Oil companies face huge risk as Kurdistan legal dispute escalates

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The future of CIOs operating in northern Iraq hangs in the balance

The long-standing dispute over how oil flows are managed 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) to Baghdad for its cooperation in this regard has taken a series of dramatic legal twists over the past week. 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 widely agreed that the KRG would export a certain volume of oil from its own fields and from Kirkuk through the Iraqi State Organization for Petroleum Marketing (SOMO) and not independently sell the oil from the fields on international markets. In return, Baghdad would make some level of payments to the KRG from the Iraqi central federal budget. From 2003 to November 2014, there was constant disagreement on both sides that the other had not honored the terms of this agreement. In November 2014, however, an agreement was reached between FGI and KRG in which KRG agreed to export up to 550,000 barrels per day (bpd) of oil from its own fields and from Kirkuk via SOMO. In return, Baghdad would send 17% of the federal budget after sovereign spending (about US$500 million at the time) per month in budgetary payments to the Kurds.

This agreement – which again only worked well sporadically – was later replaced by an agreement reached between the KRG and the new Iraqi federal government formed in October 2018 and centered on the draft budget law 2019. This obliged the FGI to transfer sufficient funds from the budget to pay the salaries of KRG employees and other financial compensation in exchange for KRG remitting the export of at least 250,000 bpd of crude oil to SOMO . Since then, however, the FGI – nominally led by various prime ministers but for a long time controlled behind the scenes by the radical cleric Moqtada a-Sadr – has been disbursing KRG employee salary funding on an unreliable monthly basis and the GRK delivered the agreed volume of oil to SOMO in the same way.

Besides the complications stemming from al-Sadr’s contribution to the deal, matters were further complicated by Russia’s huge presence in the KRG-administered region, especially after 2017. Russia effectively took the control of the oil infrastructure in the northern region of That year, Kurdistan – through its oil proxy, Rosneft – initially provided the KRG government with US$1.5 billion in funding through sales of term oil payable over the next three to five years. Then it took an 80% stake in five potentially major oil blocks in the region, along with corollary investments and technical, technological and material assistance. Finally, he established 60% ownership of the vital KRG-Turkey pipeline through a commitment to invest US$1.8 billion to increase its capacity to one million barrels per day. Moscow then considered itself well placed to take advantage of this presence in an equally powerful position in the south of the country, in particular by concluding new agreements for the exploration and development of oil and gas fields with Baghdad. These new agreements were to follow Russia’s intermediary role in the perennial dispute between Kurdistan and the IGF in Baghdad over the agreement of budget disbursements for oil. In reality, Russia – far from mediating effectively to find a solution – has instead sought to sow further discord between the two sides, as analyzed in depth in my new book on world oil markets.

It is extremely relevant to note that Baghdad’s long-standing annoyance at the KRG’s repeated adherence to any version of the oil-for-budget disbursement agreement reached in 2014 has only really begun to manifest itself in a sustained legal action after international sanctions imposed on Russia for its invasion of Ukraine. It started in earnest with two recent landmark court decisions by the FGI Supreme Court in Baghdad, and the Iraqi Oil Ministry’s proposal to establish a Kurdistan National Oil Company under federal government ownership in southern Iraq. This is intended to deprive the KRG of any authority over its heavily Russian-dominated oil industry and would make all previous contracts between the KRG and the oil companies subject to scrutiny. In this vein, the Iraqi Ministry of Petroleum has ordered the KRG to provide copies of all oil and gas contracts signed between the region’s government and the IOCs over the past 18 years, along with corresponding revenue statements. In an apparent show of support for the Iraqi federal government in Baghdad, the US government granted Baghdad one of its longest waivers ever continue to import gas and electricity from Iran as an interim solution to its domestic energy supply problems.

Last week, a Baghdad court postponed until June 20 the hearing of the Oil Ministry’s trial against seven IOCs operating in Kurdistan, so that all the defendants could be summoned and prepare the necessary documents to send authorized representatives. Around the same time, according to local reportsthe KRG initiated a separate legal action against the Ministry of Petroleum, based on the fact that the provisions of its Petroleum Law (“Law No. 22, 2007”) do not violate the Iraqi Constitution and should therefore be recognized as “permanent laws”.

A lack of legal clarity has been at the center of this ongoing dispute since the fall of Hussein in 2003. According to the KRG, it has the power under Articles 112 and 115 of the Iraqi Constitution to manage oil and gas in the Kurdistan region extracted from fields that were not in production in 2005, the year the Constitution was adopted by referendum. In addition, the KRG maintains that Article 115 states: “All powers not provided for in the exclusive competences of the federal government belong to the authorities of the regions and governorates which are not organized into regions. As such, KRG argues that, as the relevant powers are not otherwise stipulated in the Constitution, it has the power to sell and receive revenue from its oil and gas exports. The KRG also stresses that the Constitution provides that in the event of a dispute, priority must be given to the law of the regions and the governorates. However, the FGI and SOMO argue that under Article 111 of the Constitution, oil and gas belong to all Iraqi people in all regions and all governorates.

The stakes for IOCs operating in the northern region of Iraq, Kurdistan, and for Baghdad could not be higher, given the huge realized and potential oil and gas reserves in the region and the fact that much of the country’s key oil export infrastructure to Europe runs through the KRG-administered area (in the form of the pipelines entering the Turkish port of Ceyhan). The International Energy Agency (IEA) pointed out in 2012 that before the recent increase in exploration activities in the KRG region, more than half of the exploration wells in Iraq had been drilled before 1962, “a time when technical limitations and a low oil price gave a much more accurate definition of a commercially successful well than would be the case today.” Based on previous limited exploration and development oilfields in the ARK region, the proven oil reserve figure at this earlier time was first estimated to be around 4 billion barrels This was later upgraded by the KRG to around 45 billion barrels. barrels but, again, but the IEA said in 2012 that this may turn out to be a very conservative estimate. there were 25 trillion cubic feet (Tcf) of gas reserves proven and up to 198 Tcf of unproven gas resources, or about 3% of the world’s total deposits. The numbers seemed realistic, the IEA added at the time, given that the US Geological Survey estimated that undiscovered resources in Iraq’s only folded Zagros Belt, much of which falls in the KRG region , amounted to about 54 Tcf of gas.

By Simon Watkins for Oilprice.com

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