Iraq’s National Energy Strategy: Oil & Gas Production, Diversification, and Employment * , By Dr. Ali Merza

Download

Introduction

An executive summary, henceforth ES, of Iraq’s Integrated National Energy Strategy, INES, was released recently (22 pages); summarising a set of, reportedly, seven volumes. Obviously, such a brief document cannot fully describe seven volumes and as a result, commenting on it is bound to be provisional and incomplete.

Topics covered in ES have many aspects in common with a report on Iraq prepared by the International Energy Agency, IEA-Iraq (IEA, 2012). Furthermore, Iraq’s National Development Plan 2013-2017, NDP13-17, was also released recently (MOP, 2013). This article, therefore, refers to these documents (‘the three documents’) in the narrative concerning INES.

In addition to commenting on oil and gas, a main thrust of this article pertains to the interrelated major objectives of economic diversification and employment. Huge increases in oil revenues consequent on the forthcoming expansion of oil/gas production will have far-reaching economic consequences. They range from short/medium-term shortages consequent on the anticipated construction boom to long-term outcomes of development strategy: e.g. perpetuation of rentierism/one-sidedness of the economy or making tangible efforts to diversify it.

Oil production

INES suggests three different alternatives/scenarios for oil (and associated gas) production for 2013-2030; low, medium, and high, table (1). In general, production levels are usually limited by production-capacity, otherwise they violate long-term sustainability. In all newly offered technical service deals, contracted/modified plateaus determine production-capacities (after 2017) in Iraq.

Table (1) Oil Production Scenarios, mbd

Note: figure for 2012 from Ministry of Oil’s Website.

INES indicates that a production path lying between the medium and high scenarios is desirable, ES, P. 6. However, due to debilitated infrastructure, on the one hand, and desired yet uncertain developments in the short-term, on the other, it opts provisionally for the medium scenario. When desired infrastructure rehabilitation, new investments, institutional reforms, and other developments were implemented by 2015/2016, then the prospect for which scenario to adopt becomes clearer. Compared to the other documents, INES’s medium scenario corresponds to IEA-Iraq’s high scenario but falls short of NDP13-7’s figure for 2017. IEA-Iraq, however, has raised doubts about the viability of its high scenario. Furthermore, I have shown, in Merza (2011), that a production profile even slightly below INES’s medium scenario is adequate for future economic requirements of the country. INES’s high scenario, cannot, therefore, be justified economically.

From another angle, although future course of production could deviate from the medium scenario after 2015/2016, required investment in the energy sector (for 2013-2030), according to INES, amounts to $530 billion (in 2011 Dollar). This is not tied to specific scenario. IEA-Iraq sites exactly the same amount for 2013-2035 (in 2011 Dollar), but ties it to its central scenario.

World oil prices

Both INES and IEA-Iraq do not analyse or forecast the influence of future increases in Iraq’s oil production on world oil prices. They assume price levels that do not change with production scenarios; $110 and $120-125/barrel (in 2011 dollar), respectively, for 2013-2030. Alternatively, available worldwide oil forecasts, such as the base–cases in OPEC’s World Oil Outlook 2012 and EIA’s Annual Energy Outlook 2013, include ‘equilibrium’ prices, which insure balance of world supply and demand for 2013 to 2030+. Neither forecast shows Iraq’s future output or exports, and most likely, they do not anticipate the size of output/export envisaged in INES’s medium or high scenarios. It is, therefore, possible that these scenarios will have dampening effect on world oil prices.

Gas production

According to INES, gas processing and transportation infrastructure would be reasonably rehabilitated and expanded by 2015/2016. Consequently, after taking into consideration domestic requirements of dry gas and LPG, there will be a period of surplus in gas, between 2015 and 2030, which need to be exported, (ES, P. 13).

Two points are in order. First, the gas deal of southern Iraq with Shell/Mitsubishi is not mentioned in ES. That deal envisages meeting domestic requirements of dry gas/LPG and exporting LNG, LPG, and condensates, Merza (2012). Figures derived from INES’s Exhibit ES – 7, (ES, P. 13), indicate that between 2015 and 2030 average daily domestic requirements of LPG and dry gas amount to 4.4 billion cubic feet/daily (BCF/D) and production to 6.4 BCF/D, leaving average surplus of 2.0 BCF/D. This can easily accommodate the throughput of southern gas deal (2.0 BCF/D) even after 2030; especially so while noting that about 62-66% of that deal’s output can be included in domestic requirements rather than deducted from the surplus. The second point pertains to the definition of domestic requirements. They divide into three categories; first, LPG for final consumers and dry gas for electricity. The second relates to industries that use gas and derivatives as feedstock and fuel, like petrochemicals, fertilizers, and sponge iron. The third represents those using gas primarily as fuel, like steel, aluminum, etc. Apart from sponge iron, the first two types justify prioritizing domestic requirements over exports, given that efficient use is insured. Those in category three, however, need to justify priority over exports by meeting at least one of two conditions; first, economic efficiency and second, substantial forward/backward linkages beneficial to efficient sectoral/industrial growth.

Economic diversification

Like NDP13-17 and IEA-Iraq, INES considers economic diversification a primary objective: ‘develop Industries and services to diversify the economy and increase share of non-oil GDP which includes non-oil energy, government, and other sectors,’ (ES, P. 4).

In this article diversification is taken to include efforts to reduce dependence on oil, through promotion of non-oil activities that, in their totality, generate, directly and indirectly, tangible and efficient sources of foreign exchange and employment away from government services. In light of this, INES seems to adopt two somewhat disparate criteria for diversification. First, together with IEA-Iraq, it seems to consider development of oil-related and heavy energy consuming industries a fundamental part of diversification. Petrochemicals, fertilizers, steel, aluminum, cement, and bricks are the corner-stones of INES’s diversification. IEA-Iraq singles out petrochemicals, fertilizers, and cement. In both documents and also in NDP13-17, however, no attempts seem to have been made to survey, comprehensively, existing industrial structure and establishments in order to figure out what can be rehabilitated and made part of a drive towards industrialization. Furthermore, and notwithstanding INES’s recommendations to set up Strategic Industries Company and Industrial Park Authority, no serious attempts are made in the three documents to elaborate the sound industrial policy necessary to conceive, plan, and manage the process of diversification. INES’s second criterion for diversification, and this is key, implicitly includes the expansion of government services/value-added, and hence government employment, which, as we show below, contradicts diversification.

Since INES is a sectoral rather than economy-wide strategy (and it is also not a plan, as referred to in ES, P. 2), the national development plan of the country, NDP13-17, was expected to detail the energy strategies, policies, sectors, industries, investments, etc, within its economy-wide plan. In conjunction with INES it should have included a credible path of economic diversification, given that it was prepared at the same time. Instead, the very general sectoral value-added path included in NDP13-17 together with absence of detailed investment projects, action plans, benchmarks, etc, for 2013-2017, would reinforce the lopsided and rentier nature of the economy, see below.

To sum up, all three documents proclaim intentions of economic diversification without concrete visions or plans of action to achieve this goal.

Perpetuating pattern of employment: 2012-2017

Since the 1970s, and recently after 2003, expansion of government employment and public-spending-related activities were the main sources of job creation in Iraq. For instance, during 2007-2012, 59% of additional employment originated in government services, 3% only from both agriculture & manufacturing, and 38% from other sectors, table (2).

Contrary to the stated intentions for economic diversification, employment expansion pattern over the next 5 years, which can be derived from NDP13-17, in table (2) below, does not deviate from this pattern. Between 2012 and 2017, 57% of additional employment will come from government services, 7% only from both agriculture & manufacturing, and 36% from the rest.[1] This is not consistent with economic diversification.

Table (2) Employment and Labour Force 2012-2017

Sources:

(1) Employment: (i) 2007-2012: 2007: Central Statistical Organization (CSO; formerly COSIT)’s Iraq Household Socio-Economic Survey 2007. 2012:  projection to 2012 from 2011’s employment in CSO’s Iraq Knowledge Network Survey 2011 and CSO’s population figure for 2012 in 2010/2011 Abstract of Statistic (ii) 2017: sectoral employment growth rates are based on sectoral value-added growth rates in NDP13-17, as follows: government, value-added growth rate (due to UN SNA68 method of estimation)); other non-oil sectors, 40% of value-added growth rates. For crude oil within ‘other sectors’:  oil production growth rate, in INES’s medium scenario, is applied.

(2) Labour force: CSO-Based comprises population censuses’ figures and interpolations between them, including the total headcount of 2009, HCPGC (2011). UNDESA-Based refers to figures on Iraq published by Population Division in the UN Department of Economic and Social Affairs, UNDESA, for 1950-2100, UN (2011). For the projection period, CSO-Based uses the same trends of 2011-2030’s UNDESA-Based figures.

Note: government services include public administration, armed forces, health, education, and social insurance.

Labour shortages in the long-run

According to NDP13-17-based calculations, employment will increase by two millions, at the time when labour force increases by 1.75 million, between 2012 and 2017, bringing the economy close to full employment (unemployment rate of 2.8% only in 2017), table (2). With continuation and expansion of  public and private spending, commensurate with rising oil revenues, after 2017, INES states that “[total] employment, …, is expected to rise by 10 million jobs by 2030,…, bringing Iraq to a condition of full employment…,” (ES, P. 18). Barring unrealistic assumptions of sharp rise in participation rate (primarily by females), addition of 10 million jobs, will not only insure full employment but also lead to acute shortage of labour, after 2017, reminiscent of that in 1975-1982.

Between 2017 and 2030, labour force will increase by 6.4 million. Given a full-employment economy by 2017, additional jobs between 2017 and 2030 will amount to more than 8 million (10 million minus the increase in employment between 2012 and 2017). Compare this to a rise in labour force of 6.4 million and we will have a labour shortage that increases, steadily, from near-zero in 2017 to 1.6 million by 2030, table (3).

Table (3): Population and Labour Force 2011-2030

Sources: see table (2) notes for full details.

Labour shortages and higher investment demand will push average wage rates up in non-tradable sectors, and spill over to the tradables. Rising demand and higher wages lead to higher prices for non-tradables. Higher prices, however, cannot be emulated for the tradables, because of the constraint of international prices. This asymmetric situation will cause resources (labour and capital) to shift from tradables to non-tradables. On the other hand, higher oil revenues might motivate calls to revalue the Dinar. Therefore, falling profitability for tradables together with possible appreciation of real exchange rate will obstruct efforts to diversify the economy.

Absorptive capacity

Anticipated construction boom could last well into the next two decades. General economic activity and related demand and imports of consumer and capital goods will rise sharply, almost certainly faster than capacities for producing construction materials and services; including roads, ports, trade facilities, financial institutions, government bureaucracy, etc. These capacities/constraints can only support certain levels of spending, above which inflationary pressure start to climb. Given Iraq’s near-landlocked geography, the construction boom and its consequences will show most in Iraq’s only sea outlet on the Arabian Gulf. Together with these constrains, investment execution delays and labour shortages will drive production/investment costs higher. In this environment, constraints enforce each other in creating a shortage-economy with mounting inflation.

It is worth noting that NDP13-17 has neither envisaged such possible outcomes nor devised strategies, policies, and measures to counter their consequences. Therefore, possible constraints/shortages need to be identified and solutions planned for in advance. Relevant institutional set-ups are also required. In this regard, some of the institutional recommendations in INES for the ministries of oil, electricity, and industry (e.g., task forces, institutional reform committees, etc) need to be extended to the Ministry of Transportation. Alternatively, a body or high powered committee(s) could be set up to continuously monitor the infrastructure and labour situation and anticipate in advance possible shortages and suggest ways and means to relive them. Otherwise, the claim, that “in this sense, INES is a low-risk strategy”, (ES, P.19), is inaccurate.

Sustainability of investment levels

Given the constraints of absorptive capacity, and notwithstanding the scale of future spending, budgetary surpluses are expected to increase tangibly. So far, despite mounting surplus during the last three years no successful attempt has been initiated to set up stabilization/saving fund. Future surplus should be handled differently. A stabilization/saving fund needs to be set up, to deposit accumulated and future budgetary surpluses, in order to achieve three objectives; first, to avoid pro-cyclical public investment, secondly, to transparently manage accumulated surpluses in the most efficient way (highest possible low-risk return), and thirdly, to minimize the impact of high inflow of foreign exchange on exchange rate.

Domestic prices and subsidies

According to INES, oil products, electricity, and possibly other energy, prices will be liberalized in the short/medium-term. Indeed, in many cases, low energy prices lead to economic inefficiency, waste, corruption, and shortages. Some considerations, however, need to be taken care of. Subsidised gas and other energy products for industries/activities are considered important protection tools to promote industrialization and hence diversification. Likewise, cheaper electricity to industries/activities entails subsidized gas to power generation. Therefore, whom to subsidize and whom not to subsidize is a less than straightforward matter. This could entail different prices to different consumers. Multiple tariffs, however, usually lead to rent-seeking behaviour, which impairs economic efficiency. A clearer more detailed and comprehensive pricing scheme is, therefore, highly desirable.

Conclusions

(1)  Together with NDP13-17 and IEA-Iraq, the Integrated National Energy Strategy, INES, has a common objective of organizing the development of the energy sector within the wider economy in order to maximize revenues and at the same time reduce the lopsided/rentier nature of the economy; i.e. realize economic diversification. All of these documents, however, lack plausible detailed roadmap to realise the latter objective. This is more so felt in NDP13-17 which, in addition to its unsatisfactory treatment of the oil sector, does not include convincing strategy for diversification.

(2)  Although prepared almost concurrently, there is no cross references between these three documents, which could indicate the state of poor coordination between the departments of public administration in Iraq.

(3)  If economic management is not well-prepared to relieve shortages, the anticipated construction boom will result in mounting inflationary pressures, which renders tradables (the corner-stone of diversification) less competitive and affect negatively standards of living.

(4)  Labour shortages could worsen steadily during the period 2017-2030.

(5)  All three documents have not touched on how to handle future growing budgetary surpluses.

(6)  According to INES, most energy prices would be liberalized in the short/medium-term. Indeed, subsidized energy prices might lead to economic inefficiency, waste, corruption, and shortages. However, subsidised gas and other energy products for industries/activities, including power generation, could be necessary to promote industrialization and hence diversification. Therefore, whom to subsidize and whom not to subsidize require more detailed and comprehensive pricing scheme.

(7)  Apart from IEA-Iraq, disputes between the central government and the Kurdish authority, concerning future developments in the energy sector, are hardly dwelt upon in the other two documents.

References

Central Statistical Organization and Information Technology, COSIT, Kurdistan Region Statistics Organization, KRSO, World Bank (2009), Iraq Household Socio-Economic Survey, IHSES 2007, Volume II, Data tables.

Central Statistical Organization, CSO, formerly COSIT, (2011) Iraq Knowledge Network 2011, Iraqi Labour Market Conditions in Iraq, December, http://cosit.gov.iq/pdf/2011/LBfactsheet.pdf , (in Arabic).

______ (2012) Detailed Tables for the Results of Iraq Knowledge Network 2011 Survey,  http://cosit.gov.iq/pdf/2011/tab.pdf, (in Arabic).

Energy Information Administration, EIA (2013) Annual Energy Outlook 2013 with Projections to 2040, April 2013.

High Commission for Population General Census, HCPGC (2011) General Census of Buildings, Establishments, and Households, Reports Series on Numbering  [for 2009 Census], Report No. (1), http://cosit.gov.iq/pdf/2011/report_census_1.pdf, (in Arabic).

International Energy Agency, IEA (2012) Iraq Energy Outlook, World Energy Outlook Special Report, 9 October.

Merza, A. (2011), ‘Oil revenues, public expenditures and saving/stabilization fund in Iraq’, International Journal of Contemporary Iraqi Studies 5: 1, pp. 47–80, doi: 10.1386/ijcis.5.1.47_1.

______(2012) ‘Pricing and Profitability in the Gas Deal of Southern Iraq: Preliminary Evaluation’, Energy & Geopolitical Risk, Volume 3, No. 9, October.

Middle East Economic Survey, MEES (2013), ‘Document – Iraq’s Integrated National Energy Strategy’, 17 June.

Ministry of Planning, MOP (2013) National Development Plan 2013-2017, Baghdad, January (in Arabic).

OPEC (2012) World Oil Outlook 2012.

United Nations, UN (2011) ‘World Population Prospects: the 2010 Revision’, Population Division, Department of Economic and Social Affairs, DESA,

http://esa.un.org/wpp/Excel-Data/population.htm.

 *) The article appeared in Middle East Economic Survey, MEES, 12 August 2013. This version also includes some elaborations, summary conclusions, and a list of references.