Iraq Bond Investors Keeping Eyes on Barrels Per Day: Arab Credit

As Iraq’s troops battle Islamic State to retake Tikrit and the government grapples with a squeeze on revenue, a surge in oil production is helping the nation’s bonds stage their best rally since December.

Output increased to a record 3.7 million barrels a day in December, as OPEC’s second-biggest producer seeks to offset the effect of a nine-month slump in crude prices. The yield on the nation’s bonds due in January 2028 fell for the past seven days, the longest streak for more than two months, data compiled by Bloomberg show. It was trading at 7.62 percent on Wednesday.

The war against the al-Qaeda breakaway group since June has battered Iraq’s non-oil economy and, along with the slump in crude prices, will widen the budget deficit this year, according to the International Monetary Fund. Jabbar al-Abadi, a member of parliament’s finance committee, said in an interview this week that the government is struggling to find the money to pay salaries and rebuild homes destroyed in the fighting.

“The arrival of ISIS caused a big drop in the price but the bond slowly recovered,” Anthony Simond, London-based analyst for emerging-market debt at Aberdeen Asset Management Plc, said by e-mail March 3. The surge in oil production “shows that ISIS hasn’t had a major effect” on the industry, he said.

Hydrocarbon Industries

Oil exports are Iraq’s biggest source of revenue. Gross domestic product from hydrocarbon industries will probably expand 5.7 percent this year, the second-fastest pace among Middle East producers, the IMF estimates show. Production was about 3.5 million barrels a day in February.

The cost of insuring Iraq’s dollar-denominated debt against default tumbled 41 basis points, or 0.41 percentage point, in the last two weeks to 334, according to data compiled by Bloomberg. That compares with 374 basis points for Lebanon, an oil importer whose economy has been hurt by the civil war in neighboring Syria.

The gains come as Iraq’s budget is hit by the war and oil-price slump. The IMF expects the deficit to widen to 6.1 percent of gross domestic product from 4.9 percent in 2014. Gross external debt is expected to increase to 58 percent of GDP from 48 percent last year, according to HSBC Holdings Plc estimates.

‘Significant Blow’

“They need an oil price of above $100 a barrel to balance their budget,” Razan Nasser, a senior Middle East economist at HSBC in Dubai, said by phone Tuesday. “The issue is that on the expenditure side they’re quite limited in the extent to which they can cut spending given their security issues, their reconstruction and rebuilding needs.”

Brent crude traded at about $60 a barrel on Wednesday, and has risen 4 percent this year, paring a slide of almost 50 percent in the second half of 2014.

The government owes international oil companies $9 billion for 2014, Oil Minister Adel Abdul Mahdi said March 2. The government “is definitely heading to borrow money,” said Abadi, the lawmaker. The central bank said on Jan. 27 it plans to re-purchase Treasury bills from the secondary market and will help finance the budget deficit.

Iraqi bonds are still attractive to investors, in part because Islamic State’s advance has been halted, said Raza Agha, chief Middle East and Africa economist at VTB Capital Plc.

The bonds also offer better yields than other junk-rated oil producers in the region, he said by e-mail Wednesday. Nigeria’s bonds due 2023 yield about 6.65 percent.

“If you are going to have any exposure to an oil credit via traded external debt, why not earn the yield as well?” Agha said.

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