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Analysis: Iraq’s oil disputes remain unresolved

The recent Baghdad-Erbil oil deal has inspired optimism, but it avoids key details at the heart of big issues – control of territory and oil rights – on which neither side wants to compromise

Leaders in Baghdad and Erbil are still far away from achieving a long-lasting resolution to Iraq’s oil policy disputes, even though the tides of optimism have swelled in the past few weeks.

There is reason to be hopeful. In November, the autonomous Kurdistan Regional Government (KRG) began participating in federal Iraqi oil exports for the first time since 2013, and began receiving federal budget payments. On Dec. 2, the Iraqi Cabinet ratified a political agreement that could help move that cooperation into 2015 and beyond.

But the Dec. 2 deal is best understood as a confidence-building mechanism, and not as a definitive moment of reconciliation.

“This is an important step in the right direction,” said Iraqi Prime Minister Haider al-Abadi, speaking on Dec. 3 in Brussels. Even as he celebrated the political progress, Abadi emphasized the tenuous nature of the accord, calling it a “tentative agreement” that “will pave the way to a long-term agreement.”

The agreement does not address, let alone resolve, any of the fundamental disagreements that have animated the conflicts between Baghdad and the KRG over the past decade: who ultimately controls various contested oil fields, the management and export of oil, and the path of various revenue flows.

Rather than answer these questions, the Dec. 2 deal essentially stipulates a mutually agreeable outcome: Kurdistan will hand over 250,000 barrels per day (bpd) of its own production for the federal government to sell; it will pump another 300,000 bpd of federal production through the KRG’s independent pipeline; and Baghdad will pay the KRG a 17 percent share of the budget. The agreement does not define the key logistics of that cooperation.

Leaders on both sides acknowledge that those details will need to be enshrined in legislation – specifically, the 2015 budget and a long-delayed hydrocarbons law – which must pass not only the Cabinet but also the Parliament.

Until then, any cooperation between Baghdad and Erbil depends entirely on the continuing goodwill of top political leaders. The Dec. 2 agreement itself is the equivalent of a handshake: nobody put a signature to paper, and the unsigned term sheet included an unambiguous escape clause.

“The agreement says that if either side reneges, then it is no longer valid,” said KRG Deputy Prime Minister Qubad Talabani. “If we don’t give the 250,000 bpd, then they can cut our budget, and if they cut our budget, we don’t owe them 250,000 bpd.”

Like previous export agreements between Baghdad and Erbil, this one has served to open a fleeting window for further negotiations. Both sides have big incentives to cooperate, including a common enemy – the anti-government militants led by the so-called Islamic State (IS) group – and the prospect of increasing revenues for everyone.

But the Dec. 2 deal also avoids many important details, because they cut to the heart of issues on which neither side wants to compromise.

Which fields belong to Kurdistan?

The two sides have not reached an agreement on which fields Kurdistan can use to generate its 250,000 bpd share of the cooperative exports. Political leaders seem keen to dodge the issue, which is rooted in one of Iraq’s most volatile and intractable disputes.

For the past decade, the two sides have disagreed about how to draw Kurdistan’s southern boundary. Saddam Hussein pursued campaigns of ethnic cleansing and forced relocation in an effort to “Arabize” the oil-rich areas of northern Iraq, and in the wake of those historical traumas, many Arabs, Kurds, and Turkomen make competing claims to the same land. Article 140 of the Iraqi Constitution outlines a mechanism for resolving those disputes, but the issue is so volatile that all efforts at implementation have failed.

Realities on the ground have changed dramatically since June, when the Iraqi Army retreated from most of northern Iraq in the face of a massive insurgent offensive led by the IS group. Kurdish Peshmerga forces swept southward and secured of much of Kirkuk, including oil fields and related infrastructure.

In early July, the KRG used its expanded footprint to take direct control of the Bai Hassan field and Avana Dome, one of the major formations of the Kirkuk oil field – major production hubs that have historically been run by the federal Oil Ministry’s North Oil Company (NOC). Within days, the KRG had linked those fields to its pipeline network and appointed a local contractor, KAR Group, to manage the fields.

By November, oil from Bai Hassan and Avana was flowing through the KRG’s independent pipeline to Turkey – making up roughly one-third of the region’s pipeline blend, which has on some days reached as high as 350,000 bpd of exports.

Many Kurdish leaders say that Bai Hassan and Avana are outside the formal boundaries of Kirkuk province, and so should be considered part of the KRG. Other Kurdish leaders, such as Kirkuk Gov. Najmaldin Karim, say they are part of Kirkuk. Meanwhile, leaders in Baghdad have not surrendered their claims of control over those fields.

These competing views, which stem from Iraq’s unresolved territorial disputes, have the potential to derail the implementation of the Baghdad-Erbil oil deal.

If production from Bai Hassan and Avana counts as “Kurdish oil,” then the KRG could potentially meet its obligations to Baghdad by facilitating exports from fields that, before June, were fully controlled by NOC. On the other hand, if Bai Hassan and Avana count as “Kirkuk fields,” then the KRG will have to divert significant production from its major workhorse fields within undisputed KRG territory to meet the 250,000 bpd benchmark, which could reduce its independent earning power by billions of dollars per year.

Top leaders in Baghdad and Erbil – careful to avoid controversy that could shatter their fragile cooperation – have declined to comment publicly on which specific fields the KRG’s 250,000 bpd should come from. Privately, they appear to be drawing red lines.

Many KRG officials remain adamant that Bai Hassan and Avana are within the Makhmour district of Erbil province, and never should have been considered part of Kirkuk.

Baghdad officials point out that Kurdish leaders have long interpreted the Iraqi constitution to grant the federal government at least partial responsibility over any fields – such as Bai Hassan and Avana – that were producing before 2005. Even if the KRG draws its borders expansively, the Kurdish reading of the constitution admits that fields formerly managed by NOC have a different legal status than those recently developed by the KRG.

“All the areas taken after 10 June, 2014 will return to their status before that date,” said one Baghdad official close to the talks.

Without an agreement on this issue, it is very possible that the KRG will use at least some production from Bai Hassan and Avana to reach its 250,000 bpd threshold. If Baghdad leaders view that production as federal “Kirkuk oil” – and therefore see less than 250,000 bpd of “Kurdish oil” flowing to SOMO – then they could conclude that the KRG has broken the deal.

Does Kurdistan have the right to export independently?

The Dec. 2 agreement does not address the issue of what should happen to any KRG production in excess of 250,000 bpd.

The question is not merely academic: the KRG is currently producing over 450,000 bpd from a blend mostly of the Tawke, Taq Taq and Shaikan fields, the Khurmala Dome of Kirkuk field which the KRG took over in 2008, condensates from Khor Mor gas field, and Avana and Bai Hassan.

It is currently feeding domestic refineries, exporting by truck to Iran and Turkey, and sending as much as 350,000 bpd through its pipeline to Turkey. Even if the KRG were to relax its claims on Bai Hassan and Avana, it could contribute 250,000 bpd to federal exports from its undisputed fields and have additional output to spare. The expansion of the region’s fields, excluding the fate of Bai Hassan and Avana, through 2015 will add up to 150,000 bpd of additional export capacity.

Leaders in Baghdad have historically claimed that SOMO is the only entity authorized to export Iraqi oil. The Oil Ministry appeared to reaffirm this position on Sunday, when it issued a press release clarifying that the Dec. 2 agreement with the KRG did not include any recognition of the legality of Kurdish exports, except the 250,000 bpd to be handed over to SOMO.

“The position of the Oil Ministry and the Iraqi government is currently fixed on the illegality of dealing with oil outside these figures and this framework,” the statement said.

The Oil Ministry is currently pressing this prerogative in several legal venues – in cases against the KRG at the Iraqi High Court and in the U.S.; and in international arbitration against Turkey, which has facilitated independent KRG pipeline exports. Since the Dec. 2 agreement was struck, the Oil Ministry has not withdrawn its claims.

“It is a political deal, not a legal deal,” said one official familiar with Baghdad’s legal strategy, who confirmed there has been no order from Abadi or Abd al-Mahdi to wind down the legal campaign against the KRG’s independent oil exports.

Kurdish leaders have suggested that any production beyond 250,000 bpd will be used both to supply Kurdistan with fuel and to generate revenue, presumably through pipeline exports, trucking exports, or both. Excess production “will go to domestic refining, and to cover compensation to the contractors, and to pay down debt,” Talabani said.

In any event, KRG leaders do not appear to feel obliged to turn any more oil than the agreed amount over to SOMO.

“We have promised to deliver 250,000 bpd and we will. No less and no more,” Talabani added. And what happens to the excess oil, after IOCs and debt is paid off? “The KRG will sell it,” he said.

By contrast, the Iraqi Cabinet’s announcement of the deal said that “the Kurdistan region will provide at least 250,000 bpd to the federal government for the purpose of export” – implying that Kurdish exports beyond that level might also be handled by SOMO.

For now, leaders in Baghdad are eager to sustain the momentum of recent negotiations, and appear to be looking the other way as independent KRG exports continue. But as the Iraqi Cabinet drafts a 2015 budget that codifies the terms of the Dec. 2 agreement, it will have to decide whether the KRG is responsible for exactly 250,000 bpd, or “at least” that much – a technical detail with the potential to set a far-reaching precedent on Kurdish export rights.

How to calculate Kurdistan’s budget allocation?

The new oil agreement stipulates that Baghdad will pay Kurdistan a 17 percent share of the budget, consistent with political agreements dating back to 2005. But as past disputes have shown, there are different ways to make that seemingly straightforward calculation.

Recent budgets have first assessed the operating costs of the state – so-called “sovereign expenses” – and then distributed the remaining pool of money to provincial and regional governments, including 17 percent to Kurdistan. The exclusion of sovereign expenses from the Kurdish calculation has meant the KRG actually receives somewhere between 10 and 13 percent of the total federal budget.

The KRG’s expectation of a 17 percent revenue share is rooted in a political deal dating back to 2005. There is no federal legislation or provision in the Iraqi constitution that stipulates an exact percentage that Kurdistan must receive, or defines whether the ratio should be calculated before or after sovereign expenses.

In recent years, Kurdish leaders have cried foul because their own sovereign expenses have not been covered in the federal budget. They argue that Baghdad should share revenue more equitably, either by paying the full operating costs of the KRG out of the sovereign expense portion of the federal budget, or by paying a full 17 percent of the total budget to Kurdistan.

Under the Dec. 2 agreement, Talabani said, sovereign expenses will again be deducted before calculating the KRG budget. But Baghdad has made an important concession: it will allocate $1 billion for the payment of Peshmerga salaries, removing a key strain from the KRG’s balance sheet. Additional expenses previously put on the KRG’s bill may also be included in the sovereign expenses calculations, officials close to the talks have said, though none gave specific examples.

Yet one major expense has not been resolved: payments to the oil companies responsible for KRG production.

In the past, Baghdad leaders have been reluctant to include KRG oil contracting costs in federal sovereign expenses, largely because they have considered the Kurdish contracts to be illegal. By making direct payments to IOCs according to those contracts, the government would seem to be implicitly endorsing their legality, and surrendering its claims of primary authority over all Iraqi oil contracting.

But if Baghdad excludes KRG oil contractor payments from federal sovereign expenses in 2015, the KRG will likely object to an ongoing encroachment on its 17 percent.

A further complication could arise from the financial squeeze that Iraq is suffering. The falling price of oil globally has reduced the country’s revenue projections, while Baghdad’s 2015 sovereign expenses are likely to be quite large, especially considering the cost of the war against insurgents led by the IS group. Taken together, these factors could mean the KRG’s budget will be calculated from a pool of money that’s far smaller than expected.

The KRG might not complain too bitterly about being short-changed in the 2015 budget, so long as it retains the ability to make up the difference through independent oil sales.

But if Baghdad leaders drive a hard bargain on regaining control of Bai Hassan and Avana, and on asserting exclusive export rights, they would by extension be threatening the KRG’s ability to control a large, discrete revenue stream. In that case, Kurdistan would be putting its financial future firmly back in the hands of Baghdad, after working for years – and negotiating a massive strategic energy agreement with Turkey – to achieve economic independence.

There is simply no way for the two sides to forge a long-lasting agreement without painful compromise: either Baghdad has to surrender key principles related to federal control over oil contracting and exports, or the KRG has to accept some centralization in exchange for revenue guarantees. Or both.

Otherwise, the Dec. 2 agreement – which has been billed as one last hope for a unified Iraq – will meet the same fate as a handful of other temporary oil export deals that have been struck over the past five years, only to be torn apart by the strain of irreconcilable interests and divergent goals.

 By Ben Van Heuvelen and Ben Lando of Iraq Oil Report
Published Wednesday, December 10th, 2014

  Ben Van Heuvelen and Ben Lando reported from the United States.



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