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Oil fuels Iraq and Kurdistan political tensions

Baghdad’s politics are a threat to the Kurdistan Regional Government’s energy ambitions. Can the Kurds transcend Iraq’s dysfunction?

Kurdistan's oil bonanza is in full swing. Investors, lured by generous production-sharing contracts (PSCs) and the proximity of the region’s oil- and gasfields to Turkey, a needy and growing energy importer, are ploughing billions of dollars into the Kurdish upstream. In Erbil, the lounges of new five-star hotels have become a thoroughfare for dealmakers and oilmen. They rave about discovery rates in the 70% range; Kurdistan’s relative comfort and safety; and the welcoming hand of its regional government (the KRG), which runs this semi-autonomous province of northern Iraq.

The KRG’s energy minister, Ashti Hawrami, the man behind this oil rush, says by the end of the decade Kurdistan’s oil output capacity will have risen tenfold to 2 million barrels a day (b/d). Some investors believe the potential is greater. Foreign oil firms have spent $10 billion in the upstream so far, but the region has barely been explored. Recoverable reserves are around 11bn barrels, though the resource could total 45bn. Finds comparable to the 14bn barrels-in-place at Gulf Keystone Petroleum’s Shaikan field — Kurdistan’s largest — may not be repeated, but with about 50 explorers committed to the region, new discoveries are likely.

Leading the next phase of development will be some of the world’s biggest oil companies, including ExxonMobil, which sacrificed its West Qurna-1 contract in southern Iraq to take up its Kurdish position. Gazprom Neft and Total signed on earlier this year. Chevron, another new investor, says it wants to build a “legacy position” in the region, committing to “40, 50, 60 years”. Steadily, control of Kurdistan’s upstream is passing from the cash-poor wildcatters that have been finding the oil to deep-pocketed international oil companies (IOCs) with the capital and political clout to get the crude out of the ground and into the market.

Kurdistan’s oil prospects should please Baghdad, helping the central government meet ambitious targets to treble Iraq’s output, now almost 3.2m b/d, and use the export income to rebuild the country. Under Iraq’s constitution, Kurdistan is entitled to 17% of the country’s oil revenues, which are accrued centrally. In practice, the central government deducts expenses from the KRG’s allotment and sends the rest — about 10% of the total — back to the north. As long as the south’s production dwarfs Kurdistan’s, the KRG is a net beneficiary of the federal budget: Basra subsidising Kurdistan. But Hawrami says Kurdistan’s coming export prowess will soon reverse this, allowing the region to plough more into the federation than it gets out of it. Kurdish oil, he says, is for the “benefit of Iraq” and a “win-win” for the country and Kurdistan.

But Iraq’s central government does not see it that way. It considers the KRG’s contracts to be illegal and its export ambitions a threat to the federation. Allow the KRG to chart its own oil course, runs its argument, and other regions, including producing powerhouse Basra, could follow. Baghdad’s banning of investors in Kurdistan from future deals in Iraq failed to deter investors like ExxonMobil and Gazprom Neft from signing the KRG’s contracts; but the central government has other ways to retaliate, and shows every willingness to use them. It may be self-destructive, but as long as the squabble between Erbil and Baghdad — personalised in the deteriorating relations between Iraqi prime minister Nuri al-Maliki and KRG president Massoud Barzani — lasts, it remains a threat to Kurdistan and its optimistic investors.

Production in need of payment

One pressing problem is over payments for oil. Iraq’s central government controls how much and when Kurdistan’s operators are compensated for the investments they make and the oil they produce. The arrangement is contradictory. Baghdad does not recognise the contracts these companies signed with the KRG, but nonetheless recoups the profit on the oil and sets their output targets.

In September, an agreement between Erbil and Baghdad ended a standoff that saw producers idle their production, hurting the central government’s income. The truce was shortlived. Instead of paying the companies $850m as agreed in the September deal, Baghdad coughed up just $500m. (The money arrived in the accounts of Turkey’s Genel Energy and Norway’s DNO, Kurdistan’s main producers, in early December.) Hussein al-Shahristani, the Iraqi deputy prime minister with oversight of the country’s oil policy, said in November that no further payments would be made because Kurdistan had breached its side of the September deal by failing to increase output to 200,000 b/d. KRG officials say the region’s infrastructure is too dilapidated to sustain such volumes.

The dispute may become more serious next year, when Kurdistan’s producers are to lift production to 250,000 b/d. In exchange for meeting this target, the KRG sought an agreement from Baghdad to pay 4.2 trillion dinars ($3.6bn), an amount that would help recover the companies’ costs. The central government instead budgeted for payments of just 750bn dinars. A senior KRG official says Baghdad’s offer was deliberately provocative. “If they don’t pay the companies, of course production will decline,” Nechirvan Barzani, the KRG’s prime minister (nephew of the president) said earlier this month.

The situation is making producers nervous about making bigger investments — exactly the outcome Baghdad seems to seek. Kurdistan’s operators are due about $1.5bn in cost recovery. Genel claims it is owed payment for 20m barrels from its share of both the Taq Taq and Tawke fields. “Making payments under Baghdad’s supervision is pumping oil into a black hole,” says Pars Kutay, a senior executive at the firm. “To reach 250,000 b/d we need to invest. But there is no mechanism about the payments.” Some oil — perhaps 60,000 b/d — can be sold into the local market at discounted prices of $60-70 a barrel. Without payment, the rest may be shut in.

It is a worry for companies that have not yet begun producing, too. “Small companies took the risk and aren’t getting their costs back,” says Richard Herbert, head of exploration at Talisman Energy. The Canadian firm is about to spend another $100m on exploration, including a 3-D seismic survey, on a promising prospect at the Kurdamir block. Output could begin quickly, Herbert says. “But the question isn’t near-term production, it’s near-term cash flow. If we do the development, but find that exports are shut in or payments are delayed, we’ll rethink.”

This may not be a grave issue. Ironically, Baghdad’s politicking over the payments could spur the kind of consolidation in Kurdistan’s upstream that the KRG wants. Only companies with cash-flow problems are likely to be flushed out of the region; those with strong balance sheets will remain. The majors seem to agree. “The contracts are for 25 years,” says Donnie MacDonald, head of Chevron’s Kurdish business. “Maliki won’t be here that long. If a company can’t stick to its development plans, it will be bought out.” MacDonald predicts the payment issue will be over in about “three to five years”.

Dr Ashti has a plan…

For companies willing to wait out the payment problem, Iraq’s control over oil-export infrastructure — encoded in a pre-Saddam Hussein law that gives the Baghdad-controlled State Oil Marketing Organisation a monopoly on crude exports — is a more serious issue. Given the region’s hopes for 1m b/d output within the next few years, it must be resolved fast.

In September, an agreement between Erbil and Baghdad ended a standoff that saw producers idle their production, hurting the central government's income

Developing an internal pipeline network to link Kurdistan’s fields and pumping stations is the first stage. Fishkabur, a town close to the region’s Turkish border, will be the end point for this infrastructure. Genel hopes to build a 400,000 b/d pipeline to the town. At present, the company ships about 120,000 b/d of its oil around Kurdistan using an army of 40-tonne trucks, a pricey and dangerous business. The pipeline would replace this. It would be part of a pipeline network that Hawrami says will be able to handle 1 million b/d of Kurdish oil. “Dr Ashti has a plan,” says one executive, who predicts the bottlenecks and ad hoc infrastructure that have characterised the region’s oil sector so far will soon be gone.

The second stage is connecting the Kurdish pipes to export infrastructure through Turkey.

Looking at a map offers an easy solution. The Kirkuk-to-Ceyhan pipeline blazed the original northern export route out of Iraq, allowing for 1.6 million b/d to flow to the Turkish Mediterranean port. But Saddam-era sanctions and Iraq’s wars have left the pipeline and its source oilfield, Kirkuk, in disrepair, capable of shipping, at most, just a third its intended volumes. The KRG has offered to upgrade some of the infrastructure and use one of the two parallel lines to export heavy oil found in fields like Gulf Keystone’s Shaikan.

The central government, though, is against this idea, too. Iraq’s oil minister, Abdul Karim Luaibi, says the country intends to use all of the pipelines’ capacity to handle more production from the south, even though this would first require construction of a north-south strategic line to connect the big fields around Basra with Kirkuk. Given Iraq’s limited export options elsewhere, the project is essential if output is to rise in line with Baghdad’s capacity goal of 9m-10m b/d by 2020.

… And so does Ankara

Turkey’s view will be decisive in how this infrastructure is used — and increasingly Ankara seems destined to convert its growing commercial ties with Kurdistan into a full-blown energy partnership. In May, KRG and Turkish officials agreed to pursue joint energy developments, overriding Baghdad’s objections. Now a “wide-ranging and comprehensive” deal is in the works, say sources in Erbil. State-backed Turkish firms are likely to join Western majors in multi-block upstream investments in Kurdistan. The consortium is likely to open an export route for Kurdish oil to Ceyhan, using the Kirkuk line’s idle capacity on the Turkish side of the border.

“Whatever the scenario, Turkey is our market,” says a senior KRG official. Turkey, he says, has taken a strategic decision about its future, and sees Kurdish oil and gas as critical to it.

The shift is deeply significant for the region’s politics, given the long and often brutal war Turkey’s army is still waging against Kurdish separatists in Anatolia. The KRG’s promise of energy has brought a different calculus to the problem. “The Turks can smell the oil,” says one analyst. Solving Kurdistan’s energy-export conundrum will also give Ankara considerable sway over the KRG. Turkish money is pouring into Kurdistan — pristine airports in Erbil and Dohuk are fruits of this — and trade between the Turkey and the KRG reached $8 billion last year. This commercial power gives Ankara influence in Erbil, where Turkey has forged an alliance with Barzani’s ruling Kurdistan Democratic Party (KDP), demanding its help to keep Kurdish separatists in Anatolia and Syria in check.

That union between Barzani and Turkey’s prime minister, Recep Tayyip Erdogan — and more broadly between Erbil’s and Ankara’s elites — is crucial to Kurdistan. But it worries Western diplomats. The US frets that Turkey’s support for the KRG will foster economic autonomy and, eventually, political independence for Iraq’s Kurds. Belying the KRG’s hopes that ExxonMobil’s arrival would guarantee new diplomatic cover from the US, the State Department has put “enormous pressure” on Turkey to stop dealing directly with Erbil, says a source. “We don’t understand why the US keeps telling us ‘to go to Baghdad’,” says one baffled executive. But Washington worries that if Iraq’s federation breaks up, Iran, which already has much influence over Maliki’s government, will only grow more powerful in Iraq. Others worry that Turkey’s sponsorship of Barzani’s KDP will eventually persuade Kurds in the Patriotic Union of Kurdistan (PUK) — the KDP’s long-time rival, which had become a junior partner in the Kurdish governing coalition — into an equivalent relationship with Iran. While the KDP controls northern Kurdistan, the south belongs to the PUK, whose leader, Jalal Talabani, is also president of Iraq itself. Trade between Iran and southern Kurdistan is booming, too. Talabani’s links with Iran are well established. Earlier this year, he thwarted Barzani’s effort to unseat Maliki through a vote of no confidence in Baghdad, apparently on instruction from Tehran.

On the ground in Kurdistan, there is also much distrust of Turkey’s growing presence in the region. “Öcalan is our leader, too,” says a Kurdish peshmerga soldier, referring to the leader of Turkey’s Kurdish separatist movement, whom Turkey imprisoned for life in 1999. Many Kurds, including thousands of Turkish Kurds who have moved across the border into service jobs in Erbil’s booming economy, remain deeply distrustful of Ankara’s ambitions. “Barzani is trading dependence on Baghdad for dependence on Turkey, where Kurds have no institutional role,” says one Iraq analyst. “What if this doesn’t work out?”

Predictably, Baghdad is unimpressed by this burgeoning alliance. Maliki has charged Turkey with meddling in Iraq’s affairs, calling it a “hostile state”. At the same time, though, his government seems determined to push Ankara and Erbil towards their energy union. Earlier this year, the central government banished TPAO, Turkey’s state oil and gas firm, from an oil block in the south, with Shahristani blaming the decision on deteriorating relations between the two countries. (Turkey is suspicious of the Maliki government’s friendliness to Iran and its support of the Bashar al-Assad regime in Syria; Maliki is upset that Turkey gave refuge this year to Iraqi vice-president Tariq al-Hashemi after he was sentenced to death in a Baghdad court.) On 4 December, Maliki ordered Iraqi air control to deny landing rights to Turkish energy minister Taner Yildiz’s plane while the latter was already en route to Erbil to attend an oil and gas conference. Maliki, said a source, claimed the minister’s plane was carrying arms to Kurdistan. “It is amazing that Iraq can stop the Turkish energy minister’s plane from landing in Kurdistan but can’t stop Iranian planes from carrying arms to Syria,” says one KRG official.

Kirkuk powder keg

Expressing Iraqi sovereignty in such a petty way was humiliating for both Ankara and Erbil. But to the investors waiting to hear Yildiz’s speech it successfully conveyed Maliki’s point — that Baghdad retains the capacity to disrupt Kurdish ambitions. Nowhere is this clearer than in the disputed territories along the Green Line that divides Kurdistan from the rest of Iraq. In the summer, Maliki launched Operation Tigris, a military offensive in parts of northern Iraq that Kurds say should lie within Kurdish territory. Thousands of troops were sent to these disputed areas, ostensibly to deal with terrorists: Al Qaeda remains active in Iraq’s north. Iraqi police had been dealing with the problem to the satisfaction of the Kurds, Arabs and Turkomen that make up the ethnic melting pot of the disputed areas, say locals. But Bagdad thought not.

Now the arrival of the Iraqi army and the appointment by Maliki of former Ba’ath party members to lead the operation (including one said to have been involved in Saddam Hussein’s 1988 genocidal Anfal campaign against the Kurds), has enflamed sentiments in Kurdistan, deepening the animosity between Maliki and Barzani. “Old ghosts are peering over the horizon,” says a member of the KRG. Baghdad’s efforts to buy fighter jets, including a recent arms deal — which has since collapsed — with Russia, are assumed by many Kurds to be evidence of the danger Maliki poses them.

In November, a tense standoff between Tigris Operation troops and peshmerga near the town of Tuz Khormato, south of Kirkuk, led to a gunfight that killed one policeman and injured several others. Since then, peshmerga have been amassing on the Kurdish side and tanks and other artillery have arrived to reinforce the Iraqi army’s position.

Petroleum Economist visited the frontline near Kirkuk on 6 December. (The KRG provided a peshmerga escort, meaning our visit was controlled and we were not permitted into Kirkuk’s Arabic quarter.) On a ridge northwest of Kirkuk, peshmerga special forces have dug trenches and peer through binoculars at Iraqi forces on the plain below; behind the peshmerga’s lines, tanks sit beneath tarpaulins to prevent detection by Iraqi aircraft. The peshmerga have anti-aircraft guns in position, ready for use against Iraqi army helicopters. Triage tents have been erected.

The situation in Kirkuk town, which sits atop one of the world’s biggest oilfields, is also tense. According to article 140 of the Iraqi constitution, Kirkuk was to have held a referendum to decide whether it would remain in Kurdistan or not by 2007. But no vote has been held. Inside the town, no one Petroleum Economist interviewed expected the situation to be resolved legally. “We will fight to the death,” says Ederiss, a mechanic whose livelihood is suffering as Kirkuk’s economy responds to the threat of war. He and others in the town are scared, and they assume Maliki’s forces are there to cow them, not Al Qaeda. “You don’t fight terrorists with artillery,” Ederiss says.

Kurdish politicians say Maliki’s military manoeuvres have everything to do with provincial and parliamentary elections over the next two years. The prime minister, they believe, is whipping up Arab chauvinism to broaden his appeal across Sunni and Shia lines. Maliki says Kurdistan’s actions in the disputed areas — including signing oil-development contracts with ExxonMobil and Hunt Oil — risk triggering an ethnic conflict. Whether this is propagandising or not, the peshmerga are in no mood to back down. “We are ready to fight,” a Kurdish army leader told Petroleum Economist in an interview at the ministry of peshmerga. “It would be better to fight them now, while they are weak,” he added.

It may not come to that. But since the US troop withdrawal last year, Iran is the only significant regional power capable of brokering a truce. After a US envoy made no headway last month (Maliki kicked him out of talks with the Kurds), it was Quds force commander Qassem Suleimani, in a recent visit to Talabani at his home in Suleymaniya, who assured the KRG that Iran would not allow Maliki to go to war with the region. Talabani has since returned to Baghdad to negotiate with Maliki. Whether Iranian guarantees have come in time is debatable. The forces gathered near Kirkuk are now so close to one another that stopping any skirmish from escalating would need swift diplomacy. “If one peshmerga is killed, then it’s war,” says an officer on the frontline.

For its part, politicians in Baghdad point the finger squarely back at the KRG and its investors. “If ExxonMobil starts drilling, they will find tanks around them,” Sami Alaskary, a member of the Iraqi parliament and influential adviser to Maliki, told Iraq Oil Report on 12 December. “We are prepared to go to war. For oil? Yes. For Iraqi sovereignty? Yes.”

It need not come to that. Baghdad and Erbil both have much to lose by letting things escalate further — and both have much to gain from a resolution that allows investors to lift oil output and spread income around the country. Hawrami says Baghdad’s intransigence has cost the country billions of dollars in export revenue it could have earned if Kurdistan had been allowed to develop its oil sector. “If we had left it to the Iraqi central government, not a single drop of oil would be produced in Kurdistan.” Now that the region’s oil sector has taken off, Baghdad should relax and enjoy the profits.

That is unlikely, but there ought to be grounds for compromise. Despite the enthusiasm for independence among many Iraqi Kurds, the KRG’s politicians insist this is not their agenda. “We are not a threat to the unity of Iraq,” says Nechirvan Barzani, the KRG premier. “The actions of Iraqis are a threat.” Power and revenue sharing are the only way the federation will be preserved, say officials in Erbil. “We are fighting for the soul of Iraq,” one adds.

Tightening its PSCs to mollify Baghdad’s resource nationalists could be a useful concession by the KRG. For all parties, including the oil companies that were first lured into the region by the KRG’s generous tax terms, that would be preferable to more political disintegration. The problem is that no one knows if that would really end the disputes with Baghdad, which are likely to last as long as Iraq lacks laws to govern power and revenue sharing. With Turkey’s commitment to imports of Kurdish oil, the KRG can afford to act tough, too. As its oil exports rise, the KRG’s dependence on Iraq’s federal budget will end, removing one of Baghdad’s sticks and allowing the Kurdistan to negotiate from a position of strength.

In the meantime, Iraq’s dysfunctional politics pose less obvious threats, too. In Erbil’s posh hotels, the brinkmanship on display 90 minutes down the road in Kirkuk feels a world away. But the problems could spread quickly. A private security executive who spent several profitable years in Baghdad was touting for business among the Western firms in Kurdistan, and he had a glint in his eye. Investors feel safe here right now, he said, and security details are not really needed. “But all it takes is for one terrorist to drive across the border from Mosul and the attitude will change.”

 

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