The long-running dispute over how oil flows are handled in the semi-autonomous region of Kurdistan in northern Iraq – administered by its government (the KRG, in Erbil) – and how the region is rewarded by the Federal Government of Iraq (FGI) in Baghdad for its co-operation in this regard has taken a series of dramatic legal twists in the past week or so. The outcome of these developments will have significant, and potentially catastrophic, implications for the exploration, development, and extraction operations of international oil companies (IOCs) working in the KRG-administered region.
The basis of the dispute dates back to the formation of the new system of governance in Iraq in 2003, immediately after the fall of Saddam Hussein. At that time, it was broadly agreed that the KRG would export a certain volume of oil from its own fields and Kirkuk via Iraq’s State Organization for Marketing of Oil (SOMO) and would not independently sell oil from the fields on the international markets. In return, Baghdad would disburse a certain level of payments to the KRG from Iraq’s central federal budget. From 2003 to November 2014, there was constant dispute from both sides that the other had not met the terms of that understanding. In November 2014, however, a deal was struck between the FGI and the KRG in which the KRG agreed to export up to 550,000 barrels per day (bpd) of oil from its own fields and Kirkuk via SOMO. In return, Baghdad would send 17 percent of the federal budget after sovereign expenses (around US$500 million at that time) per month in budget payments to the Kurds.
This agreement – which again functioned properly only sporadically – was then superseded by an understanding reached between the KRG and the new Iraqi federal government formed in October 2018 and centred on the 2019 national budget bill. This required the FGI 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 the export of at least 250,000 bpd of crude oil to SOMO. Since then, though, the FGI – nominally headed by various prime ministers but for a long period controlled behind the scenes by radical cleric Moqtada a-Sadr – delivered the funding for the salaries of the KRG employees on a monthly basis unreliably and the KRG has delivered the agreed upon volume of oil to SOMO in the same manner.
Aside from the complications arising from the input into the deal of al-Sadr, matters were complicated further by the enormous presence of Russia in the KRG-administered region, especially after 2017. Russia effectively took control of the oil infrastructure in the northern region of Kurdistan in that year – via its corporate oil proxy, Rosneft – at first providing the KRG government with US$1.5 billion in financing through forward oil sales payable in the next three to five years. Then it took an 80 percent working interest in five potentially major oil blocks in the region together with corollary investment and technical, technology and equipment assistance. Finally, it established 60 percent ownership of the vital KRG-Turkey pipeline by dint of a commitment to invest US$1.8 billion to increase its capacity to one million barrels per day. Moscow considered itself well-placed at that point to leverage this presence into a similarly powerful position in the south of the country, in particular by striking new oil and gas field exploration and development deals with Baghdad. These new deals were to follow Russia’s role in intermediating in the perennial dispute between Kurdistan and the FGI in Baghdad on the budget disbursements-for-oil deal. In reality, Russia – far from mediating effectively to find a solution – instead sought to sow further discord between the two sides, as analysed in-depth in my new book on the global oil markets.
It is extremely apposite to note that the longstanding annoyance of Baghdad with the KRG’s on-again, off-again adherence to any version of the oil-for-budget disbursements deal struck in 2014 has only truly begun to show itself in sustained legal action following the international sanctions placed on Russia for its invasion of Ukraine. This began in earnest with two recent landmark legal rulings by the Supreme Court of the FGI in Baghdad, and the Iraq Oil Ministry’s proposal for the creation of a Kurdistan National Oil Company under the federal ownership of the government in the south of Iraq. This is aimed at stripping any authority that the KRG has over its heavily Russian-dominated oil industry and would render all previous contracts entered into between the KRG and oil companies subject to review. In this vein, Iraq’s Oil Ministry ordered the KRG to supply copies of all oil and gas contracts signed between the region’s government and IOCs over the past 18 years, as well as statements of related revenues. In an apparent show of support for Iraq’s Federal Government in Baghdad, the U.S. government granted Baghdad one of its longest ever waivers to continue to import gas and electricity from Iran as an interim solution to its domestic energy supply problems.
Last week saw a court in Baghdad postpone until June 20 a hearing of the Oil Ministry’s lawsuit against seven IOCs operating in Kurdistan, so that all of the defendants can be served with summonses and prepare the paperwork needed to send authorised representatives. At around the same time, according to local reports, the KRG initiated a separate lawsuit against the Oil Ministry, founded on the basis that the provisions of its oil law (‘Law No. 22, 2007’) do not violate the Iraqi Constitution and therefore should be recognised as ‘standing laws’.
A lack of legal clarity has been at the centre of this ongoing dispute since the fall of Hussein in 2003. 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. In addition, the KRG maintains that Article 115 states: “All powers not stipulated in the exclusive powers of the federal government belong to the authorities of the regions and governorates that are not organised in a region.” As such, the KRG maintains that as relevant powers are not otherwise stipulated in the Constitution, it has the authority to sell and receive revenue from its oil and gas exports. The KRG also highlights that the Constitution provides that, should a dispute arise, priority shall be given to the law of the regions and governorates. However, the FGI and SOMO argue 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.
The stakes for the IOCs operating in the northern Iraq region of Kurdistan and for Baghdad could not be higher, given the huge realised and potential oil and gas reserves in the region and the fact that much of the whole country’s key oil export infrastructure into Europe runs through the KRG-administered area (in the shape of the pipelines going into the Turkish port of Ceyhan). The International Energy Agency (IEA) back in 2012 highlighted that prior to the then-recent rise in exploration activity in the KRG area, more than half of the exploratory wells in Iraq had been drilled prior to 1962, ‘a time when technical limits and a low oil price gave a much tighter definition of a commercially successful well than would be the case today’. Based on the previous limited exploration and development of oil fields in the KRG area, the proven oil reserves figure at that earlier time was first put at around 4 billion barrels. This was subsequently upgraded by the KRG to around 45 billion barrels but, again, but the IEA said in 2012 that this might turn out to be a very conservative estimate. Additionally, it added, Kurdistan’s Ministry of Natural Resources estimated back in 2012 that there was 25 trillion cubic feet (Tcf) of proven gas reserves and up to 198 Tcf of unproven gas resources, around 3 percent of the world’s total deposits. The figures looked realistic, added the IEA at that point, given that the US Geological Survey believed that undiscovered resources in just the Zagros fold belt of Iraq, a large part of which falls in the KRG area, amounted to around 54 Tcf of gas.
By Simon Watkins for Oilprice.com
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