The Islamic State’s Oil Industry Is a Pipe Dream

The analysis “The Islamic State Oil Industry Is a Pipe Dream” has been initially published by Oilpro, a professional network for the oil and gas professionals.

July 3, 2016

CALGARY, Canada — While I am writing this analysis, we have still to metabolize the great sadness related to the two terrorist attacks that have occurred in the last few days. The first one at the Ataturk International Airport in Istanbul, Turkey, where more than 40 people were killed. The second one at an upscale restaurant in the diplomatic quarter of Dhaka, Bangladesh, where 20 people were killed. It’s indeed another very gloomy page of the endless terrorist attacks against civilians. These horrible attacks against innocent people are very difficult to intercept and to stop. Reality and rationality tell us that we have to live with the possible remote (per single person) occurrence of such events. Logic and probability would dictate to us that we should rationally worry more the possibility of dying of several diseases than about the possibility of being killed by a terrorist attack — but it’s not easy to be calm and rational when terrorist events occur. For sure, introducing a police state will not be a solution; introducing a lot of restrictions would enormously limit our way of living. And, living under a police state would be a victory for the terrorists of every kind.

The basis for this analysis is primarily based on a conversation I had some months ago, precisely a few days before the attacks in Paris, with a U.K. film director interested in the current developments in Syria and Iraq, i.e., the emergence of the Islamic State, a.k.a. ISIS or ISIL. The director wanted to have my opinion about the economic strength of the Islamic State; he was very well informed about the current war developments in Syria and Iraq. But, like many other researchers and journalists, he had a sort of “worried excitement” in relation to the Islamic State. I told him that I was expecting other terrorist attacks across the globe — a few days later occurred the Parisian attacks — but that with reference to the economic power of the Islamic State I was quite skeptical at least as for the possibility of establishing a real and functioning state in the areas under the Islamic State’s control. After some months, I am still deeply convinced that at the economic level the Islamic State does not have good prospects. Let’s see why.

In Iraq, the effective territorial prominence of the Islamic State started in early 2014, when during its western Iraq offensive, a.k.a. as the Anbar offensive, the Islamic State was able to push Iraq’s government forces out of key Iraqi cities. After that offensive, on June 10, 2014, the group captured Mosul, a city home to 2.5 million people and a relevant center for crude oil production located in northern Iraq. In Syria, during the Syrian Civil War, in 2013, the city of Al Raqqah was captured by the Islamic State, which in 2014 made this city its headquarters in Syria. Raqqah is the de facto capital of the territory under Islamic State’s control in Iraq and Syria. In brief, the Islamic State currently controls a vast area straddling between eastern Syria and western Iraq. In specific, the Islamic State controls vast areas of the following governorates:

• in Syria: Aleppo, Al Raqqah, Deir ez-Zour, Homs, and Rif Dimashq

• in Iraq: Al Anbar, Saladin, Kirkuk and Nineveh

Theoretically, approximately 10 million people should live in the Islamic State-controlled territory in Iraq and Syria — exactly twice as much the population of the Kurdistan Regional Government (the K.R.G.), which according to K.R.G. cabinet sources stands at 10.2 million people. It’s important to understand that both in Iraq and Syria there are large swaths of territory where, although it does not have direct control, the Islamic State is completely free to operate. According to U.N. reports, 4.8 million Syrians have been forced to flee abroad, primarily to Turkey (2.7 million) and Lebanon (registered 1 million but the refugees are probably 1.5 million exerting a huge impact on the already not brilliant Lebanese economy). In Iraq, still according to U.N. data, there should be more than 3 million people who are now internally displaced.

Since its apogee in the summer of 2014, the Islamic State has lost around 40 percent of its territory in Iraq and 10 to 20 percent of its territory in Syria. According to the latest U.S. intelligence estimates, the present number of Islamic State recruits is put at 25,000; indeed, there has been a consistent decline in the number of recruits over the previous months, although in light of the contingent situation in both Iraq and Syria, these statistics are not a 100 percent reliable. A total of 25,000 Islamic State fighters have been killed by the U.S.-led airstrikes in the region. But, unless Western countries decide to scale up their intervention, with all the unknown possible outcomes that may derive from a Western presence on the ground, reconquering the lost cities in Iraq is a very lengthy process. For instance, Ramadi, in Iraq, was reconquered by Iraq’s government forces only after an offensive that lasted several months. In Syria, where getting some sense of the civil war, an ongoing multi-sided armed conflict with international interventions, is even more complicated, trying to stabilize the country is right now almost an impossible task.

Is the Islamic State Rich? It Depends From What It Means to Be Rich  

It goes by itself that the Islamic State needs money in order to:

• fight in Iraq and Syria

• manage the territory it controls in Iraq and Syria

• conduct terrorist attacks in other countries

The difference between the Islamic State and some other terrorist groups is that it controls a vast territory. And from this territory, it derives several revenue channels. It is on a grand scale a replica of what happens in some cities across the globe (for instance, Caracas, San Pedro Sula, San Salvador) where the police do not dare to enter some neighborhoods because it would be outgunned — in other words in these cities as well as in the Islamic State-controlled territory the official rule of law is not applied. Having a precise estimate of the Islamic State’s revenues is not easy because these local revenue channels may vary consistently from month to month. At the time of this writing, three are the most important sources of revenue: taxes and property confiscation (together around 50 percent), and the sale of crude oil (43 percent). The latter was initially the most important of the Islamic State’s revenues. Other sources of financing are the sale of antiquities, drug smuggling, banks reserves, ransom for hostages, and donations. When the Islamic State conquered Mosul, it found something like half billion dollars in the Mosul branch of Iraq’s Central Bank, but of course this was a one-time revenue source.

According to the Rand Corporation, a U.S. policy think tank, in late 2008 and early 2009, the Islamic State earned around $1 million per day, while in 2014 it was able to collect an amount ranging from $1 million to $3 million per day. So, assuming that the Islamic State is able to collect $3 million per day, this is equivalent to $90 million per month (best case scenario for the terrorist group). But, these estimates are too optimistic. In fact, I.H.S., a consultancy, reported that as of March 2016, the Islamic State’s revenue per month experienced a 30 percent decrease to $56 million from a value of $80 million per month in mid-2015.

These numbers tell us one main thing: $56 million per month, but it would be the same if the Islamic State still collected $90 million, is a high amount of money in order to carry out terrorist operations around the world, but it is absolutely insufficient in order to run a territory that the Islamic State would like to transform into a fully fledged country. Managing a territory is a much more complex and expensive task. For instance, the K.R.G.’s population is practically half the Islamic State’s population. And, the Kurdish government estimates that to manage the K.R.G., an autonomous province within Iraq, it needs $850 million to $1 billion per month, which should be equivalent to the 17 percent of the federal budget. The Iraqi Constitution assigns 17 percent of the federal budget to the K.R.G. Today, between Erbil and Baghdad there is again a strong confrontation as for the distribution of the revenue obtained from selling the K.R.G.’s and Iraq proper’s oil via the Kurdish pipeline — in March 2016, Iraq’s central government decided to stop its oil exports via the Kurdish pipeline system (more details below) because of disagreements with the K.R.G. on oil revenues. In both the K.R.G. and Iraq proper, under the current strained circumstances (a war against the Islamic State, low oil prices, and 3 million of internally displaced people), it’s quite improbable that the budget may permit Baghdad to transfer $1 billion a month to Erbil, but at least it gives us an idea of the financial burden required to run a country of 5.2 million people in that area of the Middle East — although it’s true that geography of the K.R.G and that of the Islamic State territory is quite different (mountain vs. desert plain). The fact that, in 2015, the Islamic State approved a budget of $2 billion confirms that its revenues are not comparable to the revenues of a standard country.

So the real question is whether the Islamic State has abundant economic resources to at least barely run a territory spanning between Iraq and Syria. And the answer is no. The economic means that it has right now at its disposal are absolutely not sufficient. Resorting to terrorism — although a constant in Iraq’s life after the fall of Saddam Hussein — is a manifestation of a weak position versus adversaries more powerful; adversaries who cannot be won in an open political confrontation or in a fight according to international humanitarian law (I.H.L.), a.k.a., jus in bello.        

In addition to these economic considerations, after the immediate fall of Saddam Hussein and during the years of Nouri Al Maliki’s government (2006-14), the Islamic State partially found fertile ground in Iraq thanks to the disenfranchisement of the Iraqi Sunni population, around 35 percent of Iraq’s population — an important caveat: some Sunni groups helped the invasion of Iraq by the Western powers, but later they were never rewarded for their help by the new Iraqi administration. Instead, during Saddam Hussein’s period, Sunnis were the majority of the Ba’athist government and enjoyed a special treatment. In brief, today the economic conditions of most Sunnis in Iraq are at the root of their support for the Islamic State. In fact, apart from some areas in Baghdad and the city of Mosul, most of Iraq’s Sunnis are farmers, who have been hit hard by the poor harvests and food shortages of the last years — in Iraq, after 2003, agricultural productivity declined by 90 percent. In other words, poverty and political marginalization pushed many Sunnis toward the Islamic State. In the Middle East, the identitarian affiliation has always been a very powerful political tool. Especially when life is harsh and the future is bleak, the normal behavior is to more tightly embrace one’s identitarian affiliation, no matter whether the basic ideology is not supported a 100 percent. This is exactly what happened between the disenfranchised Sunnis and the Islamic State ideology.

The Islamic State and the Sale of Crude Oil

As mentioned above, the Islamic State obtains half of its revenues from taxation and confiscation in the territory it controls. It’s evident that the wider territory it controls and the more people live in that territory, the higher are the rents for the Islamic State. Over the last year the Islamic State has lost ground in both Iraq and Syria, so it has now a reduced taxable base. Despite the importance of taxation and confiscation, I would like to develop some considerations on the relation between the Islamic State and the sale of crude oil. The reason behind this choice is that last fall during my conversation with the film director a lot of attention was given to the flow of revenues the Islamic State obtains from crude oil sales — in addition to this, I am a petroleum consultant (legal and fiscal issues), while I do not know much about selling antiquities, smuggling drugs and so on.

A petro-state is a country that depends on petroleum for:

• 50 percent or more of export revenues

• 25 percent or more of G.D.P.

• 25 percent or more of government revenues

Under this definition, the Islamic State may well be defined as a petro-state. Putting aside considerations about whether it’s good for a country to be a petro-state (also the well managed Norway is a petro-state), the real issue is that the Islamic State is a “very poor” petro-state. In other words, its petroleum revenue is insufficient to administer the territory it controls. Revenues are insufficient today, when the Islamic State approximately produces 21,000 bbl/d, and were insufficient in 2014 and 2015 when its production was higher — in August 2014, before the beginning of the U.S. airstrikes production hovered around 70,000 bbl/d.

For the petroleum industry, the advance of the Islamic State has created a lot of economic damage, especially in Iraq — Syria is today a minor oil producer at the world level. Luckily the Islamic State has completely been unable to reach two out three of Iraq’s main oil-producing areas, i.e., southern Iraq and the K.R.G. The third area, Kirkuk Province, sees the presence of both Kurdish forces and Islamic State forces, but the most important oil fields, technically still under federal jurisdiction, are under Kurdish control. As a result of the presence of the Islamic State in central and western Iraq, the Kirkuk-Ceyhan pipeline has in operation only the section related to the Turkish part from Fishkhabur (Iraq-Turkey border) to the port city of Ceyhan in Turkey. The Iraqi section of the Kirkuk-Ceyhan pipeline (from Kirkuk to Fishkhabur) has been out of service since March 2014 as a consequence of repeated militant attacks. In fact, this pipeline runs through Islamic State-controlled territory. So, since May 2014, the K.R.G. has been exporting its crude oil to Turkey via its new Kurdish pipeline system, which is connected to the Turkish section of the Kirkuk-Ceyhan pipeline. This new Kurdish pipeline system was then expanded from Khurmala to the Avana dome in the Kirkuk area with the express goal of facilitating export from the Makhmour, Avana and Kirkuk area fields. In fact, these fields had been unable to export since March 2014 because the standard Kirkuk-Ceyhan pipeline had been damaged by the Islamic State.

In the territory the Islamic State has conquered in both Iraq and Syria, it has the control of practically all the oil fields and the related infrastructure, but it may use them only in a very limited way. In fact, since August 2014, the U.S.-led airstrikes have consistently reduced oil extraction inflicting a lot of damages to the oil industry. In specific, Operation Tidal Wave II, a U.S.-led military operation that started at the end of October 2015, targeted oil transport, refining and distribution facilities and infrastructure under the Islamic State control. According to the U.S. forces, in just two months, Operation Tidal Way II destroyed 90 percent of the Islamic State’s oil production. In addition to this, the Islamic State has also to face the difficulty of substituting aging as well as broken infrastructure. Similarly, it is not easy to find engineers and technicians able to operate the oil fields — the call for recruiting these types of professionals started immediately during the advance of the spring/summer of 2014. The way the group managed the Baiji refinery, which is 130 miles north of Baghdad, well testifies to these difficulties. The refinery had a capacity of 170,000 bbl/d and supplied petroleum products for northern Iraq. After the Islamic State captured the refinery in June 2014, the refinery started to produce only a fraction of its rated capacity because of lack of personnel and oil supply — Iraqi forces retook the refinery five months later.

As mentioned above, the Islamic State is experiencing a reduction in its overall oil production. It’s currently producing around 21,000 bbl/d. It’s quite evident that in order to move this oil the Islamic State has to use exclusively trucks. But shipping oil by truck is an expensive means, especially when oil prices are low. Tank trucks are described by their size or volume capacity. Large trucks typically have a capacity ranging from 20,800 liters to 43,900 liters. The present capacity of the Islamic State could be moved with as many as 76 43,900-liter tank trucks.

Furthermore, in light of its illegality, this oil has necessarily to sell at a discount. As a means of comparison, last year when prices averaged $52 a barrel, the K.R.G. was able to cash in $36 a barrel, while in February 2016, when Brent was $32 a barrel, the K.R.G. cashed in $20 a barrel. Of course, although in Baghdad someone might dissent on this point, for a potential buyer one thing is to buy from the K.R.G. and one completely different thing is to buy from a terrorist organization. In other words, the oil of the Islamic State should be consistently sold at an important discount in comparison to Brent. Reliable data are not available, but it has been reported that the Islamic State’s oil from Syria sold at as little as $18 per barrel when Brent sold at $107 per barrel.

In brief, part of the Islamic State’s oil is sold on the black market along the very much permeable borders between the Islamic State and the neighboring countries. The Islamic State primarily refines oil in small rudimentary mobile refineries having a capacity of 300 to 500 barrels per day. Also this refined oil is shipped to Turkey via truck, although some of this oil has been sold to the Syrian regime — pecunia non olet. Refining has always been a problem for the Islamic State because by October 2014, 50 percent of its refining capacity had been destroyed by the U.S.-led airstrikes. Moreover, in both Iraq and Syria, the Islamic State gets profits as well from selling oil to its captive markets at a price higher than the one obtained when exporting oil abroad. And in Iraq and Syria, people desperately need oil for their daily activities; in many areas diesel generators are essential because otherwise there would be no electricity. 

Conclusion

When assessing the Islamic State, the most important first step is to decide whether to consider it a state or a terrorist organization. If the Islamic State is state, it is indeed a poor and dysfunctional state. It may control a territory straddling between eastern Syria and western Iraq, but it will always be difficult for this hybrid state to consolidate its position. A state in order to thrive needs a functioning economy, which is something that the Islamic State completely lacks. Instead, its economy is a looting economy, i.e., an economy based on the indiscriminate taking of goods by force as part of its military victories. Continuing with looting activities (the present futile taxations based on the Islamic State-imposed new norms are nothing more than disguised looting) after several months is a clear sign that the Islamic State will never succeed in establishing a normal state. Instead, if the Islamic State is a terrorist organization, it is indeed a very rich organization in relation to its terrorist activities. Indeed, it’s an organization that has the economic capabilities of committing atrocities in several countries. Especially now, in light of the recent difficulties in the Iraqi theater, it is highly probable that Islamic State terrorists will continue to export to other countries the present Iraqi-Syrian mess. The oil business is a very complex and complicated business, so, since the beginning of its territorial expansion, it was out of question that the Islamic State, a terrorist organization, could have continued developing Iraq’s and Syria’s petroleum sector — this idea was already even more clear after the beginning of the U.S.-led airstrikes. In other words, from an economic point of view, the Islamic State may implement only one technique: pillaging.