Let’s face it: The Middle East remains a major hot-bed of energy activity. Blessed with a vast abundance of hydrocarbons not challenged until recently — and by the U.S., no less — the region continues to be a major source of the world’s oil and natural gas needs. Despite the armed conflicts and political strife, energy firms both large and small continue to flock to the Mideast seeking their fortune.

Still, as we keep finding out, those nasty geopolitical events can have a major effect on production. The Arab Spring rebellions in Egypt severely hurt that country’s output, and it took Italian energy major Eni (NYSE:E) nearly a year before it was able to start up its wells again in Libya after the fall of Muammar Gaddafi. Now, it’s Iran’s saber-rattling over its nuclear ambitions that could cut off the vital Strait of Hormuz and remove nearly 2.5 million barrels of oil equivalent (BOE) per day off the market.

Another major concern surrounding the Middle East’s oil supply has been the state of Iraq’s industry. Damaged by decades of war and underinvestment, Iraqi production dwindled under Saddam Hussein. But that’s finally changing. Driven by higher crude oil prices, investment in the previously war-torn nation continues to push production to new decade highs.

For energy firms and investors alike, Iraq could now offer a high-risk/high-reward proposition in the region.

Nine Years of Production Increases

Hard to believe, but it’s been nearly a decade since the U.S. invasion that toppled Saddam. While you can certainly debate whether or not our military efforts to free the Iraqi people from dictatorship, build a democracy and rebuild the country were worth the cost, the resulting Strategic Framework Agreement has unleashed Iraq’s oil potential.

According to the nation’s Internal Energy Ministers, the rebuilding efforts in the petroleum sector are finally paying off. Over the last six months, oil output has risen by around 350,000 BOE per day. That puts production above the 3 million barrels per day mark for the first time since the 1970s. This is certainly big news for a nation whose vast energy wealth has been relatively untapped for over three decades. At the same time, Iraq expects its production to continue growing on the back of ambitious export plans.

Another reason for optimism: Iraq currently holds the world’s fifth-largest oil reserves. Overall, it has 78 known oil fields, of which nine are classified as “super-giants” — fields estimated to hold more than 5 billion barrels of recoverable crude each.

Tapping those fields has become priority No. 1, with exporting excess production a close second. Already, Iraq has signed 12 new contracts for 15 oil and natural gas fields, which together have the potential to produce about 12 million BOE per day.

Woefully inadequate infrastructure remains an obstruction in the country’s exporting goals. But, like production, that’s changing as well. Back in March, Iraq opened a new floating “single-point mooring” (SPM) facility, which should help increase exports by 300,000 barrels per day. Likewise, new pipeline infrastructure in its major northern hub of Kirkuk and improved road/boarder transportation have helped boost exports immensely. Overall, crude exports from Iraq grew by 8.3% over last month to sit at an average of 2.51 million barrels a day. Again, the highest levels in decades.

All of these factors could lead to Iraq more than tripling its production capacity to more than 10 million barrels per day over the next six years and generate exports of 4 million barrels per day. Analysts estimate that it will be the world’s biggest source of new oil supplies over the next few years.

Already, many countries in the Middle East and Europe have been increasingly looking to Iraq to fill their petroleum needs, especially in the wake of the recent sanctions against Iran. Since being appointed to the position, Iraqi Deputy Prime Minister for Energy Hussain Al Shahristani has made it clear that “Iraq is very much interested to be a partner and a supplier of gas to not only our Arab neighbors but also to the European countries and the world at large.”

Playing Iraq’s Potential

While investing in Iraq’s oil future isn’t necessarily a slam dunk — as Exxon Mobil (NYSE:XOM) recently found out when it got dropped from Iraqi oil bidding after it signed an exploration deal with the Kurdistan Regional Government — the potential is certainly there. Given the fact that the country is pretty much starting from scratch in terms of allowing foreign energy firms into its fields, plenty of long-term opportunities can be found.

The most recent list of pre-qualified bidders for its latest block auction reads like a who’s who of energy majors, including PetroChina (NYSE:PTR), Norway’s Statoil (NYSE:STO) and Chevron (NYSE:CVX). For investors, the eventual gains could be worth the immediate risks as firms begin to stake their claims.

Already working in the nation is — my perpetual energy favorite — Royal Dutch Shell (NYSE:RDS.A, RDS.B). Partnering with Malaysia’s Petronas, Shell won the right back in 2009 to renovate Iraq’s Majoon field, which is estimated to hold around 12.6 billion barrels of crude. Shell has spent around $1 billion since taking over the field in 2010, including fees for removing landmines, and it plans to invest another $1 billion in 2012.

Most recently, Shell entered into talks to extend Majnoon’s plateau time — its period of sustained maximum output — to more than 20 years from the contracted seven. That will lower annual production in the field, but also lower costs. Shell blamed the bottlenecks in the nation’s energy infrastructure as the main reasoning behind its production cuts.

Shell is also working on building an Iraqi plant to capture natural gas as well as an ethane “cracker” to produce petrochemicals. Iraq is currently flaring off almost all of the gas produced in association with crude oil because it lacks the infrastructure necessary to use it as fuel for electricity plants or as a feedstock for petrochemicals. Shell aims to make up for lost time with these projects.

Perhaps the most interesting way to play Iraq’s oil lies in those infrastructure bottlenecks and construction of the various petrochemical plants and refiners. I’ve highlighted both Chicago Bridge & Iron (NYSE:CBI) and KBR (NYSE:KBR) as plays on America’s need for more pipelines and other major energy-based infrastructure projects. Both have been major contributors to Iraq’s rebuilding efforts and should get the nod as more these projects gain steam.

Overall, Iraq’s current rising production and future exporting goals are certainly bullish for the long-troubled nation. While investing there isn’t easy, it could offer great long-term rewards for the bold.

As of this writing, Aaron Levitt doesn’t own any securities mentioned here.