US threatens to starve Iraq of its oil dollars over Iranian influence: sources

Highlights:

• US pushes Iraqi politicians to steer clear of armed groups in new gov't, sources say
• Iraq told to exclude Iran-linked MPs from cabinet
• US controls Iraq's oil revenue dollars via Federal Reserve Bank

Washington has threatened senior Iraqi politicians with sanctions targeting the Iraqi state - including potentially its critical oil revenues - should armed groups backed by Iran be included in the next government, four sources told Reuters.

The warning is the starkest example yet of US President Donald Trump's campaign to curb Iran-linked groups' influence in Iraq, which has long walked a tightrope between its two closest allies, Washington and Tehran.

The US warning was delivered repeatedly over the past two months by the US Charge d'Affaires in Baghdad, Joshua Harris, in conversations with Iraqi officials and influential Shi'ite leaders, according to three Iraqi officials and one source familiar with the matter who spoke to Reuters for this story. The message was delivered to some heads of Iran-linked groups via intermediaries, they said.

Harris and the embassy did not respond to requests for comment. The sources requested anonymity to discuss private discussions.

Since taking office a year ago, Trump has acted to weaken the Iranian government, including via its neighbour Iraq.

Iran views Iraq as vital for keeping its economy afloat amidst sanctions and long used Baghdad's banking system to skirt the restrictions, US and Iraqi officials have said. Successive US administrations have sought to choke that dollar stream, placing sanctions on more than a dozen Iraqi banks in recent years in an effort to do so.

But Washington has never curtailed the flow of dollars from the oil revenues of Iraq, a top OPEC producer, sent via the Federal Reserve Bank of New York to the Central Bank of Iraq. The US has had de facto control over Iraq's oil revenue since it invaded the country in 2003.

Iraqi Prime Minister Mohammed Shia al-Sudani's office, the Central Bank of Iraq and Iran's mission at the UN did not respond to requests for comment.

"The United States supports Iraqi sovereignty, and the sovereignty of every country in the region. That leaves absolutely no role for Iran-backed militias that pursue malign interests, cause sectarian division, and spread terrorism across the region," a US State Department spokesperson told Reuters, in response to a request for comment.

The spokesperson did not answer Reuters questions about the sanction threats.

Trump, who bombed Iran's nuclear facilities in June, threatened to again intervene militarily in the country during protests last week.

No armed groups in new government

Among the senior politicians to whom Harris' message was passed were Prime Minister Sudani, Shi'ite politicians Ammar Hakim and Hadi Al Ameri, and Kurdish leader Masrour Barzani, three of the sources said.

The conversations with Harris started after Iraq held elections in 11 November in which Sudani's political bloc won the single-largest bloc of seats but in which Iran-backed militias also made gains, the sources said.

The message centered on 58 members of parliament viewed by the US as linked to Iran, all the sources said.

"The American line was basically that they would suspend engagement with the new government should any of those 58 MPs be represented in cabinet," one of the Iraqi officials said. The formation of a new cabinet could still be months away due to wrangling to build a majority.

When asked to elaborate "they said it meant they wouldn't deal with that government and would suspend dollar transfers," the official said.

The US has had de facto control over oil revenue dollars from Iraq, a top OPEC producer, since it invaded the country in 2003.

Iran has long supported an array of armed factions in Iraq. In recent years, several have entered the political arena, standing for election and winning seats as they seek a slice of Iraq's oil wealth.

Renad Mansour, director of the Iraq Initiative at London's Chatham House think tank, said armed groups were increasingly benefiting from positions in Iraq's massive bureaucracy and so took the threat of cutting dollar flows seriously.

"The US has significant leverage," he said. "The threat of the loss of access to US dollars, which is how Iraq's economy functions through the sale of oil, has made it very concerning."

Washington opposes first deputy speaker

One of the people Washington objects to is Adnan Faihan, a member of the powerful, Iran-backed political and armed group Asaib Ahl al-Haq (AAH), who was elected first deputy speaker of parliament in late 12 December, the Iraqi official and the source with knowledge of the matter said.

They said the US opposed Faihan's appointment to the post.

In a sign the pressure campaign was working, AAH leader Qais al-Khazali communicated a willingness to the Americans to remove Faihan as deputy speaker, the Iraqi official said. Faihan currently remains in his position.

The AAH media office and Faihan did not immediately respond to a request for comment.

In the last government, AAH held the education ministry, and Iraqi officials say it is seeking to participate in the next government too.

AAH was a key group in a sophisticated oil smuggling network generating at least a $1 billion a year for Iran and its proxies in Iraq, sources previously told Reuters.

Khazali was sanctioned by Washington in 2019 for AAH's alleged role in serious human rights abuses, related to the killing of protesters in Iraq that year and other violence, including a 2007 attack that killed five US soldiers. At the time, he dismissed the sanctions as unserious.

Dollar control

Iraq holds the bulk of proceeds from its oil export sales at a Central Bank of Iraq account at the Federal Reserve Bank of New York.

Though it is a sovereign account of the Iraqi state, the arrangement gives the US practical control over a critical choke point of Iraqi state revenues, making Baghdad reliant on Washington's goodwill.

"US efforts to achieve stability in the region are focused on ensuring states retain their sovereignty and can achieve security through mutual economic prosperity," the State Department spokesperson said in their reply to Reuters questions.

The move to pressure Baghdad with a possible suspension of dollars takes place as the US begins marketing Venezuelan oil, which followed the capture of Venezuelan leader Nicolas Maduro in Caracas by US forces and his transfer to New York to be put on trial in relation to drug charges.

The US Department of Energy has said all proceeds from Venezuelan oil sales would be initially settled in US-controlled accounts at globally recognized banks.