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Simon Watkins

Simon Watkins

Simon Watkins is a former senior FX trader and salesman, financial journalist, and best-selling author. He was Head of Forex Institutional Sales and Trading for…

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The Real Reason Why Iraq Paused Its Major Oil Deal With China

With a new man in the White House, Iraq’s Prime Minister, Mustafa al-Kadhimi, appears to believe that Iraq can begin a completely new cycle of playing off the U.S. against China and Russia, as it has been doing since the first U.S. invasion of Iraq in 2003. The game is very simple but nonetheless very effective: Baghdad sends a signal that it may move even closer to Iran or to Russia and China through various oil field awards or other contracts and the U.S. feels compelled to counter with the offer of more funding directly or indirectly through massive deals between U.S. firms and Iraqi ones. Iraq then takes the money and the contracts and continues to do what it was going to do anyway, which is to remain firmly on the side of neighbour Iran whose grip over the country is interwoven into its very fabric through political, economic, and military elements. In any event, Iraq’s announcement last week that it has put on hold its controversial and massive oil prepayment deal with China’s state-owned Zhenhua Oil Co. falls precisely into this long-established game with the U.S.

The US$2 billion five–year prepayment oil supply deal between the Federal Government of Iraq (FGI) in Baghdad and China’s Zhenhua Oil deal was announced with great care and attention to timing just after former President Donald Trump had lost the 2020 Presidential Election. Trump and his team had started his tenure out playing the usual game with Iraq, granting the country waivers to continue to import electricity and gas for power generation from Iran – despite U.S. sanctions on the Islamic Republic – for periods of two, three or even four months each time. These lengthy waivers were granted in the hope of bringing Baghdad back towards the U.S.’s side in the geopolitical power play with China and Russia going on across the Middle East, an opportunity Washington looked to leverage when al-Kadhimi visited Washington last August.

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At that time, al-Kadhimi was desperate for money. The Saudi-instigated oil price in the second quarter of 2020 had pushed Baghdad’s already perilous state finances more firmly into the red, with its oil-related revenues having fallen by nearly 50 per cent at that point. This was in line with the collapse in oil prices and the fact that about 90 per cent of Iraq’s government revenues still come from oil exports. Its finances were further negatively affected by the enduring effects of the COVID-19 pandemic and by ongoing arguments with the government of the Iraq Kurdistan region over oil-for-budget disbursements. These factors forced Baghdad into proposing delaying foreign debt payments, introducing salary cuts of 60 per cent for various state sector employees, and reducing all non-essential spending.

This cash crunch in the first half of 2020 could not have come at a worse time for al-Kadhimi as, in the following weeks, he would need to come up with at least IQD12 trillion (US$10 billion) just to pay the next two months salaries of more than four million employees, retirees, state beneficiaries, and the food relief for low-income families. These groups together constitute the majority of households in Iraq and it was rightly believed in senior Iraq government circles that any failure to pay any of these obligations could result in the sort of widespread protests, violence, and death that occurred at the end of 2019. Consequently, al-Kadhimi arrived in Washington and told the politicians, including Trump’s team, exactly what they wanted to hear in terms of Iraq’s intention to reduce its dependence on Iran for the crucial electricity and gas imports. The U.S. immediately rewarded this promise with the firming up of in-principle agreements made with five U.S. companies – Chevron, General Electric (GE), Honeywell International, Baker Hughes, and Stellar Energy - just before al-Kadhimi’s arrival in Washington, worth at least US$8 billion.

Predictably enough, and presumably as soon as the initial funds involved in the pre-financing of these deals had hit the Iraq government’s accounts in the Central Bank of Iraq, Baghdad turned around and announced that it had just signed the longest ever deal with Iran to continue to import electricity and gas from it for at least the next two years, although this could be extended with ease. At the same time, the periodic attacks on U.S. military targets in Iraq continued to go effectively unanswered by Baghdad, which had begin 2020 with Iranian surface-to-surface missiles hitting two Iraqi military bases housing U.S. troops. This was followed most notably by 30 107-mm Russian-made Katyusha rockets being fired at the U.S. allied Camp Taji military base north of Baghdad, killing three service members, and at least 15 further attacks on U.S. military and neo-military personnel (and those of its allies) in Iraq by Iran proxies over the following few months, according to U.S. military sources. Related: OPEC+ Decision To Raise Output Could Keep U.S. Gasoline Under $3

Within just a month of the al-Kadhimi visit to Washington, the Trump Administration had lost all patience with Baghdad, with one senior White House source having told OilPrice.com: “We’ve been down this road before with Pakistan – [with] the government pretending to help in the fight against AQ [Al-Qaeda] but at the same time the ISI [Inter-Services Intelligence] offering all the help it could to [Osama] bin Laden and we’re not playing that game again.” Subsequently, instead of the rolling 90- or 120- day waivers granted by Washington for Iraq to continue to import Iranian electricity and natural gas in the past, Washington granted a waiver of just 30 days and, at the same time, announced new sanctions against 20 Iran- and Iraq-based entities that were cited as funnelling money to Iran’s Islamic Revolutionary Guards Corps’ (IRGC) elite Quds Force. According to the U.S., these 20 entities were exploiting Iraq’s dependence on Iran as an electricity and gas source by smuggling Iranian petroleum through the Iraqi port of Umm Qasr and money laundering through Iraqi front companies, among other sanctions-busting activities.

With Trump’s departure from office, Baghdad moved ahead with the even more inflammatory deal with China’s Zhenhua Oil. This deal was always going to be a test for new President Biden for three key reasons. First, the deal is straight out of the playbook that Russia used in 2017 to gain control over Kurdistan, Iraq’s semi-autonomous northern region. Second, the deal between Russia’s Rosneft and the government of Kurdistan meant that Moscow was able to cause such disruption in the budget payments-for-oil deal between Kurdistan and Baghdad that the resulting financial crunch for the FGI pre-disposed Baghdad to look beneficially at the China proposal in the first place. And third, it meant that China was directly testing Biden’s ability to separate trade considerations from security considerations – as Trump frequently traded the latter off for the former – to see what the new U.S. President’s reaction will be, particularly given that Zhenhua Oil is an ‘in your face’ arm of China’s defence contractor Norinco.

The official explanation as to why this US$2billion+ prepayment deal with China has been paused was ludicrous, even by Iraq’s standards – basically, that the deal was predicated on oil prices remaining at the low end but with oil prices more stable and perhaps rising that the deal could not go ahead. “Even in Iraq, long-running oil contracts – including prepayment ones – do not consist of a single rigid figure but rather the reference price for the oil sold is based on a rolling mean average, perhaps over the previous three months, or six months, or maybe even a bit longer, which would automatically factor in a rising price trend or a falling price trend as the base price point, so this explanation makes no sense,” a senior oil and gas figure with close connections to Iraq’s Oil Ministry told OilPrice.com last week. “Instead, it looks like Baghdad is just trying to see if it can start playing its usual game with the new U.S. government from the beginning all over again by sending this signal that it is open to offers from Washington during this suspended relationship period with Beijing, ” he concluded.

By Simon Watkins for Oilprice.com

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  • Mamdouh Salameh on March 02 2021 said:
    The real reason is rising oil prices. When Iraq announced in December the $2 bn five-year prepayment oil supply deal with China’s Zhenhua Oil Co, it was very desperate for money to pay State sector employees’ salaries. However, at the time Brent crude price was $40 a barrel.

    Then oil prices started to surge with the prospect of a return of the global economy to normal business activities as a result of the global rollout of vaccines and also strengthening fundamentals in the market. Oil prices staged a very impressive performance rising from $40 to $67 on the 25 February 2021 or 68%.

    So Iraq may have decided to delay the implementation of the deal if not shelving it altogether to benefit from rising oil prices.

    Dr Mamdouh G Salameh
    International Oil Economist
    Visiting Professor of Energy Economics at ESCP Europe Business School, London

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