* Oil has provided millions of dollars for militant operations
* Officials say smuggling in Iraq down 90 pct since 2014 peak
* Air strikes, ground advances recovered most northern oilfields
By Ahmed Rasheed
BAGHDAD, July 28 (Reuters) - Islamic State, pushed off more than half the Iraqi territory it seized in 2014, has suffered a near collapse in revenue from oil smuggling, officials say, forcing it to cut fighters' pay, levy new taxes and raise fines for breaking its religious code.
The jihadist group has lost control of a series of oil fields, and is having to sell what production that remains at steep discounts to persuade truck drivers to collect it and run the gauntlet of U.S.-led air strikes.
Alongside taxes, ransoms and antiquities trading, oil has been a major fundraiser for Islamic State operations. At one point it made millions of dollars a month in sales to neighbouring Syria and Iran, or to makeshift local refineries.
However, advances by Iraqi government and Kurdish forces plus Shi'ite Muslim militias have left the militants with partial access to just two of the five Iraqi oilfields they once controlled. This has cut smuggling by at least 90 percent, according to security and municipal officials.
Islamic State - known in Arabic by its opponents as Daesh - used to sell at least 50 tanker truckloads a day from Qayara and Najma oilfields, south of the group's Mosul stronghold. This crude was mostly shipped to Syria to barter for automobile fuel, said Mosul provincial councilman Abdul Rahman al-Wagga, who moved to the Kurdish capital Erbil after the fall of Mosul.
"Now with Iraqi forces getting closer and stepping up air strikes, Daesh can hardly sell five small tankers," he said.
Precise figures on how much Islamic State raises from oil are hard to come by. Luay Al-Khatteeb, executive director of the Iraq Energy Institute who has done extensive research into Islamic State's oil smuggling, said revenues fluctuated even during their peak in the second half of 2014 when "on its best days" the group made nearly $700,000 a day from Iraqi fields.
In May, the United States estimated its revenue had been roughly halved to $250 million a year from the territory it controls in Iraq and Syria. While the militants have suffered further losses since then in Iraq, they still control several oil fields in eastern Syria, where U.S.-backed rebels have had less success in ejecting them.
LURING LOCAL TRADERS
Islamic State took the Iraqi oilfields, with a total capacity of nearly 60,000 barrels per day (bpd), when they swept through the north and west two years ago. This prompted the air strikes from the U.S.-led coalition which have targeted financial infrastructure as well as fighters and leaders.
The group has been losing production for some time. Kurdish peshmerga forces took the Ain Zala oilfield, northwest of Mosul, in late 2014.
Khatteeb's estimates are at the conservative end of the range. Security officials and an oil ministry adviser say Islamic State's revenue fell by $1 million a day in April 2015 alone when it lost the Ajil and Himreen oilfields near the city of Tikrit, which lies about 150 km (95 miles) north of Baghdad.
Now Iraqi forces pushing towards Mosul for a planned year-end offensive are close enough to Qayara and Najma fields, about 60 km (40 miles) south of the city, to reduce their operations substantially, said security and local officials.
The danger smugglers face from coalition air strikes to collect the oil has forced Islamic State to slash prices.
"Daesh is luring local traders in Mosul to buy its crude from Qayara and Najma by cutting the price from $6,000 per tanker to just $2,000," said Wagga.
An oil ministry spokesman said the militants have been using primitive mechanisms such as water irrigation pumps to extract oil from these fields.
Most of Iraq's oilfields, which provide nearly all government revenues, are in the south far from Islamic State areas of control.
Qayara and Najma were once operated by Angolan state energy group Sonangol, which pulled out in 2013 due to rising development costs and security concerns.
Qayara, with estimated reserves of 800 million barrels, had been producing 7,000 bpd of heavy crude before Islamic State seized the field and a nearby refinery with a 16,000 bpd capacity. The refinery and a smaller plant at Kasak, northwest of Mosul, stopped operating when staff fled the takeover.
Najma, mainly a gas field, used to produce around 5,000 bpd.
Advances this month have helped Iraqi forces to control Qayara airbase, which they will use for an assault on Mosul that could start within months. The gains include nearby areas adjacent to the Qayara and Najma fields.
"We have destroyed almost all facilities and storage depots used by Daesh to smuggle oil in areas near Mosul," said Sabah al-Numan, spokesman for Iraq's counterterrorism service which led the latest advances.
"We obtained all the coordinates from the Oil Ministry and air strikes have pursued every single oil smuggling truck," he said, estimating the bombardment had helped to cut smuggling by 95 percent.
PAY CUTS, SHAVING FINES
The loss of oil revenues has forced the militants to cut salaries by a third, said Muthana Jbara, a senior security official in Salahuddin province where Ajil and Himreen are located, citing sources in Islamic State-held areas.
They have also imposed more taxes on farmers, truckers and traders and increased fines for minor violations of religious bans on smoking and shaving beards, he said.
Abu Abdulla, a Mosul-based shipper, said most traders stopped buying crude from Islamic State after hundreds of trucks were destroyed by air strikes over the last six months or so.
"At least 100 drivers were killed trying to smuggle crude into Syria. Drivers are refusing to go because the smuggling route between Mosul and Syria has became a death trap," Abu Abdulla told Reuters in an internet call.
The U.S.-led coalition intensified its targeting of tanker trucks in the past year after previously avoiding such strikes for fear of killing drivers who were not clearly militants.
Abu Abdulla and four other traders and truck drivers said the trip back and forth to Syria became more difficult after Iraqi Kurdish forces retook Sinjar in November, forcing them to take a road south of Mosul to the Syrian border.
Drivers tried to evade air strikes by painting 'drinking water' on the side of their tankers, but without success, said Abu Abdulla.
"It's an open desert road that leaves us easily targeted by air strikes," said a driver who gave his name only as Muamar. "I saw my brother get killed by an air strike while sitting inside his truck. Other trucks were blown up like in a video game." (Editing by Stephen Kalin and David Stamp) ((email@example.com; +964-7901-947-131; Reuters Messaging: firstname.lastname@example.org))