It is safe to say that many of the dynamics between Erbil and Baghdad related to KRG oil exports and revenue sharing will have shifted considerably in coming months. How do you believe the entry of ISIS to central Iraq will affect these issues?
ISIS’s incursion and control of swaths of Iraqi territory was indeed a game changer in Iraqi politics, especially the relation between the federal government and the KRG. ISIS separates the KRG from the rest of Iraq with a border that stretches for about 1000 kilometers—and the KRG is not keen to help Iraq’s defeated army fight ISIS. However, the entry of ISIS will not change immediately the commercial and legal constraints on Kurdish oil sales. It does change the balance of power between the KRG and Baghdad, though. After the surprising meltdown of the Iraqi military in the face of ISIS, Baghdad’s principal leverage over the KRG remains solely economic in the form of the much-needed KRG share of the national budget. The Kurds had their share of land grab as well, controlling Kirkuk and many of its oilfields. Adding oil from Kirkuk to Kurdish oil flow could help the KRG mitigate Baghdad-imposed risks and achieve an unprecedented level of economic independence by year end.
How might these developments affect Kurdish aspirations for political independence?
We need to wait and see whether the new balance of power would encourage the Kurds to move toward political independence, or leverage it against Baghdad to gain more concessions. Such a trajectory would depend greatly on regional and international politics, especially Turkey’s position, whose commitment to the KRG is crucial to the Kurdish energy industry’s functioning and survival. Thus far, the ISIS incursion has buttressed the Turkish commitment to the KRG energy industry, and international buyers interested in Kurdish oil heed less Baghdad’s threats. I should say, moreover, that it is very important for KRG to uphold the highest standards of transparency in its independent oil sales since the viability and reputation of its industry depends on it. The fate of revenue sharing depends on the ongoing political reshuffling that is taking place as we speak.
On the same topic, do you see the instability in federal Iraq opening a door for increased US engagement or explicit support of the KRG?
Iraq has been effectively divided. It is a matter of U.S. policy whether to opt for gluing it back together or to oversee an amicable partition. The Kurds have been committed to federalism, and the Sunnis are increasingly warming up to it. Provincial authorities are primed for power devolution and decentralization. Unfortunately, the federal government was moving in the opposition direction, trying to centralize more power in Baghdad. A clash between these two tendencies was inevitable. For example, central management of the economy has glaringly failed—The government has spent $600 billion since 2004 with very little to show for, except for the development in the KRG. Indeed, the Iraqi military could not protect Mosul and Tikrit from ISIS, but residents of these provinces have not revolted against their new rulers either.
As for Washington, it has been looking at Iraq through the rear view mirror since 2011. The ISIS invasion was an unwelcome surprise and caused much commentary and debate in the U.S. media and policy circles. It was also a setback and reality check for the Washington’s ‘One Iraq’ policy. Moreover, Kurdistan’s strong rhetoric about independence after the ISIS incursion was received with reservations in Washington, and seen as a distraction from the immediate threat posed by ISIS. The KRG, on the other hand, wants the international community to realize that Baghdad is holding back Kurdistan’s potential for prosperity and for supplying energy markets with much needed crude. The KRG seems to be lobbying Washington through delegations, the business community, and Turkey to shift Washington’s policy in its favor. And we are sensing a shift in U.S. policy toward independent Kurdish oil sales—from opposition to neutrality.
There seems to be some degree of opacity regarding recent and future oil sales from Ceyhan. Has the KRG gotten past the initial stumbles of finding buyers? Can KRG oil marketers sell oil at market rates? Not yet. But the KRG is heading in the direction of independent, stable oil sales at prices close to the market. There is no shortage of oil buyers in the market, but buyers were discouraged by political warnings from Washington and legal threats from Baghdad. That could change due to the easing of U.S. stance after ISIS incursion and the formation of the new Iraqi government.
The KRG has opted for opacity with regards to monetizing its crude in fear of retribution from Baghdad. This, however, should not continue. Unfortunately, history of petrostates indicates that the energy industry is guilty unless proven innocent through transparency and oversight. Given the few actors involved in exchanging substantial amounts of cash, there are ample opportunities for corruption across the oil value chain. KRG oil sales are gaining momentum, and infrastructure investment is underway to boost export capacity. These logistical foundations must be matched with institutional checks and balances that guarantee good governance of the Kurdish oil sector. Dr. Ashti Hawrami’s recent commitment to the Kurdistan parliament for full disclosure and transparency is a step in the right direction.
Natural gas can have stronger ripple effects in the economy, by offering local industry a comparative advantage for lower cost manufacturing and agriculture.
Perhaps more importantly, has the precedent been firmly set that the KRG has a predictable export route through the KRG pipeline, and a predictable way to monetize the oil exported? Or, can we expect to see ongoing challenges?
The building blocks for a robust Kurdish energy industry are in place: increasing production, oil-thirsty markets, a cooperative transit state (Turkey), and investment in export infrastructure. Challenges I mentioned earlier—mainly legal and political—still exist, but are waning in the face of the rising opportunities. The development of the KRG’s energy industry has gone through phases. Counting on a strategy of establishing facts on the ground, the KRG started small with the so-called wildcatters. The gains were solidified with the KRG legal framework for exploiting the natural resources, including the adoption of industry-favorite production sharing contracts (PSCs). In turn, better-established companies have been attracted to Kurdistan’s energy sector. Following the mass of companies and blocks they are awarded, the KRG is eying the last and most important phase: consolidation of the industry through mergers and acquisitions by larger oil firms. Monetization of oil is crucial for the success of this last phase, since, according to the terms of the PSC, oil firms are paid a percentage of the oil revenues as cost recovery and profit. Becoming a predictable and reliable oil exporter is within sight for the KRG, granted it remains successful in investing in infrastructure and puts in place necessary governance mechanisms.
The KRG estimates that once production hits 400,000 bpd, oil revenues will reach the level at which they would no longer depend on federal budgetary allocations. What are the biggest challenges to reaching these production levels?
There are several considerations and moving parts when trying to come up with a break-even point for the KRG. Variables include new explorations, production figures and costs, and international oil prices. For example, as the Kurdish oilfields boost production, do the giant fields in the South boost production to the degree of compensating for the loss from the North? However, more important that “how much” is “how stable” oil exports are. In other words, for the KRG, ensuring and controlling a predictable flow of oil and revenue independently would be more preferable to unpredictable revenues controlled by Baghdad.
Furthermore, there are logistical challenges that could slow down the flow of Kurdish crude. Export infrastructure, including pipelines and storage capacity, fall behind production capacity. More importantly, the KRG has not yet put in place institutions capable of responsibly dealing with the windfall from oil sales. The KRG should have learned a major lesson from the suffering it incurred by Baghdad’s budget cuts. The KRG needs to build a diversified economy founded on a strong legal and institutional foundation. Up to now, the KRG’s economy can be characterized as merely a distribution system—channeling oil revenues that it did not fully control on an uncontrollably enlarging public sector. For example, it is economically wasteful and unsustainable to spend up to 70% of oil revenues on a bloated bureaucracy whose contribution to the economy is about 2%! The Kurdistan natural resources law has important clauses for wealth management, such as a sovereign wealth fund, that need to be implemented. Despite these shortcomings, the KRG has been abler in translating oil wealth into development, a case in point that the management of wealth is more crucial than its size.
The role of Turkey has been central to the KRG’s ability to export oil and, as of recently, home to the KRG’s deposit account for oil revenues accrued through sales from Ceyhan. Can we expect this degree of cooperation to lead to increased commercial ties between the two in broader ways?
Yes. KRG needs Turkey’s political support and technical expertise. Turkey, in turn, needs to diversify its energy sources and find markets for its industries. The KRG-Turkey commercial and energy cooperation is a classic example of a win-win situation that has helped both sides put many of their historical disputes behind them, and look forward. It is also an example of economic and commercial cooperation easing political tensions. The relations have so far have been resilient, weathering developments in Syria, Turkey, and Iraq. It has both short- and long-term implications for both sides’ economic and political trajectory.
The KRG should know, however, that Turkey, a NATO power, has a much larger economy and could absorb Kurdistan. In other words, independence from Baghdad should not translate to full dependence on Ankara. KRG’s leverage on Ankara is much smaller than its leverage on Baghdad. This is yet another reason that necessitates that the KRG invest in creating a robust local economy, interdependent with its neighbor.
You note in your recent report that further promoting and developing Kurdistan’s gas resources could broadly benefit its economy. Can you tell us just how and why this is the case?
Indeed, gas can be instrumental to the economic diversification I advocated for earlier. The KRG has an estimated 165 trillion cubic feet of natural gas, most of which is associated with oil. Gas can be the feedstock for many local industries, including power generation and petrochemicals. Once developed, the KRG can export gas, especially to Turkey, which sees gas as the real prize for its cooperation with the KRG. Less like oil, natural gas can have stronger ripple effects in the economy, by offering local industry a comparative advantage for lower cost manufacturing and agriculture. If exploited well, the KRG could also export electricity. In terms of the environment, gas is cleaner. However, unlike oil, gas has not received due attention. Iraq currently flares about half of gas production due to lack of capturing technology—an obvious opportunity loss.