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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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Iraq Uses Controversial Oil Deal To ‘Secure Funding’ From Washington


At June’s G7 meeting, U.S. President, Joe Biden, received the backing of the world’s seven largest advanced economies (comprised of the U.S., the U.K., Germany, France, Italy, Canada, and Japan) to set up an alternative to China’s ‘One Belt, One Road’ (OBOR) initiative as part of a broad push back against Beijing’s increasing influence around the globe. Although much of the official comments surrounding the announcement consisted of vague and fluffy statements about human rights, Joe Biden’s previous comments about China are much more informative as to what the real thrust of this U.S.-led alternative to the OBOR is.

Most appositely, in correctly grouping China together with Russia in the context of both the Middle East and Asia, Biden stated during the presidential election campaign that he regarded China as a “serious competitor” to the U.S. and Russia as an “opponent”. What this means for those countries in the Middle East who side with Washington in the ongoing power struggle with China for dominance across the region, is that even more money is on the table from both Washington and Beijing and there is no country better at playing the two sides off against one another than Iraq. This is the reason why within a very short space of time Baghdad announced that it was allowing huge infrastructure investment from China into Iraq but also cancelling the enormously controversial multi-billion oil deal that it struck with China’s Zhenhua Oil on 2 January this year.  The original Zhenhua Oil deal was for the sale of four million barrels every month for five years by Iraq’s State Organization for Marketing of Oil (SOMO) to the Chinese state corporate proxy for which SOMO would receive an initial upfront pre-payment of US$2 billion. The oil was to have been delivered on a destination-free basis, thus allowing Zhenhua Oil to re-sell the cargoes anywhere in the world to anyone it wished. At the time that the deal was announced, it was evident to anyone with knowledge of the Middle East’s oil dealings over the years – including to senior figures in the U.S. State Department - that it was straight out of the Russian power playbook that had seen state oil proxy Rosneft take control of the oil and gas resources of the northern Iraq semi-autonomous state of Kurdistan in 2017.

First, Rosneft offered the Kurdistan government (the KRG) US$1.5 billion in financing through a three to five year prepayment oil supply deal, exactly the same manoeuvre as the Zhenhua Oil deal agreed between Baghdad and China. Second, it took an 80 percent working interest in five potentially major oil blocks in the Kurdistan region together with corollary investment and technical, technology, and equipment assistance. And third, it established 60 percent ownership of the vital KRG oil pipeline into southern Europe’s port of Ceyhan in Turkey by dint of a commitment to invest US$1.8 billion to increase its capacity to one million barrels per day. From that point, Russia also began to use this leverage to expand its own interests – and those of its chief geopolitical power play partner, China – further into southern Iraq as well.

Related: UK Government Must Keep Investing In Nuclear Power Capacity The real reason for the Zhenhua Oil deal was that Iraq was in desperate needs of funds due almost entirely to the massive endemic corruption in the country that swallows up most of the money flows that should go into the government’s budgetary coffers. Iraq had long managed to stay just about afloat financially due mainly to hundreds of billions of dollars coming from the U.S. since the invasion of 2003. However, Baghdad’s failure to put into place effective measures to even begin to reduce its dependence on neighbouring Iran for ongoing gas and electricity supplies had further strained its already tense relations with Washington by the second half of last year.

These relations took an even greater turn for the worse shortly after Iraq Prime Minister, Mustafa al-Kadhimi returned from a visit to Washington in which he promised to reduce these ties to Iran in exchange for further funding that was required to avert disaster at home. Having banked the emergency funding from Washington that had been secured on the basis that Baghdad would decrease its dependence for gas and electricity imports from Iran, Iraq then signed the longest-ever deal with Iran to continue its imports of gas and electricity. This was met with sharp shrift by Washington, which duly extended its shortest-ever waiver for Iraq to continue with these imports from Iran, and U.S. State Department spokeswoman, Morgan Ortagus, also pointedly announced that new sanctions would be imposed against 20 Iran- and Iraq-based entities that were cited as funneling money to Iran’s Islamic Revolutionary Guards Corps’ (IRGC) elite Quds Force. 

Given the furious response from the U.S., Iraq began to roll-back on the Zhenhua Oil deal, announcing a pausing of it earlier this year, with the official explanation as to why the deal had been paused being ludicrous, even by Iraq’s standards, and this is the very same reason that was cited for the cancellation of the deal last week. Basically, the Iraqis have said, the deal was predicated on oil prices remaining at the low end but with oil prices more stable and perhaps rising 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. “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.

Related: Oil Markets To See Deficit Of 5 Million Bpd By End 2021

This view appears to be well-founded as there is no basis to believe that the deal with Zhenhua Oil has been cancelled forever (it can be resuscitated at any time, in fact) and Baghdad announced almost at the very same time that it had approved three huge new infrastructure initiatives heavily involving China direct into the heartland of Iraq. Last week it was announced that Baghdad just approved nearly IQD1 trillion (US$700 million) for infrastructure projects in the city of Al-Zubair in the southern Iraq oil hub of Basra. According to the city’s Governor, Abbas Al-Saadi, Phase 2 of the projects would be awarded to a Chinese company, and the Iraqi source to whom OilPrice.com spoke last week stated that this participation by China was part of the broad-based ‘oil-for-reconstruction and investment’ agreement signed by Baghdad and Beijing in September 2019 (which allows Chinese firms to invest in infrastructure projects in Iraq in exchange for oil). 

This announcement followed the awarding in the previous week of another major contract to another Chinese company, this time to build a civilian airport to replace the military base in the capital of the southern oil-rich Dhi Qar governorate. The Dhi Qar region includes two of Iraq’s potentially biggest oil fields – Gharraf and Nassiriya – and China is due to complete the airport by 2024. This project will include the construction of multiple cargo buildings and roads linking the airport to the city’s town centre and separately to other key oil areas in southern Iraq. This, in turn, followed yet another deal announced the week before in which Iraq officials stated that Chinese companies were being approached to build out Al-Sadr City, located near Baghdad, at a cost of between US$7-8 billion, also within the framework of the 2019 ‘oil-for-reconstruction and investment’ agreement. 

By Simon Watkins for Oilprice.com


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