Friday, January 31, 2014

The Kurdistan Regional Government's O&G Riches Play a Significant Role in the K.R.G.-Iraq Fault Line Conflict

January 31, 2014

BEIRUT, Lebanon In 1996 with "The Clash of Civilizations and the Remaking of  World Order" Samuel Huntington provided us with a clear understanding of "fault line wars". He defines them as wars between clans, tribes, ethnic groups, religious communities, and nations. Then, he underlines that these wars have been prevalent in every era and in every civilization and are rooted in the identities of people. These conflicts are in general particularistic, which means that they do not involve broader ideological or political issues for nonparticipants. Moreover, they tend to last for a long time, interspersed by truces and/or agreements, but they tend often to resume fighting. Professor Huntington continues saying that fault line wars are communal conflicts between states or groups from different civilizations. 

These wars may occur:

A)Between states,
B)Between nongovernmental groups and
C)Between states and nongovernmental groups.     

Let's focus on fault line conflicts within states. These may encompass groups that are located in geographically distinct areas. In such a case, a group that does not control the central government fights for independence and  still according to Huntington may or may not be ready to accept anything less than independence. The majority of times the stake is purely the control of the territory.  

The Fault Line Conflict Between the K.R.G. and Iraq Proper
Thanks to the map below it's possible to note how Iraq is a country with a clear geographical demarcation of its territory among different ethnic and religious groups. 

Ethnic and Religious Groups in Iraq - Source: Wikipedia
If we contextualize Huntington's ideas about fault line wars within contemporary Iraq, we may understand that the relations between Kurdish people and the Iraqi central government have always lent themselves to being defined as a fault line war. The only real point that does not overlap with Huntington's definition is that for the American scholar fault line wars do not involve ideological or political issues for nonparticipants and honestly it's difficult in today's Middle East not to consider the Kurdish-Iraqi dispute as something that does not affect neighboring countries. ­ ­­

To understand today's events in the Kurdistan Regional Government (the K.R.G.) it's of some help to go back to the beginning of the 20th century. After World War I, the League of Nations granted the United Kingdom (U.K.) two mandates: the first over Palestine (at that time Mandatory Palestine and Transjordan) and the second one over what later would become Iraq. On December 1, 1918, in the city of Sulaymaniyah, some Kurdish leaders demanded for Kurdistan a sort of independence under the framework of a British protectorate. The result was not positive. Indeed, the real first initial episodes of the Kurdish struggle for establishing an independent Kurdistan were the two revolts (1919 and 1922) under the leadership of Mahmud Barzanji against the British rule. 

Mahmud Barzanji
The U.K. ended these uprisings only in 1924 after consistent efforts. These two revolts may be considered as the beginning of the contemporary fault line war between the Kurdish people and the central power: a fight first against the U.K. and then after London granted independence to the Kingdom of Iraq in 1932  against the central government in Baghdad. Of course, last century saw periods of open fights and periods of relatively more diplomatic relations, but in general for all the 20th century the relations between the Kurdish people and their central government had been difficult for utilizing just an euphemism.  

Today's Iraqi Kurdistan is an autonomous region in northern Iraq, and it's officially governed by the K.R.G. with Erbil as its capital. The path to obtaining regional autonomy has been indeed very difficult. In fact, after the First Iraqi-Kurdish War (1961-70) autonomy was established in 1970, but the new Kurdish Legislative Assembly was a simple and pure emanation of Baghdad's central government and this meant that in reality there was no autonomy at all. Then, things complicated one more time with the Second Iraqi-Kurdish War of 1974-75 because at the end of this conflict Baghdad extended its control over the northern region. The central government also implemented an Arabization program moving Arab people especially to the vicinity of Kurdistan's oil fields (around the city of Kirkuk).

The situation improved only after the 1991 uprising against President Saddam Hussein at the end of the First Gulf War (1991). At that time, the U.N. Security Council with resolution 688 created a safe haven for the Kurdish people. In addition to this, a no-fly zone was established by the U.S. and the U.K. over northern Iraq (although it did not include two important cities like Sulaymaniyah and Kirkuk). Finally, in October 1991, after months of harsh fighting between President Hussein's forces and the Kurdish troops, a sort of unstable balance of power was reached. Iraqi Kurdistan got its regional autonomy. The last step for strengthening Kurdish stance toward Baghdad was during the Second Gulf War (2003-11 if we consider the timeframe up to the withdrawal of all the American personnel) when Baghdad accepted the creation of a federal system.    

What Are the Reasons for Today's Tensions Between the K.R.G. and Iraq Proper
Today's relations between the K.R.G. and Baghdad are tense, and, notwithstanding some declarations aiming to assuage the current standoff, it appears that no easy way out will be found soon. The current disagreement is based upon two main reasons:

1) The management of the K.R.G.'s oil and gas riches  Current data speak about 45 billion barrels of oil, i.e., one-third of Iraq's proven reserves (proven reserves are those with a 90 percent certainty of being produced at current prices with current commercial terms and government consent; they are known in the industry also as 1P) which are estimated at 150 billion barrels. In other words, quantitatively (not qualitatively because Erbil has heavier oil) the K.R.G. could be another Libya. In addition to oil, the K.R.G. has  3 to 6 trillion cubic meters (TCF) of potential gas reserves. The relations between Erbil and Baghdad have worsened again since the U.S. oil supermajor, ExxonMobil decided to start negotiating drilling contracts with the K.R.G. in 2011. In this way, the American energy company bypassed Baghdad's authorization. In fact, Baghdad affirms that it alone has the right to negotiate and sign energy deals for the whole Iraqi territory, the K.R.G. included. Erbil insists that Iraq's Constitution allows it to agree to contracts, and as a result to ship oil independently of the central government (for more information see: BACCI, A., Chevron and Total Continue Investing in the K.R.G. A Brief Analysis of Baghdad's T.S.C.s vs. Erbil's P.S.C.s, June 2013).

2) Territorial control of the disputed areas  All along the border between the K.R.G. and proper Iraq there are regions that during the rule of the Baath Party were massively Arabized. Historically, the majority of these regions have been inhabited by Kurdish people. With the arrival of the American army in 2003, the Kurds started to move south regaining part of that land that intrinsically they have always considered of theirs. The three governorates Nineveh, Kirkuk and Diyala are all split into two parts: one controlled by Erbil and one by Baghdad. And of course, both the K.R.G. and Iraq would like to have full control of these governorates. The huge importance of Kirkuk is linked to the fact that it sits on the giant Kirkuk oil field, which as of 1998 owned around 10 billion barrels of oil. Recently British Petroleum (B.P.) showed a certain interest for the Kirkuk oil field. 

Map of the K.R.G. and of the Disputed Territories
The K.R.G.'s Reserved Allocation of the Federal Budget 
The K.R.G. receives a 17 percent allocation of the Iraqi federal budget, which is primarily funded by revenues from oil and gas exports. Until December 2012 Erbil exported its oil through the Kirkuk-Ceyhan Pipeline (under the control of Baghdad), and it did not cash in the revenues directly. Instead, these were accrued like the revenues from other governorates to Baghdad's central coffers. Then, the resources were distributed as part of the annual budget to the different governorates in proportion to their population given the absence of an official census, the population was calculated according to the U.N. food ration system created in the 1990s and since then regularly updated.

The K.R.G. is an exception to this system because its three governorates receive a flat 17 percent allocation of the federal budget (before deductions to cover federal expenditures from which the region benefits). This system while, on the one hand, is fair for the individual Iraqi citizens because each of them receives an equal share, on the other hand, is not fair for the oil and gas producing governorates (for instance, the three K.R.G. governorates or Basra Governorate in southern Iraq), which finance also the non-producing governorates. During the last years, many K.R.G. officials have denounced the 17 percent budget allocation as unreal, because for them the K.R.G. has never received the allocation in full. "They never give us 17 percent. They only give us 10 percent" said recently Rashid Tahir, the K.R.G. deputy minister of finance. 
Recent data point out that Iraq will not be able to finance its projected 2014 budget deficit unless the K.R.G. pays its oil export revenues. In specific, it seems that if the central government keeps paying 17 percent of the budget allocation to Erbil without getting back the Kurdish oil export proceeds, Iraqi public finances will collapse. The proposed Budget Law 2014 projected a deficit of $18 billion notwithstanding the assumption that the Kurds paid the Treasury the revenues from Kurdish export of 400,000 barrels per day. The federal considerations about the difficulties of stabilizing the federal budget may be correct, but the assumptions that the K.R.G. could export 400,000 barrels per day seem, at least for now, unreal. Reliable energy sources speak of possible Kurdish exports of 255,000 barrels per day. At the moment, the payment of the 17 percent budget allocation is a very hot topic with federal ministers taking different sides. Anyway, until now, notwithstanding the fact that the K.R.G. did not meet its 2013 export commitments, Baghdad is still paying the 17 percent allocation.      

Also linked to the amount of the budget allocated for the K.R.G. is the issue of the payments of the investment and operating costs incurred by the companies working in the K.R.G. This has been a very difficult topic since the spring of 2009 when the K.R.G. exported its crude oil for the first time. This oil came from the Tawke and Taq Taq oil fields. In principle, Baghdad accepted the validity of the K.R.G. contracts signed before 2007 (when there was a stalemate as for drafting a federal hydrocarbons law and subsequently the K.R.G. issued its own hydrocarbons law in 2014 Iraq does not have yet any federal hydrocarbons law), but it does not accept them as production sharing contracts (P.S.C.s). This differentiation between the contracts on offer in proper Iraq, which are technical service contracts (T.S.C.s), and in the K.R.G., P.S.C.s, is still well present in 2014 at least on papers. The current position in Baghdad is that the contracts that the K.R.G. signed with foreign companies after February 2007 are completely illegal, unless these contracts have been sent to the federal government which may accept, modify or reject them. Contracts predating February 2007 are instead considered valid after a simple review and potential amendments. Presently in the K.R.G., there are around fifty international energy companies (among them four big names: U.S. ExxonMobil and Chevron, France's Total and Russia's Gazprom), which have invested more or less $20 billion.

Initially, Baghdad had affirmed that the profits of the companies operating in the K.R.G. (of course we are talking of companies working under contracts deemed legal by Baghdad) should come out from Erbil's annual share of the federal budget. But later, after months of difficult negotiations Baghdad accepted to reimburse the companies according to an audit of their expenses. And in November 2010, the two parts renewed their arrangement, and the new terms envisaged that the federal government utilized 50 percent of the U.S. dollar value of the export revenues to repay the companies for the investments and operating costs following presentation of the related receipts. Baghdad was available to pay the so called cost oil. Any payment for profit oil was out of question because P.S.C.s were deemed illegal. If profit oil had to be paid these funds should come from the K.R.G. budget allocation. There was also a quota of barrels that the K.R.G. had to provide. This quota has been revised several times since then, although it has always been difficult for the K.R.G. to satisfy the agreed-on barrels per day. Complaining that the federal government was not paying its dues in favor of the companies, in April 2012 the K.R.G. halted a first time its exports. Then, it resumed them in August before stopping completely them in December 2012. The 2013 budget allocated $650 million to the foreign firms while Erbil's request was $3.5 billion.     

Another point of strong budget disagreement concerns the payments requested by Erbil for its Peshmerga troops. In fact, since 2011 the K.R.G. has substituted foreign security contractors deployed on the oil and gas fields with its Peshmerga troops in both the proper K.R.G. and in the disputed areas. Since then, Erbil has been requesting the reimbursement for this deployment from the central government. Logically, Baghdad strongly has opposed any reimbursement of this type and in specific those payments related to the deployment of the Kurdish troops in the disputed areas.    

Why Does the K.R.G. Have Some Leverage Against Iraqi's Control?
Hydrocarbons mean money (at least if the endowed countries exploit oil and gas avoiding the "Dutch Disease") and money means power. Erbil could monetize its oil and gas riches exporting them to Turkey according to two different ways:

A) Exporting its riches under Baghdad's control, but with no political leverage or
B) Exporting its riches independently of  Baghdad's control with political leverage.

A preliminary consideration stands out immediately: The real customer for the K.R.G. oil an gas is Turkey, which, as recently as last November, concluded a multibillion-dollar energy deal (oil and gas) with the K.R.G.. Turkey has a huge appetite for the K.R.G. oil and gas and it has a ballooning $60 billion energy bill. Ankara needs to diversify the security of its energy supplies. Presently, it imports 92 percent of its oil and 98 percent of its gas and it depends mostly on Russia and Iran.

Until December 2012 Kurdish crude oil was exported under Baghdad's control. In fact, the K.R.G. flowed approximately 200,000 barrels per day to Turkey, via the central government export line, i.e., the Kirkuk–Ceyhan Pipeline. 

Kirkuk-Ceyhan Oil Pipeline - Source: Wikipedia
Then, Erbil closed this route because of its row with Baghdad over payments for the oil companies operating in Kurdistan. Since the stop, the Kurds have been exporting 30,000 to 50,000 barrels per day of oil via truck to Turkey. With no doubt, this was a negligible quantity, but in the meanwhile the Kurds have completed their own independent pipeline (the current capacity is 300,000 barrels per day) from the Taq Taq oil field to Fishkhabur, close to the Turkish border. From there oil enters the Kirkuk–Ceyhan oil pipeline and continues to the port city of Ceyhan. In other words, the K.R.G. “dug up the dormant half of the twin Kirkuk-Ceyhan pipeline, blocked the end coming from government of Iraq territory, and commenced to tie in their own newly built pipeline spur to it,” commented David Romano, a professor of Middle East Politics at Missouri State University. 

The Taq Taq-Fishkhabur Oil Pipeline - Source: The American Interest (Dec. 2013)
The legality of using part of the Ceyhan-Kirkuk oil pipeline, although the section located in Turkish territory, without prior consent of Iraq seems dubious on the basis of the Pipeline Tariff Agreement between Iraq and Turkey. This agreement was renewed in 2010 for 25 years. Similarly, there should be a legal ground for Baghdad to receive transit fees for the oil shipped to Ceyhan by the K.R.G..

After some tests done in December 2013, from the beginning of January 2014 the new infrastructure has been exporting oil to Ceyhan. For the moment, crude oil is being stored in terminals in Ceyhan and it will not be exported. Here, the real question is how long the Turkish state-owned pipeline operator will be able to continue storing crude oil at the Ceyhan's tanks before running out of capacity. Ceyhan's overall capacity for the K.R.G. oil consists of three tanks, each with a 2.5-million-barrel capacity. At the end of January 2014, approximately 220,000 barrels of crude oil has been stored. Recent information released by the K.R.G. Ministry of Natural Resources declared that the first parcel of 2 million barrels of oil would be sold by a tender and that monthly export parcels would increase to 4 million barrels in February and to 6 million barrels in March. The current plan is to arrive at a quantity between 10 to 12 million barrels in December 2014.     

The Turks, through Energy Minister Taner Yildiz, are trying to appease Iraq affirming that oil will not be exported without the consent of the Iraqi central government. Another profile of illegality could be that if the K.R.G. withheld its export earnings it probably would violate a U.N. Security Council resolution under which all Iraq's oil exports proceeds must be paid in a U.N.-approved account in New York, U.S. The reason of this methodology is that a five percent amount should be deducted later to pay war reparations to Kuwait for the invasion of 1990.     

Notwithstanding the construction of the Kurdish pipeline, Baghdad would like now to recreate an exporting scheme under its control. And in this regard, last months have seen Baghdad's constant proposition of exporting the K.R.G. oil through Iraq's State Oil Marketing Organization (SOMO), which alone should have the right of selling Erbil's oil and gas. In specific, Baghdad would like to place the resulting income into the Development Fund for Iraq in New York. Instead, the K.R.G. would like to withhold revenues to account for the money owed by Baghdad (17 percent annual share of the federal budget, the payment for the Peshmerga forces and the payments to the foreign oil companies) or alternatively to put oil revenues in an escrow account with Turkey's Halk Bank.

Until now, the storage tanks are far from being full. Once the tanks are full, Turkey will have to decide what to do with the stored oil. And it will not be an easy decision. And similarly, it will not be an easy decision for the companies interested in buying that oil. The reason is simple: Many companies do important business with Iraq, but why should they put themselves at the risk of Baghdad's retaliations? Especially, when crude oil from Erbil is not a game-changer quantity, while, at the same time, Baghdad controls some of the world's largest projects. We could learn a good lesson in this regard from British Petroleum (B.P.) and Royal Dutch-Shell (R.D.S.), which for economies of scale chose to stay with proper Iraq and up to now have not invested in the K.R.G. (for more information see: BACCI, A., BP Continues Investing in Iraq. With T.S.C.s the Devil Is Always in the Detail(s), October 2013, and BACCI, A., Shell's Majnoon Oilfield and the Company's Other Operations in Iraq, November 2013). In the same way, traders are wary: Switzerland's Vitol and Glencore supply Iraq with shipments of fuel and do not want to risk being banned from Iraq, as it happened to Trafigura, a Swiss trader that had previously traded Kurdish oil.   
In this chaotic situation, where both the K.R.G. and Iraq have some cards to play, it will not be easy to find a fast and durable solution. If the K.R.G. proceeds with its plan of bypassing Baghdad's control, Iraq could react implementing the following four actions:

1) Cutting the K.R.G. budget.
2) Taking legal actions against the K.R.G..
3) Taking legal actions against Turkey.
4) Taking legal actions against the companies (oil companies and traders) buying the oil shipped at Ceyhan.  

At the same time the K.R.G. knows that it could reply by:

1) Not allowing the flow of oil from the Kirkuk oilfields to Ceyhan (in fact, a stretch of the Kirkuk-Ceyhan Pipeline runs through the K.R.G. territory).
2)Not supporting Prime Minister Nuri al-Maliki of Iraq during the parliamentary elections due on April 30, 2014. Prime Minister al-Maliki wants to win a third term and needs Kurdish votes.
3) Withdrawing the support of the Peshmerga forces in contrasting al-Qaeda's operations in Iraq, especially in the disputed territories.

Is the K.R.G. Aiming to Becoming Independent?
With no doubt Iraq is one of those Middle Eastern countries whose borders the European countries carved out without a complete understanding of the complex ethnic and religious dynamics present in the area. Kurdish people are an Iranian people speaking Kurdish languages, which belong to the Iranian branch of the Indo-European languages. On the religious side, they adhere to many different religions and creeds. And historically, they have always performed their religiosity in a freer manner than that of the Arabs. In other words, with the Kurdish people we are talking about a group with not many commonalities with the Arabs present in Iraq.

During the second decade of its existence, the K.R.G. has been quite successful in the process of state-building in a complicated region. The K.R.G. is a parliamentary democracy with a regional assembly with 111 seats and has a regional government. It's a stable area with thanks to the hydrocarbons riches a fast-rising economy. What was some years ago just a guerrilla force (the Peshmerga) is now an army of approximately 200,000 soldiers equipped with heavy arms. Plus, the K.R.G. owns a fleet of Russian-made warplanes (a legacy of Saddam Hussein's era) as well as tanks obtained during the 1991 and 2003 wars. Last September, the K.R.G. showed interest for the purchase 12 new helicopters from an American company.   

Summing up, the K.R.G. is a de facto state. As Yaniv Voller of the London School of Economics (L.S.E.) puts it:

The K.R.G. is, in essence, a de facto state. It has gained domestic sovereignty, runs its own civilian affairs and has independent (informal) relations with other states. Yet, its right to have such sovereignty is constantly disputed by international society, so does any aspiration to institutionalize this independence.

Moreover, the word Kurdistan does not relate only to the K.R.G. but to an area where the Kurdish people form the majority of the  population. This area encompasses large parts of eastern Turkey, Iraqi Kurdistan , northwestern Iran and northeastern Syria. All the four involved states Turkey, Iraq, Iran and Syria have experienced difficulties to deal with the Kurdish people present in their territory. As Professor Ofra Bengio recently well explained in her article "The Elephant in the Room":
... the rise of Kurdish issues in all four states has changed the internal dynamics of Kurdish nationalism. An evolving trans-border current has produced a de facto Kurdish regional subsystem whose manifestations are several. First, the Kurds now imagine themselves to be one nation deserving to live on one united territory; this is new. Thus, the new mind’s-eye Kurdistan is portrayed as one unit divided into four parts: north Kurdistan (bakur) corresponding to the Kurdish region in Turkey, south Kurdistan (bashur) to that in Iraq, east Kurdistan (rojhelat) to that in Iran, and west Kurdistan (rojava) to that in Syria. No one should discount the power of having a common geopolitical language in a nationalist ambition.
Kurdish Inhabited Area - Source: CIA (1992)
In practice, continues Professor Bengio:

the K.R.G. in northern Iraq is the center of gravity of this new subsystem. It functions simultaneously as a quasi-state and as a political center for the other three parts of Kurdistan, as well as for the large number of Kurds in the diaspora. Despite a strong legacy of civil war, jealousy and rivalry, most Kurds now look upon the K.R.G. with great pride and view it as a model.

Considering all the elements mentioned above, it's not easy to rule out the possibility that the K.R.G. will not try to become independent, especially when hydrocarbons are giving the K.R.G. so powerful a tool for getting independence. In fact, according to Kurdish calculations, at current oil prices once Erbil reaches around 450,000 barrels per day, it will own earnings more or less equal to the $12.5 billion which Baghdad handed over to Erbil in 2013. Summing up, 450,000 barrels per day could be the threshold after which the K.R.G. would not anymore be financially dependent on Baghdad. Of course, a conditio sine qua non is to have buyers for the crude oil stored in Ceyhan.    

At that point, it's difficult to imagine why in the long term the K.R.G. should continue to be just an autonomous region within the framework of Iraq. Probably, in the short- to medium-term there could be some advantages for both the K.R.G. and Iraq in maintaining the status quo, but in the long run the above mentioned differences could play a very relevant role. Surely, the next months will be of paramount importance for the future of the K.R.G. and Iraq.