Ruba Husari, independent consultant and editor of the Iraq Oil Forum

As oil prices dwindle, Iraq needs to increase its oil output to offset missed production targets over the past few years. Yet the more the Iraqi government produces, the more it will contribute to downward pressure on global oil prices.

The oil price collapse comes at an inopportune time for Iraq. The defense and security budget is planned to balloon to nearly 25 percent of total expenditures in 2015 as the war against the Islamic State intensifies. The government must now resort to borrowing at home and abroad to cover the 2015 draft budget’s projected deficit of $21.8 billion.1 The lower oil prices drop, the bigger the deficit will grow, and this will force more borrowing and the need to increase production capacity. 

The last time oil prices dropped—from a peak of $146 per barrel in mid-2008 to $38 per barrel at the beginning of 2009—the government of Nouri al-Maliki slashed its national budget from $72 billion in 2008 to $58 billion in 2009 and opened its oil sector to foreign oil companies. Due to accumulated surpluses from previous years and the inability to spend its capital budget, the impact was hardly felt by Iraqis. Prices recovered quickly, and the 2010 national budget was again up to $71 billion. 

Today, however, prospects are bleaker. The bad policies and widespread corruption of previous governments further intensify the impact of the drop in oil prices. When oil prices climbed after the 2008–2009 economic crisis, instead of pushing for a market economy and the emergence of a healthy and vibrant private sector, Iraq used soaring oil revenues mostly to fuel public sector employment. Ruling parties have used this to expand their patronage locally and nationally. In successive budgets over the past five years, allocations set for operational expenditures—mainly salaries, pensions and social safety nets—hovered around 70 percent of total expenditures. Indeed, salaries and benefits, especially to senior officials and parliamentarians, soared at the expense of developing a viable economy. They also precluded badly needed investment in oil infrastructure.

The Abadi government’s response to the latest price drop has been to resort to borrowing. Under a proposed 2015 federal budget—calculated on the assumption of $60 per barrel of oil—the state is borrowing back from state employees by introducing a forced savings system where employees will be paid only a share of their salaries and benefits. In a novelty which is not certain to materialize, article 34 of the 2015 draft federal budget law stipulates deferring payments to international oil companies, instead issuing them treasury bonds worth up to $12 billion. This is tantamount to borrowing back foreign companies’ due fees for producing the oil, with interest. According to article 2 of the draft budget, each Iraqi province will also be allocated the equivalent of $2 per barrel of crude oil it produces or refines, of which only up to 50 percent will be dispensed and the other 50 percent subject to an increase in oil revenues during 2015. The remainder of the petro-dollar allocations are deferred to 2016.

As with previous cycles, oil prices will eventually rise again. Cuts in global capital expenditures on oil exploration and development, driven by falling dividends, will eventually lead to lower output expectations and thus higher prices—though the jury is still out as to when this upturn could happen and by how much prices could rebound. Until then, Iraq’s vicious oil Catch-22 will continue. The country must maximize its oil production in the short run and rake in more oil revenues to sustain its spiraling spending. But this will come at the expense of doubling down on an unsustainable economy dependent on the sale of oil. 

1. The draft budget was approved by the cabinet in December. Parliament is yet to vote on the final budget law.