Via Emerging Frontiers, an updated look at Iraq:

It might seem surprising that Asia Frontier Capital recently attended an investor conference in Iraq, as news coming out of the country usually focuses on Iraq’s turbulent security situation and ongoing sectarian violence. However, instability is just one side of the story.

Crude oil production in Iraq has risen from 1.3 million barrels per day (bpd) in 2003 to an expected 3.3 million bpd this year, making Iraq now the 9th largest producer of crude oil in the world. Per capita GDP at the end of the Iraq War in 2003 was US $1,352/capita but is forecasted to hit US $6,377/capita in 2013, higher than many emerging economies. The post-war resurgence in oil production has helped build up the country’s foreign reserves, now roughly US$ 70 billion, contributing to a stable macroeconomic environment for the country despite the security issues that it faces.

Iraq has the fifth highest crude oil reserves but is the 9th largest producer (as of 2012)

2013 has witnessed an increase in violence in Iraq, which has been concentrated in and around Baghdad. Most people are not aware, however, that Iraqi Kurdistan, an autonomous region in the north, is far more stable and peaceful relative to other parts of Iraq and has experienced few security-related incidents in the past five years.

Iraqi Kurdistan, located in the north-eastern part of Iraq, is recognized by the Iraqi constitution as an autonomous region with its own elected government. Though there are a number of competing political parties in Kurdistan, there appears to be consensus when it comes to maintaining stability in the region, as Kurdistan possesses much of Iraq’s oil and gas reserves. This focus on stability is one reason why many foreign oil and gas companies have established operations in Kurdistan. Erbil, the capital, has seen a fair amount of development as many foreign companies have set up offices in the city. There are plans to launch the Erbil Stock Exchange next year, which would likely lead to heightened investor interest in Iraq and Iraqi Kurdistan going forward.

Erbil is well connected to the rest of the Middle East and parts of Europe, with flights to Doha, Dubai, Istanbul, Vienna, and Frankfurt. Foreign investor interest in Kurdistan has led to the development of various five star hotels in Erbil, but supply seems limited as room rates are still quite high (US$200-250 a night). I did notice a Hilton hotel under construction close to where I was staying.Despite all the issues and concerns surrounding security, it was a good sign to see that the conference was very well attended by various foreign institutional investors focusing on frontier markets. The companies that attended were a diverse mix from the banking, telecom, and non-financial sectors. The Iraqi ISX index is skewed towards banks and telecom, as these sectors make up about 90% of the stock market capitalization due to the large market cap of the telecom giant Asiacell Communication (the Iraqi business of Ooredoo Telecom of Qatar). Going forward, Kuwait-based Zain Telecom plans to list their Iraq business in 2014.

On a macro front, the under-penetration of private banks in Iraq was striking. At present, the banking industry in Iraq is dominated by state-run banks, namely Rashid Bank and Rafidan Bank. Private banks make up just 9% of total banking assets! The primary reasons for this are that the Iraqi economy is still dominated by the state and that private banks are not on a level playing field, as they cannot lend to state institutions. Any change in these regulations would make private banks a good way to play the Iraq story, as credit to the private sector is estimated to be about 15% of GDP, much lower than in the region and also globally. If the private banks are able to increase their penetration into the economy, we could possibly see an improvement in RoEs as most private banks are not heavily levered leading to lower RoEs for the industry.

In the non-banking sector, an interesting company to keep track of is Baghdad Soft Drinks. The company has the right to produce and distribute PepsiCo products in Iraq and its current product line consists of Pepsi, 7up and Mirinda. Unfortunately, the company did not attend the conference. Sales for the company have increased by almost 3x between 2008-2012 to reach US$ 182 million. For the first 9 months of 2013, the company achieved sales of US$ 160 million. Net income has grown from a loss in 2008 to US $14 million in 2012 and US $16 million in the first nine months of 2013. Though profit has grown, margins at times have been inconsistent, but that is not surprising given the environment it operates in.

On the last evening of my stay a group of us went into town to check out the historic “Erbil Citadel Town” which is a UN World Heritage Site. The citadel town is regarded as the oldest continuously inhabited settlement in the world and is believed to have been in existence for around 7,000 years. Pretty historic! We took a cab from outside the hotel and because one of our group members spoke Arabic, communication was not an issue. Getting out of the hotel was a good way to get a feel of the Erbil way of life. The area next to the citadel was bustling – it seemed to be a meeting point for the local population.

The area outside the citadel has been developed with parks and water fountains and is also lined with various shops and restaurants, making it the preferred hang-out place for locals. I did notice a few security officers walking around with AK-47s, which didn’t surprise me, but the security situation seemed relatively calm. Unfortunately, the citadel was closed to public viewing at that time of the day so hopefully I can check it out from the inside next time!

Though there are some sticky issues between the Kurdish and Central Iraqi governments with respect to oil and gas contracts, the development of Iraqi Kurdistan provides the country with a solid platform to fulfill its potential. Hopefully, oil revenues will help Iraq emulate its peers in the region with respect to economic development. I look forward to returning to Iraqi Kurdistan next year to witness the developments the various companies have made!