Why Do I.O.C.s Have to Invest in Iraqi Kurdistan and/or Southern Iraq?

February 11, 2015

BEIRUT, Lebanon — Recent events in Iraq have shown that the Islamic State has partially lost some of its initial offensive capabilities, and it is now more on the defensive. Today it is difficult to have a clear idea of what will happen to Iraq as a country in a medium- to long-term time frame. Many are the political possibilities. But, with reference to the Iraqi oil sector it is already possible to sketch some basic features. In particular, it is emerging more and more a structural and marketing separation between the two most important Iraqi oil-producing areas, i.e., southern Iraq and northern Iraq, the latter including both the fields within the Kurdistan Regional Government (the K.R.G.) and the fields within Kirkuk Governorate. This separation is reinforced by the poor status of the main pipelines used to export crude oil produced in Iraq. At the same time, notwithstanding the current difficult conditions of doing business in the entire Iraq, for international oil companies (I.O.C.s) both the fields in northern Iraq and those in southern Iraq represent important investment opportunities on a long-term horizon. The aim of this analysis is to show why.

     

A Political Premise in Order to Better Understand the Current Oil Developments in Iraq

Recent developments in Iraq show that the Islamic State is now on the defensive. The attacks carried out by Iraqi, Kurdish and American forces are presently reversing the military gains that the Islamic State obtained last year when the terrorist organization menaced both Erbil and Baghdad. This is indeed very good news. At the same time a huge question mark is what will happen next at the political level, i.e., what will happen to Iraq as a state? In fact, political reconciliation between, primarily Sunnis and Shia, is not progressing as quickly as it should. In this regard, much of the Islamic State success in 2014 was based and facilitated by the non opposition of many Sunni communities in central and western Iraq; these communities were completely disenfranchised from the divisive policies implemented until last August by the central government in Baghdad at that time under the premiership of Nuri Kamal al-Maliki.

Iraq's new prime minister, Haider al-Abadi, who assumed office in September 2014, since last fall has been doing a great job at smoothing down the differences between the different components of the Iraqi society. His job is not easy; he faces strong opposition especially from the State of Law coalition (Shia) of Mr. al-Maliki; and he has to follow at least some directives emanating from Iran. Under these current conditions it is difficult that the central government will be able to win the hearts of the Sunni people of central and western Iraq, who are completely scared by the possibility of being, for a second time in a few years, second-tier citizens under the effects of a political marginalization, if not an ethnic cleansing. One of the possible scenarios of the coming months is that Iraq will continue to be a fragmented country where, the Islamic State, after having lost part of its military capacities, which are of paramount importance if it wants to continue conquering additional parts of Iraq, will retrench back to that ample swath of territory comprised between eastern Syria and central and western Iraq. Summing up, the months ahead won't be absolutely easy for Iraq.

Surely, in 1932, King Faisal I of Iraq's words were quite prophetic:

In this regard and with my heart filled with sadness, I have to say that it is my belief that there is no Iraqi people inside Iraq. There are only diverse groups with no national sentiments. They are filled with superstitious and false religious traditions with no common grounds between them. They easily accept rumors and are prone to chaos, prepared always to revolt against any government.

The Current Upstream Structure of Iraq's Oil Sector

The political premise was necessary in order to understand the evolution of the crude oil business in Iraqi Kurdistan and Iraq proper. According to the Oil & Gas Journal, Iraq owned 144 billion barrels of proved crude oil reserves as of January 1, 2015. These oil reserves represent around 18 percent of the proved reserves in the Middle East and 9 percent of the world's proved reserves. Iraq has the fifth largest proved crude oil reserves after Venezuela, Saudi Arabia, Canada and Iran — of course crude oils from these countries have different characteristics and different costs of extraction.

The table below released by the U.S. Energy Information Administration (E.I.A.) at the end of January 2015 well summarizes Iraq's oil current development. 

In specific, the table shows how most oil reserves are concentrated in:

• SOUTHERN IRAQ, which is a Shia area under the control of the central government
• NORTHERN IRAQ, which could be split in two sub-areas: Iraqi Kurdistan, a Kurdish area, and the Kirkuk Governorate, which has a mixed population.

Iraqi Kurdistan is already a semi-autonomous region with special powers: In practice it is a Kurdish area within an Arab country. But, with reference to Kirkuk Governorate, which is one of the three governorates disputed between the Kurdistan Regional Government and Iraq proper, things are not so straightforward. For more information please see: BACCI, A., Iraqi Kurdistan's Occupation of Kirkuk Oil Field Will Deeply Affect the Iraqi Oil Sector, June 2014. On June 12, 2014, Kirkuk was taken by Kurdish forces, which in this way blocked the possibility that the city and its precious oil reserves fell in the hands of the Islamic State.

Data from the above table clarify how the bulk of the Iraqi production comes from five giant oil fields in southern Iraq (Rumaila, West Qurna-1, West Qurna-2, Zubair and Majnoon), two oil fields in Kirkuk Governorate (Kirkuk and Bai Hasan) and three fields in the K.R.G. (Khurmala Dome, Tawke and Taq Taq). In the central Iraq under government control, for the time being, only the Ahdad field in Wasit Governorate has a relevant production capacity (140,000 bbl/d); this field is linked to the southern export infrastructure. Instead, the area under the Islamic State occupation is an area that to date has never been seriously developed with reference to oil and gas reserves. The nine oil fields mentioned above are the bulk of Iraq's oil production, which in 2014 was approximately 3.4 million bbl/d with an overall export of 2.82 million bbl/d in January 2015 (150,000 bbl/d from the K.R.G. and the remaining 2.67 million bbl/d from southern Iraq).

The separation of Iraq's two oil-producing areas (southern Iraq and northern Iraq, the latter including both the fields in the K.R.G. and in Kirkuk Governorate) is reinforced by the poor status of the main pipelines used to export crude oil produced in Iraq. In fact, of the three international crude oil pipelines present on the Iraqi soil, two are completely not operating, and the Kirkuk-Ceyhan pipeline has in operation only the section related to the Turkish part from Fishkhabur (Iraq-Turkey border) to the port city of Ceyhan in Turkey. The Iraqi section of the Kirkuk-Ceyhan pipeline (from Kirkuk to Fishkhabur) has been out of service since March 2014 as a consequence of repeated militant attacks. In fact, this pipeline runs through Islamic State-controlled territory. 

In the last years, the Kurds have built two pipelines that enter the Kirkuk-Ceyhan pipeline at Fishkhabur:

• The Khurmala Dome-Fishkhabur, which has a nameplate capacity of 300,000 bbl/d, and which moves crude oil from the Khurmala Dome field (Iraqi Kurdistan's KAR Group) and the Taq Taq field (U.K. Genel Energy and China's Sinopec) to the border with Turkey. The K.R.G. is currently working in order to increase the capacity of this pipeline.
• The Tawke field-Fishkhabur pipeline, which has a nameplate capacity of 100,000 bbl/d, and which moves oil from the Tawke field (Norway's D.N.O. and Genel Energy). The companies working at the Tawke field are presently expanding the pipeline's capacity.         

Since May 2014 the K.R.G. has been exporting its crude oil to Turkey via its new Kurdish pipeline system, which is connected to the Turkish section of the Kirkuk-Ceyhan pipeline. Baghdad strongly opposes these exports, which it deems completely illegal.

The Taq Taq-Fishkhabur Oil Pipeline - Source: The American Interest (Dec. 2013)

In addition, the Strategic pipeline, the major Iraqi internal pipeline, which runs from Kirkuk to the Persian Gulf, is not operating. This is a reversible pipeline meant to transport Kirkuk's crude oil to the port city of Basra in southern Iraq and vice versa. Today the only part of the pipeline working is the section from Basra to Karbala, and it is used in order to send crude oil to the refineries in Baghdad. 

Iraq's political framework, coupled with the current infrastructural separation between the fields of northern Iraq (the K.R.G. fields and the fields in Kirkuk Governorate) and the fields of southern Iraq, exemplify the fact that Iraq's two principal oil-producing areas are practically two separate entities. Crude oil from the northern fields no longer may be exported from the port of Basra or the port of Khor al-Amaya; northern crude oil has necessarily only one exporting route from Iraq, i.e., the one that goes north to Turkey via the Turkish section of the Kirkuk-Ceyhan pipeline. And Turkey is not only a significant oil consumer in its own right, but it is also a natural energy hub between three major oil-producing areas (Russia, the Caspian Sea basin and the Middle East) and the European consumer markets. Moreover, Ceyhan is a port that is able to accommodate very large crude carriers (V.L.C.C.) and ultra large crude carriers (U.L.C.C.).

Conversely, from southern Iraq crude oil is easily exported to Asia. In this regard, according to E.I.A. in 2014 about 95 percent (or approximately 2.47 million bbl/d) of Iraq's crude oil exports came from the country's southern export terminals in the Persian Gulf. Of the total Iraqi exports in 2014, 58 percent went to Asia — China 22 percent, India 19 percent, South Korea 9 percent, other Asian customers 8 percent) — 19 percent to Europe, 17 percent to the Americas and 6 percent to other customers. In other words, southern Iraq is a perfect location in order to ship crude oil to Asia.    

ExxonMobil Understood This Separation Between the Two Producing Areas Almost Four Years Ago

U.S. ExxonMobil perfectly understood the virtual separation of the two producing areas almost four years ago; in October 2011, the American company and the semi-autonomous Iraqi Kurdistan signed an oil deal aimed at developing six Kurdish exploration blocks, of which at least two (the Qush and Bashiqa blocks) were within the territories disputed between Erbil and Baghdad. For more information please see: BACCI., A., ExxonMobil Caught Between Erbil and Baghdad, February 2013. 

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 entire 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. After ExxonMobil other I.O.C.s followed suit. Among them, U.S. Chevron, France's Total and Russia's Gazprom Neft. An additional problem was the type of contract signed by the K.R.G. In fact, Erbil started to sign production sharing contracts (P.S.C.s), which Iraq's central government has always deemed illegal because the only oil and gas contracts legal in Iraq should be technical service contracts (T.S.C.s). For more information please 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.   

Immediately after the signature of the deal between ExxonMobil and the K.R.G., started ExxonMobil's a dispute with the central government, with the latter threatening, as a retaliatory move following the Kurdish deal, cancellation of the U.S. company's 20-year T.S.C. related to the development of the giant West Qurna-1 oilfield in southern Iraq where ExxonMobil was the operator with a 60 percent stake in the project. For more information please see: BACCI, A., ExxonMobil Caught Between Erbil and Baghdad, February 2013. Despite rolling declarations the federal government did not accomplish much. After two years, in November 2013, PetroChina agreed to buy a 25 percent stake in West Qurna-1 from ExxonMobil's stake. This move had well been planned in advance by ExxonMobil which wanted to reduce its investment in West Qurna-1 diminishing its economic exposure while at the same time remaining the operator of the field — today ExxonMobil is still the operator in West Qurna-1. After this sale, the dispute between ExxonMobil and Iraq proper left the place in the federal government's priorities to more contingent and risky events like the emergence of the Islamic State insurrection. 

ExxonMobil's position with reference to its activities in the K.R.G. also created some friction points — at least this was what emerged through public communications — with the Department of State, which was worried that I.O.C.s' investments in the K.R.G. could create irreparable fissures and cracks in the edifice of the Iraqi state with unintended consequences for the entire Middle East. But, ExxonMobil's position, as well as Chevron's position some months later, was very clear from a business perspective. Iraqi Kurdistan was, and still is today, a good investment for an I.O.C. ExxonMobil and Chevron are multinational corporations and need to manage the interests of their shareholders, employees, and worldwide affiliates that pay taxes in several different countries. In general, American I.O.C.s "act in harmony with the U.S. foreign and energy security policy only when their interests are congruent, or under severe threat, such as that of legal action." (Vivoda, 2010). With reference to the K.R.G./Iraq proper conundrum, the U.S. position has partially changed in the last months as it became apparent through the declaration of Deputy Spokesperson Marie Harf of the State Department, who at the beginning of January said "that the United States doesn't have a ban on oil sales from any part of Iraq and that Iraqis have to come to an agreement on energy issues to avoid 'any legal ramifications'."

    

The December 2014's Agreement and  Iraq's 2015 Budget   

An improvement in the relations between Erbil and Baghdad occurred last December when after three months of lengthy discussions, the two parties reached a deal with reference to the distribution of oil revenues in Iraq. According to this agreement, which should have one-year validity, the K.R.G. has to supply to Iraq's State Organization for Marketing of Oil (SOMO) 550,000 bbl/d via the Kurdish pipelines to the port city of Ceyhan. About 250,000 bbl/d will flow directly from Iraqi Kurdistan and 300,000 bbl/d from Kirkuk. According to Iraqi officials, the K.R.G. can continue to export more than 250,000 bbl/d, but there is a caveat: The legal action undertaken by the federal government against the K.R.G. regarding the K.R.G. independent oil exports will also continue. A supply of 550,000 bbl/d is not easy to achieve immediately. At the beginning of 2015, the K.R.G. is now able to move to Fishkhabur approximately 400,000 bbl/d — it plans to reach 1 million bbl/d by the end of 2015, said last December Natural Resources Minister Ashti Hawrami of the K.R.G. In this regard, on January 20, Oil Minister Adil Abdul-Mahdi of Iraq detailed a plan to export 375,000 bbl/d from Kirkuk and the Kurdistan region in the first three months of 2015. If on the one side, this agreement has improved the relationship between the K.R.G. and Iraq proper, on the other side, it is roughly outlined and defers a number of contentious issues to future discussions — in specific about the K.R.G. energy policy and the control of the Kirkuk oil field. For more information please see: BACCI, A., The Iraqi-Kurdish Oil Deal, December 2014.

After fighting the Islamic State insurgency, the most pressing problem that both the K.R.G. and Iraq proper currently have to face is the shrunken revenues linked to the plunging of oil prices; 85 percent of Iraq's economy is based on oil. The federal budget for the year 2014 was never approved, and the budget for 2015, which was approved and passed by Parliament — despite the opposition of the State of Law — at the end of January, is short of what was initially planned. The new budget is worth 119 trillion Iraqi dinars, i.e., 105 billion dollars. The price of oil envisaged by the budged is fixed at $56 a barrel — initially it was assumed a price of $70 per barrel and this price difference means that there is a deficit of 25 trillion dinars, i.e., 22 trillion dollars. The budget of the Peshmerga forces was included within the budget of Iraq's Ministry of Defense. Following the vote of the budget, the federal government is obliged to provide again 17 percent of the federal budget to the K.R.G. as written in the Iraqi Constitution — in January 2014 Baghdad stopped its payments to Erbil as a protest against the K.R.G. independent energy policy.

For an I.O.C. Investing in the K.R.G. and/or Southern Iraq Makes Sense on a Long-Term Basis

The International Energy Agency (I.E.A.) estimates that Iraq is going to account for as much as 45 percent of the increase of the global oil production until 2035. In other words, if there is a country that in the coming years could provide an additional and important crude oil supply, this country is Iraq, where, in addition to relevant supplies, production costs are very low. We are referring here to the so-called "accounting breakeven" of the project, i.e. the oil price necessary for an oil-drilling project to create profits. On average, in Iraq proper it costs about $5 to produce a barrel of oil; with reference to the K.R.G., we are in the same range. For instance, Genel Energy, one of the operators in Iraqi Kurdistan, has finding and development costs (F&D) less than $3 a barrel and operating expenses (OPEX) less than $2. Tony Hayward of Genel Energy has recently declared that his company could still profitably produce a barrel of oil with oil prices around $20 a barrel. In times of low oil prices, low production costs are a huge advantage for oil-producing countries and the companies technically doing the job.  

At the time of this writing both the fields in northern Iraq and those in southern Iraq remain unscathed by the Islamic State militants. It's probable that the Islamic State won't be able to enter easily those two areas. This means that production from those two areas will continue notwithstanding many difficulties. Moreover, with reference to the goal of improving their fiscal position, both the K.R.G. and Iraq proper have no real viable alternative to exporting crude oil. No matter what the price of oil is on the international markets, both the K.R.G. and Iraq proper need to export their oil. The current slump in the price of oil is forcing many OPEC members, and among them Iraq, to cut their price in order to defend their market share; in January, Iraq proper set the price of its Basra Light at a discount of $3.70 a barrel to the average of Middle Eastern benchmark Oman and Dubai grades (widest discount since August 2003). Iraq (including the K.R.G.) remains a member of OPEC, but the Iraqi production has not been part of any OPEC quota since March 2008.  

    

In the K.R.G. and Kirkuk Governorate the problems are primarily at the political level. The complexity of the December 2014 agreement between Erbil and Baghdad, with the postponement of addressing the most striking friction points, is a clear remainder that in the coming months there will be difficult and complex discussions between the two parties. But one point is already clear: Without the K.R.G., unless there is a complete victory over the Islamic State, it is impossible to export oil from Kirkuk. At the same time, Erbil has been exporting its crude oil to Turkey since last May because it desperately needs a source of income.      

     

In the southern oil fields the problems are primarily at the infrastructural level: According to Bassam Fattouh of the Oxford Institute for Energy Studies, there are currently "at least 200,000 [bbl/d] of southern production bottlenecked by insufficient midstream and export infrastructure." The most pressing infrastructural challenges are related to terminal storage (only seven days of storage capacity), pumping capacity, water availability for reinjection in several southern fields (Rumaila, Zubair and West Qurna-1) and gas handling. Indeed, these problems exist, but if we consider the extraction of southern crude oil as an activity that will stretch over some decades to come, today's presence of infrastructural gaps is quite normal.

With reference to investing in Iraq, the events of 2014 have been a watershed. Before 2014, for I.O.C.s there was a risk in investing in the K.R.G.; some companies that had important assets in southern Iraq preferred not to risk any quarrel with Baghdad. One of these companies was British Petroleum, which is the operator at the supergiant Rumaila field where the production capacity is 1,400,000 bbl/d. For more information please see: BACCI, A., BP Continues Investing in Iraq. With T.S.C.s the Devil Is Always in the Detail(s), October 2013. Instead, ExxonMobil presciently decided to invest both in the K.R.G. and in southern Iraq. Today, with the current working separation between the two producing areas, this decision could pay well. 

Of course, one consideration stands out above all: The companies that invest in the fields of northern Iraq and/or southern Iraq need to invest on a long-term basis. Monetizing immediately the investments is absolutely not guaranteed, as the mid-size oil companies that have invested in the K.R.G. are experiencing right now. In fact, these companies, such as Genel Energy, D.N.O. and U.K. Gulf Keystone still have not been fully paid for their 2014 exports. Genel Energy is owned $230 million, Gulf Keystone $100 million (up to last November), and D.N.O. probably $100 million. These three companies to date have received between them only $75 million with reference to their exports for 2014. And now, they are starting to sell oil on the Kurdish domestic market because there payments are more reliable. 

So, an energy company that does not have a wide portfolio of investments scattered around the globe and that probably borrowed relevant sums in order to start its operations in just a specific country needs soon stable and regular payments if it wants to avoid being in a very precarious financial condition. This is exactly what is happening with some of the companies that have invested in the K.R.G.; among them, Genel Energy has a better financial position because last year it did a bond issue through which it raised $500 million. For I.O.C.s, the picture is completely different, because they have a more solid financial position and they can do investments where profitability may be postponed as it could be the case in northern Iraq and southern Iraq. 

The K.R.G. and Its Relations with Turkey

There is a strong economic complementarity between Iraqi Kurdistan and Turkey. The latter needs the K.R.G. oil and gas, no matter who's in charge in Erbil, while the K.R.G. needs Turkey economically and politically too.

According to the E.I.A.:

In 2013, Turkey's total liquid fuels consumption averaged 734,800 bbl/d. More than 90% of crude oil consumption and significant quantities of petroleum products came from imports. According to the IEA, Turkey's crude oil imports are expected to double over the next decade. In 2012, the majority of Turkey's crude oil imports came from Iran, which supplied 35% of the country's crude oil. Russia, once the largest source country of Turkey's crude oil, has fallen behind Middle East suppliers in terms of volume and is now the fourth-largest supplier of crude oil to Turkey.

Similarly, in relation to natural gas, in 2012 Turkey consumed 1.6 trillion cubic feet, while its production was 22 billion cubic feet. The difference between consumption and production is huge. Turkey is increasingly dependent on natural gas imports as its domestic consumption rises year after year. Natural gas is used domestically mainly in the electric power sector. 

The above numbers are scary numbers for Turkey, and they explain the importance for Turkey of Iraqi Kurdistan, which is a region well endowed with oil and gas. These data explain why, with reference to Iraqi Kurdistan, in the last years, notwithstanding the opposition of the U.S., Iraq and Iran, Ankara has signed energy agreements, approved the construction of a pipeline connected with the Turkish side of the Kirkuk-Ceyhan pipeline and later transported Kurdish oil to Turkey. In other words, if crude oil from Iraqi Kurdistan goes on the market, Turkey needs to buy it or to manage it. Turkish interest toward Kurdish oil and gas is an additional positive element for the I.O.C.s that invest in the K.R.G., no matter whether Iraqi Kurdistan will continue to be a semi-autonomous region within Iraq or will become one day an independent state. The point is that in northern Iraq there are oil and gas fields (with cheap extraction costs), and they are very close to an important market, Turkey, capable of absorbing a good part of this oil and gas production.  

The Geopolitics of Energy in the Middle East

December 29, 2014

Dear friends,

I would like to share with you my video "The Geopolitics of Energy in the Middle East".

The basic idea behind this project is to provide some additional information about who I am and what my professional activity is. In fact, in the last months I have received several requests from many of you asking me to provide further details about me and what I do in the energy field in the Middle East.

Now, I hope that the video may satisfy your requests. In specific, in addition to my personal and working facts, I have tried to convey my vision of what the geopolitics of energy should be nowadays.  

Happy New Year to all of you!

Best regards,

Alessandro



 

Click here if you don't see the video

 

Below there are some preview frames of the video 

The Iraqi-Kurdish Oil Deal

December 18, 2014

BEIRUT, Lebanon — After three months of lengthy discussions, at the beginning of December, the Kurdistan Regional Government (K.R.G.) and Iraq's central government finalized a deal with reference to the distribution of oil revenues in Iraq. An important breakthrough had already happened in November when the two sides agreed on a couple of confidence-building gestures: the K.R.G. provided to Iraq's State Organization for Marketing of Oil (SOMO), 150,000 barrels per day (bbl/d) of Kurdish oil at the city port of Ceyhan (Turkey) during the final two weeks of November, and the central government made a onetime payment of the value of $500 million to the K.R.G.    

  

The final agreement, which will be implemented from January 2015, specifies that Baghdad will pay Erbil 17 percent of Iraq's national budget as defined by the Iraqi Constitution, while Erbil will provide the central government 250,000 bbl/d of Kurdish oil at Ceyhan for export. The money received from the sales of the Kurdish oil will be deposited in an escrow account in New York — until now the K.R.G. has deposited the money received from its oil sales at Halkbank, the Turkish state bank. In addition, the K.R.G. will also export via the newly built Kurdish pipeline 300,000 bbl/d of oil extracted from the oil fields of the area around Kirkuk (Bai Hassan, Dubis and Havana fields). These oil fields are under federal jurisdiction, but they are currently under Kurdish control. In fact, last June, the Peshmerga forces occupied Kirkuk in order to avoid that it could fall in the hands of the Islamic State, the terrorist organization that now controls central and western Iraq.

In total the K.R.G. will supply 550,000 bbl/d, which should provide Baghdad with approximately a billion dollars per day. Technically, shipping to Turkey via the same pipeline Kurdish crude oil (a blended medium crude oil quality with gravity of 30 to 32 API degrees) and Kirkuk crude oil (an average gravity of 36 API degrees) may be done only through batching in order not to mix the two different qualities of crude oil. Apart from the necessity of carrying out the batching of oil, another problem would be the infrastructural gap of the present Kurdish oil pipeline, which would not be able to accommodate so big a quantity of crude oil (the oil extracted from the K.R.G. and the Kirkuk oil) unless additional pumping stations are added. But, in this regard, in a conference in London, Minister of Natural Resources Ashti Hawrami of the K.R.G. recently affirmed that the pipeline to Turkey would carry 500,000 bbl/d by the end of the first quarter of next year and that during 2015 it could carry 800,000 bbl/d including the 550,000 bbl/d to be market by SOMO.       

Iraqi Kurds Pipe Oil to Turkey — Map by Lindsey Burrows

The American Interest (Dec. 2013)

From Ceyhan, all of the barrels covered by the new agreement will be exported by SOMO, although the Kurds initially demanded to market the K.R.G. oil through the Kurdistan Oil Marketing Organization (KOMO). This agreement will last for one year and could help Iraq draw Budget Law 2015 — in this regard it is important to underline that until now the central government has never approved Budget Law 2014 because of strong contrasts with Iraqi Kurdistan.

As a corollary to the deal, until the end of 2014, the K.R.G. will continue to provide SOMO with 150,000 bbl/d of Kurdish oil at Ceyhan, and Baghdad will grant the K.R.G. another $500 million. The government will also supply ground troops to support the Peshmerga forces in their fight against the Islamic State in the Iraqi northern theater, and it will transfer $100 million on a monthly basis for the salaries of the Peshmerga forces.

As a consequence of the deal, the companies operating in the K.R.G. will receive more money. In Iraqi Kurdistan, the companies extract oil and then the government sells it. The companies were owned almost $2.87 billion up to last November (both in cash and bartered goods); in general until now they have received only a small fraction of the due amount. Without at least increased payments from Erbil, it is difficult for the foreign companies to boost their operations in the K.R.G. For instance, in November, Gulf Keystone Petroleum, a company registered in Bermuda, still was owned $250 million for its activity.

It is difficult to evaluate this deal, which, as above highlighted, will have duration of only a year and has yet to be approved by the Iraqi Parliament; it is required a simple majority of the 328-seat Iraqi Council of Representatives (العراقي‎ مجلس النواب). But, if we analyze this agreement through a realistic approach, it indeed appears as probably the best solution for the concerned parties under the dire economic, political, legal and social circumstances present in today's Iraq. In other words, it is a temporary agreement that does not solve the friction points between Erbil and Baghdad but that, at least, permits Iraqi Kurdistan and Iraq proper to improve their coffers and thanks to this to wage with better means a war against their common present and clear danger, which is the Islamic State. In fact, approximately one-third of Iraq — in specific, central and western Iraq — is still under the control of this terrorist organization, which in the last months has advanced south toward Baghdad. Only the intervention of foreign powers (the coalition around the U.S., and Iran) has been capable of partially limiting the northern and southern advance of the Islamic State, which nevertheless has geographical depth because it controls a vast area straddling Iraq and Syria. All the real friction points will probably emerge one more time by the end of the fight against the Islamic State, if not before — the chickens have come home to roost.

WILL THE K.R.G. BE INDEPENDENT FROM IRAQ PROPER? 

The real goal that Iraqi Kurdistan wants to achieve is independence from Iraq proper. In 2014, Kurdish politicians have plainly expressed that independence is the real goal to achieve. Especially after the occupation of the Kirkuk oil field and the Islamic State advance toward Baghdad, the sentiment in Erbil was that the long-awaited independence was not so far. Then, the harsh reality showed that:

• The Peshmerga forces were not capable by themselves to fight and win a complete victory against the Islamic State. Many times in the past months the Peshmerga forces have been outgunned by the Islamic State fighters. Only the backing of the U.S.-led coalition airpower has permitted to regain control of villages previously lost to the Islamic State offensive. And only in October, Turkey's Special Forces started training the Kurdish fighters with reference to the use of heavy weapons.   
• Both Turkey and Iran, although on a different basis, were against the independence of the K.R.G. from Iraq. In fact, Iraqi Kurdistan is highly dependent on both countries for trade, investment and transport. It is quite unclear whether the Kurds have the strength to stand alone in a very turbulent region without the support of their neighboring countries. As Deputy Prime Minister Qubad Talabani of the K.R.G. pointed out to Al-Monitor, a media site covering the Middle East, "We have grounds to become independent, but we have to also realize we are not neighbors to Luxembourg or Switzerland.”
• The K.R.G. was on the verge of bankruptcy. In February, Baghdad stopped the payment of 17 percent of the state budget (a monthly payment worth $970 million) after the K.R.G. at the beginning of the year started independent pipeline exports to Ceyhan — although the first tanker for export in Turkey was loaded only in May. Kurdish public officials have not received their salaries for several months. Kurdish sources affirmed that before the interruption of the payments they had always received less than 17 percent of the budget (they said around 12 percent). And in the past months, in order to cover the payments of its civil servants and to fund public projects, the K.R.G. has been obliged to borrow around $4 billion from foreign companies that operate in Iraqi Kurdistan. Plus, the K.R.G. is presently sustaining a financial strain linked to the influx of refugees from Iraq.
• The slump in oil prices has been an additional problem. Oil prices were as high as $107 a barrel in late June, and today they are around $59 per barrel. Some sources affirm that as result of the unclear legality of the Kurdish exports, Erbil has always been obliged to sell its crude oil at discounted prices. It goes by itself that the current slump is an additional hurdle for Iraqi Kurdistan. Oil price analysts point out that the price of oil will not recover consistently quite soon, and that it is possible that for the whole 2015 prices will continue to be low. 

So, Kurdish independence is out of question for the time being; in the future maybe.     

BAGHDAD HAS NECESSARILY TO INCREASE ITS OIL OUTPUT

On the Baghdad side, solving once and for all the legal dispute related to Kurdish oil contracts with foreign oil companies and Kurdish oil exports independent of any authorization by Baghdad is not achievable under the current circumstances. In Iraq, the time of a clear definition of the hydrocarbons sector legal environment has to be postponed. It is pointless trying to define legal issues when: one-third of the country is occupied by the Islamic State, Iraqi Kurdistan wants to be independent, foreign countries are conducting military operations in Iraq, and a new government (Prime Minister Haider al-Abadi) is trying, amid many difficulties but with good results, to expand its consensus basis especially with the disenfranchised Sunni population. Discussing sector-specific laws or the interpretation of some articles of the Iraqi Constitution (namely Article 112) when the overall structure of the federal republic of Iraq is questioned is equivalent to put the cart in front of the horse. For the sake of knowledge, in the oil sector, the quarrel between the K.R.G. and Iraq proper started ten years ago, when Erbil awarded the first oil contract without any prior authorization by Baghdad. 

Also for Baghdad, the most important and pressing problem is now to increase its revenues. With a projected budget deficit of about $40 billion, Iraq needs to boost its production notwithstanding the current slump in oil prices and the discontent within OPEC for an increase of Iraq's oil production (now at 3.3 million bbl/d, primarily from the southern oil fields with an overall export of 2.4 million bbl/d to 2.6 million bbl/d), which could additionally sink the price of oil. Iraq has not been included in the OPEC system of quotas for almost a quarter of a century, but, according to the International Energy Agency (I.E.A.), Iraq will produce 6.1 million bbl/d by 2020 and 8.3 million bbl/d by 2035; Iraq will account for 45 percent of the total growth in global oil output by 2035. The only at the moment available and quick ways for Iraq to boost its production are:

1. to return in charge of the revenues from the Kurdish oil fields.
2. to return in charge of the production from the oil fields around Kirkuk.      

In fact, in the last ten years the Kurds have consistently developed the K.R.G. oil industry, and now ten oil fields have been declared commercial (significant production comes from four fields). The Kirkuk field was brought in production in 1934, and, notwithstanding the troubled history of the last 14 years, with proper management it should still be able to produce 400,000 bbl/d to 500,000 bbl/d. Then, upon completion of the current renovation projects by British Petroleum (BP) and the linking of the Kirkuk pipelines to the Kurdistan-Turkey Pipeline, the capacity of the Kirkuk oil field could reach 700,000 bbl/d and a million bbl/d in a year. 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. 

Kirkuk District, Oil Gusher Spouting (circa 1932)

G. Eric and Edith Matson - G. Eric and Edith Matson, Matson Photographic Collection, Library of Congress

Of course, Iraq would like to increase its oil production coming from the southern fields as well. This year the development there has proceeded quite well, but some important infrastructural gaps have already emerged and will not solved soon (not before 2017-18). "The problem in the south is that joint infrastructure, whether terminal storage and pumping capacity, water availability or gas handling, remains well behind schedule. Water injection is one of the most urgent issues" says Bassam Fattouh, the director of the Oxford Institute for Energy Studies.    

THE NEW DEAL POSTPONES ANSWERS TO DIFFICULT QUESTIONS

In the last days, both the K.R.G. and Iraq have tried to avoid answering directly and conjointly to questions related to the two most visible friction points:

• What to do with the K.R.G. oil production in excess of the quantity agreed upon by Erbil and Baghdad, and how to deal with Kurdish oil that has already been exported since May.
• The control of the Kirkuk oil field.

It would be interesting to understand what will happen to the quantity of Kurdish oil in excess of 250,000 bbl/d exported by the K.R.G. and to the previous Kurdish oil exports legally challenged by Baghdad. Last month, Iraqi Kurdistan affirmed to have exported through Turkey since May approximately 34.5 million barrels, which Baghdad considers illegally exported. According to Reuters, it seems that after the K.R.G. initial difficulties finding buyers for its exported oil, Trafigura, one of the world's most important trading firms, successfully handled some of the Kurdish cargoes to several destinations.

The point related to how handling the oil quantity in excess of 250,000 bbl/d will be relevant soon in the coming year because the K.R.G. is increasing its exporting capacity to 500,000 bbl/d by the end of the first quarter of 2015 and then to 800,000 bbl/d during 2015. Presently, Iraqi Kurdistan is already exporting around 300,000 bbl/d, while current production is 400,000 bbl/d, of which 100,000 bbl/d are used for the manufacture of the refined products consumed within the K.R.G. In practice, already in 2015, there will be a quantity of Kurdish oil in a sort of legal vacuum. In this regard, immediately after the agreement, Deputy Prime Minister Qubad Talabani of the K.R.G. said that the new deal had acknowledged the legality of the K.R.G. exports. But then, after just three days, the Oil Ministry of Iraq issued a counterstatement where it affirmed that any oil dealings outside of the numbers and frameworks included in the deal would be considered illegal. The statement continued denying the existence of any "verbal or written agreements" that could have permitted the K.R.G. to export oil outside of the framework of the agreement. Later, Mr. Hawrami said that the K.R.G. would continue to market a portion of its crude oil while negotiating the terms with Baghdad.       

Minister of Natural Resources Ashti Hawrami of the K.R.G.
Photo by Rojava News

The second important point missing in the discussions between the K.R.G. and Iraq proper is the future of the Kirkuk oil field. An initial consideration: For Baghdad it will always be difficult to administer the three governorates of Iraqi Kurdistan as if they were one of the other 16 Arab governorates of Iraq. The K.R.G. is already a semi-autonomous region with special powers: in practice it is a Kurdish area within an Arab country. But, with reference to Kirkuk Governorate, which is one of the three governorates disputed between the K.R.G. and Iraq proper, things are not so straightforward. For more information see: BACCI, A., Iraqi Kurdistan's Occupation of Kirkuk Oil Field Will Deeply Affect the Iraqi Oil Sector, June 2014.

The value of the Kirkuk oil field is tremendously important for both the contestants. In fact, according to the latest data, the Kirkuk oil field is home to at least 12 billion barrels of crude oil. Iraq's North Oil Company now claims that the reserve is much higher; it estimates the oil reserve between 20 to 25 billion barrels. In particular, losing control of the Kirkuk area would probably have relevant consequences with reference to the territorial dimensions of Iraq because it is evident that if, in the future, the Kurds maintain control of Kirkuk, then Baghdad will never be able to have a word in relations also to the oil exported from the three original Kurdish governorates. In other words, Kurdish control on a permanent basis of Kirkuk means for Baghdad that two out of three of the most important oil-producing areas in the whole Iraq would be controlled by the Kurds. Indeed, Baghdad would remain in charge of the huge and profitable southern oil fields, but it would have a curtailed influence in the oil business. Another Iraqi area where there should be sizable oil and gas reserves is Anbar Governorate, which has never been developed to date. The problem is that this governorate is under the Islamic State occupation.   

Moreover, until this summer, Kirkuk oil field used to provide 280,000 bbl/d to the Baiji refinery for the domestic consumption of 11 Iraqi provinces. Since then, the refinery has been contested by the Islamic State and Iraqi forces. Currently, it is under Iraqi control but deep in Islamic State-controlled territory. Iraq is able to refine only 600,000 bbl/d of crude oil (a small quantity for a country as big as Iraq), of which half barrels are refined by the Baiji refinery, which is strategically located in order to be well supplied with crude oil coming from Kirkuk. As a consequence of the current complex situation around the Baiji refinery, Baghdad has been already forced to import additional gasoline, diesel and L.P.G. (butane and propane). 

Baiji Oil Refinery

PUK Central Council 

HOW DOES THE BAGHDAD-ERBIL DEAL AFFECT TURKEY?    

After the deal, the exclusivity relation that Turkey has cultivated with the K.R.G. for the last three years has been partially reduced. But, it is also true that for the Kurds this tight relation with Ankara was a springboard toward first economic independence and then political independence from Baghdad. And Ankara has always opposed an independent Iraqi Kurdistan because this would have created problems in the Kurdish-inhabited parts of Turkey — 18 percent of Turkey's population is Kurd; from 1984 to 2013 the Kurdistan's Workers Party (P.K.K.) fought an armed struggle against the Turkish state for cultural and political rights and self-determination for the Kurds in Turkey. Turkey's reluctance to fully support Iraqi Kurds and Syrian Kurds (in Kobani) in their struggle against the Islamic State has to be read through the lens of Turkish opposition to any Kurdish statehood. 

The reality is that the K.R.G. and Turkey need each other. The K.R.G. has energy resources and Turkey needs them in order to diversify its energy suppliers — Turkey imports 90 percent of its oil. But in addition, this relation is substantiated by pure geography as well, because Turkey is the most evident and economically efficient route for exporting oil from the K.R.G. And similarly, until last March when the Iraqi section of the Kirkuk-Ceyhan Pipeline was damaged, Kirkuk oil was exported north to Turkey — and geographically Kirkuk is more south than the K.R.G. Moreover, for Ankara, the K.R.G. may be the only friendly entity present in the Middle Eastern neighborhood. In fact, Turkey's so magnified "zero-problems-with-neighbors" policy is long gone.