INSIGHT: US-Iran hostilities highlight Iraq’s precariousness

LONDON (ICIS)–The recent outbreak of hostilities between the US and Iran has underscored the potential for escalating tension in the Middle East to impact chemicals pricing and trade flows.  But the real present risk factor in the region may be Iraq, the battleground the two countries chose for their skirmishes.

Oil prices spiked after the killing of Iranian general Qasem Soulemani at Baghdad airport and Iran’s retaliatory strikes on US military bases in the country, but receded shortly after on both occasions, due to chronic over supply in recent years.

But if Iraq’s political system continued to deteriorate it could reduce or curtail a much larger source of oil, that could have the effect of drastically tightening oil markets extremely quickly.

Saudi Arabia’s outsized influence in OPEC discussions can serve to obscure the fact that Iraq is the second-largest player in the cartel, producing an average of 4.68m bbl/day in 2019.

Iraq’s political stability has been fragile for a long time, riven by conflicts, the collapse of neighbouring Syria, and battles with the Islamic State that led to the border between the two countries essentially collapsing for several years.

December saw the resignation of Prime Minister Adel Abdul Mahdi. As yet, there is no replacement in the frame, with President Barham Sali reportedly refusing to advance any of the names that the country’s parliament has put forward so far.

For a long time, the country’s leadership has been extremely simpatico with Iran’s, forming a Shi’ite axis in the region. The odds, however, are that the next Prime Minister may take a different turn, particularly in light of widespread protests that had gripped the country even before the US-Iran attacks.

This could lead to a shift in the predominant religious and political axis in the area, less centred around Iran, but with the potential for increased tension as a result.

The Abdul Mahdi government was about as pro-Iran as you could get,” said TS Lombard chief political research Christopher Granville. “[He was] a passive caretaker and let Iranian proxies effectively run the country.”

“Given the protest movement… [there is a] chance elections could lead to a less pro-Iranian leadership,” he added.

With the economy in the doldrums, the government at a standstill, dissatisfaction high and increasing among its populace and the additional pressure of the US-Iran tensions, the odds are increasing that the country could slip into a spiral to the point where the capacity of industry to function falls.

“The key risk factor stems from Iraq’s chronic and ever-increasing instability, where US and pro-Iranian forces are like fencers duelling on thin ice, focused entirely on each other even as cracks spread beneath their feet,” Granville added.

A series of notes from ratings agency Moody’s late last year highlighted the precariousness of the situation. They noted that the government’s capacity to respond to domestic or external shocks is extremely limited.

This was in October, before the Prime Minister had resigned and the country briefly served as a proxy battleground for the US and Iran.

The agency, which rates the creditworthiness of Iraqi government debt at Caa1, the higher end of junk, noted that social and fiscal reforms have been slow to move forward, with an improvement in the country’s budget in 2018 driven entirely by rising oil prices as opposed to government action.

Oil represents over 90% of government revenue and 99% of exports, meaning that any substantial drop in global pricing in the event of continued global economic lethargy could push the country further into unrest.

“Political fragmentation, elevated political and security risks and the authorities’ desire to avoid social unrest will continue to impede the momentum for structural and fiscal reforms,” said senior Moody’s analyst Alexander Perjessy.

There is also the issue of the Strait of Hormuz, which sees a huge proportion of global petrochemicals trade pass along its banks, along with nearly 20% of oil supplies.

Bridging the Persian Gulf and the Gulf of Oman, with Iran’s borders running along one side of the stretch and Qatar, Oman, Saudi Arabia and the Emirates running along the other, it is one of the world’s key shipping routes.

Iran is not thought to be likely to attempt to close the strait, with fallout from key market China likely to be substantial. But the possibility of renewed attacks on tankers is s factor, particularly after the humiliation of Iran’s revolutionary guard after the accidental, tragic downing of a Ukraine International Airlines flight.

Aside from a brief suspension of traffic by a few major players in the immediate aftermath of the missile attacks, the shipping market has been largely unmoved by the skirmishes so far, with none of the sharp hikes in insurance prices that followed the tanker attacks.

The key issue is that the attacks have been land-based and, with the geopolitical environment in the Middle East usually febrile at best, it would take new tanker attacks to move the needle for players in the market.

However, the potential for disruption remains high and, with companies on high alert, any disruption could have substantial and immediate repercussions for logistics pricing.

Iraq is not a significant chemicals producer, with output in the country largely based around crude and derivatives just down the value chain. The key impacts for chemicals players are around logistics and oil pricing.

The ramifications of this are especially strong for European and Asia Pacific producers, with feedstock costs substantially higher than elsewhere in the world.

The US’ increasing maturity as an oil player means the country would be far more insulated from price shocks in global crude markets, but the feedstock price disparity with Europe in particular would suffer from a substantial hike in oil prices, which a breakdown of supplies from Iraq could trigger.

Prevailing subdued oil pricing could also speed Iraq’s political deterioration, as it has been much more worse-placed than Saudi Arabia to absorb lower pricing, which may be why its production increased last year despite the ongoing OPEC cuts.

“The current Iraqi system just does not work at the current oil price,” Granville added.

Developments between the US and Iran have quieted after the tensions last week, with the downed plane cooling appetite on Iran’s side for further escalation, and both sides keen to avoid a formal land war. But this increases the odds of additional sniping on Iran’s side, with proxy battles a strong part of its strategy so far in conflicts with the US and Saudi Arabia.

With the situation in Iraq quietly growing more parlous, any further flashpoints could serve to accelerate that decline, particularly during the current political vacuum.

The importance of the Strait of Hormuz to global chemicakls trade is outlined in the ICIS ‘US-Iran conflict’ Topic Page on ICISnews

By Tom Brown