Political risk alive and well in the global oil industry

Political risk alive and well in the global oil industry

Despite innovation in the US oil patch, the big stories in oil still lie outside the US—where hydraulic fracturing and innovation in drilling technology are unlikely to play a major role in its extraction. The oil business is likely to remain messy for the foreseeable future.

For better or worse, oil will remain central to the world’s energy mix for the foreseeable future. It is a far more efficient store of energy than any technologies, currently in existence, that could feasibly replace it. Cutting it out of the energy mix would be very painful for much of the world’s population, rich and poor.

Additionally, investment in alternative energies is dwarfed by spending on new drilling. As oil prices remain relatively high, incentives for the sector to keep exploring, innovating, and producing are unlikely to vanish anytime soon.

U.S Shale not the main story in global oil

So, where will tomorrow’s oil come from? Innovations in hydraulic fracturing (fracking) in the US have made shale oil and tight oil commercially viable to extract, and many observers have been quick to claim that it will lead, almost inevitably, to independence from politically messy Middle Eastern and African oil.

At the same time, others point to innovations in drill rig design, which have made drilling faster, safer, and cheaper, as another step toward abundant, domestic US oil supplies. Oil production in the US has, indeed, jumped in recent years. However, it seems that some have gotten a bit carried away with the shale boom’s implications.

Despite the uptick in US production, growth in domestic oil production is unlikely to make the US energy independent in any meaningful way. Even if domestic oil production eclipses domestic demand, global oil prices and supply will continue to greatly influence domestic prices and supply.

Moreover, the biggest breakthrough in oil supply in coming years will almost certainly be the resurgence of Iraq’s oil sector, where according to the IEA, “almost every second barrel of world oil production growth in the next two decades” will come from. Of course, with production growth in Iraq and elsewhere comes political risk and bureaucratic headache.

Oil may indeed have a ‘bright future,’ but technical innovation and the shale boom have done relatively little to eliminate the messier elements from the vast majority of its production.

Between 2008, near the beginning of the US shale boom, and 2013, US production of crude oil jumped 2.4 million barrels per day (bpd), from 5 million to 7.4 million bpd—extremely impressive growth. But extracting shale oil has its limits, and there is ample reason for skepticism that the surging production growth can or will keep pace with recent years.

Chiefly, shale oil fields have much higher depletion rates than conventional oil reservoirs, meaning that production at the US’s biggest shale fields is requiring more and more drilling at higher and higher cost to oil companies. In North Dakota’s Bakken shale, it is estimated that 2,500 new wells must be drilled in 2014 just to maintain its current levels of production.

Iraq the place to watch

Iraq, however, would only require 60 new wells to achieve similar numbers. The country produced around 2 million bpd through the mid-2000s, but the trend is moving steeply upward. February 2014 recorded production of 3.6 million bpd—the most the country has ever produced—and production will not likely level off any time soon. Officials and analysts suggest that oil production could rise to over 10 million bpd by the end of the decade, as fields in the south are better developed and exploration and production becomes further established in the Kurdish north.

The potential is clear: production growth in Iraq has the potential to stand several multiples above the rates witnessed by the shale revolution in North America. If America’s 2.4 million bpd production growth in recent years has been a game changer, Iraq’s potential 8 million bpd growth would be a revolution.

However, the challenges and opportunities of producing Iraqi oil are above the ground. They are political and bureaucratic. Efficiency of institutions, more than that of drilling technologies, is what will make or break this opportunity. The current list of challenges includes:

  • Baghdad’s Technical Service Contracts (TSCs) with international oil companies (IOCs) offer little upside to IOC investment in the sector. This has led to poor showings at oil field auctions.
  • Tension between Baghdad and Erbil, the capital of the Kurdistan Regional Government (KRG) in Iraq’s north, over the KRG’s right to independent exports, makes exports increasingly difficult, creates (limited) political risk for IOCs that have signed with the KRG, and puts pressure on the few IOCs that are operating in both the north and south of the country.
  • Poor export infrastructure, particularly in Basra, make getting oil to international markets challenging and slow.
  • Delays in auctioning oilfields to IOCs have slowed the process of getting the sector operating at capacity.

While Iraq is unique in the magnitude of its potential production growth, the political and bureaucratic challenges to production present in the country are common. Venezuela, which sits atop the world’s largest proven oil reserves, is a basket case. Kazakhstan has lots of oil, but also has governance that repels IOCs. Mexico is having trouble liberalizing its oil industry, and Brazil’s government is increasingly interfering in its own. Nigeria is home to a separatist movement in its oil-rich Niger Delta region. Libya is a mess. Russia is invading its neighbors. Saudi Arabia, renowned for the efficiency of its oil sector, even has its bearish analysts. The list goes on.

Shale oil and efficient new drilling techniques have certainly increased oil supply in very consequential ways, and might even nudge the oil industry’s influence westward. But let’s not get ahead of ourselves. Oil is still a messy business, and will be for a while.

About Author

Brady Jewett

Brady has spent the past two years in the Kurdistan Region of Iraq, analyzing investment and business in the region, and is currently based in Washington, DC. Brady holds a BA from UC Santa Barbara and an MSc from the London School of Economics.