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[casi] Iraq Oil Production Analysis and Overall Forecast from STRATFOR



Charles Jenks, attorney at law
President of the Core Group
Traprock Peace Center
103A Keets Road
Deerfield, MA 01342
413-773-1633; Fax 413-773-7507

From: Strategic Forecasting Alert Full Analysis

Net Assessment: New Equilibrium for Oil Markets [Originally published on Jul
11, 2003]

After a year that can best be described as epileptic, oil markets are
finally in for a protracted period of relative calm as the U.S. recovery and
OPEC backpedaling absorb nearly all fresh production from Iraq and Russia.

Two primary themes will drive oil markets for the next year: OPEC's ability
to manage the return of Iraqi oil to the market, and the U.S. economic
recovery [let's not overstate this]. Other issues will be a factor in the
markets, but it is these two that will dominate movements at the highest
level in the medium term.
Damage Assessment: Iraq

Iraq's return to the oil markets has been slower than the markets' best-case
scenario anticipated, but the problems have not been due to war damage. The
Army Corps of Engineers completed its assessment in the first week of July,
revealing that total war-related damage to the Iraqi oil complex was a mere
$250 million to $350 million -- an amount well within the $500 million
contract initially granted to Halliburton's Kellogg, Brown and Root.
But from that high point, the damage assessment news turns sour. New reports
from the Iraqi Oil Ministry indicate that what began as random looting
eventually took a turn toward much more organization, with indications of
flatbed semis and cranes being used in the wholesale theft of large
"immobile" pieces of equipment. Though the looting has died down
considerably since April and May, it continues to plague operations,
particularly in the south. Looting alone has added some $750 million to the
repair bill, and that excludes any of the recent sabotage attacks.

Total income from Iraq's postwar oil sales to date totals $200 million.
Those sabotage attacks -- combined with what can only be described as
sophisticated looting -- have hamstrung the sector's recovery. Recent
attacks clearly have involved individuals knowledgeable about the sector's
operation, who have targeted monitoring stations, valves and pipelines
joints -- at times in synchronized attacks -- in an effort to maximize
disruption with minimal effort. Also complicating repairs is the substantial
sanctions aftereffect, which will take months to overcome.

Sanctions starved the Iraqi oil complex of equipment and spare parts for 12
years. The newest technology in Iraq dates from the 1970s, and much of the
local equipment used to craft replacement parts is of World War II vintage.

The dearth of equipment means that when a pipeline is damaged, it takes
Iraqi repair crews weeks get the infrastructure back up and running. In the
case of a well-apportioned oil complex, the necessary repairs would take
hours, or at worst, days. Needless to say, this makes easy work for the

Location, Location, Location: A Safe Infrastructure with an Achilles Heel

For purposes of the oil industry, Iraq can be clearly delineated in
three>sections: south, central and north.

The south has suffered the least from sabotage attacks but the most from
looting. The population of the region is predominantly Shia, the
dispossessed majority that suffered greatly under the rule of Saddam
Hussein. Initially, the Rumaila super-field suffered considerably from
looting -- a manifestation of Shias trying to get whatever slice ofthe pie
they could for themselves.

That situation has changed.

Now the greatest concern is theft of crude. Before the Iraq war, Hussein
used hundreds of small shippers to smuggle crude out of the country through
the Persian Gulf. Now some of those shippers are tapping into Iraq's export
lines -- but instead of filling up buckets and pots, Iraq's thieves are
filling up tanker trucks.

They then drive the crude past Basra, fill up their ships and set sail
through the Persian Gulf for other ports, where they can sell it. The United
States has shown in the past that it can crack down on such smuggling, but
these efforts require a political commitment from high up the U.S. chain of
command that has not yet materialized. Northern Iraq has been quiet in
comparison. Unlike the southern Shia, Iraq's northern Kurds exercised de
facto control over their own affairs before the war and have their own
governing and security structures. Looting in the north has been minimal --
limited mainly to the cities -- and Kirkuk's fields have been left mostly
intact. The Kurdish leaders also possess a very clear understanding that the
future of their "state" depends upon both continued good relations with the
Americans on one hand, and sustained income from oil revenues on the other.

It is in central Iraq, dominated by Sunni Arabs, that nearly all attacks
against U.S. personnel and infrastructure have occurred.

On the surface this is crushing; it is impossible to reconstruct a ravaged
country without basic security. But a closer look reveals a more optimistic
picture: More than 90 percent of the attacks have occurred in a triangular
region bounded by Ramadi, Tikrit and Baghdad.

With the exception of the East Baghdad field -- which is rather
insignificant from an export point of view -- there is only one important
piece of critical infrastructure in this region. This item is the
north-south Iraqi Strategic Line, a reversible pipeline that allows Rumaila
crude to be shipped north and Kirkuk crude to move south. Though the line is
still in partial use, U.S. forces during the war bombed a pumping station on
it near Al Hadithah in order to disable an associated pipeline that exported
crude through Syria. This effectively severed the Iraqi Strategic Line from
an export perspective and dramatically limited its usefulness for internal

The point of all this is that the violence, the nucleus of opposition to the
U.S. occupation and the source of damage to infrastructure is not within
areas that are critical to the export of crude oil. The northern route lies
primarily in Kurdish territory; the southern route deep within Shia
territory. In both cases, local forces have an interest in protecting the
energy assets. The fields themselves are no longer in direct danger and the
routes are relatively easy to patroland fairly limited in distance. The
entire southern route, for example, is on land for less than 70 kilometers.
Within two months, some 20,000 additional foreign troops (Poles, Japanese,
Filipinos, Italians and others) will arrive in Iraq to assist with security.
That alone should prove more than enough to provide basic patrols for the
two export routes. If security personnel limit their focus to these two
routes -- which from a revenue standpoint are clearly the most significant
chunks of infrastructure in the country -- the security task becomes much

The one exception to this is the city of Baiji, some 200 km north-northwest
of Baghdad. Baiji not only is predominantly Sunni, like the elevated risk
one, but itlies only 50 km from Hussein's hometown, Tikrit. Whereas the
identity of the population in the north (Kurdish) or the south (Shia) keeps
a lid on potential sabotage, Baiji's population is predominantly Sunni, and
its people may be willing to shelter those opposing the U.S.- imposed order.
Although U.S. troops in Baiji have come under very little fire compared to
their counterparts in the elevated risk zone farther south, there have been
at least three infrastructure attacks on the northern export route in the
immediate vicinity of the town. Baiji is also home to Iraq's largest
refinery, making the city a target in its own right for those seeking to
disrupt U.S. plans in general.
Iraqi and OPEC: Muzzled Pooch?

The bottom line is that the obstacles to the return of Iraqi crude to the
market are quite real, but they are also manageable. Pipelines can be
patrolled, pumping stations can be protected, oil refineries can be placed
under surveillance, and there is really only one exposed location. New
shipments of equipment will drastically reduce both the reaction time to
respond to infrastructure attacks and the losses from those attacks, and the
arrival of new foreign forces should help shore up shoddy security.

But dreams of a rapid return of Iraqi crude to global markets are dead. The
Army Corps of Engineers now expects only 1.0 million bpd of total
production, about half earmarked for exports, by the end of the summer -- up
from the 800,000 bpd being pumped currently. That is a realistic, if
conservative, estimate, given the security circumstances. It will take that
long for the first contracts for which the Army Corps of Engineers is
currently seeking tenders to begin having any effect. From that point,
production rates will begin rising more sharply, but not with such speed
that the markets will be unduly disrupted.

Such an incremental return -- as opposed to a tidal wave of new production
-- is the type of homecoming that OPEC can manage. The cartel can easily
match Iraqi production increases with its own barrel-for-barrel reductions,
so long as the monthly Iraqi increase is less than 250,000 bpd, as appears
likely. Problems with OPEC discipline inevitably will lead to price drops,
but the relative sloth with which Iraq is re-entering the equation rules out
price crashes.

This does not mean that OPEC has nothing to fight or fret about.

Political instability will continue to wrack two of its bedrock members,
Nigeria and Venezuela. For Nigeria, this is par for the course, since the
country has an inherent ability to tolerate an impressive level of violence
with only minimal impact on oil production. Stratfor expects sporadic
production reductions in response to occasional flare-ups, but Nigerian
President Olusegun Obasanjo has proven adept at solidifying his political
control in the aftermath of his re-election. That alone should limit any
discussion of serious Nigerian "disruptions" to mere talk. Venezuela's
situation is as quiet as Nigeria's is loud. Since the labor strikes in early
2002 that shut down state-run Petroleos de Venezuela, President Hugo Chavez
has felt it necessary to root out any source of opposition from within the
company. As a result, more than half of the company's staff has been fired.
PDVSA now lacks the ability to develop new fields, complete advanced
maintenance at existing heavy crude production sites, efficiently operate
its refinery network or even file its taxes on time. The result is and will
continue to be a slow, steady decline in total Venezuelan crude exports
until the company can regenerate itself. Even in the best-case scenario --
the immediate ouster of Chavez, the immediate instatement of a skilled,
responsible management and total domestic tranquility in Venezuela -- this
would take years.
Other OPEC states are not particularly worried about Nigerian and Venezuelan
problems, since any troubles they have keep crude off the market --
translating into more market share and profits for the other members. Of
greater concern is the fact that a number of OPEC states are implementing
plans to vastly increase their production capacity. Of these, the plans of
Algeria and Kuwait are the only ones of mid-term interest. Combined, the two
states hope to add just less than 1.0 million bpd of daily production by the
end of 2004, compared to the beginning of 2003. Several other members also
have expansion plans, but these are much longer term. These plans -- all in
sharp contrast to OPEC's avowed goal of market management -- will produce a
great deal of behind-closed-doors shouting within the cartel, but will have
only minimal impact on markets during the next year.

This reasonably balanced state of affairs will last until Iraq reache its
pre-Kuwait invasion production level of 3.0 million barrels per day, which
most likely will happen in mid-2004. At that point, OPEC's production cuts
will cease to be easy, and all of its members will be itching to cheat.
Iraq's itch will be the most notable. No matter who is in charge, Baghdad
has an interest in maximizing its oil revenues. Since it boasts the world's
cheapest lifting and transport costs, this almost by necessity means
maximizing production as well.

But that is for the future. Internal OPEC dynamics, combined with Iraq's
painfully slow return to the markets, should provide for 12 months of
relatively stable, if slowly declining, oil prices as OPEC sans Iraq
steadily reduces output.

Enter the Bear

Beyond Iraq and OPEC, the only player to watch is Russia. Total Russian oil
exports -- including those delivered via pipeline, rail and barge -- as well
as refined products topped 6.0 million bpd on production of more than 8
million bpd in the second quarter, clearly marking Russia as the world's
second-largest exporter and producer. Though Russia's exports normally surge
in the summer months as new export routes open up, this summer's production
increase has been much more than simply a seasonal spike. Low interest rates
in the West, combined with fiscal probity in the Kremlin, have given Russian
companies the ability to tap foreign capital and know-how to expand their
domestic operations. This has led to sharp and sustained production
increases, a steady modernization of the Soviet refining complex and
increased capacity for Russia's pipeline network.

None of these factors will go away within the next year. In fact, most will
intensify while the state expands the export network. By 2005, pipeline firm
Transneft plans to triple the current 240,000-bpd capacity of its Baltic Sea
export point of Primorsk. Meanwhile, Russian crude producers in July gained
access to the primary Kazakh export route -- the Caspian Pipeline Consortium
line -- that terminates on the Black Sea. These two factors alone will add
about 500,000 bpd within the next 12 months.
This is not to say there is no movement in non-OPEC oil beyond Russia --
mild increases by Angola and Oman, for example, roughly cancel out Norway's
decrease -- but it does mean that Russia is the one player with the ability
to move markets in appreciable ways. All told, the country's total
production will brush against 9.5 million bpd by the middle of 2004, with
all but 2.5 million bpd of that amount tagged for export. That will
translate into a net increase of approximately 1.0 million bpd of production
from non-OPEC members. But even with the expected increases, Russia is not
positioned to overturn global market stability yet.

That will happen in 2005, when it surpasses Saudi Arabia as the world's
largest exporter.
The Other Side of the Coin: U.S. Demand

On the demand side, there is really only one show in town: the United
States. Much has been made of low U.S. commercial crude inventories, which
were down 15 percent in first quarter 2003 as compared to the 2001 average.
Largely ignored, however, is the fact that non-U.S. OECD crude inventories
are actually up slightly more than 1 percent for the same period. Stratfor
has no argument with the generally held belief that U.S.crude nventories are
a heavily bullish factor affecting the markets. What has been missed,
however, is that inventories elsewhere -- while perhaps not as robust as
they could be -- are well out of the danger zone.

Similarly, there is a disconnect between the United States and the other
economic powers in both past and future demand growth.

Despite the "recession" that U.S. media have been obsessing about, U.S.
economic growth continues to outpace that of Europe and that is reflected in
the country's energy demand. The International Energy Agency expects global
demand to grow by 2.5 million bpd from the beginning of 2002 to the end of
2004, of which 1.0 million bpd is expected to be in the United States --
versus only 0.4 million bpd from the rest of the developed world combined.
In the cases of Europe and Japan, poor economic growth and the steady switch
to natural gas as a cleaner energy source are to blame. The European
Commission again downgraded EU growth prospects July 7, this time to a mere
0.8 percent for the year -- which would mean a rather sharp acceleration
from current activity. Similarly, the Japanese government expectation for
GDP growth remains less than 1.0 percent. By comparison, U.S. economic
growth for 2003 is now projected to be between 2.5 and 3.0 percent.

In Japan, there is an additional factor in play that indicates weaker oil
demand. Seventeen of Japan's fleet of 51 civilian nuclear power reactors
have been offline for the past three quarters, due to revelations that
officials at Tokyo Electric Power Company (Tepco) had fabricated safety
reports. The capacity reduction has increased Japan's oil intake by some
650,000 bpd as Tepco has been forced to rely on mothballed thermal plants to
meet electricity demand. Now that the necessary inspections are nearly
complete (the first of the reactors are already back online) that surge in
demand is about to evaporate, leading to some slack in Pacific energy
markets that the U.S. West Coast will happily lap up.

The Short Version
When all the numbers are counted, the markets will be left to examine two
basic trends during the next 12 months.

* First, OPEC will do a rather competent job of cutting its production to
make up for Iraq's return. Increases from Algeria and Kuwait will outweigh
Venezuela's protracted decline, leading to a small net production increase
by OPEC.
* Second, global consumption should raise demand about 1 million bpd, mostly
because of an increase in U.S. and developing world demand -- if Stratfor's
sources at the U.S. Energy Information Administration have crunched their
numbers right. This will not unbalance markets, since Russia will increase
its exports by a mathematically convenient 1 million bpd.

The end result is a market roughly in balance for the first time since 1995,
so long as U.S. forces don't invade another major oil-producing country.
Prices are doomed to fall as Iraqi and Russian production strengthens, which
by default will weaken OPEC's market control. But the gradual rate with
which those increases are happening, combined with the black-hole nature of
U.S. commercial reserves, will keep the price declines gradual.

(c) 2003 Strategic Forecasting, Inc. All rights reserved.

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