Same-Day Analysis

Iraqi Government Recognises Kurdish Oil Contracts, Opening for Global Investment

Published: 2/7/2011
In a recent interview, Iraqi prime minister, Nuri al-Maliki, has said that the production-sharing agreements (PSA) signed by the autonomous Iraqi Kurdistan region will be "respected" by the central government in a move confirming that a broad deal over the region's oil autonomy has been struck, which officially will remove the legal uncertainties and open the growing Kurdish oil play up for investment by larger oil companies.

IHS Global Insight Perspective

 

Significance

Speaking in an interview to news agency Agence France-Presse (AFP), Iraqi prime minister, Nuri al-Maliki has pledged to honour the production-sharing agreements (PSA)-based oil contracts signed between oil companies and the Kurdistan Regional Government under the region's unilaterally passed oil law, removing a vast swathe of legal uncertainty in the region and opening up for upstream investment as well as a likely flurry of merger and acquisition (M&A) activity.

Implications

The statements by al-Maliki seem to remove one of the largest uncertainties surrounding the investment climate in Iraqi Kurdistan and will open up the region to a host of larger oil players, as well as other companies seeing this as a reassurance of the region's long-term autonomy. The acceptance of Kurdish contracts also mean that Iraq proper is likely to again start looking at using PSA-based contracts for some of its future planned exploration contracts, in order to draw investment to some of its high-potential, but also high risk, acreage.

Outlook

The prime minister's words mean that the Kurds seem to have succeeded in pushing through yet another of their main demands to support the current Iraqi government and, while both sides will benefit from the removed uncertainty, it is clear that recognising the Kurdish oil autonomy will place Iraq's own economy on a much more self-sustained foundation.

Full Recognition

In an interview with news agency Agence France-Presse (AFP) on Saturday (5 February) the Iraqi prime minister said that the Iraqi government will respect the production-sharing agreements (PSA)-based contracts signed by the Kurdistan Regional Government (KRG), in what appears to give the region's oil companies full recognition of their profit margin entitlements and ends the spat over the region's autonomy over its oil resources. "The oil ministry accepted these contracts because the nature of the extraction in Kurdistan is different from Basra", al-Maliki told AFP, adding that "there is a need for bigger efforts there, while in Basra it (oil) is closer to the surface. It's difficult to have service contracts in Kurdistan but it's normal to have them in southern Iraq". Al-Maliki further told the reporter that "the companies continue producing according to the contract signed between them and the KRG, and will take their share, and what is left will come to the state budget”, in the statement, leaving no doubt of his intentions. "The Kurds will not take anything other than the companies' share", he ended, signalling to Iraqis that companies will receive their production-share first as the crude is marketed and after that, the export revenue will go into the Iraqi state budget, from which Iraqi Kurdistan is receiving a share equivalent to its share of the overall Iraqi population. The Iraqi prime minister's statement was immediately welcomed by Iraqi Kurdistan's prime minister Barham Saleh, AFP reports.

All in the Boat?

Using phrases like the central government "respecting" Kurdish profit-sharing contracts and talking about the region's oil deals being "accepted", al-Maliki will make it hard to backtrack on the issue, especially since he also went into some detail in the interview about how the export revenue will be divided. A senior official close to al-Maliki contacted by Reuters yesterday, however, said he was unaware of any decision to accept the contracts, while the Iraqi Oil Ministry did not comment on the issue. The fact that the decision does not seem to have been widely made might harbour further problems, although it looks like al-Maliki's decision to so strongly endorse the previously rumoured breakthrough between the central government and the KRG in the oil sphere to the media, has been designed to create a sense of political fait accompli.

Reactions over the coming days, especially from influential former oil minister and current deputy prime minister for energy, Hussein al-Shahristani, will be particularly interesting to gauge, as he for years has been the main driver behind demands to centralise control over Iraq's oil and gas resources, and during the last parliamentary term emerged as the bulwark against KRG autonomy over its oil sector, calling the region's oil law and IOC contracts "illegal". Of more importance, however, will be the reactions of new oil minister, Abdul-Karim al-Luaibi, who although close to al-Shahristani, has maintained a much less poisoned working relationship with his Kurdish counterparties and might be less inclined to pursue his own line in the face of an increasingly determined prime minister. Reactions in the Iraqi Parliament could also be interesting, although of less direct importance, other than as a thermometer for Iraqi nationalism and resource nationalism vis-a-vis Kurdish autonomy.

A Wider Political Agreement?

Al-Maliki's comments are likely to put an effective end to the ongoing contracts spat between the two sides, but it also signals a major political development. After all, the dispute has been largely political in nature, pertaining to the seemingly conflicting interests of two competing nationalisms. The underlying assumption on the Iraqi side is that Iraqi Kurds are preparing the ground for an eventual move towards complete self-determination. According to this argument, the land-locked region's economic viability would be secured by a fully developed oil and gas industry. The Kurds, meanwhile, are boosting both their own economy as well as Iraq's dependence on a prosperous Kurdistan, and in that way are also raising their political capital in Iraqi decision-making.

The Iraqi government's acceptance of the Kurdish oil contracts signals the possibility that a wider political agreement has been struck as a result of the Kurdish support for al-Maliki's government, which contributed greatly to breaking the nine-month political deadlock after the elections in March 2010. Indeed, the deep roots of the oil dispute means that it is merely one of several such disagreements that have remained unresolved for several years. Many of the issues were outlined by the Kurdish political list consisting of the ruling Kurdistan Democratic Party (KDP) and the Patriotic Union of Kurdistan (PUK) in their negotiations with al-Maliki over the formation of a new government last year. The Kurds set a 19-point programme as a precondition for backing al-Maliki’s bid for power. At the time, the document was considered by many analysts as being overly ambitious and unrealistic. The Kurds, meanwhile, have insisted that their demands had been agreed by the premier, without any official acknowledgement form the government in Baghdad, which has been struggling with the unpopularity of many of the Kurdish demands with its other coalition allies.

This latest development could nevertheless imply the prospect of some degree of medium-term agreement on other issues of dispute: the stalled hydrocarbons law, mechanisms for revenue sharing, the status of disputed areas which the Kurds seek to incorporate within the realm of the Kurdistan region, and the budget for the Kurdish Peshmerga security forces, amongst other issues. The possibility that some form of wider political agreement has been negotiated was to some degree substantiated by Al-Sumaria satellite TV last week, which reported that a resolution of the budget dispute over the federal government's decision to include a clause in the draft budget that links the region's export of 150,000 b/d of oil to its rights to 17% (roughly equivalent to the size of the Kurdish population within Iraq) of the state budget. Al-Sumaria said that the export volume had been brought down to 100,000 barrels a day, as the Kurds had requested. KRG oil production will most likely reach 150,000-200,000 b/d this year if oil companies indeed get paid for their work, however, it will take until the second half of the year before production will be able to reach such levels, since contractual uncertainty has made the two companies with ready-to-produce assets wary of investing in further development since exports were previously attempted in mid-2009.

While these developments are undoubtedly signs of political progress, the divide between Iraq proper and the Kurdistan Region is deep-rooted and will continue to cause difficulties. Each of the issues of disagreement between the two sides is highly controversial and the federal government is likely to face considerable opposition from many of its constituent parties in attempting to resolve these issues in a way that seems favourable to the Kurds. In particular, since Iraqqiya and the Sadrist Movement's electoral successes has raised the representation of Iraqi nationalists in parliament and government.   

Investments to Iraqi Kurdistan to Rise

The resolution to the oil contract dispute will also come as good news to many non-oil companies. Many investors which have sought to enter the Kurdish market have long been dissuaded by fears over black-listing by the Iraqi central government in the same way that oil companies with Kurdish investments have been banned by the powers in Baghdad. To be sure, the Iraqi government has never explicitly stated that it would punish non-oil companies, but the regulatory uncertainties in the country have contributed to fears over these types of unknown risks. With Kurdish oil contracts approved, the road is clear for companies that have sought to protect prospective interests in Iraq proper too. This pertains perhaps particularly to large multi-national companies for which any potential punitive action from the Iraqi government would have been a major setback.

Outlook and Implications

News that al-Maliki himself has endorsed and recognised the KRG oil contracts framework will no doubt be greeted with vast optimism by the oil companies that have braved the political and legal risks and invested in exploration contracts throughout the autonomous Kurdish region. Several oil companies have made significant discoveries, with Norway's DNO already having developed some production capacity on the Tawke field and Turkey's Genel Enerji alongside China's Sinopec having brought the pre-existing Taq Taq discovery onstream. A large number of the 20-plus oil companies in the region are also very optimistic about making discoveries, as the deluge of small risk-taking minnows entering Iraqi Kurdistan in 2007-08 are now making progress with their drilling campaigns. Not many of these companies are, however, of a size where it would be possible for them to develop larger discoveries by themselves and even if they are, they would require some contractual certainly about their profit margins before committing to development investment. If a deal now has been struck and looks likely to be upheld, the exploration and development activity in Iraqi Kurdistan should quickly pick up speed, while larger oil companies, which so far have either been afraid of black-listing by the central Iraqi government or unable to justify the legal risk and uncertainty to their shareholders, or both, now will start looking at buying their way into the region, which increasingly is proving itself a prolific oil and gas play on its own. After a little more clarification, the speed at which large well-known industrial brands will start bidding for some of the discovered assets might be surprising.

In Iraq proper, it is not unlikely that the government is looking at the PSA-frameworks as a future solution to better attract investment into untested exploration areas of the country. Offering technical service contracts (TSCs) as it has done on existing brownfield developments was never popular with investors, however, it could be justified by the absence of geological risk. PSAs were originally envisioned as the framework of choice by al-Shahristani back in 2006-07, and even after a resource-nationalist backlash in parliament and within the ruling coalition, the idea of using PSA contracts as a basis for greenfield exploration in the Western Desert was alive throughout much of 2008. Given the low interest from established players for some of Iraq's main gas fields, one of them in the Western Desert in the late-2010 gas licensing round, the Iraqi government might have again realised that it will have to offer a more attractive risk/reward ratio, even if gas investment arguably is different from oil.

For the Kurdistan Region, these developments come as a considerable victory. The region's leadership has stubbornly held on to its own oil contracts, refusing to cede what it has claimed to be a constitutional right. It is also a victory over the federal government's centralising tendencies; by having its regionally signed contracts (under its regional oil law) approved, the Kurds will become further emboldened to limit the prospect of a rollback of their regional status of self-rule. This will create a difficult political balance for al-Maliki to sustain.

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