Bright Expectations, Tough Challenges: On Iraq’s Energy Outlook interview with Faith Birol

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Fatih Birol is the Chief Economist at the International Energy Agency (IEA) and is responsible for the IEA’s flagship World Energy Outlook publication. He is the Chairman of the World Economic Forum’s (Davos) Energy Advisory Board and has served as a member of the UN Secretary-General’s “High-level Group on Sustainable Energy for All."

Following the release of the International Energy Agency (IEA)’s annual World Energy Outlook report, the Journal sits down with the man responsible for its publication– Dr. Fatih Birol– to speak about the future of Iraq’s energy sector, and the impact this dynamic shift will have upon both the region and the world.
GJIA: Your special World Energy Outlook report indicates that Iraqi oil production could increase to 6.1 million barrels a day by 2020 and to 8.3 million barrels a day by 2035, and could eclipse Russia to become the world’s sec- ond largest oil exporter. What are the biggest obstacles that need to be overcome for Iraq to reach these goals?

Birol: Iraq has extremely large resources and these resources are not only huge, but also very cheap to produce. Com- pared to Brazil, Venezuela, or Norway, the production of one barrel of oil in Iraq is about twenty-five to thirty times cheaper. There are bountiful oil and gas reserves, and production is cheap. However, there are two major obstacles; the first one– and it is the most crucial one– is that there is no legal framework agreed upon. There is a central government in Baghdad and regional governments, but there is no legal framework to supervise the oil and gas sector.

There is a second issue in that Iraq experiences several infrastructure problems, particularly regarding pipelines and export channels. The key issue is Iraq’s lack of water. To extract oil normally, water is injected in the field to put pressure so that the oil comes out. In Iraq there is not enough water for the production of oil. Therefore the supplying of seawater through pipelines to the field is needed in order to extract the oil.

To sum up, there are two challenges; one, the need of legal reforms to provide a clear framework for companies seeking to invest in Iraq; the second, to make the necessary investments for the infrastructural development of the country.

GJIA: The report notes that $530 billion in cumulative investments are needed for the projections on oil, gas, and power supply to be met by 2035. This is well above the $9 billion a year currently coming in. What needs to be done by Iraq and by the international community to encourage these investments?

Birol:Iraq has such large resources that under normal conditions international oil and gas companies would have a great incentive to invest in the country. So there is no problem from this point of view. The issue is that Iraq’s investment framework is still very fragile; there are several questions and uncertainties– implying risks for the investors. I see these as the main challenge for the country, other than the lack of money itself, because the oil companies are ready to invest in Iraq given the many options open to them. The main issue is the lack of a clear legal framework.

GJIA: What was the Iraqi government’s reaction to the release of the report? Have the authorities lowered their targets since? What is the relationship between an organization like yourself and a government seeking to foster such targets?

Birol: When we started this project, I was very keen to conduct it in close cooperation with the Iraqi government, while keeping our independence of analysis. I think we were able to succeed in finding a good balance. I had three Iraqis in my team of about forty people. We shared information and data; my colleagues and I made several fact-finding visits to Baghdad, Erbil, and Basra. We released the report in Baghdad together with the Deputy Prime Minister Hussain al-Shahristani and with oil and electricity ministries representation. As I mentioned in the launch ceremony, we have different views, but both parties believe that Iraq can have a very bright future. We have seen several press statements that indicate that the government has been revising its oil production targets after our report was released, but of course it remains to be seen whether or not these official statements are verified in practice.

GJIA: If all goes well, you predict that Iraq stands to gain almost $5 trillion in revenues from oil exports by 2035 and grow its GDP to 5 times its present size, giving its economy and population immense potential for prosperity. Yet, you readily admit that the link between this increased national wealth and social welfare is not assured. What can be done to use this growth from the energy sector to better the lives of the people?

Birol: There are two elements of uncertainty here. The first one regards whether or not the projections will be verified, and thus whether or not we can expect the revenues that would result from an increase in production. It is also uncertain how these revenues will be used– whether they will be injected in an efficient and transparent manner into the real economy of Iraq. Regarding the second challenge, we recommended in our report that it is crucial that the oil revenues in an efficient way in order to create jobs, and to make investments in schools, hospitals, and so on. We also suggested that the money be spent in a transparent way.

My main worry is that about 75 percent of the Iraqi economy relies on oil revenues these days, which is extremely high. The economy therefore needs to be diversified. Oil revenues should be used to make investments into non-oil sectors that can create many jobs; the oil sector is not a sector that can provide many jobs. Iraq is a very young country. There are about 30 million people in Iraq, and that figure should double in the next twenty years, with a particular increase in the proportion of young people, and so the demand for jobs will increase drastically. Therefore, the money should be used efficiently, transparently, and in a way to favor the growth of the real economy. It will remain essential to see whether or not the oil revenues can enable the diversification of the economy.

Access to electricity is a major issue. A significant portion of Iraqis cannot use electricity.This is grotesque given the country’s endowment of oil and gas. If the revenues spurring from the energy sector are used to address the electricity needs of the people through the construction of power plants, for example, then it will be beneficial to Iraqis. And the Iraqi government wishes the international community to feel that it is engaging on a path of develop- ment with these oil revenues.

GJIA: Rising oil and natural gas pro- duction within Iraq will increase its clout relative to the countries that sur- rounds it, and specifically within the Organization of the Petroleum Exporting Countries (OPEC). How will Iraq’s role change within OPEC as its oil export capabilities develop?

Birol: You are right that if Iraq’s production increases, its role in the oil markets will be enhanced, but keep in mind once again that our projections are much lower that the government’s official targets. Even our projections bring some implications for Iraq’s fellow oil producers. The Iraqis could make the following argument before the fellow oil producers: “Dear friends, during years and years there was conflict on our soil and we could not increase oil production. We were excluded from the virtuous circle started by a higher oil production while you were increasing yours thus implying substantial revenues for your economies. Now, it is our time to increase production in order to reconstruct our country. We therefore need this production and it shouldn’t be hampered.” If the Iraqi experts make such a point, I think it would have a strong point.

GJIA: Were this to occur, how would global markets react to such a change in supply?

Birol: If Iraq increases its production to 6 million barrels a day in the next eight to nine years, such increase will be very much welcome. My worries are that this may not be realized, resulting in a lower global supply of oil. First, a tightened market is expected to bring the price up by $15, which is significant. Second, this would be similar to a cold shower for the Iraqi citizens because revenues would be much lower than expected.

GJIA: If the world is experiencing a slowdown in demand, why is a potentially lower supply than expected from Iraq so significant?

Birol: In the United States today, 700 people out of 1000 own a car. In Europe, 500 out of 1000 own a car. In China, however, the figure is only 30, and in India, only seven people out of 1000 own a car! The citizens of China and India want what people have in the United States and in Europe. With the GDP growths China and India are experiencing, people are getting richer and one of the first things they do is buy a car for convenience or prestige reasons. This will increase the demand for oil and so the question is: how are we going to meet that demand? Where would the oil production come from? When looking at the entire supply map, I cannot see any other country than Iraq with the capability to meet this increasing demand at the low- est costs. Production increases will originate from Brazil, Kazakhstan, Africa, and the United States, but these amounts are not as significant as the proportion potentially originating from Iraq. Therefore, if expectations in terms of meeting production tar- gets in Iraq look unfavorable, we can expect higher prices and volatility as a result.

GJIA: If a failure on the part of Iraq to meet the report’s projections might portend volatility within the global markets, is there any international legislation you would recommend to stabilize this market?

Birol: Oil markets have regulatory frameworks within which to operate. While it is not a major issue, what would be important is to render the markets more transparent. One key issue is transparency regarding the reserves. Currently, we do not know the energy reserves held by many producer countries. If a nation says, “I have this much reserve” and the other one says “I have this much reserve,” we just have to believe them. There is no internationally recognized system assessing the reserves that should be held by producers and this can be an issue. Apart from this need for transparency regarding reserves, as well as transparency in terms of data, certain regulatory frameworks can be strengthened. For example, within the producer countries themselves, well-regulated investment frameworks are always beneficial to spur confidence from investors.

GJIA: Iraq has only a minor coastal access to the Persian Gulf. How significant is this disadvantage for its oil and gas exports? What will be the major routes for exports given Iraq’s geographical position and also given the regions geopolitical challenges?

Birol: Iraq has a huge gas production, but up until now the Iraqi government did not see gas as an important source of wealth. Today, about 60 percent of the gas is lost; money is just going out of the window. Gas in Iraq should be used first for Iraq’s domestic electricity generation– to provide electricity to Iraqi citizens. Once everybody has access to electricity, the surplus can be exported. Regarding gas exports, there are three options available to Iraq. One of them would be exporting to Turkey and Europe, which is a very cost-effective option compared to others we are discussing in Europe today. The second option is to ship the gas from the south of Iraq to Asia. The third option is, of course, to export the oil to some of Iraq’s close neighbors such as Saudi Arabia, Kuwait, and others. It will be up to the Iraqi government to decide, but Iraq is considered to have a substantial cost-advantage in the production of oil from an economic point of view. When considering gas projects, there are multiple elements to be analyzed pertaining to other fields than economics, but just from an economics point of view, Iraqi gas is a very advan- tageous resources base.

GJIA: How does the ongoing ‘Arab Awakening’ factor into your assessments of the future, both for Iraq and the entire region?

Birol: My profession mandates economics and energy, but unfortunately energy and geopolitics are and will be increasingly interwoven. In almost every country, the foreign minister often has to deal with energy issues as they become more and more linked to geopolitics. From an energy perspective, I cannot say at this stage that the so-called Arab Spring brought necessarily good news for the energy sectorI can mention two elements here.

First, in many countries of the Middle East, there are huge subsidies on fossil fuel consumption to keep oil, gas and electricity prices low. This is suboptimal because, as a consequence, people use the resources very inefficiently. When something is cheap, you tend to use it in a very wasteful manner. Another consequence is that some other energy sources such as solar energy cannot compete with such cheap gas or oil. Because of this, all of these countries wanted to reform their subsidy policies. However, after the Arab Spring, many changed their minds and they now may even want to increase subsidies. This is very bad news because, apart from the potential inefficiencies mentioned before, a lower price will mean a substantially higher oil demand at home and so decreasing export capabilities.

The second problem is that after the Arab Spring, many of those countries have revised their investment targets for oil and gas production. They are tempted to increasingly use oil revenues to boost their budgets, partly because prices and the cost of living more generally are much higher than before the Arab Spring. Given the fragile nature of the global economy, this issue is critical. I am not in a position to comment on whether or not the Arab Spring brought political change and democracy to those countries, but from an energy point of view, the future looks less favorable.

Fatih Birol was interviewed by William Handel and Catalina de la Sota on 20 October 2012.