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Why An Oil Deal Between Kurdistan And Baghdad Is Unlikely

The recent transfer of IQD200 billion (US$137 million) from the Federal Government of Iraq (FGI) in Baghdad to the semi-autonomous region of Kurdistan’s government (KRG) in Erbil raised hopes that a new era of cooperation across the two regions’ enormous oil and gas resources might be dawning. However, according to a series of statements from both sides, this transfer of funds was a one-time payment only and not the beginning of a monthly series of payments from Baghdad’s central government budget to the KRG in exchange for oil from the north. In short, the Iraq oil and gas sector is back to where it was before November 2014 – that is, in complete disarray. In November 2014, a deal had been 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 Iraq’s State Oil Marketing Organization (SOMO) and, in return, Baghdad would send 17 per cent of the federal budget after sovereign expenses (around USD500 million at that time) per month in budget payments to the KRG. This agreement ended the perennial squabbling between Baghdad and Erbil that had characterised the dealings in Iraq’s oil and gas sector since the very formation of the new system of governance in Iraq in 2003, immediately after the fall of Saddam Hussein. 

The November 2014 agreement, though, never worked properly, with only sporadic compliance to their obligations on both sides. It was then superseded by an understanding reached between the KRG and the new FGI government formed in October 2018 and centred on the 2019 national budget bill. This required 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 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 al-Sadr – delivered the funding for the salaries of the KRG employees on a monthly basis less than reliably and the KRG has delivered the agreed upon volume of oil to SOMO on the same ad hoc basis.

Related: Japan’s Overambitious LNG Targets Could Transform The Industry The key sticking point for the two sides right now is the same as it has been since 2003 and this is the precise amount of budget disbursements and oil transfers that should be involved in the deal on an ongoing basis. The situation was worsened by the ‘yes’ referendum vote for independence in Kurdistan in September 2017. 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 in 2017, the 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 fields 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 ISIS and Kurdistan’s Peshmerga military force moved in to prevent the militants from seizing the region’s oilfields. From after the Kurdish independence referendum in September 2017 onwards, though, the starting point of any negotiations for the FGI in Baghdad over budget disbursements to the KRG 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 per cent – a long way from the 17 per cent of the federal budget after sovereign expenses that had been the cornerstone assumption of the November 2014 deal.

The 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 clarify the situation. 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. 

Related: Biden Administration Takes Aim At ‘Soaring’ Gasoline Prices

Given this impasse and the extreme likelihood that it will continue just as it has done since 2003 – that is, utterly chaotically – what are the implications for the oil price? Ironically, they are good if you are an oil producer looking for higher prices, as Iraq remains – even more than neighbouring Iran – the greatest relatively underdeveloped oil frontier in the Middle East and the world. Officially, it holds a very conservatively estimated 145 billion barrels of proven crude oil reserves (nearly 17 per cent of the Middle East’s total, and the fifth biggest on the planet). This oil can be lifted at an average of around US$1-2 per barrel excluding capital expenditure or USD4-6 per barrel including capital expenditure – the same world-low level as Saudi Arabia and Iran. 

Unofficially, though, the amount of oil across Iraq – north and south – is likely to be much higher. In October 2010, at the same time as producing the official crude oil reserves figures, Iraq’s Oil Ministry stated that Iraq’s undiscovered resources amounted to around 215 billion barrels. This was also a figure that had been arrived at in a 1997 detailed study by respected oil and gas firm Petrolog. Even this, though, did not include large parts of Iraqi Kurdistan. 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.

Even using the most conservative figures, Iraq has thus far produced only around 15% of its ultimately recoverable oil resources, compared with 23% for the Middle East as a whole, according to the IEA. Further exploration is highly likely to add substantially to the proven reserves figure over the coming decades, particularly given the high success rate of drilled prospects in Iraq. For example, less than half of the potential hydrocarbon-bearing geological prospects identified by geophysical means in Iraq have been drilled but, of these, oil has been found in 65% of them. In sum, the IEA puts the level of ultimately recoverable resources at around 246 billion barrels. 

Following on from these discoveries, Iraq’s Oil Ministry drafted ‘the Integrated National Energy Strategy’ (INES) in 2013 that contained new crude oil production targets under three different operational scenarios. The INES’ best-case scenario was for crude oil production capacity to increase to 13 million bpd, peaking at around that level until 2023 and finally gradually declining to around 10 million bpd for a long-sustained period thereafter. The mid-range production scenario was for Iraq to reach 9 million bpd. The worst-case INES scenario was for production to reach 6 mbpd, which would still mean Iraq overtaking Canada as the world’s fourth largest crude oil producer. 

With the right international oil companies investing the right sums of money in the right areas – and none of that disappearing into Iraq’s black hole of endemic corruption – there is little doubt that Iraq would be able to go through the gears of higher crude oil production very quickly. The prospect of these various production benchmarks being met and then their realisation would weigh on oil prices that are already weighed on by the prospect of oversupply against an uneven demand profile. 

By Simon Watkins for Oilprice.com

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Leave a comment
  • Kenneth Paxton on August 12 2021 said:
    Excellent article! I had no idea that the estimated cost "to lift" is USD 4 to 6 dollars a barrel.

    Why would Iraq want to join the Cooperation Council for the Arab States of the Gulf? One of the great mysteries of Iraq is their currency. For years many have placed their hopes and dreams into the dinar. Waiting for the big pay day. Scammers, gurus and speculators have had their say.
    Yet, eventually something has to give. The future of the US dollar doesn't look so good. Inflation is real. It is a currency killer. The Iraqi currency is undervalued. So, something has to give.

    It would take a genius to determine the destiny of the Iraqi dinar. And a genius is what Iraq needs. A leader that can bring the country together. Someone who can bring a world class economy and viable currency to Iraq.

    My comment is choppy. But no one will read this anyway.

    World governments are indeed converging on Iraq even though the people of the world have little clue to its potential. It's potential is unlimited!
  • Hugh Williams on August 14 2021 said:
    For the Iraqis the US sponsored use of Iraqi territory to form Kurdistan will be seen as the creation of Kuwait from another part of Iraq.

Leave a comment




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