Russia And China Are Battling For Influence In Oil Rich Iraq

By Simon Watkins

With the U.S.’s patience wearing thin on its dealings with neighbouring Iran, endemic corruption still prevalent in both the south of the country and in the northern semi-autonomous region of Kurdistan, and enduring political chaos with frequently-changing prime ministers popping up whilst the real power remains with firebrand cleric Moqtada al-Sadr, the last thing Iraq needed was Saudi’s oil price war. Even before Saudi Arabia embarked yet again on exactly the same oil price strategy that nearly bankrupted it and all of its neighbours the last time it tried and failed to destroy the U.S. shale oil industry in 2014 to 2016, Iraq was trying to minimise outgoing payments to the international oil companies (IOCs) that operate its fields and to come to some accommodation the government of Kurdistan (the KRG) on co-ordinating oil exports and sales revenues. All of this now hangs on a thread, and Russia and China are just waiting for it all to collapse so that they can continue to accelerate their drive to further dominate Iraq’s oil (and gas) sectors.

At the beginning of this month, Iraq’s economic parliamentary committee suggested that IOCs be paid with crude oil rather than cash or cash-equivalents as a means to reduce near-term state expenditure. It also proposed delaying payments of foreign debt (including reparations to Kuwait), introducing salary cuts of 60 per cent for various state sector employees, and reducing all non-essential spending. Despite pumping at least 4.65 million barrels per day (bpd) of oil in February – above its OPEC+ quota of 4.46 million bpd – and exporting around 3.4 million bpd of crude that month, and almost the same in March, Iraq’s oil-related revenues had fallen by nearly 50 per cent at that point. This is in line with the collapse in oil prices and the fact that about 90 per cent of Iraq’s government revenues still come from oil, hence the requests to the IOCs.

“The problem with the idea of reducing output to reduce per barrel reimbursements to the IOCs is that in some cases Iraq is liable under the terms of the TSCs [technical service contracts] to pay out very large amounts in compensation to the same IOCs for lost production, and this includes such operations as those at Rumaila [run by BP and CNPC], West Qurna 1 [ExxonMobil] and West Qurna 2 [Lukoil], and Zubair [ENI], among others,” a senior oil industry figure who works closely with Iraq’s Oil Ministry told OilPrice.com last week. “Some of the operators have already signalled or action some degree of cutting expenditure due to the demand effect of the coronavirus, such as BP [which announced a 25 per cent capital expenditure cut this year from the previous US$12 billion across its entire global portfolio] but this doesn’t necessarily mean any extra cuts in Iraq and even if it does include Iraq in part, it doesn’t meant that actual oil output will be significantly reduced,” he added.Related: The Most Critical Oil Storage In The United States

With extremely limited scope for further manoeuvre in cutting payments to the IOCs, then, last week saw a last-ditch attempt at the least-likely option for success in improving its financial position: doing a deal with the KRG in Erbil. To this effect, a Kurdish  delegation –  led by the KRG’s Finance Minister, Awat Sheikh Janab – arrived in Baghdad to discuss oil production and the federal budget, in a familiar dance of death that has been occurring on and off since 2014. In November of that year, faced with an equally ruinous economic scenario, this one almost entirely due to industrial-scale graft – according to the Oil Minister at the time, Adil Abdul Mahdi, Iraq “lost US$14,448,146,000” from the beginning of 2011 up to the end of 2014 as “cash compensation” payments relating to these fields’ development – Baghdad and Erbil struck the first of its oil-for-budget payments deals.

This 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, 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 semi-autonomous Kurdistan region in the north. 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, including much of the energy-starved Former Soviet Union states, Turkey, and Israel, among others. Baghdad has sought to take the KRG to court repeatedly to stop such activity on the basis that it is illegal.

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For its part, Baghdad has at various times withheld payments or underpaid, and at one point, shortly after the 2017 ‘yes’ vote in the Kurdistan independence referendum, sought to change the entire parameters of the deal, completely to the detriment of Kurdistan. Specifically, Baghdad came up with a particularly tricky new tactic to base all payments to Kurdistan on its analysis of what percentage of Iraq’s total population is made up of Kurds living in the KRG region. Although this figure is impossible to pinpoint – ranging from around 10 per cent to about 20 per cent – Baghdad managed to pinpoint it, at 12.67 per cent, in fact. At around that point, the KRG teamed up with Russia and suggested to Baghdad that the Kurdistan area receive 40 per cent of the revenues for the oil that it sends to the south as a starting point. On top of that, though, the KRG suggested an additional sliding scale of further payments to compensate it for the security for the fields that would be provided by the Kurdish Peshmerga in light of ongoing threats from Islamic State and similar outfits, which would have brought the total up to between 55 and 58 per cent for the KRG.

It was finally agreed between the KRG and the new Iraqi federal government formed in October 2018 (now gone, of course) – centred on the 2019 national budget bill – that Baghdad transfer sufficient funds from the federal 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. This deal also broke down a number of times – either because the KRG did not send the required oil in exchange for the payments received or because Baghdad did not send the required money for the oil received – but is nonetheless the same deal that is now back on the table. In the interim, following an order from Baghdad’s Council of Ministers on 16 April, the federal government did not send any budget transfer to the KRG in April.

The tacit threat from the KRG is that it will increase the pace of its independent exports of all, which Baghdad maintains is illegal, although the Iraq Constitution is unclear on the issue, which does not help matters. According to a senior lawyer spoken to by OilPrice.com throughout the breakdown of the various KRG/Baghdad deals, the basic legal architecture that defines the Iraqi oil industry has been the battleground for bitter disputes between the two sides for years and will continue to be so. A test-case in May 2014 that prompted the November agreement, failed to finalise the dispute but acts as a neat example of why the disputes between the two sides continue.

At the time, Iraq’s Oil Ministry, represented by SOMO, filed an arbitration claim with the International Chamber of Commerce claiming that: “By transporting and storing crude oil from Kurdistan, and by loading that crude oil onto a tanker in Ceyhan, all without the authorisation of the Iraqi Ministry of Oil, Turkey and BOTAS [Turkey’s state owned pipeline operator] have breached their obligations under the Iraq-Turkey Pipeline [ITP] Agreement.” In this context, the Kurdistan government maintained, and still maintains, that it is entitled to export oil through the ITP, and that the Federal (Iraq) government does not have exclusive exporting authority under the 2005 Iraq Constitution that sought to delineate the legal boundaries within which the energy sector would operate.

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, argued, and still 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.

By Simon Watkins for Oilprice.com

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