DUBAI: A sophisticated fuel oil smuggling network that some experts believe generates at least $1 billion a year for Iran and its proxies has flourished in Iraq since Prime Minister Mohammed Shia al-Sudani took office in 2022, five sources with knowledge of the matter told Reuters.

The operation exploits a government policy under which Iraq allocates fuel oil to asphalt plants at heavily subsidised prices and involves a network of companies, groups and individuals in Iraq, Iran and Gulf states, according to the five people and three Western intelligence reports, two from August this year and one which was undated.

Under the scheme, anywhere from 500,000 to 750,000 metric tons of heavy fuel oil (HFO), including high sulphur fuel oil (HSFO) - equivalent to 3.4 million to 5 million barrels of oil - is diverted from the plants each month and exported, mostly to Asia, two of the sources said.

The extent of the fuel oil smuggling since Sudani came to power and the involvement of multiple entities within Iraq in the illicit trade have not previously been reported.

Iranian and Iraqi officials did not respond to detailed requests for comment about the findings in the Reuters story.

Iran views its neighbour and ally Iraq as an economic lung and wields considerable military, political and economic influence there through the powerful Shia militias and political parties it backs. It also sources hard currency from Iraq through exports and avoids US sanctions via its banking system, Iraqi and US officials say.

While Baghdad has been delicately balancing its role as an ally of both Washington and Tehran for years, with President-elect Donald Trump expected to take a hard line on Iran’s attempts to skirt US sanctions, its activities in neighbouring Iraq are expected to come under increasing scrutiny.

Of the two main routes the fuel oil takes out of Iraq, one involves blending it with similar product from Iran and passing it off as purely Iraqi, helping Tehran evade tough US sanctions on energy exports, said the five sources, who declined to be named due to the sensitivity of the matter.

The other involves exporting the fuel oil that was originally meant for the subsidy programme using forged documentation to mask its origins.

Iran benefits directly from the first route. Iranian fuel oil typically sells at a discount due to sanctions but it can sell it for a higher price if it is passed off as Iraqi. The second route, meanwhile, benefits the Iranian-backed militias in Iraq that control the smuggling scheme.

Three sources estimated how much both routes were bringing in based on assumptions about the volumes traded and relative prices. Their estimates ranged from $1 billion a year to over $3 billion.

The illicit trade potentially puts Iraqi institutions and officials at risk of US sanctions for helping Iran and some Iraqi officials are concerned a Trump administration could target them, the three sources said.

However, Iraqi leaders rely heavily on the support of influential Iranian-backed Shiagroups to stay in power, making it difficult for them to crack down on illicit activities, such as the fuel oil smuggling, the sources said.

Sudani’s office did not respond to requests for comment about the trade, the risk of sanctions or government attempts to curb the business.

The lucrative smuggling and its links to Iran and individuals under US sanctions are already on Washington’s radar. The subject came up in discussions between US officials and Sudani when the Iraqi prime minister visited the United States in September, one of the sources said.

Asked by Reuters whether smuggling had been raised, a State Department official said: “While we do not comment on specific discussions, we can affirm the Department has emphasized with our Iraqi counterparts the harms of illicit trade and our support for bringing oil transparently to market.”

The US Treasury did not respond to questions about the fuel oil trade or whether Iraqi entities and officials were at risk of sanctions.

US sanctions on Iran are chiefly in response to its nuclear programme and its support for groups across the Middle East that the US sees as terrorist organisations, including Hamas in Gaza, Hezbollah in Lebanon and the Houthis in Yemen.