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Taking a chance in Kurdish Iraq

The KRG referendum result and subsequent Iraqi army offensive against the Kurds underline how risky it is for companies involved in the export and sale of Kurdish crude

The long-standing energy issues on which Erbil and Baghdad disagree essentially relate to the differing interpretations on the part of the Kurdish Regional Government (KRG) and the Federal Government of Iraq (FGI) over provisions of the Iraqi Constitution.

In short, the KRG claims that it's entitled under the Constitution to enact its own oil and gas legislation, passing Law No 22 of 2007, the KRG Oil and Gas Law, under which the regional government granted itself powers to enter into production-sharing contracts (PSCs) with international oil companies (IOCs). The FGI asserts that the KRG Oil and Gas Law and the PSCs entered into by the KRG are unconstitutional and therefore invalid. The Baghdad government also maintains that the State Oil Marketing Organisation (SOMO) is the only entity entitled to market and authorise the export of petroleum produced anywhere in Iraq.

The FGI has always fiercely contested the KRG's right to export oil independently and has pursued a number of actions to try to prevent this. These include legal proceedings against third parties to prevent the successful unloading of Kurdish crude oil, as well as blacklisting companies involved in the export and sale of it. The FGI has also previously begun legal proceedings against the KRG before the Iraq Supreme Court, relating to the interpretation of the constitutional position of the KRG's PSCs and its independent oil exports. However, the Supreme Court has been prevented from rendering a substantive decision on constitutionality as the KRG has so far refused to attend any hearings.

Following the emergence of the Islamic State group, relations between the FGI and the KRG appeared to thaw somewhat and the two sides informally agreed to the joint export of crude oil produced from the Kirkuk fields through the Iraq-Turkey Pipeline (ITP).

However, in a sign of increasing tensions between the two sides, in June 2017 the FGI took legal action against the tanker Neverland, which had departed Turkey loaded with Kurdish crude. Most alarming for the FGI, the Neverland was heading for the US—a successful offloading there would be seen to lend an air of legitimacy to Kurdish exports. The FGI also stated publicly that it would be taking legal action to prevent all independent crude exports by the KRG, targeting all third parties involved in the trade of such crude.

Risky business

It's clear that the risks involved in the independent export and sale of Kurdish crude oil are significant. These include the uncertainty regarding the validity of the transfer of title to the crude and the right of the KRG to export it. There are also a number of other practical risks, including the commercial and reputational risks of being blacklisted by one of the biggest global oil producers, as well as the threat of being the subject of legal proceedings by the FGI.

Following the independence referendum, and the successful Iraqi military operation to retake Kirkuk—not to mention the predominantly critical international response to the referendum, and the predominantly critical international response, particularly from neighbouring countries with large Kurdish populations—there's also a significant risk that the already limited avenues available for exporting Kurdish crude will be closed. Critically, Turkey has threatened to shut down its borders with Iraqi Kurdistan and shut-off the ITP. Such a course could devastate the oil-reliant Kurdish economy, preventing or delaying payments to IOCs and potentially leading to a number of disputes as they seek to suspend, terminate or renegotiate the terms of existing PSCs. This would come at a time when the KRG has recently improved its commercial standing by paying long-outstanding amounts to IOCs and by agreeing a deal with Rosneft to invest in gas infrastructure in Kurdistan, including a new gas pipeline to Turkey.

In light of the referendum and clashes between forces of the FGI and KRG, it's unlikely that there will be any early resolution to the uncertainty regarding the risks involved in the export and sale of Kurdish crude. Despite some positive recent signs, the risks confronting IOCs considering investment in Iraqi Kurdistan, as well as companies looking to trade in Kurdish crude, remain significant.

CAROLINE KEHOE is a Partner in law firm Herbert Smith Freehills

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