There is no doubt that the escalation in the Syrian crisis has played a part in the recent increase oil prices. We have maintained for a while that beyond the strength in fundamentals, the oil market needed a fear factor of contagion, military strikes or risks of closure of transport pathways for the flat price to align with the extremely strong time spreads, and Syria provided exactly that. However, it is also fair to say that well before Syria returned to the headlines, the fundamentals of the oil market were tightening, and that over the past week, that tightness has increased.

If anything, the events in Syria are, to a certain extent, distracting attention from how tight the physical market currently is. Libya and Iraq lie at the heart of this tightness. Libyan oil production, which was disrupted throughout August due to protests at oil fields and ports, worsened in the last days of the month, falling to just over 100,000 b/d from an average of 550,000 b/d through the month and compared to a total capacity of 1.5mn b/d. Iraqi oil output, on the other hand, has fallen below 3mn b/d for several months (see p13), with continuous bombings on the Kirkuk-Ceyhan pipeline in particular impacting northern exports.

Both Libya and Iraq were countries that showed great promise last year and even started 2013 on a strong note. Libyan production rebounded far more quickly than markets expected after the overthrow of Mu’ammar al-Qadhafi, higher year-on-year by 1mn b/d to average 1.4mn b/d in 2012. Iraq, meanwhile, continued to grow at its fastest rate since 1999, adding another 300,000 b/d of production in 2012 following similar growth rates the year before, taking total output back above 3mn b/d for the first time since 1980. Consensus expectations were for production in both these countries to keep growing in 2013: Libya by around 100,000 b/d and Iraq by around 400,000 b/d. Yet, both these countries have become the Achilles heels of oil supplies in the last few months and 2013 production is now set to decline versus 2012 in both, by nearly 400,000 b/d in Libya and by around 30,000 b/d in Iraq. Thus, the cumulative swing in 2013 balances from these two countries – that is to say likely actual 2013 production versus expectations – is set to amount to nearly 900,000 b/d, with global outages currently running higher than levels seen during the peak of the Arab Spring in 2Q11.

The situations in Libya and Iraq are distinctly different. While the problems in Iraq can arguably be assigned to a combination of increasing sectarian violence, project delays linked to bureaucratic issues, and infrastructure bottlenecks, the problems in Libya are less tangible and seemingly more temperamental. The disruptions there relate to a lack of jobs and dissatisfaction with salaries along with concerns about security. But with the government exerting little control over the situation, the outbursts have become unpredictable and difficult to discern. Yet for both countries, most of these disruptions arise from deep-rooted structural problems that are unlikely to be quickly fixed unless the government has deep pockets and substantial patience. And neither country can boast a surplus of these attributes.


The Libyan problems date back to October 2011, when Qadhafi was finally ousted and attempts to repair the country ravaged by dictatorship began.

The revolution was not won by a single group with cohesive aims, but a collection of diverse militias. From the outset, there was a high degree of tension between several tribal factions, all vying for a share of power. Libya did not have institutions to step in and run the country, and unlike Egypt it did not have a strong army to maintain order following the removal of Qadhafi, nor did it have any powerful figure emerge as a clear cut leader. Rather, the vacuum created by the ouster of Qadhafi was filled by a prolonged power struggle and an absence of political institutions. Not surprisingly, governance has been difficult and that has hampered the return of foreign firms and capital back into the Libyan oil industry, as security challenges and divisions within the ranks of the one-time revolutionaries have been a constant worry. Added to this, public expectations after the revolution were unrealistically high. Libyans from all parts of the country expected jobs, security and a share in the country’s mineral wealth—after all they had taken part in the fight to topple Qadhafi. First the National Transitional Council and now Prime Minister Zeidan’s government have not been able to deliver improvements at a pace that matches these expectations. Their efforts have been hampered by the militia groups, which since the revolution have proved unwilling to hand over their weapons and let the government find its feet, instead these groups have tried to carve out a continuing role, often as guards to important oil installations (the Petroleum Facilities Guard - PFG) but also by frequently blockading government ministries and the National Assembly to make their case. The weak national security forces have been unable to displace these militia groups and even the formation of the PFG has done little to wrest control away from these armed tribal groups. Indeed, in a country still awash with weapons, violence has been rising over the last year as bombings and assassinations become a frequent feature of life in Libya’s main cities.

Libyan disruptions due to protests extend back to late last year, with the Repsol-operated 340,000 b/d Sharara field shut for part of December and both the Zueitina terminal and Ras Lanuf refinery being impacted during January. However, the outages were relatively sporadic, with the exception being the Ras Lanuf refinery that was under a three week Force Majeure from mid-February following strikes and technical faults, which actually meant more Libyan crude was available to export. The impact of these disruptions on Libyan production was limited at first, with output averaging 1.37mn b/d in 1Q13. The number of protests that impacted fields and exports terminals rose through May and June, and in mid-June Libya’s National Oil Corporation (NOC) issued a statement that protests had briefly caused production to drop below 1mn b/d. This began to show up in production estimates, which fell to 1.2mn b/d for June. Protests stepped up again in July, and then worsened significantly through August. The major Ras Lanuf and Es Sider terminals were both shut for the whole of August, forcing the shut-in of a number of Libyan oil fields. Many other fields and terminals also experienced protests, and overall around 1mn b/d of output was offline last month. The worst problems have been in eastern Libya, but the west of the country has not been immune and both the Elephant (Feel) and Sharara fields were shut by protests in the final days of August. Currently, only 10% of Libya’s production is online, and the country is fast running out of crude in storage, forcing refineries to shut down and making Libya reliant on imported fuel.


Ultimately, the problems impacting the oil and gas industry go well beyond widespread weapons or demands of higher wages and jobs. The issue is one of a political vacuum, in a country riddled with tribal and regional divisions. More importantly, there is little that can be done overnight to fix these problems. The government can try to satisfy the demands of individual groups of protestors, and that is why delegations of politicians are often on the road promising more jobs, better wages and improved security. However these promises frequently fail to be fulfilled and, if they all were, the costs would quickly spiral out of control. For the government to actually get a grip on the situation it will need several things to happen. First, the security situation will have to be improved significantly. Second, the power of the militias will need to be tackled, and more groups will need to be disarmed and disbanded. Third, the much-delayed constitution drafting process will need to be finished and the document will need to win the support of all of Libya’s many tribal factions to secure legitimacy for the national government and political process. These are slow and difficult tasks, particularly as they need to be achieved in parallel, and it is far from clear that the Libyan government has the capacity or public support to see them through, most recently demonstrated by the Deputy Prime Minister’s resignation in August.

Moreover, recent developments could signify a turning point in the Libyan crisis, as the Libyan Prime Minister has accused the Petroleum Facilities Guard protestors of wanting to export oil independently of NOC. He warned that the government would use “any means” including military force to stop this from happening. Without wanting to sound alarmist, the dispute in Libya has moved to a different level now, with key protests morphing from local disagreements over wages and jobs into a wider issue about Libya’s eastern region centered on Benghazi wanting greater autonomy from the government in Tripoli. Calls for regional independence and demands of autonomy have rarely been resolved overnight in other countries and we suspect Libya will be no different. Complicating matters is the fact that over 90% of the Libyan government’s revenue comes from oil and two-thirds of the country’s production is in the eastern region, primarily from the Sirte basin. Thus, the changing nature of the disputes may well be the start to a long and potentially violent showdown that could keep Libyan supplies off the market for a prolonged period of time.


Given the worsening in the situation in Libya, we expect Libyan production to be significantly impacted in the second half of 2013, bringing average production for 2013 down to 1mn b/d, down 400,000 b/d on the average 2012 figure. The impact is even more significant compared to expectations in late 2012, when many commentators expected Libyan production to continue improving in 2013 and average 1.5mn b/d, meaning the gap between expectations and reality will be close to 500,000 b/d on average and be even higher than this during 2H13. As a result, international market support for light sweet grades will continue.

If Libya was the only country facing supply problems, the oil market, arguably, would not have seen balances affected significantly given the surge in light crude output from the US. The problem is that the Libyan outages come at a time when Nigeria has seen its production reduced to below 2mn b/d for five months due to growing oil theft; Russian exports have been curtailed due to strong domestic demand; the resumption of South Sudanese output has been erratic; substantial production losses continue from Iran, Syria and Yemen; and most importantly, Iraqi production, which was set to grow this year by 400,000 b/d with four new large fields starting up, has been on a decline for the last four months.


At the start of the year, 2013 looked set to see significant new additions to Iraqi production. Four field start-ups in southern Iraq were expected to add 435,000 b/d by the end of the year. However, the reality has turned out to be quite different. Shell’s Majnoun field, already delayed by slow construction of a pipeline to Zubair, was aiming for start-up in 1Q13. Although the pipeline is complete, equipment deliveries have been held up by government approval processes and Majnoun to only likely to start production in 4Q13 in the best case scenario. The Badra field, which was due to begin producing 60,000 b/d by August, has been significantly delayed by services firm Schlumberger’s decision to stop drilling due to tough geological conditions. We now anticipate production from Badra starting in 2Q14 at the earliest. Similarly, Lukoil’s West Qurna-2 field is also facing delays due to a range of issues, including uncertainties around pipelines, slow government bureaucracy and landmine clearance and we expect it to start in 2Q14. So far in 2013, only one field has started up – Petronas’s Gharaf, which began producing at 35,000 b/d b/d in early September (see p4). We predict that at most about 150,000 b/d of new field additions will come online by the end of this year, with the risk that Majnoun also slips into 2014.


Of course, a discussion of Iraq must include a mention of its infrastructure – the key constraining factor for Iraqi production growth in recent years. The fact that Iraq’s infrastructure is aging and in a poor state is hardly surprising after decades of conflict – much of which took place in and around oil fields in the Basra region – and sanctions that prevented access to equipment and expertise for maintenance and improvements. Post-Saddam Iraq has faced huge challenges in extracting and transporting oil to markets, from well drilling and water injection to pipelines and export facilities. Iraq formally announced the start-up of two 850,000 b/d Single Point Moorings (SPM) that link to the key onshore Fao terminal in the Gulf in March 2012 but the actual increase in loading capacity has been less than 900,000 b/d in total as it is only possible to use one SPM at a time. Capacity is constrained by the lack of supporting pipeline network, pumping stations and storage facilities, as oil is currently being pumped offshore via a temporary arrangement from Zubair, rather than directly from the Fao terminal.

In late July, Iraq announced the schedule for the first stage of maintenance to install a new combined metering and manifold platform, which will eventually connect both SPMs and onshore jetties and boost loading capacity significantly. But exports would be cut by 500,000 b/d during the maintenance to connect the first SPM, which is set to last for up to 45 days through September and part of October. Limited storage capacity makes the situation worse, as Iraq will struggle to store the oil that cannot be exported and then make up for the exports once the maintenance is completed. However, prompted by the negative reaction from buyers to the announcement of maintenance, the Iraqi government and South Oil Company considered postponing the maintenance and issued several contradictory statements, some of which pointed to a postponement in the maintenance while others suggested that the maintenance will not impact Basra exports to the extent (500,000 b/d for 30-45 days) stated in the original announcement. Our understanding is that at least part of the maintenance work will take place in September and that this cannot go ahead without disrupting exports as infrastructure will need to be offline to connect the platform, and shipping in the terminal area will face disruptions while work is being carried out. In fact, the initial loading programs for September show a sharp 400,000 b/d drop, confirming our suspicion. Further disruptions from the installation of the new platform are due in 1Q14 and later next year as well. Oil storage capacity in the south will rise to around 11mn barrels at best in 2014, meaning exports are likely to be impacted again.


Equally, no discussion on Iraq is complete without mentioning sectarian problems and the general political backdrop. August was another month of sectarian violence, with the UN estimating over 800 people died, as Iraq’s security forces appear unable to contain the growing sectarian violence, which is partly fuelled by the conflict in neighboring Syria. As civil war in Syria tears that country apart, it is also straining the sectarian balance of the Iraqi state. While oil producing facilities in the south of Iraq are not seriously threatened by the sectarian violence, the Kirkuk-Ceyhan pipeline that carries exports to Turkey has come under frequent attack.

Another dimension of the sectarian issues affecting Iraq is the stand-off between the Kurdistan Regional Government (KRG) and Maliki’s government in Baghdad. Since December, the KRG has halted pipeline exports and is trucking 20-30,000 b/d of crude to Turkey without the approval of Baghdad. A committee set up in April to try and address the numerous issues between Erbil and Baghdad has made no headway, with the close links between the KRG and Turkey complicating the prospects for any deal. Meanwhile, a new pipeline being built by Anglo-Turkish independent Genel Energy to transport oil from the Taq Taq and Tawke fields is nearing completion, with Genel stating it would be finished by the end of the year in an earnings call last week. The latest indications are that the pipeline will extend right to the Iraq-Turkey border so a tie-in to the Kirkuk-Ceyhan pipeline can happen beyond the Fishkabur pumping station of the Iraqi state North Oil Company. That is more realistic than getting approval from Baghdad for a tie-in, but we still see issues with the agreement governing the pipeline and the handling of title and sales from the Turkish Mediterranean port of Ceyhan that Baghdad will use to hold up the plans. While the new pipeline could eventually lead to a resumption of 200,000 b/d or more of Kurdish exports, we see this happening well into 2014 at the earliest and still being far from certain given the political disagreements involved.


The combination of increasing violence and the dilapidated state of infrastructure has affected the 300,000 b/d Kirkuk-Ceyhan export pipeline. While it has been no stranger to disruptions in recent years, the last few months have seen an escalation of outages due to a combination of militant attacks and maintenance issues. The combination of bombings, lack of security holding up repairs and the generally poor state of the pipeline has meant the pipeline was operational for only around eight days in August and 11 days in July. As a result, Iraq’s northern exports to the Mediterranean fell by 100,000 b/d in June and by almost 150,000 b/d in July, at a time when Russian supplies in the region has dried up as well. The disruptions to Kirkuk-Ceyhan are likely to be both frequent and prolonged in the months ahead.


Consequently, the delays to field start-ups, the poor state of infrastructure compounded by port maintenance and bombings and the loss of exports from the North have resulted in a significant reduction in Iraq’s production prospects for 2013. Indeed, while at the start of the year consensus estimates for 2013 growth ranged from 300,000 b/d to 500,000 b/d (Energy Aspect estimates were for 200,000 b/d growth in 2013), Iraqi production is now set to fall for 2013 as a whole relative to 2012 in our view.

Although the size of the decline – which we believe will be around 30,000 b/d to below 3mn b/d – is not significant, the swing in forecasts is substantial. Much like Libya, the disappointment in Iraqi output this year has been to the tune of 350,000-500,000 b/d, and makes reaching IEA’s base case scenario of Iraq producing 4.2mn b/d by 2015 a herculean task, as it would require an average growth of 600,000 b/d over the next two years. While we do expect Gharaf, Majnoun, Badra and West Qurna-2 to start ramping up in the coming two years, they will be marred by delays and setbacks. Equally, while some exports from Kurdistan may resume next year after the new pipeline is completed, the strained relationship between Baghdad and Erbil will hardly make smooth operation likely. Finally, sectarian violence is likely to continue, given the broader political backdrop in the region, and with no quick fixes available for the Kirkuk-Ceyhan pipeline. Thus, on an optimistic scenario, Iraqi production is likely to grow by an average 400,000 b/d in each of the next two years, to reach an average of 3.8mn b/d in 2015. More realistically, Iraqi production will probably average around 3.5mn b/d by 2015, with the many problems that face the Iraqi oil sector above the ground once again dominating the prodigious oil reserves below ground.


The shortfalls on the supply side are rising fast. What is remarkable is despite significant refinery outages and upcoming maintenance in Europe, Russia and the US, the scale of supply outages is such that various physical grades around the world, for instance Russia’s ESPO Blend, Azeri Light from the Caspian and Abu Dhabi’s Murban, are trading at or near record high differentials. Moreover, even prompt Brent spreads have strengthened to nearly $2/B. While futures markets such as Brent and WTI can come under the influence of hedge fund positioning and high frequency trading, illiquid physical grades are a function of pure supply and demand fundamentals.

These physical differentials show that even without Syria, the oil market is tight enough to warrant higher prices. In fact, even with Saudi Arabia producing at or around 10mn b/d in August, OPEC production fell further, due to ongoing disruptions to Libyan, Nigerian and Iraqi output, with the cumulative loss in output from these countries and planned maintenance now nearly at 200mn barrels since the start of June (excluding Iran).

In other words, the rise in oil prices is justified on grounds of supply-demand balances, even without the Syria factor, in our view.

*Amrita Sen is Chief Oil Analyst and Richard Mallinson is Chief Policy Analyst at Energy Aspects.