You are using an outdated browser. Please upgrade your browser or activate Google Chrome Frame to improve your experience.

For full functionality of this site it is necessary to enable JavaScript. Here are the instructions how to enable JavaScript in your web browser.

A fragile construction

Erbil, Ankara and Baghdad

The Energy Potential of Iraq's Kurdistan Region

Erbil, Ankara and Baghdad Erbil, Ankara and Baghdad
Grafik: Energlobe

A dramatic reversal of Turkish foreign policy over the past five years has opened up Iraq’s Kurdistan region as a major new source of potential oil and gas supply. Turkey has begun to spend significant financial and geopolitical capital to give the landlocked Iraqi Kurds pipeline access to Turkish ports and, by extension, international markets. If successful, this Turkish-Kurdish cooperation will provide world markets with more than 1 million barrels per day (bpd) of new oil supply this decade and give Turkey access to at least 10 billion cubic meters annually (bcma) of natural gas, which it will need to continue fueling its rapid economic growth. This energy cooperation would also greatly enhance the Kurdistan Regional Government’s (KRG) leverage in its struggles with Baghdad for greater autonomy within Iraq’s federal system. Although Turkish and Kurdish leaders insist they are working to enhance the unity of Iraq, their energy deal also promises to sever the ties of financial dependence that bind the KRG to Baghdad, laying the foundation for what could eventually become an independent Kurdistan.

Kurdistan’s Latent Potential

Oil and gas companies have flocked to Iraq’s autonomous Kurdistan region. In contrast to the federal Oil Ministry in Baghdad, which has forged partnerships with international oil companies (IOCs) using a technical service contract model, the KRG’s Ministry of Natural Resources (MNR) has offered production-sharing contracts (PSCs) with relatively high profit margins. Dozens of oil companies have signed more than fifty contracts, and the players entering the KRG have gotten progressively larger, including ExxonMobil, Chevron, Gazprom Neft, and Total. The Kurdish oil sector is only a decade old, and already the region has developed more than 429,000 bpd of oil-production capacity, according to calculations compiled by Iraq Oil Report, based on aggregated company disclosures and other reporting. Kurdistan’s oil contractors have also proven more than 2 billion barrels of reserves recoverable on a P1 or P2 basis, and total resources of more than 17.7 billion barrels. (KRG officials sometimes claim reserves of 45 billion barrels, but there are no public data available to support this assessment.) KRG Minister of Natural Resources Ashti Hawrami has ambitiously claimed that the region can raise its capacity to 1 million bpd by 2015.

The KRG may be even more promising as a gas play. So far, only the Khor Mor field has entered production, generating 335 million standard cubic feet per day (scf/d). Around the region, companies have discovered more than 12 trillion cubic feet of gas recoverable on a P1 or P2 basis, and total resources of more than 38 trillion cubic feet. Just two fields, Miran and Bina Bawi, together hold at least 8 trillion cubic feet of recoverable gas.

Much of this potential has been locked in for the past decade, however, because of a political conflict between the KRG and the federal government in Baghdad. Iraqi prime minister Nouri al-Maliki’s administration has consistently argued that the federal Oil Ministry has primary authority over Iraq’s oil sector, while the KRG claims independent authority to sign contracts within its territory, manage those fields, and export oil and gas. The dispute stems from radically different interpretations of Iraq’s 2005 constitution and, by extension, diverging visions for the shape of the Iraqi state. The two sides came close to passing oil legislation in 2007, which could have harmonized the lines of hydrocarbon authority in Iraq, but a final agreement proved elusive. Instead, the KRG passed its own regional oil law, and leaders in Erbil and Baghdad have signed contracts and ushered in billions of dollars’ worth of foreign investment under contrasting legal frameworks.

Until recently, Baghdad appeared to have the upper hand in this conflict because the central government has controlled the country’s export pipelines. The landlocked Kurds have occasionally struck temporary political agreements with Baghdad to feed crude into the Iraq-Turkey Pipeline (ITP), which runs to the Turkish port of Ceyhan, but all of those deals have fallen apart. Their primary opponent has been Deputy Prime Minister for Energy Hussain al-Shahristani. He considers all of Kurdistan’s contracts to be illegal, and has been reluctant to authorize payments to the KRG’s contractors, since doing so could implicitly validate the legal basis of Kurdistan’s oil sector. Shahristani also argues that the KRG should be assessed for the independent oil revenues it has generated through domestic sales and trucking exports, which have not been paid to the federal treasury. As a result, the KRG and its contractors have received payment for only a fraction of the oil they have exported through the federal pipeline system.

This political risk has also caused IOCs to think twice about investing. Even those companies that have already signed contracts in Kurdistan still must make medium-term decisions about how quickly to move from the exploration to the production phase of development, and how much production capacity to build. Nobody wants to invest billions of dollars to develop several hundred thousand barrels per day of capacity, only to find there is not a working pipeline to deliver the resulting crude to international markets. Companies with massive capital budgets still need to see evidence that they will be able to monetize their investments.

Kurdistan can rise to 1 million bpd of production capacity and beyond, as Hawrami has projected, only if IOCs are willing to invest the capital necessary to support that level of development. This means that the KRG needs to show companies like Exxon and Chevron that they can reliably export, and be paid for, their oil. While relations with Baghdad remain frosty, Erbil seems to have found a new pipeline patron in Ankara.

Turkey’s Policy Shift

Turkey’s unresolved “Kurdish question” was once a seemingly immovable wedge preventing any functional relationship with the KRG. Turkey opposed Kurdish autonomy in Iraq for fear of emboldening Kurdish separatists at home. Moreover, the militants of the Kurdistan Workers’ Party (PKK), labeled a terrorist organization by Turkey and the United States, were launching regular attacks on Turkish armed forces from safe havens in northern Iraq’s Qandil Mountains. The KRG did not sanction these attacks, but it also did little to stop them. Tensions rose so high that, as recently as 2008, Turkey had massed tens of thousands of troops on its southern border and was conducting large air and ground operations against the PKK inside Iraqi Kurdish territory, provoking threats of violent retaliation from Kurdistan president Massoud Barzani.

In this atmosphere of hostility, Turkey’s foreign policy apparatus treated Iraq as a security issue, and primary responsibility rested with the Turkish General Staff. But that posture began to shift in 2008, when Prime Minister Recep Tayyip Erdogan transferred the Iraq file to a special office in the Foreign Ministry, headed by Murat Ozcelik, who would later become the Turkish ambassador in Baghdad. Ozcelik was among a handful of Foreign Ministry leaders who thought Turkey could mitigate the security threat emanating from Iraq most effectively by building economic ties in both the Arab-majority south and the Kurdish north. He undertook a mission to establish relationships with Kurdish leaders and find points of potential economic cooperation. The United States also pushed for the rapprochement, eager to avoid conflict in the only part of Iraq that had remained stable after the 2003 invasion.

After exchanging visits of increasingly senior delegations between the Turkish and Kurdish capitals, Erdogan himself visited Erbil, on March 29, 2011. By that time, Turkey’s leaders estimated that 70 percent of their economic activity in Iraq was focused on Kurdistan. They were also aware of the hydrocarbon resources there. When Erdogan first arrived in Erbil, Hawrami brought geological maps with him to the airport, ensuring that even if Erdogan’s visit were cut short for some reason, he would at least receive a briefing on the oil and gas potential just across his southern border.

Turkey’s interest in Kurdistan was further galvanized several months later, on October 18, 2011, when ExxonMobil signed six production-sharing contracts with the KRG. This milestone for the Kurdish oil sector signaled that more super-majors would soon follow, and asset prices would be rising. It also caused many Turkish policymakers to believe that the United States was tacitly supporting the KRG’s independent oil ambitions. The US State Department had long discouraged oil companies from signing contracts with the KRG by warning them of the significant legal and political risks. But many senior Turkish officials have said in background interviews that they found it hard to believe Exxon would be “allowed” to do anything that truly ran afoul of American foreign-policy priorities. From their perspective, the United States was staking out massive energy interests just across the Turkish border, in both northern and southern Iraq. Meanwhile, Turkey had been conducting its state-sponsored energy investment— according to Baghdad’s wishes—solely through Iraq’s federal Oil Ministry.

Turkey has set a high-profile goal of becoming a top-ten world economy by 2023, and it will need an enormous supply of natural gas to get there. Turkey’s economy has grown at an average annual rate of about 5 percent over the past decade, and its electricity demand at roughly 7 to 8 percent. The country consumes about 47 bcma of gas currently, and many analysts expect that demand to rise by nearly half in the next decade.

Where will this new supply come from? Turkey already depends on Russia for more than half of its gas, and its imports from Iran are both expensive and fraught with sanctions-related difficulty. Its other major supplier, Azerbaijan, has agreed to earmark 6 bcma for Turkey from the massive Shah Deniz 2 field, but that will only cover about a quarter of Turkey’s projected medium-term gas demand growth. Just across Turkey’s southern border, the unexploited gas fields of the KRG are a potential game-changer.

An Energy Deal Takes Shape

Turkish and Kurdish leaders first began to discuss a potential energy alliance in early 2012, and by the fall of that year, the contours of a massive deal were taking shape. Given the political complications with Baghdad and Iraq’s uncertain legal environment, the two sides decided to structure the deal not as a stateto- state agreement, but as a commercial arrangement. Turkey’s deal-making vehicle would be a new entity originally called Salus Energy Company, which was registered in Jersey in October 2012 as a private company wholly owned by the Turkish state company, Botas. The name was kept secret for nearly a year, partially because some Turkish officials worried that Salus, which means “salvation” in Latin, was an unnecessarily provocative name for a company that would likely help to empower the Kurds in their struggles with Baghdad. On July 31, 2013, the name was changed to the Turkish Energy Company (TEC).

Although the contours of cooperation were defined in late 2012, it wasn’t until March 25, 2013, that the deal was finalized in the form of a commercial framework agreement between TEC (which was still called Salus at the time) and the KRG. Kurdish prime minister Nechirvan Barzani traveled to Ankara for the signing, where he was hosted by Erdogan. The text of that agreement remains secret, but several officials involved in the deal-making have confirmed that it calls on TEC to invest in at least a half-dozen exploration blocks, and to facilitate the export of both crude oil and natural gas through Turkey. The comprehensive nature of the agreement reflects the different interests that have brought the two sides together: Turkey is primarily interested in cheap and plentiful natural gas, while the KRG’s priority is to monetize its crude production.

Turkey has already begun preparing for natural gas imports. The framework agreement guarantees Turkey at least 10 bcma, and as of this writing, the two sides are still in the process of negotiating a gas supply agreement (GSA) that could see this amount increase. Several officials involved in that negotiation say that they have agreed on an initial pricing mechanism— which will make KRG gas far cheaper than Turkish supplies from Russia or Iran—but that they have not yet fully answered the question of how and when the price can be renegotiated. Turkey is apparently confident enough in the medium-term success of those negotiations, however, that it has begun extending its gas pipeline network toward the KRG border. Botas has already begun the construction of a pipeline from Bismil to Mardin, and is preparing to tender for the construction of a final leg, from Mardin to Silopi, at the Turkey-KRG border. The pipeline will be forty or forty-two inches in diameter, enough to handle 16 to 20 bcma of imports.

Meanwhile, the KRG has nearly completed a crude pipeline to the Turkish border. The first leg of this pipeline begins at the Taq Taq field and runs to Khurmala, near Kirkuk; the second leg goes up to the border city of Feyshkabour, all without leaving KRG territory. Initially, KRG officials say they will ramp up to 300,000 bpd of pipeline exports in early 2014. Hawrami has also recently announced a second pipeline project, for heavier crude.

On the Turkish side of the border, crude will flow into the existing Iraq-Turkey Pipeline (ITP), which is actually composed of two parallel lines. The forty-six-inch line is currently being used to transport federally controlled Iraqi oil from Kirkuk to Ceyhan. But the second line, forty inches in diameter, has been dormant due to poor maintenance and lack of crude supply. The plan is to connect the new KRG pipeline into the latent forty-inch line just before the Turkish border, downstream of the federal North Oil Company’s (NOC) final metering station. In effect, Erbil and Ankara will be appropriating half of the ITP for KRG exports, despite stark objections from Baghdad.

On the upstream side, TEC and the MNR have finalized terms for investment in at least six exploration blocks. As of this writing, however, Turkish officials speaking on background have denied that any PSCs have been signed. It is also not clear whether TEC will buy stakes in some, or all, of Exxon’s exploration blocks. Erdogan himself has commented publicly that Turkey intends to partner with Exxon, but none of the parties have revealed what such a deal would look like, or the current status of negotiations.

Most crucially from the KRG’s perspective, Turkish leaders appear committed to ensuring that the KRG receives direct payments for its exports. The Turkish government has already sanctioned the trucking of 30,000 to 40,000 bpd of crude from the KRG’s Taq Taq field to the Turkish port of Mersin. Under this arrangement, the private buyer of the crude—a Turkish-owned, Singaporeregistered company called PowerTrans— makes payments that go directly to the KRG and its contractor, TTOPCO, which is a consortium led by the Anglo-Turkish company, Genel Energy. Turkey will likely use a similar model for facilitating the KRG’s pipeline exports, with TEC or another intermediary functioning as the official buyer of KRG crude.

Geopolitical Crosscurrents

Leaders in Baghdad vehemently oppose this Turkish “meddling” in Iraqi domestic affairs, and say that Iraq’s sovereignty is at stake. Like every other oil-exporting government in the world, Iraq’s central government claims authority to regulate international exports, and has traditionally controlled all of the country’s export pipelines, including the ITP. Baghdad leaders cite Article 110 of the Iraqi constitution, which gives the federal government “exclusive authority” in “formulating foreign sovereign economic and trade policy.” They also argue that Turkey has affirmed Baghdad’s sovereign authority over exports in the agreement governing the ITP, which was signed by Shahristani and Turkish energy minister Taner Yildiz in 2010.

The Obama administration has been pushing for a so-called “win-win-win” solution, through which Turkey would avoid any alleged breach of sovereignty and Baghdad would condone KRG exports. When Erdogan visited the White House in May 2013, Obama affirmed his administration’s position, which has been reiterated in high-level meetings since then. Although leaders in Ankara and Erbil have not indicated any willingness to compromise the fundamental contours of the deal, there appears to be a dim hope of a revived relationship with Baghdad, stemming from Maliki’s current political weakness.

Maliki faces reelection in 2014, and will almost certainly need Kurdish support to win a third term. He is also likely eager to ensure that Turkey does not work to assemble a unified Sunni political bloc in Iraq, as it did in 2009 and 2010. This would make it more difficult for Maliki to form a postelection coalition, for which he would likely need support from a moderate slice of Sunni parties. Against this political backdrop, Maliki has confirmed that he will visit Ankara before the end of 2013. His relationship with Erdogan has been famously antagonistic—Erdogan once compared him to Yazid, the Umayyad caliph who killed Imam Hussein, the most revered figure in Shiite Islam—so it is not clear how far such a dialogue can go.

The biggest sticking point for Baghdad is likely to be the question of payments. Kurdistan currently relies on allocations from the federal budget for the vast majority of its regional budget—more than $11 billion in 2013—and this dependency has been the primary tie that still binds the two sides together. (Aside from this key financial tether, the KRG also has many trappings of a sovereign state: The government commands its own security forces, provides all public services, flies its own flag, and controls its borders and customs—including its heavily fortified southern border with the rest of Iraq.) If Turkey were to accept Kurdish crude via pipeline, and ensure direct delivery of payments, then the KRG would effectively become economically independent from Baghdad as soon as it could generate enough production capacity and revenue to offset its share of the federal budget. Such economic self-determination is an explicit goal of the KRG, while Baghdad wants to retain its levers of control.

Given those opposing prerogatives, it is difficult to imagine how Turkey can move forward without taking sides—and Erdogan has left little doubt that he sees deeper interests in the relationship with Erbil than with Baghdad. Although there is far more oil in southern Iraq than the KRG, Baghdad cannot offer the strategic commodity Turkey most craves: natural gas. Even by the optimistic projections of the Oil Ministry, Iraq will not be a net exporter of gas until 2020, and at that point the government has provisionally committed to export via liquefied natural gas (LNG) terminals in Basra. By contrast, the KRG has already committed at least 10 bcma to Turkey at a favorable price, with exports to begin this decade. Moreover, Erdogan has established a good rapport with both Massoud and Nechirvan Barzani, and he has shown willingness to exert his rising influence over the KRG in the pursuit of other objectives: modulating the activities of Kurdish rebel groups in Syria; pursuing a rapprochement with the PKK; and building domestic political support among the Kurdish BDP party in Turkey.

Given this calculus of interests, it seems likely that Turkey will continue building its alliance with the KRG—a message that was reinforced in a late October 2013 meeting between Erdogan and Nechirvan Barzani. But there are also signs that the American opposition has given Erdogan pause, and that leaders in Ankara feel less urgency than their counterparts in Erbil. Hawrami once optimistically predicted pipeline exports would begin by September 2013, but as of this writing, Botas has not yet begun refurbishing the Turkish side of the forty-inch ITP line. The delay does not necessarily reflect political hesitation from Turkey; it may be a Turkish negotiating tactic designed to extract more-favorable terms in the GSA, or it could simply be a symptom of the technical complexity of the deal. Regardless, there are several significant political, legal, and logistical obstacles that remain.

Obstacles

If Turkey forges ahead with Erbil, without a “win-win-win” solution, Baghdad’s most likely potential recourse would be legal action. The Iraqi government could try to sue unsanctioned buyers of KRG crude, or it could initiate arbitration proceedings directly against Turkey, as the terms of the 2010 ITP agreement appear to allow. Such lawsuits have the potential to drive down KRG crude prices and, if successful, stymie the flow of exports. Yet they also carry a risk for Baghdad. Given Iraq’s ambiguous constitution and legal environment, it is hardly clear which side would prevail— and if a credible international arbitrator were to rule on the side of Ankara and Erbil, that precedent would help to validate the Turkish and Kurdish position.

Baghdad could also respond by making significant reductions to the KRG’s portion of the federal budget. Shahristani has already indicated that he is seeking to cut $10 billion in 2014—almost the entire KRG allocation—in recompense for past crude revenues that the KRG has not delivered to the federal treasury. Maliki has distanced himself from this position, however. The prime minister will likely need Kurdish support if he is to win a third term in 2014, and his spokesman has said that, although Erbil and Baghdad do have a difficult reckoning of debts to address, “there might be a number of alternative ways” beyond a unilateral deduction in the budget.

A further challenge concerns the logistics of payment. Iraqi oil revenues are still subject to UN-imposed regulations and US legal protections. Five percent of all Iraqi crude sales are deducted to pay reparations, mostly to Kuwait, stemming from the Saddam Hussein regime. The remaining funds are held in an account at the Federal Reserve Bank of New York (FRBNY), which is protected by a US executive order from other legal claims. In background interviews, Turkish officials have confirmed that payments for KRG crude will not go to the FRBNY, but without that mechanism, it is not clear how Turkey will facilitate payments to the KRG without running afoul of the UN and exposing those funds to Iraq’s creditors.

Beyond the legal difficulties, Turkey’s patronage of the KRG could have unintended and destabilizing consequences within Iraq. One major problem stems from Iraq’s territorial disputes. After decades of gerrymandering and ethnic cleansing under Saddam, several different groups now lay competing claims to a swath of land between federally controlled Iraq and the KRG. Kurdish authorities intend to develop oil and gas resources in much of this territory, including two of the exploration blocks earmarked for TEC. One of those blocks includes the disputed city of Tuz Khurmatu, where, one year ago, Kurdish and federal Iraqi security forces engaged in a deadly gun battle that led to a prolonged period of tense militarization along the KRG’s southern border. Within the past year, leaders in Baghdad have threatened to respond with force if oil companies begin drilling in disputed areas. In light of Iraq’s rising security problems, stemming largely from the resurgence of al-Qaeda, it now seems unlikely that Baghdad would take military action in response to oil sector provocations. Nonetheless, these tensions have been severe enough to cause ExxonMobil to modulate exploration plans in its own disputed acreage.

Perhaps the greatest uncertainty stems from the prospect of Kurdistan’s rising independence. Turkey’s leaders deny that they are trying to facilitate the birth of a new state, and in the short term they seem to have an abundance of leverage to ensure that Kurdistan remains a part of Iraq while also becoming a quasi-client state of Turkey. But if they can successfully implement their energy deal, the KRG will likely gain significant clout. Not only could Turkey end up depending on the KRG for a large and difficult-to-replace portion of its gas supply, but the KRG would also be gaining geopolitical stature as its crude exports rise toward the 1 million bpd mark, and beyond. In light of this possibility, the greatest obstacle to Turkey’s budding alliance with the KRG might ultimately be Turkey’s own anxiety over following its plans to their logical conclusion.

Ben Van Heuvelen is the managing editor of Iraq Oil Report and a contributing reporter for the Washington Post. He reports regulary throughout Iraq, Turkey, and the region. His article was first published only a few weeks ago in "A Eurasien Energy Primer: The Transatlantic Perspective/Atlantic Council" Dec 2013

»THE CRISIS IN THE CONCEPT OF THE

WORLD ORDER (IS) THE ULTIMATE

INTERNATIONAL PROBLEM OF OUR DAYS.«

Henry Kissinger,„World Order“, August 2014