Iraq’s National Energy Strategy: Oil And Gas Output, Diversification and Employment

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

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

In addition to commenting on oil and gas, a main thrust of this article deals with the interrelated major objectives of economic diversification and employment. Huge increases in oil revenues as a result of the forthcoming expansion of oil and gas production will have far-reaching economic consequences. These range from short/medium-term shortages caused by the anticipated construction boom to the long-term consequences of development strategy, eg the perpetuation of a rentier economy or tangible efforts at diversification.

OIL PRODUCTION

INES suggests three alternative scenarios for oil (and associated gas) production for 2013-30: low, medium, and high (see table 1). In general, production levels are usually limited by production capacity, and in all newly offered technical service deals in Iraq, contracted plateaus determine production capacity after 2017.

INES indicates that a production path lying between the medium and high scenarios is desirable (ES, p6). However, due to debilitated infrastructure on the one hand and the uncertain short-term outlook on the other it opts provisionally for the medium scenario. INES’s medium scenario corresponds to the IEA’s high scenario for Iraq, but falls short of NDP 2013-17’s figure for 2017. IEA-Iraq, however, expresses doubt about the viability of its high scenario. Furthermore, as I have shown elsewhere, even a production profile slightly below INES’s medium scenario is adequate for the future economic requirements of the country, and INES’s high scenario cannot therefore be justified economically.

From another angle, although the future evolution of production could deviate from the medium scenario after 2015-16, INES puts the required investment in the energy sector for 2013-30 at $530bn (in 2011 dollars), although this is not tied to any specific scenario. IEA-Iraq cites exactly the same amount for 2013-35, but ties it to its central scenario.

WORLD OIL PRICES

Neither INES nor IEA-Iraq analyses the impact of future increases in Iraq’s oil production on world oil prices. They assume price levels that do not change with production scenarios: $110/B and $120-125/B in 2011 dollars respectively for 2013-30. Available alternative worldwide oil forecasts, such as the base-cases in OPEC’s World Oil Outlook 2012 and the EIA’s Annual Energy Outlook 2013, include ‘equilibrium prices’ which ensure a balance between world supply and demand for 2013-30 and beyond. Neither forecast shows Iraq’s future output or exports, and it seems likely that they fail to anticipate the output gains envisaged in INES’s medium or high scenarios. It is, therefore, possible that these scenarios will have a negative effect on world oil prices.

GAS PRODUCTION

According to INES, gas processing and transportation infrastructure will be reasonably rehabilitated and expanded by 2015-16. Consequently, after taking into consideration domestic requirements of dry gas and LPG, there will be surplus gas for export between 2015 and 2030 (INES, p13).

Two points are in order. First, the gas deal in southern Iraq with Shell/Mitsubishi [the $17.2bn ‘Basra Gas company joint venture – MEES, 19 July] is not mentioned in ES. That deal envisages meeting domestic requirements of dry gas/LPG and exporting LNG, LPG, and condensates. Figures derived from ES’s ‘Exhibit 7’ (ES, p13) indicate that between 2015 and 2030 average domestic requirements of LPG and dry gas will amount to 4.4bn cfd and production will amount to 6.4bn cfd, leaving an average surplus of 2bn cfd. The second point relates to the definition of domestic requirements. They fall into three categories; first, LPG for final consumers and dry gas for electricity; second, industries using gas and derivatives as feedstock and fuel, such as petrochemicals, fertilizers and sponge iron; and industries using gas primarily as fuel, such as steel and aluminum. Apart from sponge iron, the first two categories justify prioritizing domestic requirements over exports, given that efficient use is ensured. Consumers in category three, however, need to justify their priority over exports by meeting at least one of two conditions: either economic efficiency and/or substantial forward/backward linkages beneficial to efficient industrial growth.

ECONOMIC DIVERSIFICATION

Like NDP 2013-17 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, p4).

In this article diversification is taken to include efforts to reduce dependence on oil through the 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 heavily energy dependent industries to be a fundamental part of diversification. Petrochemicals, fertilizers, steel, aluminum, cement and bricks are the cornerstones of INES’s diversification. IEA-Iraq singles out petrochemicals, fertilizers and cement. In both documents, and also in NDP 2013-17, however, no attempt seems to have been made to carry out a comprehensive survey of existing industrial structures and establishments in order to assess what can be rehabilitated and included in a drive towards industrialization. Furthermore, and notwithstanding INES’s recommendation to set up a ‘Strategic Industries Company’ and ‘Industrial Park Authority’, no serious attempts are made in the three documents to draw up 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 and hence government employment, which, as is shown below, is the opposite of diversification.

Since INES is a sectoral rather than economy-wide strategy, the national development plan for the country, NDP 2013-17, was expected to detail the energy strategies, policies, sectors, industries and investments within its economy-wide plan. In conjunction with INES it should have included a credible plan for economic diversification, given that it was prepared at the same time. Instead, the very general sectoral value-added plans included in NDP 2013-17 would be likely to reinforce the lopsided nature of a rentier economy.

To sum up, all three documents proclaim their intention to diversify economically without including concrete visions or plans of action to achieve this goal.

PERPETUATING PATTERN OF EMPLOYMENT: 2012-17

Since the 1970s, government employment and public-spending-related activities have been the main sources of job creation in Iraq. For instance, between 2007 and 2012, 59% of additional employment originated in government services, only 3% from agriculture and manufacturing, and 38% from other sectors (see table 2).

Contrary to the stated intention of economic diversification, the expansion of employment over the next five years, which can be derived from NDP 2013-17, does not depart from this pattern. Between 2012 and 2017, 57% of additional employment will come from government services, 7% from agriculture and manufacturing and 36% from the rest. This is not consistent with INES’s plans for economic diversification.

LABOR SHORTAGES IN THE LONG-RUN

According to calculations based on NDP 2013-17, between 2012 and 2017 employment will increase by two million while the labor force will increase by 1.75mn, bringing the economy close to full employment in 2017. According to INES the continuation and expansion of public and private spending commensurate with rising oil revenues after 2017 means that “[total] employment...is expected to rise by 10mn jobs by 2030...bringing Iraq to a condition of full employment” (ES, p18). Barring unrealistic assumptions of a sharp rise in participation rates (primarily by females), the addition of 10mn jobs will not only ensure full employment but also lead to an acute shortage of labor after 2017 reminiscent of that in 1975-82.

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

Labor 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 (labor 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

The anticipated construction boom could last well into the next two decades. General economic activity and the related demand for imports of consumer and capital goods will rise sharply, almost certainly faster than capacity to produce construction materials and services including roads, ports, trade facilities and financial institutions. These capacities/constraints can only support certain levels of spending, above which inflationary pressures 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 constraints, investment execution delays and labor shortages will drive production/investment costs higher. In this environment, constraints reinforce each other in creating a shortage economy with mounting inflation.

It is worth noting that NDP 2013-17 has neither considered such possible outcomes nor devised policies and measures to counter their consequences. Therefore, possible constraints and shortages need to be identified and solutions planned for in advance. Relevant institutional measures are also required. In this regard, some of the institutional recommendations in INES for the ministries of oil, electricity, and industry (eg task forces, institutional reform committees, etc) need to be extended to the Ministry of Transportation. Alternatively, a body or high powered committee could be set up to monitor the infrastructure and labor situation, anticipate possible shortages and suggest ways and means to relieve them. Otherwise, the claim that “in this sense, INES is a low-risk strategy” (ES, p19) 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 growing surpluses during the last three years no successful attempt has been made to set up a stabilization/saving fund. Future surpluses should be handled differently. A stabilization/investment fund needs to be set up in which to deposit accumulated and future budgetary surpluses with three objectives; firstly, to avoid pro-cyclical public investment, secondly, to manage accumulated surpluses transparently and efficiently; and thirdly to minimize the impact of high inflows of foreign exchange on the exchange rate.

DOMESTIC PRICES AND SUBSIDIES

According to INES, the price of oil products, electricity and possibly other energy will be liberalized in the short to 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. Subsidized gas and other energy products for industries/activities are considered important tools to promote industrialization and hence diversification. Likewise, cheaper electricity for industries/activities entails subsidized gas for power generation. Therefore, whom to subsidize and whom not to subsidize is a less than straightforward matter. This could entail different prices for different consumers. Multiple tariffs, however, usually lead to rent-seeking behaviour, which impairs economic efficiency. A clearer and more comprehensive pricing scheme is therefore highly desirable.

*Dr Ali Merza has worked for the Iraqi Ministries of Oil and Planning and for the United Nations Department of Economic and Social Affairs in the Middle East and North Africa.

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