Missing the long game: Washington’s high-risk energy diplomacy in Iraq

Washington’s foreign relations in the Middle East are often characterized by ebb and flow, tracking the region’s dynamic politics. But when it comes to Iraq, this ebb and flow is especially turbulent.

Events surrounding the assassination of Iranian Gen. Qassem Soleimani, the head of the Islamic Revolutionary Guard Corps Quds Force, at the beginning of the year have made clear Iraq’s fragile economic and geopolitical situation. Three years ago, Baghdad and Washington fought a fierce war against ISIS to combat the threat of international terrorism. Today, in the wake of the Soleimani assassination and its aftermath, this close relationship is now at risk of withering. In the foreground, Iraq’s energy sector has been thrown under the spotlight as Washington presses Baghdad to take swift action to ensure its “energy independence” from Iran.

Energy sector challenges

Iraq’s energy endowment, despite being the cash cow for financing the economy, is also the country’s Achilles’ heel. It contributes 60 percent of GDP, 99 percent of export revenues, and more than 90 percent of the government’s fiscal budget. This vulnerability has been exacerbated by the recent oil price collapse. Iraq’s 2020 draft budget revenues are based on a price of $56 per exported barrel with a planned deficit of 30 percent. As a price war intensifies in the oil market, the country may find itself incapable of sustaining public payroll and spending at $30 per barrel. For the last five years, Iraq has been running deficits with operating expenditures making up 75 percent of total expenses. As a result, the country may need to adopt harsh austerity measures to compensate.

Since 2003, when the Saddam Hussein regime fell, officials have failed to produce a national strategy to diversify Iraq’s economy away from oil or support the growth of the private sector. Furthermore, the cumulative effect of years of war, sanctions, terrorism, and mismanagement has made Iraq a net importer of refined petroleum products and natural gas. The latter has become a point of contention with the United States, as Iran enjoys a first-mover advantage by exporting up to 1,200 million standard cubic feet of natural gas per day (scf/d). Additionally, Iran provides around 1,200 megawatts (MW) of electricity during the hot summer months, when the demand for power peaks. While unprecedented strides were made last year, with Basra and other southern provinces being provided with an average of nearly 24 hours of power a day, the electricity sector still suffers from a supply-to-peak-demand deficit of 6,000 MW in the summer, according to analysis from the Iraq Energy Institute (IEI).

Iraq’s problem is a classic case of a poorly coordinated, bloated public sector. This is not due to a lack of strategic planning, however. In 2012, the Iraq Integrated National Energy Strategy, developed in conjunction with the World Bank, called for the simultaneous development of natural gas infrastructure by the Ministry of Oil and the addition of gas-fired power capacity by the Ministry of Electricity. The plan’s target was for all gas production to be captured, processed, and made available for transport to end users by 2015. 

While almost 60 percent of the country’s power plants are gas powered by design, only 30 percent of that capacity operates on gas volumes fulfilled domestically, according to IEI. Non-incentivizing contracts awarded to international investors, delayed project financing, and bureaucracy at the Ministry of Oil have led to more than half of the raw gas produced being flared, according to an IEI report. Iraq’s raw gas production is estimated at 2,875 million scf\d, of which 1,594 million scf/d is being flared. This represents an estimated economic loss of $3.5 billion annually, according to IEI — not to mention the adverse environmental and climate consequences. Iraq is the second largest gas flaring country in the world after Russia. Only around 1,165 million scf/d, or 40 percent, of associated gas — gas that is produced as a byproduct of crude oil production— is being utilized.

To compensate, natural gas is imported from neighboring Iran. In total, Iranian-sourced gas and electricity constitute about 4,000 MW, or 20 percent, of Iraq’s 19,500-MW peak summer production capacity. While significant and essential, supply from Iran has been intermittent at times, especially in winter, due to peak demand for heating in Iran itself. 

Measures for self-sufficiency

In 2018, the United States government imposed sanctions on Iranian energy exports. Given Iraq’s sensitive situation, sanction waivers were issued by the State Department with the understanding that Baghdad would meet its short-term energy needs while taking steps to reduce dependence on Iranian imports. 

Since the end of 2018, Iraq has taken measures to increase gas capturing by Basra Gas Company and at the nationally operated Halfaya, Nasiriya, and Gharraf oil fields, by an additional 900 million scf\d. The Ministry of Electricity added 3,500 MW of power in 2019 with another 4,000 MW scheduled to enter operation in 2020, subject to Baghdad meeting its financial commitments to contracts signed with multinational companies, like Siemens and GE — a task that is becoming increasingly difficult with the delay in passing the draft budget law.

In September 2019, Iraq signed an interconnectivity framework agreement with the Gulf Cooperation Council Interconnection Authority with the initial goal of supplying 500 MW of power from Kuwait to Basra. Aiming to both diversify power imports and create a regional utility market, Iraq is negotiating similar frameworks with Jordan and Turkey. 

The boldest actions came in January as the Energy Ministerial Council approved the long-delayed fifth bidding round contracts for oil and gas fields bordering Iran and Kuwait. In three years, these fields are expected to be capable of producing 750 million scf/d, which is equivalent to Iran’s current gas supply to Baghdad via Diyala. Also, long-awaitedfast-track associated gas capture and pipeline network projects could deliver around 500 million scf/d from the south to the north. This infrastructure will benefit new-generation, natural-gas-powered projects, replacing the 25 percent of electricity generation capacity lost to ISIS. The government will seek to finance these infrastructure projects in 12 months.

In addition, the federal government will also begin negotiations with gas developers in the Kurdistan Region of Iraq (KRI), where as much as 300 million scf/d of surplus gas can potentially be secured from the Khor Mor gas field in one year. Building on the positive political climate between Baghdad and Erbil, the integration of the KRI and national power grids is a prospect under consideration as well. This climate had been built on the soft approach of outgoing Prime Minister Adel Abdul-Mahdi with Erbil. While the prospects of new government formation are still unclear, it is unlikely that these plans will change in the short to medium term, as Baghdad needs to continue on built momentum toward securing another waiver.

Negotiations are also ongoing with Honeywell and Bechtel for the development of the Ratawi gas hub, a multi-stage major gas processing complex, with the first stage expected to provide 300 million scf/d. In the mid to long term, Iraq needs to refocus on the non-associated gas fields of Mansouriya and Akkas in the Diyala and Anbar provinces, which can produce an estimated 620 million scf/d once developed. All in all, and if not hindered, Iraq is steadily moving toward establishing a gas production capacity of at least 2,800 million scf/d in 36 months’ time.

In Baghdad, there is talk of a last-minute “change of heart” by the U.S. administration that resulted in a reduction of the time allotted for the final Iranian gas import waiver from 120 to 45 days in retaliation for political pressure on the Ministry of Oil to backtrack on some of the Ministerial Energy Council’s decisions. This waiver was granted on Feb. 12 and is expected to expire on March 28. On the other end, Iraqi insiders point to a “factional split” within Washington where long-time American Iraq experts and bureaucrats are desperately pushing against hawkish “zero-sum” advocates, who view Iraq through the lens of the “maximum pressure” strategy against Iran.
 

Opportunities from weaknesses

Iraq’s electricity grid is nearly a half a century old, built in a golden age of highly educated urbanites living in well-planned cities with an absence of power piracy and squatters. For 12 million Iraqis in 1980, 1,700 MW of electricity was sufficient given the higher efficiency (in terms of both service provision and demand-side applications)  and lower supply-side technological requirements of the era, according to a history of Iraq’s electricity sector published by the Ministry of Electricity. Fast forward to 2003: the Saddam regime fell, leaving behind 30 million Iraqis facing frequent blackouts and a 3,000-MW power grid suffering the effects of three wars and a decade of sanctions. 

Subsequent governments have added almost 16,000 MW in capacity, but a population growth rate of 7 percent (equivalent to almost 2,000 MW of additional power demand per annum), along with erratic urban expansion, cheap and inefficient imported appliances, corruption, mismanagement, heavily subsidized tariffs, and damage from terrorism, means even more investment is needed to bridge the gap between supply and demand, while developing fuel feedstock and reforming the sector’s entire business model.

While an estimated $18 billion in infrastructure is needed by 2025 to reach a domestic gas production capacity of 3,200 million scf/d, to cover a projected demand of 37,000 MW, IEI figures suggest that another $35 billion may be required on top of that to rehabilitate the power generation, transmission, and distribution sectors. In sum, Iraq needs to attract a considerable amount of foreign direct investment in its energy sector. 

In a country where current expenditures — chiefly salaries and pensions — constitute almost 75 percent of the government budget, little capital is dedicated to infrastructure projects. Following the traditional approach of state financing, procurement, and implementation, it is difficult for Iraq to pursue many of these ambitious targets unless structural changes are made to the governance and management of the energy sector. 

Iraqi lawmakers have proposed integrating the oil, gas, and electricity portfolios under a new Ministry of Energy. Unifying the workforce, policies, and development plans of both of the existing ministries may help reduce bureaucracy, assimilate fuel supply chains, and allow broader liberalizing reforms through the creation of a regulator. For investors, a one-stop shop for energy projects would also help to reduce risk and red tape. For the public, such a move may concentrate accountability, ending years of blame games. However, it is unclear how or if this proposal will proceed given that the formation of a new government in Baghdad currently hangs in the balance.

The long game

In January, the threat of U.S. sanctions by President Donald Trump forced many in Baghdad to seriously reassess the country’s economic vulnerabilities. Severing the flow of petrodollars and limiting access to global markets wouldcertainly have a direct impact on regular Iraqis as they are almost completely dependent on imported goods, especially food and medicine. The impact would be far greater than that of sanctions in Iran, a country with a relatively stronger domestic industrial base than Iraq. 

Talk of sanctions also brings back bad memories of the blockade in the 1990s and early 2000s. From 1991 to 2003, Iraq lost the equivalent of 15 percent of GDP annually and saw its infrastructure knocked back to the pre-industrial age after the Gulf War, according to a UN assessment in 1991. Saddam’s regime made effective use of the sanctions for anti-U.S. propaganda both domestically and on the world stage. If imposed again, at any level, sanctions would definitely backfire against Washington’s interests in Iraq. They would become a platform for those with populist anti-Western agendas and serve as a stark reminder of an era of widespread food shortages and marked by the death of hundreds of thousands of Iraqi children. 

Iraq is a rentier state with a bloated public sector, and as billions in investment are required for the energy sector, as well as the reconstruction and development of the overall economy, Baghdad will likely increasingly find itself looking for large infusions of capital from China and Russia. A good example of this is the recently signed financial framework agreement with Beijing, offering oil in return for infrastructure projects. In response, the U.S. should take an active role in supporting a U.S. business presence in Iraq’s economy with a focus on the southern provinces, not just Kurdistan and liberated Sunni areas.

Prioritizing a narrow and kinetic counterterrorism approach over nation building and strengthening Iraq’s civilian institutions threatens to reverse 17 years of American security, economic, and political leverage in Iraq. Furthermore, it would hurt existing American commercial interests and deny U.S. companies future access to major reconstruction projects, especially lucrative ones in the energy sector.

Iraq’s politics are complicated, but its economic prospects are attractive. The U.S. should support the development of an economically strong and politically independent Iraq. It is the sole successful model of America’s presence in the region. The administration’s short-to-medium-term strategy in Iraq will determine whether the U.S. is interested in sustaining a stabilizing role that is beneficial to both nations. Alternatively, there is a risk of throwing away years of involvement by reducing Iraq to a pawn in a larger geopolitical game with Iran, one which will likely have no winners.

Yesar Al-Maleki is a non-resident scholar at MEI, energy economist, and Middle East observer with an extensive knowledge of the intertwining subjects of energy, geopolitics, and economics in the region. He is the managing director of the Iraq Energy Institute (IEI) in Baghdad, where he leads research programs on Iraq’s and Iraqi Kurdistan's oil, natural gas, and power sectors, as well as water and environmental challenges, economy, and politics.

Acknowledgment: The author would like to thank Dr. Luay Al-Khatteeb, Iraq’s minister of electricity, for granting him exclusive access, in addition to the IEI for sharing exclusive data and analysis. 

Photo by HAIDAR MOHAMMED ALI/AFP via Getty Images