Why international oil companies are turning their back on Bagdhad

Iraqi Kurdistan has fairly suddenly become a magnet for international oil companies (IOCs), who are increasingly turning their back on the central government in Bagdhad and seeking their fortunes in Erbil. The reasons for this change have to do with Bagdhad's inability to create a reliable investment framework, but they are also geopolitical in nature. With the Syrian crisis, two alliances have formed in the region: the Ankara-Erbil axis, supported by the US and the Gulf States and the Tehran-Baghdad-Damascus axis. As a result, energy investments in Kurdistan will inevitably have political overtones, as they will serve as support for one party over the other.

Kurdistan oil field (c) Mirza Khazar
Iraq's Kurdistan region nowadays ranks at the top of world energy investment destinations. Global leaders pay frequent direct visits to Erbil, while the international media love to speculate on Kurdistan's energy potential. In the last ten months, at least ten international conferences have been held to discuss issues related to oil and gas in Iraqi Kurdistan, and the Kurdistan Regional Government (KRG) has become the Western world's rising star in energy. Europe's growing energy demand, the KRG's rich oil and gas sources, and Iraq's effort to stabilise and secure the region have all helped to make engagement attractive.

At the same time, the recent Syrian uprising has created a new polarisation in the region, with one grouping forming around Ankara and Erbil and a second around Damascus, Tehran, and Baghdad. This political bipolarisation has given new momentum to standing problems, while also boosting Kurdistan's attractiveness for energy investments. 

Particularly noteworthy is that the large international oil companies (IOCs), which for a long time shunned the area, are now openly exploring opportunities there. Over the past year, four international oil companies (France's Total, Russia's Gazprom, and US firms ExxonMobil and Chevron) have shown up in Kurdistan. Exxon even choose to abandon its West Qurna stake in southern Iraq when Baghdad's central government warned Exxon it had to choose between Kurdistan or the south.

This is in marked contrast to the situation following the first Kurdish regional legislative elections in January 2005, following the fall of the Baathist regime. In that period only some smaller independent company, such as Hunt Oil, HKN, Marathon Oil, Murphy Oil, and Hess were interested in Erbil's territories. 

Also noteworthy is the Turkish interest in the Kurdistan region. In 2002, Genel Enerji from Turkey was the first oil company to sign a contract with the Kurdistan authorities, in pursuit of exploiting the Taq Taq oil field. In a sign of changing times, in 2012 Vallares, the investment vehicle  founded by ex-CEO of BP Tony Hayward, financier Nathaniel Rothschild and banker Julian Metherell, bought that Turkish energy group for $2.1 billion. Genel Enerji is now moving towards being the largest investor in the region.

Turkey's overall presence in Kurdistan continues to grow. The KRG announced an agreement on May 20, 2012 with Turkey for oil and gas pipelines to link Kurdistan's fields with the Turkish Mediterranean port of Ceyhan. Compare this to as late as 2007, when Turkey was blaming the KRG for supporting the PKK, a Kurdish terrorist group in Turkey, and threatening to impose economic sanctions.

Virgin territory

Where did this drastic change come from?

The first point is the EU Southern Energy Corridor project's search for natural gas sources. The

Genel Enerji is now moving towards being the largest investor in the region

Southern Energy Corridor was originally developed by European companies backed by the EU in the late 1990s to carry Turkmen and Azeri gas to Europe via Turkey. The objective was to reduce European and Turkish dependency on Russian gas sources.

Turkmenistan, however, has chosen to direct its energies towards Eastern markets, in particular China, rather than the West. This left Azerbaijan's offshore gas fields as the sole source for the corridor. With economic growth and rising energy demand in Turkey, Turkish firms naturally turned their attention towards the virgin gas fields in Iraqi Kurdistan.

Then there are the oil resources. Tony Hayward, now CEO of the new Anglo-Turkish combination Genel Enerji, in a recent interview noted that the Kurdistan region is almost the only virgin territory in the Middle East open to private sector oil exploration.

Kurdistan's proven oil reserves are estimated at 45 billion barrels of oil, which represents one third of Iraq's total estimated capacity, putting Kurdistan in the top-10 of largest oil resource holders, almost equivalent to Libya. Kurdistan's proven gas reserves are estimated at 2.8 trillion cubic metres (tcm) of gas (as against 3.6 tcm for Iraq as a whole), about 25% more than for instance Norway's reserves. 

The region's rich oil and gas sources remained virgin due to its conflicts with Baghdad during the Baathist era (1968-2003). Even Kirkuk fields that were discovered in the 1920s saw no considerable investments during this period. 

Constitutional rights

To understand why major international oil companies are turning to Kurdistan en masse, it is necessary to consider what happened after 2003, when a US-led coalition of forces overthrew Baathist leader Saddam Hussein.

In January 2005, the first Kurdistan Region legislative elections were held following the fall of the Baathist regime. In October of the same year, Iraq approved its new constitution, which defined Iraqi Kurdistan as a federal entity of Iraq. The 2005 constitution manifested Iraq's demand for shifting from a 31-year old state-operated oil industry to an industry open to private foreign investment.

In 2007, to allow foreign companies to invest in Iraqi territories with reliable contracts, the central government proposed legislation for the hydrocarbon sector, including a policy on revenue sharing. However, federal and regional bodies did not agree on their roles and authorities regarding the management of hydrocarbon sources, the regulation of foreign participation, or the oil and gas revenue sharing formula.

The dispute derives from different interpretations of Articles 111 and 112 of the constitution, which

Tony Hayward, CEO of the new Anglo-Turkish combination Genel Enerji, noted that the Kurdistan region is almost the only virgin territory in the Middle East open to private sector oil exploration
define the authority of the federal government and regional authorities over hydrocarbon sources. Article 111 states that "oil and gas are owned by all the people of Iraq in all the regions and governorates". For Massoud Barzani, founder of the Kurdistan Democratic Party and the first president of the KRG, this meant that regions and governorates retain ownership rights and power, which is not the view held by Nouri al-Maliki, Iraq's prime minister.

The problem for the federal government is that as a result of deep-seated differences of opinion in the parliament, it has not yet been able to agree on any bill fixing terms for the management and development of oil and natural gas resources.

Unlike the federal government, the KRG did pass an oil and gas investment law, already in late 2007. In May 2006 it also made the clever move of appointing Ashti Hawrami as its first minister of natural resources. Hawrami, who worked for the Iraqi National Oil Company (INOC) in the early 1970s, has a long history in the UK oil industry. With his Iraqi-English bi-cultural background, he has been able to play the role of facilitator between Iraqi Kurdistan and international partners.

In 2008, the KRG, defined as a federal entity of Iraq by constitutional rights, then emboldened with an elected government with a minister for natural resources, and supported by its own jurisdictional basis, began signing the first production sharing agreements with foreign investors. By this time security and stability had largely been restored.

Nevertheless, the disagreements with the federal government had by no means been solved. In fact, with the KRG passing its own regional oil and gas investment law in 2007, the problem was further complicated, as article 155 of the constitution grants primacy to regional laws when they clash with federal laws. Subsequently, Baghdad condemned foreign energy investment activities conducted with the KRG, declaring them illegal. For this reason, the multinationals continued to regard Kurdistan's investment climate as unreliable. Only smaller independent oil companies took the risk of dealing with Erbil.

Then, in November 2011, ExxonMobil was the first IOC to change its mind and to make an agreement with the KRG. Despite the fury of Baghdad with which this decision was met, the US company has subsequently been followed by others. What made the IOC's change their minds recently? There may have been geopolitical considerations involved.

Syrian uprising

In March 2012 the Syrian uprising began. For the last 20 months Syria has been in a state of civil war, and rebel and government forces appear to be stalemated. With the effects of the crisis, two groupings have formed in the region: Tehran, Baghdad and Damascus on one side, versus Ankara and Erbil on the other. In the background there are wider geopolitical interests involved - with Russia and perhaps to some extent China at least partly supporting one side and the US and the Arab Gulf states on the other.

The Turkish government clearly seems to have made up its mind to cast its lot on the Kurdish side. In May 2012, Ankara and Erbil announced significant oil and gas pipeline agreements. A proposed new oil

Europe, when it fills its Southern Energy Corridor with gas from the KRG, inevitably joins the Ankara-Erbil alliance

pipeline would run from the Khurmala Dome oil field, in the south of the region, to Fish Khabur on the Iraqi-Turkish border. There it would tie into the existing Kirkuk-Yumurtalýk oil pipeline, which has been running below capacity since 1996 sanctions by the UN. A proposed gas pipeline project consists of completing the Kurdish gas pipeline running from Erbil to Dohuk at the KRG-Turkish border and then on to connect to Turkey's domestic grid.

These agreements have led to increased tensions between Ankara and Baghdad. As the Iraqi state oil company SOMO controls the Fish Khabur pumping station on the Turkish-Iraqi border, Baghdad would keep its supervision over Kurdistan oil exports. The  oil pipeline between Kirkuk in Iraq and Turkey's Mediterranean port, Yumurtalýk, which has been running since 1973, would also continue to work effectively.

But Baghdad remains suspicious. If relations between Erbil and Baghdad broke down, the KRG could fairly easily tie in the pipeline across the border in Turkey and take back control of its own exports from Baghdad.

As a sign of Baghdad's growing frustration with Ankara, recently, on December 4, 2012, Iraqi air control did not allow a Turkish ministerial plane to land in Erbil. Taner Yýldýz, Turkey's minister of energy and natural resources had wanted to attend an oil and gas conference supported by energy giants like ExxonMobil, Chevron, Total, and Gazprom, but was not allowed to. In the following days, Iraqi prime minister al-Maliki invited Kemal Kýlýçdaroðlu, Turkey's main opposition leader, to Baghdad for talks. 

In addition, Baghdad has begun supporting a competing energy transit project. In July 2012, Tehran, Baghdad and Damascus signed a contract to build a new gas pipeline that would run from the Iranian port Assalouyeh, near the South Pars gas field in the Persian Gulf, to Damascus in Syria via Iraqi territory. Ultimately, the pipeline, if it ever gets built, is intended to extend to Lebanon's Mediterranean port, from where the gas would be delivered to EU markets. The pipeline would also deliver gas to Syria. The pipeline is envisioned to cost $10 billion and would take three years to complete.

Thus, the attractiveness of Kurdistan's oil and gas sources in the last eighteen months must be looked at from the perspective of the EU's continuing search for diversification, internal political tensions in Iraq, and the Syrian civil war, which has led to a new (geo-)political constellation. For international investors, this means that when they are working with the KRG, they also show their support for the Ankara-Erbil alliance, as opposed to the Tehran, Baghdad, and Damascus axis.

Moreover, Europe, when it fills its Southern Energy Corridor with gas from the KRG, inevitably joins the Ankara-Erbil alliance. Considering the fact that the Southern Energy Corridor aims to reduce Europe's dependence on Russia, and Russia's support for Syria, Europeans should be ready to contemplate new moves from Russia in this energy chess game.

A final important question is how stable a divergence inside Iraq would be between the Kurdish region and the rest of Iraq. The International Energy Agency (IEA) in its most recent World Energy Outlook, which came out in November 2012, notes that Iraq, if it manages to create a stable investment framework for the country as a whole, would become "the second-largest global exporter after Saudi Arabia and a key supplier to fast growing markets in Asia." The IEA adds that "without such supply growth from Iraq, oil markets would be set for very difficult times, characterised by higher and in all probability more volatile prices, that would reach almost $140 per barrel in 2035 in real terms."

 

Olgu Okumus (olgu.okumus@sciences-po.org_) is finishing her PhD on "The Role of Turkey in EU Energy Security" at Sciences Po-CERI in Paris. She is also an affiliated lecturer in energy diplomacy at Collège Universitaire de Sciences Po, Paris.