Observations from Basra

An Iraqi man holds up a national flag at a rally in the southern city of Basra.(AHMAD AL-RUBAYE/AFP/Getty Images)

Analysis


Editor's Note: The renewed insurgency in central Iraq led by the Islamic State in Iraq and the Levant has prompted Bret Boyd, Stratfor's Vice President of Custom Intelligence Services, to reflect on the potential spillover effects in the country's south. He recently returned from Basra and offers his observations on the region. Boyd has been to Iraq previously, having deployed four times with the infantry and Army Rangers. While the views expressed here are personal and not institutional, we are publishing them in light of Boyd's unique insight.

I began to write this set of reflections from downtown Basra, overlooking the Shatt al Arab River. I left Iraq during this most recent visit four days before a Sunni Islamist insurgency overran Mosul. Since then, the erratic march of the Islamic State in Iraq and the Levant has captured the world's headlines and once again riveted attention on the country's basic ethnosectarian split along Sunni, Shiite and Kurdish lines.

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Many of the secondary headlines have keyed on Basra, Iraq's second largest city, with a population of just over 2 million. It is a largely Shiite city, but more heterogeneous and cosmopolitan than others due in part to the fact that it is a port city. It controls Iraq's access to the Persian Gulf, primarily through the ports of Um Qasr, Al Maqal, Khor al Zubair and Mina al Bakr. Basra was occupied by the British after defeating the Ottoman troops at the Battle of Basra in 1914, and was more recently managed primarily by British troops after the 2003 invasion through the withdrawal of coalition forces in 2011.

As violence flares anew in the north, Basra garners global attention because it is the gateway to Iraq's southern oil fields, which contain the overwhelming majority of Iraq's hydrocarbon resources. Eighty percent of Iraq's petroleum reserves are estimated to be in the south, reflected by seven major fields -- Rumaila, Majnoon, West Qurna-1, West Qurna-2, Zubair, Halfaya and Maysan. The majority of Iraq's energy export infrastructure also flows south through Basra, to the Al-Faw Peninsula and the Al Basra Offshore Terminal in the Persian Gulf.

Basra has been scarred by war, both from the Iran-Iraq war and the more recent occupation by the British and Americans. One does not have to look hard to find toppled structures or bomb craters. Basra is years away from the fine hotels and modern infrastructure seen in the northern Iraqi city of Arbil. Yet there is a vibrancy to the town, and there is growth. Streets have been repaved and bridges built. A large shopping mall is being built -- aspiringly titled Times Square Basra.

Many foreign businesses operate in this region, primarily in the energy sector. However, given the concentration of hydrocarbon resources and infrastructure development in the area, the lack of American businesses here is striking. ExxonMobil, Halliburton and others are present at some level, but the seven major fields in southern Iraq are overwhelmingly operated by Russian, Chinese and European firms.

This is immediately apparent before even setting foot in Iraq. The Emirates flight I arrived on, which operates daily from Dubai at the time of writing, was populated primarily by Russian and Chinese oil field workers. I admittedly make this generalization from the observation of a single data point, but am told that this is typically the case. I did not identify another American on the flight and have encountered very few after several days of staying at a hotel downtown and eating at local restaurants.

My general assessment after many conversations with Iraqis and others operating in the country is that Russian and Chinese state-owned or state-sponsored firms are realizing the economic benefit of the eight years of blood and treasure that the United States and its allies poured into Iraq. I readily admit to personal bias, being an American citizen and having participated in our most recent Iraq war. I perhaps also suffer from aspiration bias, as I deeply respect the Iraqi people both as antagonists in conflict and partners in rebuilding, and desire to see American industry continue to support their growth.

Some of the lack of investment relates to perceptions of Iraqi instability and its impact on energy producing regions. Iraq has two primary ethnically and culturally homogeneous regions that provide relatively high levels of safety: the Kurdish region in the north and Shiite Arab core in the south. The majority of the Iraqi violence occurs in Iraq's borderlands, places where population centers blend the lines between Sunnis, Kurds and Shia. Baghdad, in addition to now representing Shiite political hegemony over Iraq, lies at the crossroads of these divisions and is often a focus of insurgent attacks.

But Iraq's distinct ethnic and sectarian population centers also create very distinct realities on the ground; even while many in the mainstream media report from Arbil on the violence raging to the south of the Kurdish region's borders, they neglect to illustrate the stability and lack of violence in both the Kurdish region and Basra. The Kurdish and Shiite communities have rallied local forces in defense of their sizable regional oil reserves, and Baghdad's success in preventing the Islamic State in Iraq and the Levant from directly impacting this oil production relies heavily on security coordination with locals. While the rebels continue to lead a pro-Sunni offensive north of Baghdad, Iraq's primary oil exporting regions remain relatively calm. Political and bureaucratic impediments pose a bigger challenge to Iraq's steadily growing oil industry than jihadists and insurgent attacks.

There are significant growth opportunities in Iraq. The sanctions regime imposed from 1991-2003, combined with the reality that oil production was less a strategic priority for Saddam Hussein than was internal control, led to underdevelopment. The small influx of foreign investment in 2010 and 2011 has caused oil production to increase -- a trend that is likely to continue as production gains from modern technologies have not yet been fully realized. Iraqi production is currently at its highest level ever, yet is nowhere near capacity. In May 2014, Iraq produced 3.37 million barrels of oil per day, an increase of 1.2 million barrels per day from pre-invasion production levels in 2002.

Production forecasts have fluctuated in recent years, but the disagreement has been over the magnitude of growth, as opposed to the likelihood of growth. The federal government in Baghdad and international bodies like the International Energy Association have recently come closer together, forecasting production targets from 6-8 million barrels per day by 2020. Growth of 3-5 million barrels per day over the next six years presents a remarkable opportunity. The only other markets that the International Energy Association forecast to grow by more than 2 million barrels per day during this time period are the United States, Canada and Brazil, and all show less growth potential than Iraq.

To be clear, there is risk here alongside opportunity. This is still Iraq, a nation struggling from decades of conflict as well as the complexity resulting from the forced convergence of unique and ancient peoples, with rich and conflict-ridden histories. The Kurdish north and the Shiite south each have some measure of physical security resulting from relative cultural homogeneity and the shared interest of safeguarding hydrocarbon resources. But challenges remain, especially in central and western Iraq.

The recent election, budget impasse and machinations required to form a new coalition government exacerbate these challenges. This process will inevitably be lengthy. Some of the violence recently experienced in Ramadi, Samarra and elsewhere is likely a manifestation of post-election politics, as different groups exert influence and vie for power. Current levels of violence are unlikely to abate in the near term, but they will generally remain contained to a central Sunni belt in Iraq, leaving the south relatively stable.

However, businesses that operate in complex emerging and frontier market environments understand that they get paid for risk. Risk often creates outsized returns and thus is an element of business to be managed, not necessarily avoided. Understandably, the costs associated with managing risks sometimes provide for a poor investment, regardless of the potential value of the opportunity. Perhaps that is the case with Iraq today.

But perhaps not. The businesses that can best calculate and manage risk are naturally positioned to capture emerging opportunities and achieve risk-adjusted return. This is simply a statement of fact, not a political statement, security assessment or endorsement that companies should necessarily flock to Iraq, American or otherwise.

The opportunities in hydrocarbons, infrastructure projects and both consumer and services markets are of such potential magnitude that they merit thoughtful evaluation. As I sit, sipping instant coffee, unguarded, watching Iraqis walk the boulevard of the Shatt al Arab, I wonder if American firms are mispricing risk and thus bequeathing gains from the rise of this region to the Russians, Chinese and others.

American firms are eager to engage Iraq's large -- and growing -- hydrocarbons sector. The difficulty lies in navigating a patchwork of local and national political interests, a system that violence in northern Iraq is revealing to be fraught with competition and that requires a deep awareness of local sensibilities. Baghdad is set to face a period of both regional security challenges and a difficult and complex political negotiation involving Kurds, Sunni and Shia. Despite these challenges, we expect oil exports to continue to grow and the stability of Iraq's Kurdish and core Shiite regions to endure.