Challenges of The Iraqi Kurdistan’s Oil Sector

2 weeks agoPolicy Reports


By Mohammed Hussein

Introduction 
In the mid-2000s, the Kurdistan Regional Government (KRG), with the support of international oil companies, began investing in oil and gas infrastructure. In a relatively short period, it succeeded in both exporting its oil to international markets and using its produced gas to supply local power plants. However, the KRG failed to establish a successful economic policy to manage its natural resources. Such governance would have ensured managed growth and supported its oil and gas sector. Instead, the KRG’s oil and gas project became a root cause of a constitutional dispute with the Federal Government of Iraq (FGI) that resulted in political and economic damage to the region. Regardless of its lost opportunities, the KRG can still use the Kurdistan’s natural gas reserves to regrow its collapsed economy and achieve political stability. However, this is dependent on its willingness to implement structural economic reforms.

The Hopes and Big Mistakes Underpinned KRG’s Energy Sector
Kurdish officials were expecting their energy sector attract global and regional powers’ support to their historical Kurdish dream and cause. Initially, a significant number of multinational oil companies, such as ExxonMobil, GASPROM, Genal Energy and Total Global flocked to the region. While the KRG succeeded in attracting these companies, it failed to achieve political and economic overtures from Iraq and the international community. Instead, the region became subject to a retraction of its political relationship with FGI, regional powers and the international community. As a result, its economy faced significant damage. 
Many Kurdish leaders saw the development of the Kurdistan Region of Iraq (KRI)’s oil sector as a significant political achievement. In this regard, in the region’s general election of 2013, the Kurdistan Democratic Party referenced the regions newly established oil pipelines as s symbol of economic growth and political success. This optimism was so confident and widespread across the Kurdistan Region that in 2013 all of the Kurdish political parties voted, without the necessary economic due diligence, to make Kurdish oil sales independent of the Iraqi Federal Government. At no point were the FGI’s threats to cut the KRG’s federal budget share taken seriously by the Kurdish leadership.
The Kurdish leadership labelled its independent oil sales “an independent economy”. These Kurdish steps resulted in the Kurds’ selling oil independently of Baghdad, which cut off the Kurdish share of the Iraqi Federal budget.
In the first year of independent Kurdish oil sales Kurdistan made an estimated oi-income $2.3 billion (this estimate does not subtract the money owed to private oil companies), when their share of the Iraqi Federal budget was 17%; estimated at $7 billion (without subtracting the sovereign expenditures). (1) These estimates reveal that under these new arrangements the Kurds lost 77% of the amount they should have received from FGI. This loss of income was the first shock of the KRI’s new economic model; however, for political reasons, the Kurdish leadership maintained their pursuit of this new economy. Since 2014, Kurdish oil sales have never compensated its cut budget from FGI.

Basic Economic Truths
Those who designed this new oil-based independent economy for the Kurdistan Region ignored the basic figures of the Iraq’s oil sector. No indicator suggests that Kurdistan could have been better off selling its oil independently. Contrary, all the figures show that Kurds will be worse off. The latest data regarding Iraqi and Kurdish oil exports reveal that in August 2019 the KRG exported 474,000 barrels per day, 13% of the amount exported by the Iraqi federal government (3.6 million barrels per day). (2) Aside from the low export numbers, Kurdish profits from oil sales have further reduced as a result of litigation surrounding the sector, which has presented Kurdish oil as a risky investment. Furthermore, the cost of extraction, marketing, and export of Kurdish oil is four times that of Iraqi oil. For example, to export one barrel of oil, FGI pays approximately $6 (3), while the KRG pays about $ 25 (4) and a further $18 as transit fees to Turkey and its linked companies. While the average price of the Kurdistan’s oil was $54 per barrel in the last quarter of 2018, the KRG only received $29 for each barrel(5). Knowing these simple facts, it is clear to see the extent of economic damage caused to the Kurdistan Region of Iraq, when Iraq cut the region’s 17% share national budget share.
All these problems made the KRI unable to depend on its oil income, and it has kept depending on FGI’s monthly transfer. Many of the economic issues that currently face the KRG and the legal lawsuits that have blocked its oil and energy sector were for the most part expected. Iraq’s federal leaders warned Kurdish officials about these consequences; however, the Kurdish officials ignored them.

The KRI’s Oil Gamble
Until 2009, the most significant issue between Erbil and Baghdad was that of the Iraqi disputed territories, but when foreign oil companies flocked to Kurdistan the subject of the disputed territories shifted to a second-priority. Disagreements and discussions over the management of the natural resources (in particular oil and gas) became the issue that fuelled the degradation of relations between the two sides. As a result, the disagreements blocked the proposed oil and gas legislation from being passed, which in turn prevented the creation of a legal framework to resolve the issues. Relations between FGI and KRG continued to deteriorate to the extent that even the fight against a common enemy (the Islamic State of Iraq and Syria) had little effect in improving relations.
Also, the Kurdish energy sector did not have many supporters in the international community. The events that followed the Kurdish independence referendum in October 2017 demonstrated how the global powers whose companies were working in the Kurdish energy sector (such as the United States, Turkey, the European Union, China and Russia) ultimately supported a united Iraq. They chose to remain silent on the Iraqi federal government and the Iraqi Popular Mobilisation Forces’ assault on the Kurdish held Iraqi disputed territories. This event alone and the subsequent loss of Kirkuk’s oil fields reduced Kurdish daily oil exports from 609,000  to 240,000 barrels. (6) This demonstrates that Kurdish oil and natural gas can’t serve the interests of international powers better than those of the FGI.
The story of the Kurdish oil and gas sector and its independent economy began when Turkish companies like Genel Energy and the Turkish Energy Company invested in the KRI. Further to this, the KRG became entirely dependent on the pipeline that delivered its oil to the Turkish port of Ceyhan. The day following the Kurdistan independence referendum of September 2017, Recep Tayib Erdogan, the Turkish President, on an official visit to a joint military exercise between Iraq and Turkey on the border with Zaho threatened the KRI saying, “It will be over when we close the oil taps, all [their] revenues will vanish, and they will not be able to find food when our trucks stop going to northern Iraq.” (7) 
It is now clear that most of the political plans and decisions that were taken by the Kurdish leadership were not well thought out. Instead, the methods worked to regress the gains in autonomy already made by the Iraqi Kurds since 1991. The KRG failed to take into considerations the threats and difficulties that the geopolitics of the region posed to its plans to create an independent economy. As a result, it was clear that the new Kurdish economy, which Kurdish officials termed independent, resulted in the opposite. The KRI regressed both politically and economically when they could have used the opportunity presented by the Islamic State’s invasion of Iraq to reconcile their differences with the FGI. If they had taken this step, then the international community would have supported them.
Moreover, in 2014, 2015 and 2016, the United States helped to achieve financial and military agreements between the two sides. However, neither party was successful in reaching a deal as the political willingness did not exist for a resolution. Had the government in Erbil been willing to hand over control of the KRI’s oil in 2014 as it has today, the economic damage it is currently facing would have been significantly less. Furthermore, the territorial losses it suffered in October 2017 would not have occurred. Instead, the Iraqi government may have been willing to make more overtures to the KRG as it was in a significantly weaker position after losing one-third of its territory to the Islamic State. 

Natural Gas in the Kurdistan Region of Iraq
The KRG holds three percent of proven global gas reserves, which is estimated at 200 trillion cubic meters. (8) These reserves put the region at the eighth largest proven reserves in the world after the United Arab Emirates and more than that which Iraq has (112 trillion cubic meters). (9) If the Kurdish leadership takes lessons from its mistakes in the management of its oil sector, its natural gas reserves can be utilised as a new cornerstone for its economy and gain more political stability by selling its gas to the FGI. Natural gas is one of the Iraq’s most sought as it is required to resolve Iraq’s electricity shortages.
The KRG’s Ministry of Natural Resources (MNR) had plans with Turkey’s Genal Energy to export its natural gas to Turkey. They planned to increase exports to 20 million cubic meters annually by early 2020. However, this plan was not implemented due to the events following the 2017 Kurdistan independence referendum and the war against the Islamic State. Following this, the KRG agreed with Russian Energy Company ROSNEFT to build a $1 million-gas pipeline to export the region’s natural gas to Turkey and the European countries. The proposed pipeline would have the capacity to ship 30 billion cubic meters of natural gas annually. (10)
While investors and Kurdish officials want the KRG to export its natural gas to Turkey and the European Union, some economic experts believe that the best market for Kurdish natural gas is Iraq itself, not Turkey. By exporting to Iraq, the KRG can take significant steps towards achieving stability and its broader political goals. These objectives can form a part of any agreement on natural gas sales between the FGI and the KRG. If the KRG can broker a win-win deal, Kurdish natural gas will become a factor of political stability. It will play a role in reducing tensions between the two sides. However, if the Kurds press on with only exporting to Turkey and the European Union through the ROSNEFT pipeline, it is not clear what the KRI can achieve politically. If its previous oil sales are anything to go by, then challenges for relations between the FGI and the KRG are clear and worrying. 
For the KRG, Iraq is a closed market and does not come with significant cost to establish an export infrastructure. Most of the Kurdish natural gas fields in the region are located around Sulaymaniyah, Chamchamal and Duhok, and they can be used to fuel the electricity power plants across Iraq. With such a deal, the KRI would be free from paying significant transit taxes to the Turkish government and companies. Currently, the KRG pays $6 per barrel to export its oil through its pipeline with Turkey and also pays taxes and other costs to the Turkish government. According to Deloitte’s figures, the KRG sells its oil for $29 per barrel in 2017. Based on this ROSNEFT and KAR Company, who owns the Kurdistan pipeline to Turkey, gain more than 20 percent of what the KRG gains. Moreover, the taxes and costs paid to the Turkish government are even more. The exact amount is unclear due to the lack of transparency in the Kurdish oil sector. 
For Iraq, Kurdish natural gas would be a cheap and easy source of energy. Currently, the Iraqi government pays $11.23 per cubic meter of Iranian gas. In comparison, Germany purchases the same amount from Russia for $5.42 and Kuwait pays $6.49 for the same amount. (11) For Iraq, Iranian natural gas is not only expensive but comes with a significant headache for the Iraqi federal leaders as it must break the United States’ sanctions imposed on Iran. To import from Iran, the Iraqi government must agree to several U.S. conditions, and these conditions would get renewed every six months. 
A deal between the FGI and the KRG can help Iraq move away from Iranian gas and replace it with the Kurdistan’s gas. Such a deal would pave the way for a strategic partnership between the two sides that will serve the interests of peace and stability on their border and create significant economic advantages for both parties. If Kurdish natural gas allows for Iraqi city’s like Baghdad and Najaf to meet their electricity needs, it will not be easy for Baghdad to take future decisions that would damage the KRG. On the flip side, if the FGI becomes main buyer of Kurdish natural gas and a significant source of the KRI’s revenue, it will become difficult for Kurdish leaders to utilise their 20th-century nationalistic rhetoric to endanger the economic interests. Moreover, given that both governments are under internal pressures to deliver services for their people, they have no choice but to put economic cooperation before their historic personal and ethnic divides. 
On the international level, investment in the natural gas sector is on the increase as western governments are increasingly focused on delivering greener energy alternatives. For these government’s natural gas may be a more viable alternative to oil as it has a 30 percent less pollution rate. (12) Regarding business and markets, gas prices are more stable than those of oil. Oil is less stable and fluctuates in line with political, economic and military events. However, natural gas does not have a standard international price and relies more on agreements between buyers and sellers. The price takes into account geographies and the distance that the gas need to be transferred from seller to buyer. These facts reveal that the Kurdistan’s natural gas reserves can become a stable and reliable source of income compared to oil. 
Without a doubt, after Iraqi Turkey can be viewed as the second-largest potential buyer, thereby diversifying its market. Currently, Russian ROSNEFT, which is one of the leading investors of Kurdish natural gas, wants to export Kurdish natural gas to Europe via Turkey. Moreover, Turkey is looking to reduce its reliance on natural gas from Iran, Russian and Azerbaijan. For this, the Kurdistan Region of Iraq is the closest and most suited source of natural gas for Turkey as several sources of the region’s natural gas is located in Duhok, on the border with Turkey. Therefore, Kurdistan can provide natural gas to Turkey and with significantly reduced costs. 

For Oil and Gas, Kurdistan Needs a New Vision and Economic Policy
To date, the KRG has engaged in an economic model that uses oil revenues to fund public services. This model places Kurdistan into the bottom of the list of rentier countries that subject to multiple crises. This rentier economy has proven to be a significant challenge to other countries elsewhere. For example, Saudi Arabia, producing more than 10 million barrels of oil per day, is now attempting to divert its economy away from oil dependency through its Vision 2030 Plan. In Kurdistan and Iraq, both officials and ordinary people are demanding the diversification of revenue-sources; however, these demands have yet to be acted on by the respective governments. 
The plan for economic diversification is not a one or two-year policy decision; instead, it is a process that requires long time period. It needs implementing at a specific time where the income from oil and gas can support the introduction of new industries into the economy. Decisions to diversify revenue sources cannot only be taken as a response to crises to calm discontent and not be acted on, as happened in the KRI when its government responded to the 2017 economic crash.
Income from Kurdish oil and gas sales can be utilised to reinvigorate the KRI’s economy and infrastructure. It can also be used to improve the state of public services. Instead, what we see is this income is funding a huge payroll with millions of employees, but one that cannot improve public services. It is for the KRG to take the final decision on which of these paths it wishes the Kurdistan to be on. If it continues on its current path, then it should expect to face continued crises like that of 2017. On the flip side, the KRG can choose a reform path, like the models currently under implementation by Iran and Saudi Arabia, to diversify its economy away from oil.
The majority of literature written on the rentier economic model sees the model in a negative light, describing it as an “oil curse”. It begins with the fundamental truth that the nature of income and sources of income that a state relies on ultimately dictates its political character. If a government relies solely on the revenue it receives from the sale of natural resources, it will have no motivation to serve the interests and demands of its citizenry. Moreover, it makes the public powerless and unable to influence the government of the day. Hence, the level of democracy and human rights is comparatively lower in rentier states. If a government and political leaders have enough wealth at their disposal that they can effectively purchase the hearts and minds of its people then that government has no motivation to change and will continue to govern through the distribution of wealth. 
For the KRG, the same is true. If it wants to have better and more fitting governance, then the rentier model that it currently engages does not serve this will. It is for this reason that a program of economic reform to move away from oil and gas must be a primary objective of the KRG. Going forward, the KRG must provide employment and develop its economy through new economic sectors such as agriculture, tourism and business. Moreover, any income that it receives through the sale of its oil and gas should be reinvested in those sectors. The KRG’s current model is intrinsically weak and cannot continue to provide for the Kurdistan Region indefinitely. Moreover, it will continue to make the region unstable, in particular as it is susceptible to economic shocks and turbulence internationally. Oil and gas is only a curse because it is mismanaged, if it is managed and reinvested correctly, then oil and gas could be blessing for the Kurdistan.

Conclusion 
The KRI made a significant investment in its oil and gas. It was able to attract international companies into the KRG’s gas sector. However, numerous economic and political mismanagement and wrong calculations around the industry brought the region into a confrontation with the FGI. This confrontation caused significant damage to the region. Most of the economic and political objectives behind the attempt to make the Kurdistan’s independent oil sales failed to materialise; instead, its effort in most cases had the reverse effects. However, this is not the end of the road as the Kurdistan Region still maintains the opportunity to take advantage of its economic resources to develop its economy and achieve political stability. 
The Kurdistan Region’s gas reserves can become a significant source of income for the region and become a factor for achieving political stability between Erbil and Baghdad. In effect, the Kurdistan’s natural gas reserves provides the region with a second chance to reach the objectives it has set itself and failed to meet previously with its oil sales. To achieve these objectives, Kurdistan must synchronise economic reforms with the sale of natural gas. It must take the window of opportunity to diversify its economy away from a renter model. While Kurdish natural gas reserves are vast and have the potential to provide a significant income for the Kurdistan Region, if economic reforms are ignored, then the Kurdistan Region will become subject to the same problems that it has faced in its recent sale of oil.  

References
(1) Hussein, Mohammed. 2018. The Collateral Damage of the KRI’s Economic Policy. Middle East Center. Accessed 2019. https://blogs.lse.ac.uk/mec/2018/04/17/the-collateral-damage-of-the-kris-economic-policy/.
(2) KULLAB, SAMYA. Total Iraqi oil exports rise to 4.077m BPD in August. Iraq Oil Report. https://www.iraqoilreport.com/news/total-iraqi-oil-exports-rise-to-4-077m-bpd-in-august-42079/
(3) KNOEMA Cost of Oil Production by Country. https://knoema.com/vyronoe/cost-of-oil-production-by-country. 
(4) Deloitte. 2019. Kurdistan Region – Iraq Oil & Gas Sector Review January 1, 2017, to June 30, 2017. KRG. Accessed 2019. http://previous.cabinet.gov.krd/uploads/documents/2018/KRG_Oil_and_Gas_Sector__Infographics_ENG_KU_AR.pdf.
(5) KRG. 2019. Oil production, export, consumption and revenue for the period October 1, 2018, to December 31 2018. May 26. Accessed September 12, 2019. http://previous.cabinet.gov.krd/uploads/documents/2019/q4/Q4_2018_Public_Report.pdf.
(6) Roberts, John M., 2018. “TURKEY AND THE KURDISTAN REGION OF IRAQ: STRAINED ENERGY RELATIONS .” Turkish Policy Quarterly.
(7) BBC. 2017. Iraqi Kurds must give up on independence or go hungry - Erdogan. September 26. Accessed September 10, 2019. https://www.bbc.com/news/world-middle-east-41398199.
(8) Ministry of Natural Resources. 2013. Vision. August 25. Accessed September 11, 2019. http://mnr.krg.org/index.php/en/gas/vision-gas.
(9) IndexMundi. n.d. Natural Gas Reserves by Country. https://www.indexmundi.com/energy/?product=gas&graph=reserves&display=rank.
 (10) Ministry of Natural Resources, Kurdistan Regional Government. 2017. “KRG and ROSNEFT Deal on Construction of Natural Gas Pipeline, Exports Expected in 2020.” http://mnr.krg.org. September 18. Accessed September 10, 2019. http://mnr.krg.org/index.php/en/press-releases/596-krg-and-rosneft-deal-on-construction-of-natural-gas-pipeline,-exports-expected-in-2020.
(11) BP. 2018. “BP Statistical Review of World Energy.” https://www.bp.com. BP. June. Accessed September 9, 2019. https://www.bp.com/content/dam/bp/business-sites/en/global/corporate/pdfs/energy-economics/statistical-review/bp-stats-review-2018-full-report.pdf.
(12) Energy Matters. n.d. Is natural gas environmentally friendly? https://www.enbridge.com/energy-matters/energy-school/natgas-enviro-friendly.


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