The Supreme Court of the Federal Government of Iraq (FGI) in Baghdad has made two landmark legal rulings that have significant, if not catastrophic, implications for the exploration, development, and extraction operations of international oil companies (IOCs) working in the northern Iraq semi-autonomous region of Kurdistan. First, it ruled last week that sales of oil and gas by the region’s government, the KRG, independent of the central government in Baghdad, is unconstitutional and that the KRG must hand over all oil production to the Federal Government of Iraq, represented by the Ministry of Oil. Second, and an even greater direct threat to all oil and gas operations of IOCs operating in northern Iraq’s Kurdistan region, the Supreme Court of the Federal Government ruled that the Ministry of Oil has the right to: “Follow up on the invalidity of oil contracts concluded by the Kurdistan Regional Government with foreign parties, countries and companies regarding oil exploration, extraction, export and sale.”
The basis of this legal ruling harks back to a deal that was struck between the two sides – the FGI and the KRG - in November 2014 in which the KRG agreed to export up to 550,000 barrels per day (bpd) of oil from its own fields and Kirkuk via the FGI’s Baghdad-based State Oil Marketing Organisation (SOMO). In return for this, Baghdad would send 17 percent of the federal budget after sovereign expenses per month in budget payments to the KRG in Erbil. This agreement was superseded by another in October 2018 that required Baghdad to transfer sufficient funds from the budget to pay the salaries of KRG employees in exchange for the KRG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 controlled behind the scenes by radical cleric Moqtada a-Sadr and his ‘Sairoon’ (‘Marching Forward’) faction – has not reliably delivered the monthly funding for the salaries of KRG employees and the KRG has not reliably delivered the agreed-upon volume of oil to SOMO. The key sticking point on both sides in fulfilling their obligations agreed in November 2014 has been disagreement over the number of budget dispersals and oil transfers that should be involved in the deal on an ongoing basis.
This disagreement over the number of budget dispersals from the FGI and oil deliveries from the KRG became much worse after the ‘yes’ referendum vote for independence in Kurdistan in September 2017, as analyzed in-depth in my new book on the global oil markets. Before this, Kurdistan had been hoping to raise oil exports above 1 million bpd, becoming one of the world’s fastest-growing oil regions and allowing for the full resumption of the November 2014 deal. After the ‘yes’ vote, the very basis of the deal became null and void when FGI and Iranian forces took back control of the oilfields in Kurdistan, including the major oil sites around Kirkuk.
The FGI argued that the Kirkuk oilfields had been occupied illegally in the first place, having been under Kurdish control only since 2014 when the Iraqi army collapsed in the face of the Islamic State and Kurdistan’s Peshmerga military force moved in. Consequently, from September 2017, the FGI’s new starting point of any negotiations with the KRG for a new iteration of the original 2014 budget disbursements-for-oil deal was that they should accord with the percentage share of the Kurdistan population in the overall population of Iraq. This, according to the FGI, was 12.67 percent – a long way from the 17 percent of the Federal Budget after sovereign expenses that had been the cornerstone assumption of the November 2014 deal.
At the same time as the 2017 impasse was playing out, Russia intervened, in its standard geopolitical strategy of exploiting pockets of chaos into which it can project its own solutions and thus extend its power. The Kremlin’s corporate oil proxy, Rosneft, effectively took over the ownership of Kurdistan’s oil sector in 2017 through three principal means. First, Russia 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 percent 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 percent ownership of the vital KRG pipeline by dint of a commitment to invest US$1.8 billion to increase its capacity to one million barrels per day.
The prize for Russia and Rosneft was twofold and remains so. Firstly, prior to the 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, as highlighted by the International Energy Agency (IEA). Based on the previous limited exploration and development of oil fields in the KRG area, the proven oil reserves figure was first put at around four billion barrels. This has been subsequently upgraded by the KRG to around 45 billion barrels but, again, this may well be a very conservative estimate, according to the IEA. Secondly, such a presence in northern Iraq would allow Russia to play both sides against the other, thus allowing it to extend its influence in each, and this is precisely what it has tried to do since.
With Rosneft, and its Kremlin supporters, making its own demands in the KRG-administered north, 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, as also examined in depth in my new book on the global oil markets, it looked to strike new oil and gas field exploration and development deals with Baghdad and to intermediate to its own advantage in the budget disbursements-for-oil deal dispute. Moscow 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 percent stake in the Kirkuk-Ceyhan pipeline. Moscow also wanted the FGI in Baghdad 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 percent stake in each.
It may be that part of the reason for the new-found vigor of the FGI’s Supreme Court in giving the Ministry of Oil the right to “follow up on the invalidity of oil contracts concluded by the Kurdistan Regional Government with foreign parties, countries and companies regarding oil exploration, extraction, export and sale” is not primarily directed at Western IOCs after all but rather at checking the increasing power of Russia in northern Iraq. This would accord with some signs in recent months that Baghdad is prepared to offer Washington new ways of dealing with it in the south following the U.S.’s ‘end of combat mission’ in Iraq at the end of 2021.
The true legal position relating to the Iraqi oil industry and the distribution of its revenue sharing between the KRG area and the rest of the country does not help either the FGI or the KRG, as it is unclear, and both sides have claimed – with some justification – a right to the revenues from the disputed oil flows. 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.
By Simon Watkins for Oilprice.com
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