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Simon Watkins

Simon Watkins

Simon Watkins is a former senior FX trader and salesman, financial journalist, and best-selling author. He was Head of Forex Institutional Sales and Trading for…

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The Oil Deal That Could Break Up Iraq

Since the formation of the new system of governance in Iraq in 2003 immediately after the fall of Saddam Hussein there have been a slew of problems between the Federal Government of Iraq (FGI), centred in Baghdad, and the semi-autonomous Kurdistan Region of Iraq (KRI), governed in large part by its government (the KRG) based in Erbil. Back then in 2003/4 it was broadly agreed that the KRG would export a certain volume of oil from its own fields and Kirkuk via the FGI’s State Oil Marketing Organization (SOMO) and would absolutely not independently sell oil from the fields on the international markets. In return, the FGI from Baghdad would disburse a certain level of payments to the KRG from Iraq’s central budget. From that point to this there has been near constant dispute over this arrangement but the latest one seriously threatens the decisive splitting of the FGI ad KRI into two completely separate regions, as had also been promised to the KRI by the U.S. in exchange for its army (the Peshmerga) agreeing to be the West’s boots-on-the-ground fighting force against the Islamic State insurgence from 2014.

According to reports from Iraq, the KRI’s government, the KRG, is currently in the process of preparing its own separate annual budget for the first time since a new working budget agreement was agreed in November 2014 between it and the Baghdad-based government of the FGI. The November 2014 agreement required that the KRG would agree to export up to 550,000 barrels per day (bpd) of oil from its own fields and Kirkuk via SOMO and, in return, Baghdad would send 17 per cent of the federal budget after sovereign expenses (around US$500 million at that time) per month in budget payments to the KRG. This would allow the KRG to pay the expenses of the semi-autonomous government, most notably the salaries of the large number of direct and indirect KRG employees, plus all other expenses. This 2014 agreement, which functioned properly only sporadically, was then superseded by an understanding reached between the KRG and the new government of the FGI formed in October 2018 centred on the 2019 national budget bill. This required the FGI in Baghdad to transfer sufficient funds from the budget to pay the salaries of KRG employees along with other financial compensation in exchange for the KRG handing over responsibility for the export of at least 250,000 bpd of crude oil to SOMO. Shortly thereafter, though, the FGI – nominally headed at that point by Prime Minister Adil Abdul-Mahdi but controlled behind the scenes by radical cleric Moqtada a-Sadr – started to deliver the funding for the salaries of the KRG employees on a monthly basis, and after that he KRG started to deliver the agreed upon volume of oil to SOMO on a more ad hoc basis. This has been the pattern ever since.

This already difficult relationship was complicated further – and remains so – by the input of the Kremlin, in the shape of its proxy oil giant, Rosneft, which holds a vice-like grip over the KRI’s oil and gas sector, and, by extension, over the KRG’s decision-making process. Rosneft effectively took over the ownership of Kurdistan’s oil sector in 2017 through three principal means. First, Russia had provided the KRG with US$1.5 billion in financing through forward oil sales payable in the following three to five years. Second, it took an 80 per cent working interest in five potentially major oil blocks in the region together with corollary investment and technical, technology, and equipment assistance. And third, it established 60 per cent ownership of the vital KRG export pipeline to the port of Ceyhan in Turkey by dint of a commitment to invest US$1.8 billion to increase its capacity to one million barrels per day. After securing this influence over the KRG, the Kremlin found that it could exert power over the FGI in the south, as the KRG controlled the only fully-functioning oil export pipeline into Europe (through Ceyhan) anywhere in Iraq, which affected at least 300,000 bpd of crude oil previously pumped in the Kirkuk province. Consequently, the Kremlin insisted through the KRG that oil flows would not restart until pipeline transit fees and pumping tariffs were paid to Rosneft, which by that point had its 60 per cent stake in the Kirkuk-Ceyhan pipeline. Moscow also wanted the FGI to look again at its decision to deem ‘invalid’ the assignment to Rosneft by the KRG of five exploration blocks in Kurdish territory. These are estimated to have aggregate 3P reserves of 670 million barrels, and Rosneft has an 80 per cent stake in each. Related: Is A Career In Oil Still A Safe Bet?

Overlaying all of this was the extreme bad-feeling and complete lack of trust that the Kurdish people of the KRI had developed both in the West as a whole, and the U.S. in particular – with the anger in the short-term focused on the FGI in Baghdad – over what was seen as a double betrayal of the Kurds. The first was the West’s failure to follow-through on its back-room promise to fully support full independence for the northern Kurdish region of Iraq in exchange for its Peshmerga army leading the sustained fight against Islamic State for the three particularly bloody years of fighting from 2014-2017. Specifically, September 2017 saw a referendum on independence for the KRI, which was voted for by over 90 per cent of the Kurds in the region. Although the results of that referendum were not mandatory, the Kurds fully expected that the U.S. would use the resounding vote for independence to quietly manoeuvre the FGI in Baghdad to accept the establishment of an independent Kurdistan state to its north in the coming three to five years. Instead, from the Kurdish perspective, the U.S. did nothing except stand by and watch as Iranian forces, predominantly, rolled into the KRI – particularly around the main oil areas surrounding Kirkuk – and ‘restored order’, as diplomats put it, following riots in the region after the ‘yes’ vote was ignored. The second piece of betrayal from the Kurdish perspective came after former U.S. President Donald Trump made statements in October 2019 that the U.S. was going to allow the Kurds deadliest enemy – Turkey – to invade northern Syria, in which many hundreds of Kurdish Peshmerga fighters were active (doing what the U.S. had asked them to do – that is, fight the remnants of Islamic State) and would almost certainly be slaughtered by the Turkish Army. In the event, according to former U.S. National Security Advisor, John Bolton, pressure was brought on Trump to ensure with the Turks that this did not happen.

As it now stands, then, the fact that the KRG is preparing its own budget that does not include any budget disbursements from Baghdad in exchange for oil going to SOMO – alongside another version that does include this budget funding - underlines that the endgame for Iraq as a unified nation may be in play. If Baghdad does not fully fund the KRG in accordance with the November 2014 deal then the KRG will have no other option than to sell its oil independently in full, which Baghdad regards as an unforgivable and illegal breach of its sovereignty. In order to circumvent this option, the FGI in Baghdad has already requested the International Chamber of Commerce's International Court of Arbitration for US$26 billion in damages based on Turkey’s alleged ongoing independent purchases of oil from the KRI, without agreement from Baghdad. According to the KRG, it has authority under Articles 112 and 115 of the Iraq Constitution to man­age oil and gas in the Kurdistan Region extracted from fields that were not in production in 2005 - the year that the Constitution was adopted by referendum. SOMO, however, has argued that under Article 111 of the Constitution oil and gas are under the ownership of all the people of Iraq in all the regions and governorates.

If the ruling goes against the KRG then there is little doubt that it will seek to broaden and deepen its relationship with Russia further. If the ruling goes for the KRG then there is little doubt that it will continue to independently export oil to Turkey, so further alienating the FGI in Baghdad.

By Simon Watkins for Oilprice.com

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