With an economy so reliant on oil, Iraq has long faced a tough balancing act between the short-term gains that can come from ramping up production and the long-term problems that can arise from overproduction.

Last week, the Iraqi oil ministry announced that it was rectifying a swing too far in one direction when it announced that it would be curbing oil exports to 3.3 million barrels per day (bpd) after having exceeded since January a quota imposed by the OPEC+ oil cartel.

Production for March will be 130,000 bpd lower than in February, which will keep Iraq’s partners in the Organization of the Petroleum Exporting Countries (OPEC) content.

But future tensions could arise if Iraq hits any unforeseen economic hurdles and falls back on overproduction.

“The whole political economy is driven by oil,” an analyst, who asked to withhold their name due to the sensitivity of their work, told Al Jazeera.

“The budget is set by the oil price. If the price drops, they produce more.”

Reliance on oil

The Iraqi government needs to maximise the income it generates after parliament voted last year to pass a record-high budget of $153bn a year until 2025. It was presented as an investment in building Iraq’s future.

The country’s vast oil reserves played a huge role in its economy rebounding, a little over six years after victory was declared over ISIL (ISIS), which had previously taken over vast swaths of territory.

But some of the huge budget’s planned expenditure will also be spent on adding hundreds of thousands of jobs to an already bloated public sector to, according to analysts, gain the goodwill of Iraq’s 46 million-strong population, which grows by about a million people a year.

“That’s a fast rate of growth while the resources of the country are not only not growing at the same pace but actually, in some important areas, are in decline,” Sarhang Hamasaeed, director of the Middle East Program at the United States Institute for Peace (USIP), told Al Jazeera.

The Iraqi government relies on oil for more than 90 percent of its revenue. While non-oil gross domestic product (GDP) should grow in 2024, the overall economic outlook is tenuous.

In recent years, oil wealth led to growth, but the International Monetary Fund has predicted that growth would end due to OPEC-mandated production cuts and the shutdown of a pipeline between Iraq and Turkey.

Economists and analysts warn that the government’s plans rely on the price of oil remaining at $70 per barrel or above and production at 3.5 million bpd because any dips would derail the budget and cause myriad problems.

In short, they say, a series of short-term fixes could inflict long-term damage.

A decline could lead to serious economic instability, which would mean issues that have plagued the Iraqi federal government might return.

“This destabilising effect on the country has had and will have implications for vulnerability to employment or recruitment by violent extremists, terrorist organisations like al-Qaeda and ISIS, or armed groups,” Hamasaeed said.

Another potential issue is that the government is relying in its calculations on the inclusion of oil production from Iraq’s Kurdish region, governed by the Kurdistan Regional Government (KRG), which has not had a smooth relationship with Baghdad.

Tension with KRG

One of the key issues the Iraqi government needs to figure out, analysts say, is the complicated relationship with the KRG – a semi-autonomous region that remains legally beholden to the federal government.

One of the most contentious issues between the KRG and the federal government has been the management and sale of oil and gas.

“The KRG has interpreted its semi-autonomy to mean full autonomy at times, which has put it into conflict with Baghdad,” the analyst who asked that their name be withheld told Al Jazeera.

Last year’s massive budget passed in part because of a prior deal between Baghdad and Kurdish capital Erbil that gave Iraq’s federal government the power to monitor and audit the KRG’s oil and gas income.

However, even since the deal was agreed, the KRG has often circumvented the federal government and sold natural resources directly to foreign partners, leading to tension between it and Baghdad.

“Because of this, the federal government has used the national budget as a punitive measure: the constitution/law states that the KRG should get 17 percent of the national budget; the federal government has only been giving 12 percent until they can resolve the dispute on matters of oil and gas sale,” the analyst said.

At least some of the KRG and Baghdad’s disputes are over the relationship with Turkey. The International Chamber of Commerce ordered Ankara in 2023 to pay $1.5bn in damages to Baghdad after the KRG sent oil directly to Turkey from 2014 to 2018.

Since then, Iraq’s oil ministry and the Association of the Petroleum Industry of Kurdistan have traded blame over a lack of progress toward reopening the pipeline.

In mid-March, Iraq agreed to ban the Kurdistan Workers’ Party (PKK) – a group that has fought a war against the Turkish state since the 1980s, and that Turkey has targeted with a military operation inside Iraq since April 2022. The deal is part of a political negotiation in exchange for supporting an infrastructure project by Iraqi Prime Minister Mohammed Shia al-Sudani, the unnamed analyst told Al Jazeera.

“[Al-]Sudani is betting Iraq’s economic future on this infrastructure project that will employ people, benefit construction companies captured by security actors, and open a pathway into Turkey and Europe,” they said. “Turkey would back this project if Iraq bans the PKK.”

Water has also come up as a bargaining chip in exchange for oil between Turkey and Iraq, a situation where Iraq has little leverage, according to a report by USIP.

In recent decades, Turkey built a series of 22 dams, including the Ataturk Dam, the third-largest in the world. The dams have cut off much of the water into Iraq and led to serious environmental concerns.

While Turkey tends to help Baghdad in times of extreme water distress, there has been little incentive for Ankara to make wider concessions.

The Iraqi parliament has been debating a new oil and gas law for more than a decade. The main hold-ups are over the management of oil fields and distribution abroad.

The federal government has threatened oil companies working in federal areas that buying oil directly from the KRG would lead to the termination of their contracts.

Iraq is the world’s sixth-largest oil producer and OPEC’s second-largest after Saudi Arabia, producing around 4.2 million bpd over the last year, before the current drop in production.

The KRG produces around 400,000 barrels per day, according to the Middle East Institute, and “presides over at least 25 trillion cubic feet (tcf) of proven gas reserves and up to 198 tcf of largely unproven gas”, according to a report published last year by the Middle East Council on Global Affairs.

Regional differences

The dispute over oil and gas management and distribution is representative of a larger issue between the KRG and the federal government.

These two areas are increasingly different, not simply in terms of language and culture, but also in emerging class differences.

A 2017 referendum overwhelmingly backed the independence of the Kurdish region of northern Iraq, but was rejected by the central government and regional powers.

“The lack of social cohesion stems from the dual reality that people are living with,” Farah Al Shami, a senior fellow at the Arab Reform Initiative, told Al Jazeera. “Cities in the Kurdistan region are more developed and enjoy better living standards than the others.”

The disparity in living standards causes tension on the “political and sociological” levels, she said, adding that the “federal system is really undermining the role of the central government”.

There is also the widespread issue of corruption, which is endemic in Iraq. The country was ranked 154 out of 180 countries in Transparency International’s 2023 Corruption Perceptions Index. While it is less of an issue in the KRG, its institutions also suffer from corruption.

“In the past 20 years, the business of politics has become paralysed in Iraq,” Hamasaeed said. “Corruption has been the biggest barrier.”

The overreliance on oil and engrained corruption has made collaboration between the KRG and federal government difficult and has a discernible impact on the population of Iraq.

The lack of economic diversification also has a ripple effect on society, impacting not only what kind of jobs are available, but also internal migration, desires to emigrate, and much more.

Without serious political and economic reforms, any semblance of progress Iraq has made in terms of stability in recent years could give way. But it’s a long road ahead, as there are no quick fixes.

“This is not a sustainable economic reality, at all,” Al Shami said. “If there is a solution, it will definitely be in the long term.”