Oil’s Fragile Peace Is Threatened by Iraq’s Desperate Reality

(Bloomberg) -- In his 20 years as a high-school English teacher in Baghdad, Abu Majeed has seen his fair share of conflict and upheaval. Yet, he’s rarely felt so desperate as one of the world’s largest oil producers lurches into another crisis.

The government was late paying his salary of $900 in May, and this month he thinks officials will go a step further and cut it. That would force the 47-year-old father of four to scrimp on food—let alone other things—and find a second source of income, probably as a taxi driver.

“I have no idea how much I’ll get paid this month,” Majeed said by telephone from his home in the south of the Iraqi capital, where he’s holed up during the coronavirus pandemic. “This country is bankrupt. I wonder where its fortunes went. Why didn’t they save for such days?”

As Covid-19 ravages economies across the globe, Iraqis are feeling a sense of dread again. Their country has been at the crossroads of Middle East tension, a hotbed of sectarian conflict and the proxy war between Iran and the U.S. Now it’s a question of financial survival, and a fight with rival oil exporters is threatening to undermine the fragile peace within the OPEC+ group.

Saudi Arabia and Russia have run out of patience with Iraq for failing to reduce production as much as agreed. While a breakthrough in negotiations meant an agreement is set to be signed off at a meeting this weekend, the battle over compliance is unlikely to be over.

Read More: Oil Unity Shaken as Iraq Pushed to Atone for Cheating

In truth, this was always going to be a tough year for Iraq, and reneging on commitments to sell fewer barrels of crude reflect a country on the brink.

At the start of 2020, it was still reeling from nationwide protests—triggered by rampant corruption and failing services—that led to the collapse of the government in November. Security forces had killed hundreds of demonstrators.

The situation worsened in January when U.S. President Donald Trump ordered a drone strike on one of Iran’s most senior generals in Baghdad, an assassination that threatened to turn Iraq into a battleground between the two rivals. Then came the hammer blows of the coronavirus and crash in the price of oil. The pandemic has shuttered businesses and the country reimposed curfews in early June as infection rates climbed.

The private sector is “paralyzed,” said Mudher Saleh, an economic adviser to Prime Minister Mustafa Al-Kadhimi, a former intelligence chief and journalist who was sworn in last month. The government had to borrow 3 trillion dinars ($2.5 billion) from local banks in May to cover salaries, and will probably do the same this month, he said.

“The real economy is so sick that people need government support,” said Marcus Chenevix, a Middle East analyst at TS Lombard, a London-based research firm. “Without it, we’d see a reverse in livelihoods back to the 1960s. It would be devastating. You could see bread riots.”

No major producer has avoided deep pain from crude’s near 40% drop since December. Prices are now back around $40 a barrel, though the damage was done. Saudi Arabia has tripled value-added tax, Russia and Mexico’s currencies have slumped, and more than 2 million Texans have lost their jobs since March.

Yet even among them, Iraq stands out. Crude accounts for more than 90% of government revenue. The economy will contract by 10% this year, the World Bank reckons, and gross domestic product per capita will plummet to $4,282, the lowest level since 2006.

Iraq’s plight is causing rifts with OPEC. The cartel and its partners, a group of 23 countries known as OPEC+, negotiated record cuts to oil exports in April to prop up prices. Iraq agreed, like most others, to lower production in May and June by almost 25%. So far, it’s managed a reduction of less than 10%, one of the worst rates of compliance in the group.

The government’s failure to fulfill its promise is angering Saudi Arabia and Russia, the drivers behind the price war that had sent the market tumbling earlier this year. Iraq’s finance and acting oil minister, Ali Allawi, traveled to the kingdom, as well as Kuwait and the United Arab Emirates, in late May to seek emergency funding and debt relief. 

Iraq said it will improve its compliance. But doing so will be tough for a nation so cash-strapped and would risk a backlash from politicians loath to accede to foreign pressure.

“The Iraqis have long shirked on their OPEC responsibilities,” said Ehsan Khoman, head of Middle East and North Africa research at Japan’s Bank MUFG. “It’s entirely conceivable that they’ll continue to overproduce unless they face external monitoring with some form of penalty for failing to comply.”

Iraq’s status as OPEC’s biggest producer after Saudi Arabia and its ability to pump more than 4.5 million barrels a day should have helped cushion it against a slump. But since the U.S. invasion of 2003 that toppled Saddam Hussein, it’s faced everything from insurgencies by Islamist militants to a push for independence by the Kurds in the north.

Amid all the instability, state spending has ballooned to levels the government admitted were unsustainable even before this year, and meant it had almost no savings to fall back on. Some of the splurge couldn’t be helped. Iraq spent tens of billions of dollars defeating Islamic State and repairing the schools, hospitals and other infrastructure the extremist group destroyed.

Much of it, however, was down to huge increases in salaries for civil servants and politicians that have left Iraq with one of the world’s highest wage bills as a proportion of the economy. The budget deficit will hit 22% of GDP this year, higher than anywhere else in the Middle East and North Africa, according to the International Monetary Fund.

“It’s one of the most oil-rich places in the world and so you wonder how it’s struggling with its finances,” said Emily Hawthorne, a Texas-based analyst with Stratfor, which advises clients on geopolitical risks. “But it’s incredible how much they’ve spent. The economy’s now in deep disarray.”

Indeed, problems are mounting for Al-Kadhimi’s government that suggest cutting oil output won’t be the priority. Islamic State attacks and kidnappings have spiked in the past two months in western and northern areas. That’s partly because Covid-19 is restricting the movement of U.S. and Iraqi troops in those regions, according to Stratfor.

For now, protests have died down. After months of chaos and political wrangling, Iraqis seem happy to have a new government in place and to give it a chance. Yet Iraq’s complicated system of government designed to bring all sectarian and ethnic sides together often leads to them fighting over the spoils, making it difficult to implement changes at the best of times.

Ahmed Ali, a Baghdad taxi driver, is far from convinced life will get better anytime soon as the pandemic rages on and his finances are squeezed.

“I would prefer to die of coronavirus than hunger,” the 33-year-old said as police stopped him at a roadblock for defying the curfew. “I can’t stand helpless if my son or daughter asks me for food.”

©2020 Bloomberg L.P.