The Next Frontier Could Be in Iraq

Emerging markets are where the money is now, but the wild “frontier” markets are where the really big money will be next. Think of the blue-chip emerging markets, like Brazil and China, 20 years ago, when they were seen as too unstable for a sane investor to even consider. Now they’re foundations of every institutional portfolio. It’s usually a good sign that a frontier market is physically dangerous. It keeps away the casual investment riffraff. If a market is already widely discussed as a future frontier, as Bangladesh or Nigeria are today, it’s already too late, because they’ve been discovered.

A fresh candidate is Iraq. It’s certainly dangerous. A friend of mine recently went there with some other maniac frontier investors. Protected by eight moonlighting Iraqi soldiers in full battle gear, the trembling investors traveled in a massive armored vehicle, escorted by pickup trucks mounted with 50-caliber machine guns, their itinerary subject to change due to car-bomb alerts. Nevertheless my friend returned enthusiastic, if frightened.

The Iraq story is simple. It is a big country by Middle East standards, with 32 million people located in the heart of the historic Fertile Crescent watered by the Tigris and Euphrates rivers. Baghdad was the intellectual and political capital of the Muslim world from the ninth to the 13th centuries. Before the Gulf wars it was perhaps the most cosmopolitan city in the Middle East, with a vibrant street life, fine museums, hospitals, hotels, and restaurants. The Iraqis have always been highly educated, capitalistic, and entrepreneurial. In 1985 the literacy rate was 100 percent (though it is probably lower now). Women are relatively liberated and broadly employed. One in five workers is in agriculture, producing wheat, barley, vegetables, and dates. Soon Iraq will become an important food exporter again.

Though all economic data out of Iraq are considered suspect, a legacy of the dodgy Saddam regime, the unemployment rate is reported to be 15 percent, and GDP last year was $112 billion, up 4.3 percent from 2008. GDP per capita is very low at $3,600, which ranks 159th in the world, but that only demonstrates the growth potential. Inflation is reported at 6.8 percent, and the central bank has successfully stabilized the price of the dinar. Demand is reviving as Iraq rebuilds. Current cement-production capacity is 4 million tons a year, and the market needs 6 million to 10 million, but peak domestic production in 1980 was 28 million.

The growth story lies in oil reserves. Officially proven reserves are at 115 billion barrels of oil and 3.17 trillion cubic meters of natural gas, but there has been virtually no exploration for a decade. Despite the 5,000 Americans who died during Operation Iraqi Freedom, it appears China has the inside track on oil exploration and development. But in 10 years Iraq is likely to be one of the top three oil and gas exporters, and almost certainly the low-cost oil producer, because tapping its fields costs as little as $3 a barrel, compared with, say, $70 in the Gulf of Mexico. International oil companies have already won bids to develop 10 million barrels a day of additional capacity, which the Oil Ministry hopes to have in place in six years. This would make Iraq the biggest producer in the world. The time frame is probably unrealistic because of the infrastructure that has yet to be built, but the basic goal is not. It’s not too much of a stretch to suggest that Iraq could be the next Saudi Arabia.

An oil boom will skyrocket the Baghdad stock exchange, for now a sleepy place with a market capitalization of just $3 billion, where groups of somewhat seedy old men sit around in rickety folding chairs. My friend suspects they are there for the wheezy air conditioning. And my source for trading intel is a weekly letter from Rabee Securities, which is long on gossip and short on real data. As best as I can tell, in a typical week, trading volume runs at about $2 million to $4 million, and foreigners execute only a few dozen trades.

Admittedly, it’s not clear Iraq will get past its internal divides to make it as a functioning country. But in the past it has always been a beneficial thing to lose a war to America. Witness Germany and Japan. And many developing countries have figured out that creating a stock market and attracting foreign capital is a fast track to national wealth. Iraq could be next.

Biggs is managing partner of Traxis Partners hedge fund in New York.