent with supporting OPEC's price target, "makes sense."
WoodMac arrives at a similar conclusion but also factors in the capital spending required to develop the added capacity and hence factors in the net present value of the money spent and revenues earned. It compares an "unconstrained" production case for Iraq with one consistent with support of OPEC's price band. Unconstrained production levels also means almost double the up-front spending. But the resulting collapse in oil price from all that extra Iraqi crude would wipe out much of the potential revenue from the increased volumes. WoodMac projects state revenues higher than in this low-price scenario, peaking at $27 billion/year in 2014.
"This represents a much more efficient use of reserves, on a per-barrel basis, when compared to the unconstrained, low oil price scenario."
Sounds just like OPEC's current strategy.
(Online July 5, 2003; author's e-mail: [email protected])