Islamic State’s bootleg petro-state may prove unsustainable

With up to $2 million in daily revenue from black market oil, the Islamic State insurgency not only holds sway over swathes of Syria and Iraq but has also begun to lay the foundations to become a small petro-state. Such is the extent of the threat posed by the network that Defense Secretary Chuck Hagel on Thursday called the group “as sophisticated and well-funded as any group that we’ve seen” and “beyond just a terrorist group.”

But even as Western military leaders ratchet up rhetoric about the Islamic State, considered to be the world's wealthiest extremist network, analysts say the fledgling petro-state is already running into problems.

Though details of the group’s oil smuggling operations are murky, the Islamic State and its Sunni allies are known to have dominion over extensive smuggling routes into Jordan, Turkey and Iran, which some experts believe have been turning a blind eye to the group's illicit tankers and makeshift pipelines. There are also unconfirmed reports of the Islamic State bribing the Syrian regime with oil to avert airstrikes — even as the group counts itself among Syria’s anti-Assad rebellion. “We’re talking about a regional black market extending from Syria to Iraq, from Jordan to the southern part of Turkey,” said Luay al-Khatteeb, director of the Iraq Energy Institute.

In contrast with similarly minded extremist groups in Libya and Nigeria, who have periodically raided oil tankers and pipelines and seriously disrupted state oil production, the Islamic State has actually coerced employees of oil facilities in Syria and Iraq to keep working, stabilizing oil production to an unprecedented degree for a non-state actor. It’s an approach that reflects the Islamic State’s emphasis on governance and self-sufficiency in land it seizes — a departure from the practices of the Al-Qaeda movement from which it drew inspiration — as well as its immediate need for cash to bankroll ambitious plans of regional expansion.

But, as is the nature of an illicit oil smuggling operation, the Islamic State's black market trade is hugely inefficient, hindered by its illegality at every leg of the production and distribution chain.

At the extraction stage, the insurgents will never be able to match maximum flow rates without the investment and expertise of private oil companies, who of course won’t want to do business with a feared extremist group. Then, once it’s out of the ground, Islamic State oil needs to be pawned off to middlemen at rates discounted by up to 75 percent, according to some estimates, because a fixed distribution network — pipelines and the like — would be easy pickings for U.S. and Iraqi missiles.

According to Richard Mallinson, a geopolitical analyst at London-based consultancy Energy Aspects, these middlemen, who vary from corrupt businessmen to more organized smuggling operations, “capture a lot of the value, offering one price to whoever controls the fields and then caging quite a high mark-up, which will still be well below the local market price.”

Finding a buyer willing to purchase oil, even indirectly, from an armed network reviled for its brutality is not easy, even if it comes with a drastically reduced price tag. According to Mallinson, “This really restricts the scale of operations. There’s always a market for smuggled oil at that low price, but not one that will simply expand and expand.”

Through a combination of smuggling crude oil and refining smaller quantities itself at its refineries in Syria, the Sunni Islamic State is still projected by some experts to pull in over $700 million in a year (though many feel that estimate is generous) if they can manage to hang on to their vast but fragile holdings. After leading an astonishing takeover of Sunni lands in Iraq in June, the Islamic State is now fighting tooth and nail to wrest control of the Baiji oil refinery, outside the IS-held city of Mosul, from Iraqi forces, which would allow the group expand refining operations into Iraq. The Kurdish-majority city of Kirkuk looms as another lucrative oil-rich target for the Islamic State.

But they have been pushed back on several fronts by U.S. air strikes, which began earlier this month, and recently U.S. military officials have begun to suggest that wider intervention in Iraq and perhaps even Syria could be on the horizon. Many suspect the caliphate could still be wiped out in its infancy.

There are further questions about just how long Iraq’s Sunnis will continue to tolerate the extremist takeover of their lands, support that has been critical to the group’s astonishing surge this summer. The Islamic State has piggybacked on popular resentment of the Shia-led Baghdad government, which among other things stands accused of failing to share Iraq’s considerable oil revenues with Sunnis and Kurds, and have thusly framed their black market operation as a means of returning oil wealth to the people.

But as Michael Knights of the Washington Institute for Near East Policy put it in an interview with Foreign Policy, in declaring their caliphate the Islamic State has “gone from being the world's richest terrorist organization to the world's poorest state,” propped up mainly by extortion and oil smuggling.

That revenue stream has become ever vulnerable as the Obama administration takes aim at the extremists. “Now that Western forces are operating more surveillance on Islamic State terrorists, I’m sure they can better identify where trucks are being filled, what routes they’re taking, what borders they’re crossing,” said Mallinson.

It is just as important to ensure that adequate supplies reach Iraqi Kurdistan, which is suffering from considerable fuel shortages due to an influx of hundreds of thousands of refugees, as well as other places where the Islamic State’s oil is smuggled. “If you have shortages, it creates an environment where black market oil proliferates," Mallinson said. "If the price is low enough, someone will always buy it.”

A more robust embargo on the oil trade in Iraq and better enforcement along Iraq’s borders are essential to stifling the illicit flow of oil and suffocating the insurgency, al-Khatteeb added. “It is stoppable, but it needs very serious measures. Regional nations really need to put their political differences aside and unite in this war on terror.”