According to Business Monitor International (BMI), Baghdad and Erbil have taken the first step to reconciling relations through a temporary budget payment and oil export agreement. While this is a critical first step, a permanent deal on oil revenue sharing remains elusive, which will dissuade investment by oil majors in Kurdistan, limiting production growth potential in Iraq.
According to Reuters, citing finance Minister Hoshiyar Zebari, Baghdad and Erbil have come to a temporary agreement on restarting federal budget payments to, and oil exports from the region of Kurdistan. This supports BMI’s view that the installation of a more inclusive government and a common enemy in IS will ease tensions between Baghdad and Erbil. The growing threat of fiscal strain from lower oil prices has also increased the importance of working together.
Baghdad will restart federal payments to the Kurdistan Regional Government (KRG) nine months after they were halted. The first tranche will be a US$ 500 million transfer, which will cover public sector wages for October and will be followed by a second payment of US$ 1 billion in November. This will be crucial for the KRG, as approximately one in five workers are employed by the government – including the Peshmerga forces combating IS – many of which have not been paid in months.
In return Erbil will contribute 150 000 bpd of its oil exports to the federal budget. At the current time, 150 000 bpd is equivalent to approximately 50% of Iraqi Kurdistan production of 300 000 bpd. However, with increased production from the Taq Taq and Tawke fields BMI expects this to increase to approximately 400 000 bpd going into 2015.
Support for soft production growth
BMI have previously indicated the importance of the Kurdistan region to Iraqi production growth. The low returns oil and gas companies receive from projects in southern Iraq, generally approximately US$ 2/bbl, has seen a number of companies renegotiate plateau production levels and delay expansion projects, significantly curbing production growth prospects. The more favourable production sharing contracts (PSCs) offered by the KRG are driving more aggressive investment. With a lower price environment, the low lifting costs and PSCs make Kurdistan an attractive investment opportunity, particularly as companies search for high margin projects.
Most interestingly, the agreement between Baghdad and Erbil legitimizes exports of 150 000 bpd of oil from the Port of Ceyhan, where Iraqi Kurdistan oil is sent. The Iraqi Ministry of Oil has not officially recorded oil exports from Ceyhan since March 2014 when IS destroyed the pipeline link from Kirkuk. The new deal will therefore allow exports from the northern route to increase by 150 000 bpd over the last few months of the year, and if sustained will boost Iraqi exports in 2015. It will also give Iraq an alternative export route, critical for ensuring diversification in sourcing of oil revenues.
That said, this puts oil exports from the region of Kurdistan in a grey area, as it appears the 150 000 bpd exports are not under the control of State Marketing Oil Organisation (SOMO). If the KRG markets oil independently, then transfers revenues from Baghdad, this could open a wave of new exports from the region. According to reports, flows through the Iraq-Turkey pipeline were as much as 180 000 bpd in September 2014 and could increase to 400 000 bpd by early 2015. The Baghdad government will therefore look to counter act this through curb any excess oil exports by limiting federal budget payments accordingly. Mistrust between the two sides is therefore unlikely to subside.
The first step
The importance of the first step in reconciling Baghdad-Erbil relations should not be underestimated, according to BMI. However, a long term oil revenue sharing agreement still remains elusive. The current deal is essentially for two months, but it is likely to be sufficiently beneficial to both sides to see it rolled over on a multi-month basis. Securing a permanent deal will be more challenging given ongoing distrust, highlighted by the KRG Prime Minister’s statement following the deal: “We will not give full control of oil sales to Baghdad again. That is not possible”.
BMI still expect negotiations to be drawn out over a number of years before a long lasting solution to oil revenue sharing is found. Due to this it is likely to dissuade oil major from committing significant investment to the Kurdistan region, which will limits its production upside. The key benefactors will be smaller companies focusing on Kurdistan such as Genel, DNO and Gulf Keystone.
Adapted from a report by Emma McAleavey.
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