OPEC predicts that, by the year 2035, the world’s primary energy needs will increase by 54%. This upsurge, which also reflects an 87% increase in the demand for fossil fuels, is largely based on the expected needs of emerging Asian economies. In addition, forecasts also predict that this increase in demand will be accompanied by a rise in the price of oil from its current cost of $100 per barrel to around $120 per barrel in 2025 and $155 per barrel by 2035.

Iraq in general and the Kurdistan Region in particular are well positioned to benefit from this growing global demand for oil. In 2012, Iraq became OPEC’s second largest oil producer. This development was fueled at least in part by the output gains in the Kurdistan Region. In addition, an already established European market coupled with the expanding needs of the developing economy of Turkey brought further opportunities to Kurdistan, where the potential for export is huge.

As a result of its vast oil reserves and a production capacity that seems to rise by the month, the Kurdistan Region is quickly becoming a powerful player in world energy markets. At present, the Region is home to a total of 57 discovered oil and gas fields, with estimated proven reserves of 45 billion barrels (as well as 25 billion barrels of potential reserves) and 100-200 trillion cubic feet (TCF) of natural gas reserves. To fully capitalize on these resources, the KRG Ministry of Natural Resources (MNR) has established an ambitious program to increase production capacity from its current level of 200,000 barrels per day (bpd) to 250,000 bpd by the end of 2013, 1 million bpd by 2015, and 2 million bpd by the end of the decade.

Around 40 oil and gas companies are now active in Kurdistan, with the world’s energy leaders increasingly taking note of the opportunities present in the Region. Supermajors such as Chevron, ExxonMobil, and Total have already established their presence in Kurdistan, with the three companies alone holding interest in a total of 11 oil and gas exploration blocks. Moreover, a huge push to develop the energy infrastructure of the Region promises to deliver Kurdistan’s abundant energy resources to world markets quicker and more reliably than ever before. Indeed, the continued progress made in exploration and production combined with improved infrastructure is expected to go a long way towards allowing the Kurdistan Region to establish itself as a significant factor on the world stage.

Legal Guidelines

The legislative framework for the energy sector of the Kurdistan Region has its roots in the 2005 Iraqi Constitution. Amongst others, there are three key components of the Constitution that are of particular significance to the energy industry in the Region. Article 112 states that, “The federal government, with the producing regional and governorate governments, shall together formulate the necessary strategic policies to develop the oil and gas wealth in a way that achieves the highest benefit to the Iraqi people using the most advanced techniques of the market principles and encouraging investment.”

Article 115 states, “All powers not stipulated in the exclusive powers of the federal government belong to the authorities of the regions and governorates that are not organized in a region. With regard to other powers shared between the federal government and the regional government, priority shall be given to the law of the regions and governorates not organized in a region in case of dispute.” The latter article gives priority to the laws of the Kurdistan Region over federal laws, and is invoked when no agreement is reached on oil and gas management and revenue distribution.

In addition, as there were already oil and gas companies active in the Region prior to the creation of the Iraqi Constitution, Article 141 stipulates that, “Legislation enacted in the region of Kurdistan since 1992 shall remain in force, and decisions issued by the government of the region of Kurdistan, including court decisions and contracts, shall be considered valid unless they are amended or annulled pursuant to the laws of the region of Kurdistan by the competent entity in the region, provided that they do not contradict with the Constitution.” Thus, the agreements signed between the KRG and the international oil companies (IOCs) that had already established a presence in the Region were legally binding and federally recognized.

It should be noted that the Iraqi central government has taken a very different stance regarding oil and gas exploration and production than the one advocated by the KRG. The central government argues that it alone has the authority to license IOCs to work in Iraq and to determine proper avenues for export. The Baghdad government has therefore declared many of the contracts offered by the KRG to be illegal, and has accused the government in Kurdistan of exporting crude oil without first coordinating with the federal government.

Per the Iraqi Constitution, in August 2007, the Kurdistan Regional Parliament approved the Kurdistan Oil and Gas Law (OGL), which became active upon the authorization of President Masoud Barzani. The law provided a legal framework from which the Kurdistan Region could further develop its potentially vast oil and gas industry. Under Article 24 of the OGL, the Minister of Natural Resources was given the authority to sign exploration and development contracts with private companies. Perhaps most notably, Article 24 confirms that, “…A Petroleum Contract may be based on a Production Sharing Contract, or on other contracts which the Minister considers to provide good and timely returns to the people of the Region...”

Production Sharing Contracts (PSCs)

In contrast to the 20-year technical service contracts (TSCs) utilized by the Iraqi central government, the KRG elected to award operators in the Region PSCs (usually with levies for development of local infrastructure). As discussed by industry expert Pedro van Meurs, “It is fundamentally important to structure fiscal terms in such a manner that the profitability to the investor is aligned with the goals of the government. If the profitability and goals are aligned, investors will automatically take decisions in such a manner that the value of the government revenues is maximized because in this way also their profits will be maximized.” Dr. Meurs concludes that under the TSCs offered by Baghdad, the interests of the government and the contractors were seriously misaligned. In contrast, he notes that a “PSC would be considered in the national interests by many host governments because it does provide the framework for an optimal level of production and recovery of oil and gas from the reservoirs while creating a high value of government revenues.”

According to Chapter 10 of the OGL, the exploration phase of a typical PSC would last for 5-7 years (depending on renewals). If an IOC declares a commercial discovery, a 20-year period for development and production is granted (with options for automatic extensions). The maximum contract period is 39 years for an oil development and 41 years for a gas development. In addition, in contrast to Baghdad contracts (which stipulate strict contract limits and specified handover dates), the PSCs of the Kurdistan Region are far more flexible.

Exploration and Development

As a result of the PSCs offered by the MNR (as well as Article 141 in the Iraqi Constitution), multiple IOCs were soon involved in the Region. Two of Kurdistan’s earliest entrants, Genel Energy and DNO, remain highly active today. Genel, the Anglo-Turkish energy firm, began its operations in Kurdistan in 2002 and was one of the pioneers in the development of the Region’s oil resources. The company found rapid success in Kurdistan, and now holds interest in a total of 8 different exploration blocks. In 2004, Norway’s DNO, which was also an early proponent of the Region’s potential, entered into its first PSC to develop the giant Tawke oil field, which has a production capacity of nearly 100,000 bpd. Earlier this summer, the company recorded both its highest production in a single day (113,000 barrels) and its highest sales in a single day (102,000 barrels).

Other medium sized IOCs began to see the potential of the Kurdistan Region, with now critically important entities such as Addax Petroleum, Talisman Energy, Western Zagros, and Gulf Keystone Petroleum (GKP) beginning their operations in the area. Indeed, in late 2007, GKP secured interest in the Shaikan and Akri-Bijeel blocks. Today, it has diversified its portfolio by adding two more blocks, and now sits atop the largest onshore oil discovery not currently in the hands of a major company. As noted by GKP Country Manager Umur Eminkahyagil, “According to gross mean oil in place reserve estimates, the four blocks in which GKP have interest hold at least 19 billion barrels of oil.”

The Changing Landscape

In recent years, the lure of the Region’s extensive oil and gas reserves coupled with the attractive terms offered by the KRG have attracted a number of the world’s dominant energy players. The first major to establish itself was Exxon Mobil, which signed an agreement to enter the Region in November 2011. French giant Total followed suit, entering the Region in 2012 by acquiring a 35% interest in each of the Harir and Safin blocks. The company plans to develop those areas jointly with Marathon Oil Company, which itself acquired interest in the blocks in 2010. Total further expanded its activities in 2013 when it acquired a majority interest in the Baranan block. Chevron elected to forego prospects in the south to pursue opportunities in the Kurdistan Region in 2012. Chevron purchased 80% stakes in the Sarta and Rovi blocks in the Region. The company elected to further expand its involvement in the Region by acquiring interest in and operatorship of the Qara Dagh exploration block.

There is good reason for this increased interest in the Kurdistan Region. The aggressive goals established by the KRG provide a clear message to IOCs that the Region is ready and willing to engage in mutually beneficial partnerships. Indeed, the MNR target of 2 million bpd by 2019 would surpass the current output capacities of multiple globally recognizable oil producers, including Libya. Beyond its resource wealth, the Region also offers more stability and safety than does the rest of Iraq, and its PSCs have much higher rates of return (25-35%) than do the TSCs (15-18%) favored by Baghdad.

Refineries

In addition to developments in exploration, the Region is also expanding its refining capabilities, with two major facilities already in place.

The Kalak Refinery, which is located in the Erbil governorate and is operated by KAR Group, currently has a capacity of 100,000 bpd. However, with the help of American engineering firm Ventech, the company hopes to expand that capacity to 200,000 bpd in the near future.

In the Slemani governorate, the Bazian refinery has been operated by Qaiwan Group since 2009. The facility will soon have a refining capacity of 34,000 bpd after its own expansion, which is also being assisted by Ventech. The Bazian refinery is currently producing kerosene and diesel, and will start producing gasoline for the domestic market this year.

Dana Gas Refinery
Dana Gas Refinery
Kar Group Refinery
Kar Group Refinery

Tensions with Baghdad

The differing interpretations of the Iraqi Constitution by the federal government and the KRG have led to prolonged tension between the two sides. Authorities in Baghdad maintain that licensing should only be conducted by the central government and that the individual regions are permitted to participate in the process rather than hold their own independent licensing rounds. In addition, Baghdad has argued that the Kurdistan Region’s attempts to export crude oil abroad violate the terms of the Constitution, as doing so potentially removes the KRG’s need to repatriate funds earned from such sales. For its part, the KRG has denied accusations that the Region is exporting crude oil without coordinating with Baghdad. KRG Minister of Natural Resources Dr. Ashti Hawrami has instead argued that potential exports are legal and that the Region is returning 50% of the profits made to the state treasury.

Tensions further escalated in January 2013, when the KRG suspended oil exports through the central government-controlled pipelines as a result of Baghdad’s refusal to pay certain fees. The KRG alleged that the central government owed the Region nearly $3.5 billion for outstanding payments covering all exports between 2010 and 2013, as well as for compensation for the costs of the oil companies operating in Kurdistan.

Baghdad, which still refuses to pay arrears for foreign oil companies operating in the Kurdistan Region, viewed the PSCs signed by the KRG as illegal and in violation of the country’s sovereignty. In addition, the central government claims that the KRG has not been turning over all of its profits to the central government, has not been forthcoming with its official records, and has not met its export quotas. As a result, the 2013 federal budget, passed by the Iraqi Parliament in March, authorized only $646 million of the requested $3.5 billion.

In April, the Kurdistan Regional Parliament passed Law Number 5, which authorized the Region to begin exporting oil if Baghdad does not agree to pay debts claimed by the KRG. In his interview with IIG, Minister Dr. Hawrami noted, “This is an important piece of legislation that… will form the legal basis for the settlement of outstanding revenue issues between the KRG and Baghdad. Essentially, the law outlines a mechanism for defining and then obtaining the outstanding revenues owed to the Kurdistan Region by the federal government since 2004… It will also include items such as the KRG’s share of sovereign expenditure revenues owed to the Region’s security forces (the peshmerga) and payments to the Region as compensation for damage done by the former regime. The new law sets out a pathway to implement Iraq’s Constitution, and by implementing the Constitutional requirements for power and wealth sharing, everyone in Iraq will benefit, citizens and investors alike.” If the debts claimed by the KRG, believed to be in excess of $20 billion are not paid, then the new law provides for the KRG to begin exporting oil and gas abroad in order to raise the requisite funds.

In late April 2013, a high level Kurdish delegation headed by Prime Minister Nechirvan Barzani paid a visit to Baghdad to resolve differences between the both sides. However, the relationship between Erbil and Baghdad remains tense, despite the fact that both sides agreed to form a committee to oversee legislation relating to revenue sharing during this visit. Questions still remain regarding the Region’s export policy, the federal budget, and the future of the disputed territories (most notably Kirkuk, which is home to 40% of Iraq’s total oil reserves).

Direct Connections

Despite the issues between Baghdad and Erbil, the KRG continues to push forward with its ambitious production targets by pursuing plans to begin exporting oil to world markets through its own channels. Once operational, the pipeline will enable the Region to export crude oil directly to world markets without the prior approval of the central government in Baghdad. A long-awaited pipeline linking fields in the Kurdistan Region with the Kirkuk-Ceyhan pipeline is expected to be in operation by the end of 2013. The new line will connect a number of fields in Kurdistan (including those operated by both Genel and DNO) to the existing pipeline at the Fishkhabur pumping station, located in the northwestern corner of the Region near the Turkish border.

Estimates indicate that the new line could allow the Kurdistan Region to earn nearly $1 billion per month. Thus, it will likely soon become a reality that, for the first time, Kurdistan will earn more from its own oil resources than it does from its share of the total Iraqi revenues authorized by the central government.

The pipeline, which was initially designed for natural gas but was later converted to carry oil, will allow for the transportation of up to 300,000 bpd. Sources within the KRG have also indicated that construction of a second pipeline with a capacity of 500,000 bpd could begin in 2014, and would connect Turkey with the oil fields in the Akre, Shaikan, and Barda Rash exploration blocks.

Turkey’s Expanding Influence

Turkey currently imports over $50 billion of energy each year to satisfy the massive demand of its growing economy. As such, and in hopes of reducing its overwhelming reliance on Russia and Iran, the regional power has been actively investigating alternatives to meet its rising needs. The Kurdistan Region has provided such an opportunity. In May 2013, Turkish Prime Minister Recep Tayyip Erdogan publicly announced the completion of a landmark agreement regarding oil and gas exploration within the Kurdistan Region. The deal would see Turkish state petroleum company, Turkish Petroleum (TPAO), working jointly with ExxonMobil and the KRG in oil exploration.

The Kurdistan Region, Turkey, Oil & Energy

Second Pipeline

In October, Dr. Ashti Hawrami, the KRG’s Minister for Natural Resources, announced that the KRG is planning the construction of a second oil pipeline from the Kurdistan Region into Turkey. The second pipeline will contribute hugely to this acceleration of exports, increasing the Region’s export capacity by over 1 million bpd. The pipeline is projected to be completed within 18-24 months. As with the first pipeline, the export volumes of the second will be independently monitored by the Kurdistan Region, as a result of tensions with Baghdad regarding revenue sharing disagreements between the KRG and federal government.

The Gas Industry

Kurdistan has approximately 100-200 TCF of gas reserves. This figure proves that the gas industry will play a crucial role in Kurdistan’s future.

The MNR estimates that the Kurdistan Region is home to approximately 100-200 TCF of natural gas reserves. This figure represents between 1.5-3% of the world’s total reserves and provides a clear indicator of the prominent role the Region is expected to play in regional gas markets. The KRG has therefore established a plan for effective gas utilization, which involves first satisfying domestic need for power and industrial usage before moving on to the possibility of export (which could begin as early as 2016). In addition, the MNR has implemented a strict policy regarding gas flaring that seeks to ensure, “… that all gas is used and flaring is kept to an absolute minimum.” Instead, the Ministry has encouraged companies to develop plans for effective gas utilization.

A number of operators have taken that message to heart. Dana Gas, which initially entered the Region in 2007 as part of a joint-strategic alliance with Crescent Petroleum and the KRG, has actively sought to secure the necessary natural gas to run the Region’s power plants. The company now operates a Liquefied Petroleum Gas (LPG) facility, which is capable of producing a total of 330 million cubic feet (mcf) per day. Endeavors such as this have helped to improve the Region’s developing electricity sector and make plans for gas export far more feasible. Turkey presents an obvious destination for export, as the country’s developing economy requires significant quantities of gas to fuel power generation.

Miran & Bina Bawi hold a combined 8-18 TCF

Genel Energy is likely to significantly raise its estimate of the amount of gas it has discovered in the Kurdistan Region. The company now believes that its gasfields at Miran and Bina Bawi hold a combined 8-18 trillion cubic feet of gas, a figure that represents more than twice its previous estimate of gas resources. These developments come amidst important progress on a comprehensive energy-export agreement between the KRG and Turkey that would see 20-25 percent of Turkey’s annual gas consumption [10bn cubic meters] supplied by pipelines from the Region.

Electricity: Powering the Region

By 2016, the KRG aims to produce enough electricity to satify the Region’s energy needs and allow for the export of power to neighboring countries.

Growth in electricity demand, generation, and transmission has contributed significantly to broader economic growth in Kurdistan. Moreover, developments in the sector over the past decade paint an optimistic picture for the sector’s future. Until 2009, very little of the Region’s electricity was generated locally, making Kurdistan dependent on Iraq’s national grid and imported power from Turkey. Despite the fact that demand was low and distribution infrastructure was underdeveloped, the Region still suffered from a dearth of available power and often faced blackouts. However, decisive leadership by the KRG’s Ministry of Electricity (MOE) and vigorous development by the private sector have largely ameliorated the situation and laid the groundwork for even more impressive developments.

Whereas demand in 2009 was just over 2,000 megawatts (MW), it has since jumped to 3,750 MW in 2013—an increase of almost 88% in just four years. This is due to a combination of increasing economic development, a growing population, and improved transmission infrastructure. In the same period, the number of electricity consumers shifted from 705,000 to 1.1 million, and the number of transformers from 20,000 to 28,000. Companies such as MITAS have built much of the Region’s transmission infrastructure, and the KRG recently signed a contract with Siemens to develop a Region-wide communications and power grid over the next four years. In terms of power generation, the growth is equally striking. In 2007, the Region only produced 482 MW of electricity. As of November 2013, the Region was capable of producing 2,800 MW. Much of the growth in generation is due to the construction of three major gas power plants located in Erbil, Slemani, and Dohuk, built and operated by Mass Group Holding. The targeted capacity of these three stations alone is 3,500 MW, with room for additional growth.

Developments in electricity generation and transmission have brought available electricity to the Region to over 23 hours 30 minutes per day—a number that was in the low single digits not long ago. Furthermore, nearly all of the power results from local production. The success of the sector has the Region’s policymakers hopeful for the future: projections for power generation in 2016 are in the neighborhood of 6,000 MW, and there is talk of exporting the Region’s surplus electricity to cities in central Iraq. The major reversal at play in the sector is not only cause for optimism, but also demonstrates how far the Region has progressed in the past decade.

Erbil Power Plant

Following a push by the KRG to increase the efficiency and capacity of its energy infrastructure, Mass Global has contracted GE to supply two steam turbines that will augment output at the Erbil Power Plant by 500 MW. The project will also increase thermal efficiency by over 48%. This should supply enough additional electricity to power 100,000 Iraqi residences and will make Erbil one of the most efficient power plants in all of Iraq. Turkey’s ENKA Construction & Industry Company will build the new combined-cycle plant, which is scheduled to begin commercial service in the latter half of 2014.