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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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Iraq’s Ambitious Oil Plan Faces One Major Problem

The Federal Government of Iraq (FGI) in Baghdad moved swiftly when the U.S. re-imposed sanctions against Iran, ordering its Oil Ministry to breach part of the supply gap by increasing its targets for crude oil production to 6.2 million barrels per day (bpd) by end-2020 and 9 million bpd by end-2023. These targets include oil output from the semi-autonomous region of Kurdistan in the country’s north – an area under the leadership of the KRG. Crucially, the KRG also controls a key pipeline in Iraq’s northern export route to Europe via the Turkish port of Ceyhan. All of this is under threat over a row involving budget payments from the FGI to the KRG in exchange for Kurdistan’s co-operation on oil transfers and exports.

The dispute is not a transitory disagreement but dates back to the very 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 Oil Marketing Organization (SOMO) and would absolutely 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 budget. From 2003 to November 2014, there were constant accusations 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 bpd of oil from its own fields and Kirkuk via SOMO and, in return, Baghdad would send 17% 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 This agreement – which again functioned properly only sporadically - was then superseded by an understanding reached between the KRG and the new Iraqi federal government formed in October 2018 centred on the 2019 national budget bill.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 the beginning of this year, the FGI – nominally headed by Prime Minister Adil Abdul-Mahdi but controlled behind the scenes by radical cleric Moqtada a-Sadr - has delivered the funding for the salaries of the KRG employees on a monthly basis. The KRG, though, has not delivered the agreed upon volume of oil to SOMO. Related: Oil Set For Worst Monthly Drop Since November

The key sticking point for the two sides is a fundamental disagreement over the amount of budget dispersals and oil transfers that should be involved in the deal on an ongoing basis – the same reason that the November 2014 deal did not survive intact for long. 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, the very basis of the deal became entirely null and void when FGI and Iranian forces took back control of the oilfields in Kurdistan, including the major sites around the oil city of 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 Islamic State, and Kurdistan’s Peshmerga military force moved in to prevent the militants from seizing the region’s oilfields. From September onwards, 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, is 12.67% - a long way from the 17% 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 has done little to clarify the ongoing impasse. 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. 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.

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. Additionally, the Con­stitution provides that, should a dispute arise, priority shall be given to the law of the regions and governorates.

Since the ‘yes’ vote on independence, Russia has further complicated matters, regarding the growing schism between the FGI and the KRG as a significant opportunity to take control of the oil and gas assets of the Kurdistan region whilst also maintaining its foothold in the south. The Kremlin’s corporate oil proxy, Rosneft – which has now effectively taken over the ownership of Kurdistan’s export oil and gas pipelines, as part of an agreement to provide it with over US$2.1 billion in prepayment deals under the long-term supply contract, valid until 2020 – has made its own demands of the FGI through the KRG.  A senior oil and gas industry source who works closely with Iraq’s Oil Ministry told OilPrice.com that Moscow is insisting that Kurdistan oil flows would not restart until pipeline transit fees are paid to Rosneft, which now also has a 60% stake in the Kirkuk-Ceyhan pipeline. Moscow also wants the FGI to look again at its decision to deem ‘invalid’ the assignment last October to Rosneft by the KRG of five exploration blocks in Kurdish territory.

Rosneft’s involvement not only threatens Iraq’s plans to meet its new in-house oil production targets but also its potential export routes for the new flows, given the Russian company’s involvement in the northern pipelines leading into Turkey’s Ceyhan port. The original Kirkuk to Ceyhan Pipeline - also called the Iraq-Turkey Pipeline (ITP) - consisted of two pipes, which had a nameplate capacity of 1.6 million bpd combined (1.1 million bpd for the 46 inch diameter pipe, and 0.5 million bpd for the 40 inch one). Related: OPEC Oil Output Set For Drop Despite Saudi Production Boost

Although subject to regular sabotage by militants of various descriptions, the FGI-controlled pipeline’s export capacity reached between 250,000 to 400,000 bpd when running normally, Richard Mallinson, senior oil and gas analyst for global energy consultancy, Energy Aspects, in London, told OilPrice.com. Meanwhile, the KRG, in response to the regular attacks on the FGI pipeline, completed its own single-side track Taq Taq field-Khurmala-Kirkuk/Ceyhan pipeline in the border town of Fishkhabur. This was part of its drive to raise oil exports above 1 million bpd.

Under the previous FGI administration of Haider al-Abadi, the signs were that some accommodation of the demands of Rosneft, and the KRG, might be in the offing, according to the Iraq source. “There had been some movement on the percentage basis for the budget compensation, up from just under 13%, in the early part of last year, and there had been a ratification of the idea that Baghdad would return to significant volumes of oil to Kurdistan for local refining and it had even been acknowledged that a pumping tariff might be paid to Rosneft,” he said.

“At that time, [Jabar] al-Luaibi [Iraq’s Oil Minister] even said that he was willing to accommodate Rosneft in the Kirkuk oil hub itself, highlighting that Baghdad did not want to close the doors in the face of anyone who wants to help,” he added. The only condition at that point was that Rosneft should work with BP (a company that owns a 19.75% stake in Rosneft), which does not appear to be an insurmountable requirement. “The view of the KRG is that al-Sadr will eventually go along with what had been agreed, as it [the KRG] thinks that he is more likely to do deals with Russia than with the US, which he hates with every fibre of his being,” he concluded.

By Simon Watkins for Oilprice.com

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