1- Preface

As from January 2014, the Kurdistan Regional Government (KRG) has begun to export crude oil directly to world oil markets through a new pipeline to the Turkish port of Ceyhan from oil fields under its control. Dispatched without the approval of Iraq’s central government, with the first shipment put up for sale before the end of January 2014.

With the political and financial support of Turkey, the KRG has completed an independent pipeline inside the Iraqi territory that could export crude oil beyond Baghdad’s control. The new infrastructure has the potential to undermine the federal government’s assertions of primary authority over contracting and exports of oil & gas – and has prompted deputy prime minister for energy, Dr. Shahristani to issue strict threats against the KRG, Turkey, and would-be buyers of independently exported crude oil.

At the same time we should underline the fact that the KRG informed the Federal Oil Ministry (FOM) in 2012 that they were able to export 175,000 bpd (barrels per day) in that year. That was followed by sending an official letter to the Oil Ministry and Finance Ministry in Baghdad stating that they could export an average for 2013 of 250,000 bpd. Later they told the Federal Finance Ministry, during the period of preparing the draft law of the 2014 budget, that their average exports for 2014 would be 400,000 bpd. These statistics are not the Oil Ministry’s estimates, but they were figures sent from the KRG to the Federal Finance Ministry to be included in the Federal budgets.(1)

However, during the past seven years, since the KRG started producing oil from areas under its control in 2007, to this date, the KRG failed to deliver any of the crude oil they produced to the Iraqi State Oil Marketing Organization (SOMO), with the exception of two months only (delivery of November and December 2012).

2-The Turkish Government’s approach-

Turkey’s support of the KRG’s policies has exasperated Baghdad, which asserts sole authority to manage Iraqi oil and says KRG’s efforts towards oil independence could lead to the break-up of Iraq.

Turkey has set up the Turkish Energy Company (TEC), a state-backed entity which has struck partnership deals with Exxon and will be Turkey’s counterparty in dealings with the KRG.

A first KRG-sponsored oil pipeline, which is now complete, links up to an existing Iraq-Turkey pipeline and began carrying KRG’s oil to world markets from December 2013.

The existing Iraqi oil pipeline from Kirkuk to Turkey’s Mediterranean port of Ceyhan is currently carrying only a fraction of its 1.6 million bpd capacity, and could in theory pump up to 700,000 bpd of Iraqi Kurdistan’s oil.

But as the KRG’s output grows, with several new fields coming online this year and next, a second pipeline will be needed.

The second pipeline will be mainly for the heavy oil that will come from the northern fields. Taq Taq and Tawke crude oil is very high quality and blending the two grades would depreciate the value of both crudes. The Turkish state pipeline company Botas will be instrumental in building the second pipeline. The new pipeline will have a capacity of at least 1 million bpd of crude oil, KRG natural resources minister Ashti Hawrami said in Istanbul in January. The exports will be metered independently from SOMO (the State Oil Marketing Organization).(2)

Turkey is set to pass Britain as Europe’s third biggest power consumer in a decade and is hostage to expensive Russian gas. It also buys natural gas from Azerbaijan and Iran and liquefied natural gas from Algeria but is looking to diversify.

With the new pipeline from KRG’s areas, Turkey will be able to import at least 10 billion cubic meters (bcm) per year of KRG’s gas more cheaply than from current suppliers, with its total capacity potentially up to double that according to Turkish officials. A Turkish government source said “Turkey’s existing infrastructure is almost ready for this tie-up. KRG will build its own pipeline, but Turkey could be instrumental here as well, and Botas could play a role”.

A gas purchasing agreement was signed in December 2013 between TEC and KRG and the construction of the pipeline with gas processing plants, anticipated to cost billions of dollars, could start this year, with the first flow of gas targeted for early 2017.

Anglo-Turkish firm Genel Energy, headed by former BP chief executive Tony Hayward, is expected to be the first company to export gas to Turkey from its Miran and Bina Bawi fields, which contain sour gas.(2)

There has been little love lost between the Turkish and the Iraqi governments because of Turkey’s cooperation with the KRG in the energy field, the Turkish government’s interference in internal Iraqi policies, as well as differences over Syria.

Turkey nevertheless appears reluctant to aggravate the situation with Iraq further given the increasing instability and turmoil in the region due to the Syria crisis. There is also the estimated trade of about $12 billion annually between Turkey and Iraq that has to be factored in by Ankara. Foreign Minister Ahmet Davutoglu visited the Iraqi capital in November 2013 for talks designed to smooth the path for a rapprochement between the sides.

Iraqi suspicions increased after media reports in Turkey indicated that the first batch of KRG oil in Ceyhan, worth $90 million, had been sold through the Trans Petroleum Co. in Singapore without approval from Baghdad. Ankara, however, has denied these reports.(3)

3-KRG’s strategy and its outcome

The KRG are disappointed that a comprehensive package of agreements signed with Turkey in November 2013 has not become fully operational yet.

The package includes an agreement on multibillion-dollar oil pipelines connecting northern Iraq with Turkey, which would enable the KRG to eventually export up to 2 million barrels of oil per day when fully implemented, making it an important regional energy player independent of the central government.

In the meantime, the KRG has been trucking smaller amounts of crude oil to Turkey for domestic consumption, but this is considered to be negligible compared with the potential that exists if the proposed system of pipelines is fully up and running.

KRG Prime Minister Nechirvan Barzani shuttled between Istanbul and Baghdad again in the first two months of 2014 in an attempt at overcoming the problem, but with little apparent success. The Federal Government to this time appears determined to stick to its guns and prevent the KRG from selling oil from northern Iraq unilaterally, stating that this violates Iraq’s constitution.(3)

The dispute has reached this seemingly decisive point after more than a year of planning by the KRG and Turkey, but the pace quickened after a January 8^th surprise announcement by the KRG that it was going to begin tanker loadings at the Turkish port of Ceyhan by the end of January, in a process completely independent of Baghdad, to be executed by the KRG’s Oil Marketing Organization (KOMO), and using one of the two pipelines in the Iraq-Turkey Pipeline network that it now claimed as its own.(4)

4-What course is the Federal Oil Ministry (FOM) pursuing?

Facilitating the independent KRG exports via the pipeline or sales at the Ceyhan port, breaks the agreement governing the Iraq-Turkey Pipeline (ITP), which was amended and extended as recent as 2010.

The Iraqi oil minister Mr. Luabi, told Reuters in January that “‪The Iraqi government is going to file a lawsuit against the Turkish government and we have informed them about this step, through the Foreign Ministry, which resulted from the violation of the signed agreement between the two countries”. He also accused Turkey of breaching treaty obligations by collaborating with the KRG to commandeer a leg of the Iraq-Turkey Pipeline (ITP). He also stated that, “The Iraqi Ministry of Oil (IMO), represented by SOMO, is the exclusive sole official body authorized to enter into contracts for the export of hydrocarbon resources, including crude oil and gas, therefore companies, bodies and/or persons who collaborate in such wrongdoings through participating in contracting for purchase or sale of crude oil and gas produced from Kurdistan oilfields or any other fields in Iraq with any entities other than SOMO, shall be subjected to legal proceedings and pursuance as the crude exported in such a way is considered as “smuggled crude” and in violation of the valid laws.”(4)

Iraq’s constitutionsays oil revenues, regardless of where the reserves are located in the country, have to go through Baghdad and allocates the KRG 17% of total revenues.

The federal government argues that the KRG can only export its oil after an agreement is reached between Erbil and Baghdad on how to proceed in this matter, and has also threatened to cut the KRG out of its share of Iraq’s vast oil revenues, should it go ahead and sell its oil unilaterally.

The KRG-Turkish deals, which could have important geo-political consequences for the Middle East, could see KRG export some 2 million barrels per day of oil to world markets and at least 10 billion cubic metres per year of gas to Turkey before 2017.(2)

Iraqi Prime Minister Nuri al-Maliki, said that Kurdistan’s missed export targets had cost Iraq $9 billion in lost revenue in recent years. (5)

Deputy Prime Minister for energy, Dr. Hussain Al-Shahristany stated in an interview with journalists on 10th February 2014 that “Those contracts signed by the region were not shown to the central government and were not approved by the Council of Ministers. For the federal government, our position is still unchanged, that these contracts are illegal, but aside from the legality of those contracts, any produced oil is Iraqi oil and should be exported through the Iraqi export mechanisms, so the region was informed about this situation, and so was Turkey”.

Dr. Shahristany added, “We told them that we welcome the oil exports but it should be measured at Feyshkabour, at the Iraqi metering station. And the exports should be through SOMO, the national company that is in charge of marketing all Iraqi oil. Then to sell it according to international prices, at prices set by SOMO, the same as other Iraqi oil. Then the revenues should be put at the DFI (Development Fund for Iraq) according to the United Nations Security Council resolution, until we finish paying compensation to Kuwait”.

He continued to say, “The contracts signed by the region are production sharing contracts (PSC), which allow the IOCs to own a particular percentage of the extracted oil. We told them that the oil, according to the law, belongs only to Iraq. It is the property of the Iraqi people and will not be delivered to any other party. But for [the KRG] – and according to their deals with the IOCs – they could do the calculations, they wanted to allocate a certain amount of money in the budget to pay those companies”.(1)

5- Conclusions

1-This article should be read in conjunction with my analyses of June 2013 in which I covered several issues not repeated here, and the developments on the ground in the past year has demonstrate the accuracy of the analyses.(7)

One of the issues I covered in the June 2013 analyses is “The shape of the financial quota system” in any agreement between the federal government and the KRG.

In it, I suggested that – The most sensible and fair method for both the FOM and the KRG, would be if the federal ministry of oil were to count every barrel of oil produced in the KRG areas, and should add gas production as “oil equivalent” (6000 cubic feet of gas equivalent to 1 barrel of oil) as part of the total production in Iraq in each financial year. And if the quantity of production of “oil equivalent” in the KRG is equal to the number agreed upon between the two governments as being the KRG’s share, then there should be no additional payments made by the federal government to the KRG. This will be regardless of the amount of money the KRG received from the IOCs for each barrel of “oil equivalent” as a result of the production sharing contracts (PSCs) held between the KRG and IOCs.(7)

It looks like that the Federal Oil Ministry (FOM) is now coming to the same conclusions, as they are proposing a similar method in dealing with the KRG’s claims.

2-For the first time the Federal Government’s strategies regarding the independent KRG’s oil export are becoming comprehensible and can be acknowledged as follows :

a-Any quantity of exported oil from north of Iraq should be measured at Feyshkabour at the Iraqi’s central government metering station.

b-The exports should be through SOMO (the State Oil Marketing Organization), the national company that is in charge of marketing all Iraqi oil.

c-The sale of oil should be in accordance with international prices, at prices set by SOMO, the same as other Iraqi oil.

d-The revenues should be placed with the DFI (Development Fund for Iraq) according to the United Nations Security Council resolution, until Iraq finishes paying compensation to Kuwait”.

e-The KRG are responsible for the contracts that they signed with the IOC’s, and they should pay those companies from the region’s percentage of the federal budget, which is now set at 17 percent, for the time being – until there will is a general census for the three provinces that compose the KRG.

Also the FOM is responsible for its contracts, which it pays from the budget allocated to the ministry from the 83 percent of the federal budget of Iraq. This proposal is fair, because it holds every side responsible for its contracts. (1)

It is important to stress that such an energy strategy will be supported by the majority of the Iraqi people, as it is an even-handed solution to both parties and will clear the way to solve the deep differences in energy strategies between the central government and the KRG

3– On 15th January 2014, the Iraqi Cabinet approved a draft 2014 budget that not only called on the KRG to send 400,000 bpd through the Baghdad-controlled export and sales system, but included a deduction from the KRG’s annual revenue sharing allocation, the dollar value of any amounts missing from the 400,000 bpd target.(6)

This budget to this date, is still not approved by Iraqi’s Federal Parliament, due to disagreements with KRG and some other Iraqi political parties and is not expected to be pass in its structure until after Iraq’s General election on the 30th of April.

4– It is likely that the Iraqi Government will undertake a number of measures to penalize Turkey and KRG, as well as foreign companies, for any involvement in KRG’s exports of “smuggled” oil without Baghdad’s consent.(5)

The oil minister, Mr. Abdul Kareem Luaibi told reporters “the government was preparing legal action against Ankara and would blacklist any companies dealing with oil piped to Turkey from Iraq’s autonomous northern region without permission from Baghdad”. He added that “it was not in Turkey’s interest to jeopardise bilateral trade worth $12 billion a year”, saying “Baghdad would consider boycotting all Turkish companies and cancelling all contracts with Turkish firms if the oil exports went ahead”, and he added that “If Turkey allows the export of oil from the region, it is meddling in the division of Iraq, and this is a red line.”

Mr Luaibi added that the Finance Ministry had been told to calculate how much should be deducted from Iraqi Kurdistan’s 17 percent share of the federal budget if the region failed to meet a government-set target for authorised crude exports via Iraq’s State Oil Marketing Organisation this year of 400,000 barrels per day.(5)

5- The KRG is discovering just how landlocked it is in terms of utilizing the vast oil reserves under its control as 1.3 million barrels of its oil are stuck in the Turkish Mediterranean port of Ceyhan, unable to be sold on the world market because of its continuing clash with Baghdad.(3)

The Financial Times, in a report on January 26^th is bound to have displeased the Kurdish leadership, as it indicated that although Kurdish crude is now flowing to Ceyhan, where it is being stored, major oil companies are shying away from responding to the KRG’s call for bids for this oil. The paper quoted an unnamed senior executive from what it said was one of the world’s largest energy companies, “We will not be involved in KRG tenders until we have a much better understanding of the ramifications for our relationship with Iraq”.

6- Regardless of the KRG’s effort to utilize nationalist rhetoric, holding the Federal Government responsible for the problems facing them, blaming the United States for a lack of support and pressing IOCs for payments, the KRG’s attempts to influence Baghdad and independently export oil remain unproductive. This is due to the internal domestic political crises in Iraqi’s Kurdish areas, the difficulties facing their main ally, the Turkish Government, together with ongoing legal, political and technical obstacles. In the absence of a legal transit route or feasible alternative income source, and with growing criticism by the Kurdish opposition parties, the KRG will be hard-pressed to compromise with Baghdad. If not, the landlocked region risks undermining the economic and political gains it has made thus far while leaving its population and key institutions vulnerable to social, political and financial instability.(8)

References:

1- Iraq Oil Report- Q&A: Deputy Prime Minister for Energy Hussain al-Shahristani