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Time for settlement

Economic disorder, sectarian strife and the northern oil dispute continue to threaten Iraq’s integrity. Only political unity can solve the country’s many problems

In mid-June, Christine Lagarde, managing director of the IMF, received a letter of intent from Hoshyar Mahmoud Zebari, Iraq's minister of finance, and Ali Mohsen Ismail Al Allaq, acting governor of Baghdad's central bank. The letter detailed the many shocks that have hit the country's economy since mid-2014, what it plans to do about it, and a request for financial assistance.

It wasn't the first letter Lagarde had received from the region in recent times. Strapped for cash, the Kurdish Regional Government (KRG), had already been lobbying both the IMF and Baghdad to make sure it got a share of the $20bn in potential loans from the fund.

At just about the same time as the letter was sent out, Baghdad was reaching out to Erbil-the seat of the KRG-to effectively legitimise independent Kurdish oil exports.

This was important. In itself it was a tacit admission that the region's earlier strategy-to use exports to fund an autonomous economy and, eventually, independence-was not working.

Massoud Barzani, the KRG's president, may still tout independence for his regional audience, but it is an ever more distant prospect. As such the KRG has become ever more willing to deal again with Baghdad, demanding $1bn a month, in exchange for formally exporting more crude through Turkey. The proposal suggests that exports would be independently audited and revenues subtracted from the 17% that-according to Iraq's constitution-is the Kurdish share of the federal budget.

But what about Iraq? The new agreement is symptomatic of its lack of strategic planning. Once again, the country is circumventing the constitution for a short-term fix. The Kurds will get to keep exporting oil; and Baghdad's outlet for exports in the north is strengthened.

Iraq needs an overarching legal framework for revenue and export rights, and the provincial rights to develop new fields

The deal has no legal standing and threatens the country's very fabric. If it goes ahead, other oil-producing provinces are sure to demand a similar cut.

This might even prompt the KRG to push for even better terms, instilling a dangerous cycle of shake-downs. The prospect of "lawfare"-deploying laws, or their interpretations of them, to fight political battles-between provinces and the centre is real. And it would take place in a void of national energy policy. Further political paralysis would be the likeliest outcome.

Recent history hardly augurs well for the deal either. Similar agreements in November 2011, September 2012, December 2013 and December 2014 all failed, sometimes within months.

What Iraq needs is an overarching legal framework for revenue and export rights, and the provincial rights to develop new fields.

This would cement the viability of Iraq as a strong federal state for decades and revitalise an energy value chain that used to run-literally-from Basra in the south to Kirkuk in the north and beyond, in the form of the reversible Strategic Pipeline. The infrastructure no longer exists.

Unfolding liabilities

The KRG's economy is wilting. Debts to domestic and international institutions have exceeded $20bn, a huge burden for a small region. Producing oil and gas assets are heavily disputed: either politically, as with the supergiant Kirkuk oilfield; or legally, as with the disagreement between the Dana Gas-led consortium and the KRG over the Kor Mor and Chemchemal gas fields.

Dangerous factionalisation of Kurdish politics has also re-appeared, as the new dispute between the Patriotic Union of Kurdistan and Goran against the ruling Kurdistan Democratic Party (KDP) demonstrates.

A suggested agreement to split some of the IMF funds between Baghdad and Erbil can also only be a superficial fix. Baghdad has mismanaged its 2016 budget, which it based on an oil-price forecast of $45 a barrel, when actual revenues have come in at $29, on average, so far this year. Last year, Iraq earned $49bn, but this year the total might be even lower, at $40bn. Even severe austerity measures may not be enough to deal with this shortfall, and foreign currency reserves are estimated to be just $45bn, at most.

Meanwhile, the KRG's legally disputed oil sales continue to be made at a 25% discount to international market prices. This has burdened Baghdad and Erbil with further financial challenges, derailing contractual commitments to repay international oil companies (IOCs).

Although both federal and regional administrations are trying their best to renegotiate their repayment terms with IOCs, any cut in payments will force operators in the south to limit their production at current rates, hitting supply-growth plans. Operators in the north might also do the same, reducing their operations and, in turn, forcing the KRG to depend on Kirkuk's cluster of oilfield.

This, in turn, could exacerbate the potential dispute between Kurdish factions on one hand, and between Baghdad and Erbil on the other.

Amid this chaos, Iraq's factions must instead agree on a constitutional settlement and cease ad hoc export arrangements. Calls for a confederate Iraq will require constitutional changes that are difficult to achieve, and Kurdish calls to secede from Iraq will require a solid Kurdish unity that does not exist today.

Furthermore, recent events in Turkey have reminded allies of the Erdogan government, including the KDP-currently the dominant faction in the region-that autocracy does not bring stability. For landlocked Kurdistan, this should be a major concern, and a reminder that short-term alliances are far from certain. Recent attacks on Kurdish oil infrastructure show just how vulnerable the KDP's secession strategy is looking.

Such uncertainty, combined with the acute financial pressures, means that a lasting arrangement is imperative. The first 12 months after Islamic State's now almost inevitable defeat will be vital for Iraq and the KRG-both burdened with internally displaced people-and they should coordinate efforts for quick reconstruction and resettlement.

Reform in a crux

The worst outcome now would be for the Iraqi government to become destabilised by the cost of rebuilding, risking even more political violence.

Already, Iraq is ranked as "high alert" on the Fragile States Index and prime minister Haider al-Abadi is struggling to overcome the legacy of a decade's worth of zero-sum politics in Baghdad. This was clear when he came to office even as Iraq faced the existential threat of low oil prices and the most organised terror organisation in history.

Neither Washington nor Tehran, being the main backers of Iraq's government, are interested in seeing the displacement of the ruling parties.

Mosul, still in the hands of IS for now, will be open for any number of reform scenarios upon liberalisation and as the general elections scheduled for April 2018 approach.

If the political elite do not seize the chance to reform, the next 20 months will see little other than the continuous burning of federal-currency reserves-unless the government completely renegotiates its contracts with the IOCs. That's a risky prospect, as Iran's slow progress with its new upstream contracts starts to become more and more obvious.

Avoiding crisis now will require sustained financial assistance from the international community. At present, even the $2.1bn raised at the Washington donor conference is less than a third of the nearly $8bn being spent on the coalition to fight IS. And much of the money will flow through the UN, not to Baghdad.

Iraq earned $3.744bn in July from its southern exports of 3.2m barrels a day, and $479m was earned from exports of 0.5m b/d through the KRG. So there is still a steady stream of income to be relied on.

But deep institutional and economic reform, political reconciliation, and sound renegotiation with operators and debtors is necessary to make this money not a source of conflict, but a source of trust and reconstruction.

Baghdad and the centre-not a splintered array of provinces-has the resources and capacity to carry out megaprojects, including upgrading refining infrastructure and stopping the attrition of exports through domestic oil consumption. But reforms are needed.

Mutually beneficial-and legally codified-agreements must be put in place to create the framework for a national energy strategy for all Iraqis. This will only happen when Iraqi and Kurdish politicians realise they are increasingly dependent on each other.

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