How Kurdistan Is Taking Advantage Of Iraq’s Oil Crisis

Yves here. I’m not able to opine on the analysis below, but the notion that the Kurds are trying to muscle a weakened Iraq government is entirely plausible. However, the routine demonization of Russia gives grounds for discounting the “dastardly Russians” thesis. The Kurds are out to sell their oil. Given that they are at odds with the Iraq government, that means to buyers not allied with the US (yes, the Iraqis are deeply unhappy with the US, but this still looks more like a bad marriage than a divorce).

By Simon Watkins, a former senior FX trader and salesman, financial journalist, and best-selling author who has written extensively on oil and gas, Forex, equities, bonds, economics and geopolitics for many leading publications. He has also worked as a geopolitical risk consultant for a number of major hedge funds in London, Moscow, and Dubai. Originally published at OilPrice

Iraq is facing a desperate financial situation: obliged to pay billions of dollars in state salaries, pensions, and other disbursements whilst its ability to generate revenue to do so is severely constrained by a low oil price environment and OPEC+-mandated production quotas. Making matters worse is that the government of the semi-autonomous Kurdistan region in the north – the KRG – is using Baghdad’s deteriorating financial position to advance its own agenda and, by extension, the agenda of its principal state-sponsor, Russia.

Baghdad had little choice earlier this year but to overshoot its OPEC+ crude oil production quotas, given that by the middle of the year its oil revenues had fallen by nearly 50 per cent, while the government still derives 90 per cent of its revenues come from crude oil sales. At the same time, the then-new Prime Minister, Mustafa al-Kadhimi, needed IQD12 trillion (US$10 billion) just to pay the next two months salaries of more than four million employees, retirees, state beneficiaries, and the food relief for low-income families. It was believed in Iraqi government circles that any failure to pay any of these obligations could result in the sort of widespread protests that occurred at the end of last year.

The problem for Baghdad is that these payments are regular ones, the price of oil has not improved, and it was already quietly censured by OPEC+ for breaking its quota. Given Iraq’s unusually high level of economic dependence on crude oil sales, the IMF recently stated that it expects the country to see a 12.1 per cent drop in its GDP for 2020. These factors also mean that any opportunity that Iraq has to raise money in the international capital markets will come at a preclusively high price, with yields on its dollar-denominated bonds having risen to more than 10 per cent, the highest in the region.

To ease the burden of adhering to the OPEC+-mandated production quotas, Baghdad had been looking to the KRG, based in Erbil, to make cuts from its own output in the semi-autonomous region. In response, the KRG last week made it clear that it would consider doing so only on two conditions. The first is that the Federal Government of Iraq (FGI) in Baghdad pays what the KRG says it owes by dint of the long-standing ‘oil-for-budget payments deal’. The second is that this is augmented by further money that compensates the KRG for the loss of revenue from not producing the output that it was previously producing. In other words, not only would Baghdad lose revenues from not producing to its own full capacity in the south but it would have to spend more of these vastly reduced revenues on paying the north not to produce to capacity as well.

This scenario for Baghdad gets worse for two reasons. Firstly – and having learned a trick from Russia and Saudi in the run-up to setting production quotas based on previous output – the Kurdish region dramatically ramped-up its crude oil production last month. Kurdish crude oil exports for September increased by 5.6 per cent month-on-month, to 450,000 barrels per day (bpd), according to industry figures. In the meantime, its compliance with the OPEC+ production quotas for August/September was just 79 per cent, compared to the 102 per cent compliance in the south of the country (as a result of it having to make up for the earlier overshoots). Indeed, according to industry figures, in order for the south to make up for the overproduction earlier this year, it will have to underproduce by 698,000 bpd to the end of this year.

Secondly, aside from the opportunity cost payments to be made to the region for not producing to previous capacity, the additional payments ‘owed’ by Baghdad to the KRG under the standing ‘oil-for-budget payments deal’ have been matter of high contention ever since the structure of the deal was formulated in 2014. Originally this deal envisaged the KRG exporting up to 550,000 bpd of oil from its own fields and Kirkuk via Iraq’s State Oil Marketing Organization (SOMO), in return for which 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. From the start, both sides relentlessly cheated on the deal, with the KRG at various times stopping all oil shipments to SOMO and preferring instead to try to sell it to a range of other countries. Baghdad has sought to take the KRG to court repeatedly to stop such activity on the basis that it is illegal.

Crucially in this context – and absolutely vital in understanding another key development last week – is the very different legal view that Erbil and Baghdad have on the ownership of oil rights and export sales rights in the KRG area. According to the KRG, it has authority under Articles 112 and 115 of the 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, argues that under Article 111 of the Iraq Constitution oil and gas are 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 argument runs, the KRG says 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. Moreover, the Constitution provides that, should a dispute arise, priority shall be given to the law of the regions and governorates.

Given the KRG’s legal view, then, news last week that it is considering transferring its oil assets to the federal government in Baghdad in exchange for it paying its public sector salary bill, is entirely consistent. Consistent also with KRG views is that, in reality, according to a senior oil and gas industry source who works closely with Iran’s Petroleum Ministry spoken to by OilPrice.com last week, the KRG has little intention of allowing the full and meaningful transfer of assets to the south. Even those which it does partially transfer will only be done for a very short time indeed – just long enough to get it over the current financial hump it also faces. “The KRG will negotiate on the basis that the additional financial payments from Baghdad are delivered in large part first, before anything happens with the KRG assets,” he told OilPrice.com.

Ensuring as much of these payments are upfront is vital for the KRG as its current deficit is around U$68 billion, in significant part representing months of unpaid sector salaries (three out of four workers in the region are state employees in some way). This figure compares to the current US$270 million per month that Baghdad is supposed to be paying Erbil under the ‘oil-for-budget payments deal’ in exchange for the KRG supposedly handing over to SOMO for export at least 250,000 bpd. The remainder of the KRG’s oil – nearly the same amount again – goes for export via a pipeline under KRG control to the Turkish port of Ceyhan.

This degree of chaos is a perfect arena for Russia to exploit, which is precisely what it is busy doing. Moscow gained effective control over the Kurdistan region in 2017 by dint of a series of deals done by its corporate proxy Rosneft and since then it has been looking to leverage this presence into a similarly powerful position in the south of the country. Russia has looked to achieve this by striking new oil and gas field exploration and development deals with Baghdad as part of Moscow’s role in intermediating in the ‘budget-disbursements-for-oil’ deal. These ambitions were put on hold for some time, as Russia did not want to be obviously associated with the increasingly Iran-driven anti-American militancy in southern Iraq that resulted in a number of deadly strikes against U.S. military installations over the past couple of years. However, a sign of Russia’s renewed determination to press ahead with its Iraq plan began with the recent deal to develop Iraq’s Block 17 by Russia’s Stroytransgaz, which Moscow intends to be part of an energy and transportation corridor from Iran through Iraq and into Syria, with an additional export route south east via Basra port to the East.

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8 comments

  1. harry

    Strongly disagree with the basic premise. Moscow does not have control of Kurdistan. If any country has disproportionate influence it is the US. Its true the US can’t stop the smuggling of Iranian oil, but there is a reason why the US consulate in Erbil is enormous.

    Anyone who visits Kurdistan knows the place is lousy with US “contractors”.

    Yes Rosneft has picked up blocks. That’s mostly cos the US majors are pulling out.

    Reply
    1. Yves Smith Post author

      Ahem, please read the piece again. While I appreciate the input on the region, the “basic premise” isn’t the role of Russia but how Kurdistan is outplaying Iraq.

      First, I flagged skepticism about the article’s position on Russia at the very top. Second, the article is almost entirely about the row between Kurdistan and Iraq, with the role of Russia a big aside, and not the point of the piece. And at the top, it makes the less aggressive claim that Russia is the Kurd’s main state sponsor, and does not mention Russia again until the very end.

      Reply
      1. Harry

        Apologies Yves. You are absolutely right with respect to those points. The Kurds take an extreme position with respect to their claim over oil assets in Kurdistan, which is at odds with Federal Iraq’s position. Were Federal Iraq in a stronger position I suspect they would try to stamp this out. But they are and have been too weak. Worth noting that Covid has affected Iraq very badly. A friend of mine from Erbil has been trapped in Baghdad for at least 6months, while his family lives in Erbil. No intra Iraq travel is permitted.

        In the meantime, the Kurds have been busy trying to build out their defacto independence for the last 10 years. And there seems to be a faction of American FP community which is both encouraging and facilitating that drive. Personally, I wouldnt lend these guys $5. Nice guys (and very clever) but completely untrustworthy, unless you are a member of their clan (being Kurdish is not sufficient). But as I hinted, you come across a weird bunch of elderly ex-US serviceman, who are now acting as “security consultants” to various Kurdish oligarchs. Same with British ex-serviceman.

        Someone somewhere very clearly was aiming at an independent Kurdistan. Whether that goals is still their longer term aim I cannot say. But Federal Iraq will never tolerate it while they they have the strength to oppose it. Worth noting that very few urban parts of Kurdistan are monolithically Kurdish. Which makes me far less sympathetic to Kurdish ambitions for independence. Kurdish independence would be a disaster for the Arabs living among them.

        Reply
        1. Harry

          One other point of interest is that there is so much smuggling of Iranian oil (ironic cos they hate Iranians, but business is business), that I wonder how much of the apparent increase in production is really cheating on quotas, and how much is simply laundering of Iranian oil which they then export to Turkey?

          But I am speculating.

          Reply
        2. Bob

          The Kurds have been seeking to be an independent nation for many years at least since WW1.
          And the Great Powers have happily alternately restrained and encouraged the Kurds.

          What is different this time is that the Kurds have a significant income stream that they lacked in the past.

          So will the Iraqis and the various and sundry Great Powers allow this to continue ?

          Reply
  2. Synoia

    Does the Kurdistan oil get to markets through Basra, or across the Syrian desert?

    When I was a child is was through pipelines across the Syrian desert to Mediterranean ports; which might be a “unreliable” route at present.

    Reply
  3. jpr

    Sounds like a latter day version of “scramble for Africa”. This “Kurdistan” will be a worthy successor to Manchukuo and Katanga in the sordid annals of Imperialism.

    Of course, with possibility of the likes of Samantha Power and her favorite foreign policy tool of “Responsibility to Protect” (R2P to cognoscenti) coming back to power, this will no doubt turn out to be another excellent adventure. Don’t forget that notions like “Humanitarian Intervention” were completely discredited by the early 20’th century after centuries of British, French, Dutch, Spanish, Portuguese, etc. selective use of this handy tool of Imperial statecraft. Here’s some info on the only three powers that were brazen enough to try using it in the first half of last century:

    When Japan invaded Manchuria in September 1931, it initially characterized the intervention as necessary to protect Japanese nationals and businesses from acts of violence by Chinese military forces. As time passed and Japanese troops remained in Manchuria, the rationale shifted to an emphasis on a duty to protect the inhabitants of the region generally, Japan argued that:

    It was Japan’s clear duty to render her steps of self-defense as little disturbing as possible to the peaceable inhabitants of the region. It would have been a breach of that duty to have left the population a prey to anarchy — deprived of the apparatus of civilized life. Therefore, the Japanese military have, at considerable sacrifice, expended much time and energy in securing the safety of persons and property in the districts where the native authorities had become ineffective. This is a responsibility which was thrust upon them by events, and one which they had as little desire to evade.

    In October 1935 Italian forces invaded Ethiopia from their neighboring colony, Somaliland. The League of Nations condemned the invasion and imposed sanctions on the basis that Italy had violated its obligations under Article 12 of the Covenant of the League of Nations. Italy argued to the League that:

    The Italian government had abolished slavery in the occupied territories, giving to 16,000 slaves that liberty from which they would have awaited in vain from the Government of Addis Ababa, despite the clauses of the Covenant and the undertakings assumed at the moment of its admission as a member of the League of Nations. The liberated populations see in Italy, not the aggressor state, but the power which has the right and the capacity of extending that high protection which the very Covenant of the League of Nations, in its Article 22, recognizes as the civilizing mission incumbent upon the more advanced nations.

    Adolph Hitler’s decree of March 16 on the establishment of the Protectorate of Bohemia and Moravia asserted that the Czechoslovak state and its rulers had not succeeded in organizing the different national groups present in Bohemia and Moravia, which in turn had led to “continuous disturbances in these regions,” which were of “decisive importance” to Germany’s own peace and security “and to the general welfare and the general peace.” The preamble to the declaration ended with the following:

    Filled with earnest desire to serve the true interests of the peoples dwelling in this area, to safeguard the national individuality of the German and Czech peoples, and to further the peace and social welfare of all, I therefore order the following, in the name of the German Reich, as the basis for the future common inhabitants of these regions.

    Reply

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