China’s Unsuccessful Swoop Into the Iraqi Oil Sector: (Not) the End of the Story?

COVID-19 and collapsed oil prices have dealt a severe blow to Iraq’s economy, where approximately 90 percent of state budget revenues came from oil exports. As a result, the economy has contracted by 11 percent, prompting Iraq to urgently seek new sources of income to prop up its ailing economy. As a representative of Iraq’s oil ministry noted, to be able to deal with piling socio-economic challenges as well as foreign debts and obligations, the country urgently needs “cash in advance for some of [Iraq’s] oil sales.”

At this juncture, the Federal Government of Iraq (FGI) had hoped that its agreement with Chinese ZhenHua Oil Co. (part of Norinco defense corporation) – a deal preceded by an intense competition between several bidders, including two unnamed European players – would become a source of much-needed revenues. According to the conditions of the agreement, the Iraqi side pledges to supply the Chinese company with 48 million barrels of oil per year from 2021 to 2025 in exchange for US$2 billion to be paid upfront. Had it been actualized, this deal could have had far-reaching consequences, becoming an essential milestone in achieving key objectives of China’s energy security strategy (“Energy in China’s New Era“) and increasing Beijing’s overall influence in Iraq, integrating it into the Belt and Road Initiative (BRI) project.

At least for now, however, the advancement of the Chinese side has been stalled: the Iraqi government has announced its decision not to go ahead with the contract. Nonetheless, this obstacle does not mean that Beijing is likely to abandon its ambitious plans in Iraq.

China’s Ambitions Encompass More than Oil

China, which has become the de facto main importer of Iraqi oil, has managed to achieve visible success via two primary mechanisms. First, it promotes a policy of non-involvement in Iraq’s domestic political affairs. Secondly, it emphasizes a readiness to “make one step back to make two steps ahead.” For example, China’s 1997 purchase, and 2008 renewal, of the Al Ahdab oil deposit in southern Iraq was thought at a time to have been a bad investment – but ultimately proved to be very profitable, with the extraction of approximately 120.000 barrels per day. This example clearly demonstrates that China prefers to think (and act) strategically in expanding its influence in Iraq, and displays its willingness to sacrifice immediate profits for long-term gain. Incidentally, this approach is clearly visible in the above-mentioned – and to some extent unique – deal, where oil was to have been effectively used as security for a loan.

By pursuing this approach, China attempted to kill two birds with one stone. On the one hand – aside from gaining access to the vast Iraqi oil reserves, an area where China has achieved breathtaking progress – Beijing made an attempt to forge a path toward gaining control over Iraq’s oil infrastructure. For instance, Iraq’s Ministry of Oil signed an outline agreement with a Chinese consortium for the development of the Dhi Qar refinery in southern Iraq, which has a capacity of 100,000 barrels per day. On the other hand, by pursuing this approach, China is also effectively engaging in the non-resource sector of Iraq’s economy, including cement factories, power plants, and water treatment facilities. In fact, based on data from 2019, expansion of China’s export capabilities made Iraq one of the biggest consumers of Chinese goods in the Middle East.

Pulling off or Putting Off the Deal

Iraq’s decision not to conclude the agreement rests on three main pillars. The first is changes in the global oil market. There is a huge difference between the situation now and that at the time of Baghdad’s initial negotiations with China. Since November 2020, oil prices have soared 62 percent to around $63 a barrel, which is primarily due to the roll-out of coronavirus vaccines and growing global demand for oil. Iraq’s government saw an opportunity in price increase; considering that they agreed upon the original terms at a time when Iraq’s position was very weak – perhaps even the worst among the OPEC countries – the deal is no longer in Iraq’s benefit.

The second pillar is the “American factor”. While it is still premature to make far-reaching forecasts, based on the most recent developments it appears that Washington is unlikely to dramatically change its course on relations with Beijing, which the new administration views as the U.S.’s main geopolitical competitor. Most likely, Iraq – given its security-related problems and the role of the U.S. in its national security (both current and prospective) – would not want to opt for full cooperation with China, thereby alienating the U.S. This primarily stems from the fact that China will not give any assistance to Iraq in solving its security-related problems. Conversely, many Chinese experts felt ill at ease with expanding economic cooperation with Baghdad because of grave security challenges that the country faces. As Ji Kaiyun, head of the Iraqi Research Centre at Southwest China University, notes, “companies with Chinese capital have found it difficult to operate in some parts of the territory and some contracts that had been closed earlier between the two countries have not been honoured because of the power void.”

The third and final pillar is the “Russian factor”. For decades (since the 1970s), Russia has had strategic interests in Iraq’s oil sector. Now, with Russia’s economy in bad shape – due to western economic sanctions, the impact of COVID-19, and instability in the global oil market – the Kremlin’s strategic objective is to increase its oil exports to China. At the moment, these exports are not maximized. While China has indeed increased import of oil by 7.3 percent (to a record 10.85 million barrels per day), Russia has found itself occupying second position (after Saudi Arabia) – even though its exports to China in 2020 stood for 83.57 million barrel (7.6 percent more than in 2019) – while Iraq occupied third place and its export rose by 16.1 percent (60.12 million barrel).

In practice, these developments mean that Iraq’s role in China’s energy security has been increasing, which Russia sees as a challenging factor. Moreover, the Russian side is concerned with China’s plans to set up crude oil storage facilities to process Iraqi oil as part of a plan to boost oil sales to Asia. That said, Iraq has no desire to sour its relations with Russia. First off, according to the Russian Ministry of Defence (MOD), since 2019 Iraq has been expressing keen interest in products of the Russian Defense Industrial Complex, becoming an emerging buyer of Russia’s arms. Secondly, Russia’s largest companies such as Lukoil and Rosneft are tightly embroiled in Iraq’s oil industry.

For China, the setback over Iraq’s decision to walk away from the oil deal will become a nuisance, not a catastrophe. This is stipulated by a number of interdependent factors. On the one hand, China has already gained solid presence in Iraq’s oil industry, and this presence is unlikely to weaken. At the same time, given the number of producers eager to supply oil to China, including Russia, Beijing will not experience shortages of supply. Moreover, Iraq’s decision does not necessarily mean that Beijing will depart from its course on further increasing its presence in Iraq. Ultimately, much will depend on the course of the new U.S. administration, the overall milieu in the region, and changes in oil prices.

Dr. Sergey Sukhankin is a Fellow at the Jamestown Foundation, and an Advisor at Gulf State Analytics (Washington, D.C.). He received his PhD from the Autonomous University of Barcelona.

The views and opinions expressed in this article are those of the authors and do not necessarily reflect the views of Gulf International Forum.