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Iraqi Kurdistan sinking fast

The future of the KRI's oil sector is uncertain, with the federal government determined to bring all the country's production and exports back under its wing

With so much happening that was out of the ordinary it was a surprise to find something routine taking place. On 10 November, international oil companies operating in the Kurdish Region of Iraq (KRI) announced they had received their regular monthly payment for oil sales. So far so good. But the relief felt by those companies will be nothing compared to their anxiety about the future. The Kurdish Regional Government (KRG) paid out a total of $100m to IOCs in November. It's inconceivable that outlays of this magnitude will be possible for long.

The KRG often struggled to keep up with its IOC payments, just as it had difficulty providing regular wages to civil servants and Peshmerga fighters long before the September independence referendum and traumatic aftermath. Now the KRI faces bankruptcy. Make no mistake: the price for botching the referendum gamble will be enormous.

When the Iraqi army moved into contested territory that had been seized by the Peshmerga in 2014 it restored Baghdad's control over all the oilfields around Kirkuk. In particular, the Kurds were forced to relinquish their hold on the Avana Dome of the Kirkuk oilfield and the Bai Hassan field. In a matter of hours, 280,000 barrels a day of oil, from those two fields alone, was whisked out of the KRG's hands. A further 78,000 b/d was also lost—this figure includes the 70,000 b/d that the state North Oil Company (NOC) had allocated for export through the KRG's pipeline infrastructure.

The effect was immediate and dramatic. Before October and the Iraqi army takeover of Kirkuk, KRG exports were running at around 0.58m b/d. Since then the export rate through the Iraq Turkey Pipeline (ITP) has more than halved, to around 230,000 b/d—with the obvious negative impact on revenue.

In 2014, when the Baghdad government stopped providing the KRG with the 17% of national oil income it had promised in monthly payments from the federal budget, the Iraqi Kurds took matters into their own hands and began independent exports. This meant that the state marketing company, Somo, was excluded from the process of selling northern Iraqi oil and could focus only on southern exports. The government of Haider al-Abadi is now insisting that Somo should resume its previous monopoly of marketing all the oil produced in Iraq. Somo announced on 2 November that it was arranging with the Turkish authorities to take over oil sales at Ceyhan.

This is where the serious negotiations between Baghdad and Erbil start, an encounter that's likely to be difficult and protracted. Even before the two sides get down to arguing over figures, there's a fundamental difference of opinion over basic issues. Not only does the federal government regard the KRG's independent oil sales as illegal, but it also insists that the Kurdish authorities had no legal right to sign contracts with IOCs without the approval of the oil ministry in Baghdad. An Iraqi oil ministry spokesman told online journal Al-Monitor that "the federal government should control all the oil wells, even those in the Kurdistan region". If the Abadi government makes the renegotiation of contracts a condition for an agreement with Erbil, then the KRI oil sector could face serious disruption.

Payments dispute

On virtually all the subjects that will need to be discussed, the KRG finds itself in a weak position because, in the absence of the revenue it received pre-October, it badly needs the restoration of payments from the federal budget. KRG prime minister Nechirvan Barzani has said the region is prepared to hand over its oil to the federal authorities for export on condition that it receives the 17% payment from the central purse.

The Abadi government says it's prepared to resume payments, but only at the rate of 12.67% of federal revenues because it doubts the stated figures for the population of the KRI and the number of civil servants. To add insult to injury it plans to send money direct to the governorates, rather than through Erbil. The 2018 budget, incidentally, has dropped references to the Kurdistan Regional Government, calling it instead—to the fury of the KRG—the "Government of the Governorates".

The KRG, in a statement, said reducing the budget share of the Kurdistan region "violates an agreement between the KRG and the federal government that was arrived at in lieu of an official, credible census…As a federal region and partner, the KRG has had neither a say in the sovereign budget nor has benefited from it". As for civil servants, the Abadi administration says it will pay their wages, but questions whether the claimed 1.2m Iraqi Kurds actually work for the Kurdish government. So the 2018 draft budget has allocated only $286m for their wages, far short of the $0.772bn that Iraqi Kurds say is needed.

In response, the KRG said it was "prepared to submit all payroll lists and necessary information regarding salaries, supported by biometric data to confirm accurate numbers". Expect many months of bargaining on this subject.

The KRG has raised other concerns about the budget: it doesn't "clearly allocate any amount" for the Peshmerga forces; and while the KRI is "required to export 250,000 b/d", there's no "reference to paying the financial dues of the IOCs". The Abadi government hasn't said yet whether the central government will pay the IOCs operating in the KRI. But given that Baghdad doesn't recognise their contracts one can expect the Abadi government to use the IOC payment issue as a strong bargaining card.

Outstanding debts

The KRG's financial woes don't stop there. The region has made a range of commitments to traders to supply them with crude oil in the coming months. The federal government has declined to honour those commitments or the repayment of loans—thought to be in the region of $3bn—part of which were secured on the prospect of expanding production from the Kirkuk oilfields. To make matters worse, Iraq's central bank has ordered private banks to close their branches in the KRI.

The Kurds' hands, though, aren't entirely empty. The section of the ITP linking Kirkuk directly with Ceyhan was severely damaged during the battles with Islamic State. Some reports say the pipelines and compressor units are beyond repair. The federal oil ministry is studying how this problem should be tackled, but oil isn't likely to be flowing through this section of the pipeline in the immediate future. So in the meantime, once NOC has all its fields up and running, it will have to rely on the KRG's connection to the ITP for exports to Ceyhan.

In the end, with many questions about the future of the oil sector in the Kurdish region awaiting answers, one thing is clear. As KRG-focused energy analyst Patrick Osgood wrote in Petroleum Economist's latest annual book, Outlook 2018, "the loss of Bai Hassan and Avana alone kills any hope of economic independence". For the fields comprised "45% of independent export volumes, and a large share of the KRI's oil growth". Furthermore, if a way isn't found soon to maintain IOC payments, "disinvestment and a return to operator-driven shut-ins could follow".

As a sign of the times, the KRG's Ministry of Natural Resources' normally ebullient website has become eerily silent. On 7 November, it posted a brief notice saying that because of "the current logistical and other circumstances affecting the Kurdistan Region" it was withdrawing its support for a planned oil and gas conference in London in December, hoping it will be rescheduled for 2018. If the federal government gets its way then it could be the end of the road for KRI energy gatherings of this kind, or any other manifestations of energy independence.

Source: Petroleum Economist

This article is part of a report series on Iraq. The next article is: Iraqi Kurdistan's wrong turn

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