Significance: An agreement in principle between the Iraqi government and the Kurdistan Regional Government (KRG) is understood to have been reached about how to resolve the oil production and export impasse, with KRG oil exports now expected to resume by 1 February, although the crucial issue about who will pay the IOCs that produce the region's oil still remains unclear.

Implications: Agreements over the KRG's oil contracts and exports have been reported before, but have always fallen on the crunch point of sharing the remuneration of the IOCs for their work under the KRG’s production-sharing agreements (PSAs). The fact that a new date for resuming exports has been set indicates that some form of understanding might have been reached, but it might also be another KRG show of goodwill to placate central Iraqi unwillingness to compromise.

Outlook: Until key Iraqi government officials actually confirm that their view of the KRG contracts' legality has changed and commit to a formula for how to split the IOCs production share between the central and KRG budgets, celebrating a breakthrough is premature, although naming a date for the start of exports,at least shows that talks about finding a solution have intensified.

Purported Breakthrough

"[We had a] Productive meeting with [Iraqi] Prime Minister [Nuri al-Maliki, and we] agreed to resume oil exports from Kurdistan by Feb. 1," Kurdistan Regional Government (KRG) prime minister, Barham Salih was today reported by Dow Jones to have written on the micro-blogging service Twitter, following a high level meeting including Iraq's deputy prime minister for energy, Hussein al-Shahristani and the oil minister, Abdul-Karim al-Luaibi. The Iraqi prime minister and the KRG prime minister were also both reported by Iraqi media to have jointly commented after their meeting on the new planned 1 February resumption of Iraqi Kurdistan oil exports. Comments by Salih to Iraqi media, in the presence of al-Maliki, also seemed to indicate that a general understanding had been reached about the KRG oil export's volume contribution to the national budget and perhaps also about the division of IOCs remuneration, although the wording seemed quite vague. Discussions will now be held on a more technical level between the appropriate KRG officials and their finance and oil ministry counterparties.

The Budget Issue

Since the short-lived KRG oil exports were halted in mid-2009, the KRG has repeatedly made the point that Iraqi central government intransigence on not agreeing to carry their fair share of what should be regarded as the region’s oil production costs was holding back significant volumes of oil exports and revenues from the central budget. At a time of deep Iraqi budget deficits, this has of course been a powerful argument, especially when the vast Iraqi infrastructural and government service reconstruction needs have been weighed in.

This KRG strategy to paint the central government in an obscurantist light has been paired with the general political push during the protracted government formation negotiations last year to connect crucial parliamentary support from the Kurdish factions for a new al-Maliki-led government to securing a deal which would recognise the autonomous province's oil contracts. While that appears to have been achieved to some degree, it is still unclear what guarantees the KRG has for al-Maliki to later not rescind on a commitment to reach a deal with the Kurds, recognising at least most of their autonomy over their oil resources. Also, during the government formation negotiations and ahead of this year’s budget, the central Iraqi government effectively devised a counter policy, taking some of the KRG oil minister, Ashti Hawrami's most optimistic production capacity promises for the region at face value and factoring them into the national budget, the effect of which being that if exports at those levels were not achieved, the national budget would be compensated by dipping into the 17% share of the national income which directly goes to the KRG budget, to a corresponding amount. While incendiary in the eyes of the KRG, this policy has seemed to focus minds on both sides in order to avoid the practical financial fallout, as well as the potential breakdown in relations.

Hence it is encouraging to hear statements about a breakthrough in the budget issue being reached, although, as with the core issue of how to compensate the IOCs producing the oil in the KRG under oil contracts deemed illegal by the central government, the lack of detail indicates that there might still be some way to go before a negotiated solution is hammered out.

Who Gets the Money?

The core issue at the bottom of KRG and Iraqi central government oil and gas relations of how to compensate the oil companies that have signed contracts under the unilaterally enacted Iraqi Kurdistan oil law, still requires a firm answer. Right now only two oilfields, Tawke, operated by Norway's DNO, and Taq Taq, operated by China’s Sinopec and Turkish partner Genel Enerji, are on standby with a significant developed production capacity of about 100,000 b/d jointly and rapid abilities to raise the output to between 150,000-200,000 b/d in less then a year. Two other companies, Gulf Keystone and Heritage might be able to add some sustainable smaller streams from early production and long-term test flows, but would likely not contribute more than about 20,000 b/d jointly during most of this year. Should a deal be reached, developments would nevertheless get launched swiftly, with a handful of fields likely to be brought into stable rising production over the coming 18-24 months, as right now the uncertainty over monetisation opportunities is holding back early development commitments.

Under the KRG production-sharing agreements (PSAs), most IOCs receive a production share of about 15-18%, with the Taq Taq venture receiving less as the field was previously known, but undeveloped. If the KRG, as the Iraqi central government has been demanding since 2009, had to compensate IOCs producing in its region from its 17% share of its oil exports, virtually nothing would be gained (although the KRG still of course also receives 17% from all other Iraqi income, namely the vast southern exports) except the investment, industrial development, and job creation accompanying the oil boom. Hence, the KRG demands that KRG oil export income should be divided after the producers have received their production share, a principle which sounds reasonable from a purely technical perspective given that it would mean the division of the pure profit from the sale of the oil and not leave one of the two sides paying for all production costs. A lot is at stake for the central government, however, with national control over all upstream resources seen as a cornerstone to preserving the central state's authority and making sure that there is no slippery slope towards a future break-up of Iraq. The Iraqi government has also chosen to prefer technical service contracts (TSCs) rather than PSAs as the framework for developing its oil industry from a resource-nationalistic point of view, although the notion of developing exploration tracts, mostly in Iraqi Kurdistan, under the more suitable PSAs has not been completely ruled out.

Outlook and Implications

Without a clear commitment from the Iraqi government recognising the KRG contracts as legal, or the KRG agreeing to convert the PSAs into TSCs of some form, which potentially could be highly damaging to the IOCs investment appetite in the region, it appears too early to celebrate a breakthrough. The fact that a date has been set for the start of exports, however, indicates that some form of understanding might have been reached, as the KRG is unlikely to again begin production only to realise after a few months that its oil companies are not being paid. A deal could centre around the Iraqi Oil Ministry agreeing to remunerate IOCs under TSC principles but at levels commensurate with their KRG contracts, although the technical challenge involved in this means that it is likely that we would have heard more details leaked on the matter by now. Rather, there is room to hope that the KRG's conditions for supporting a new al-Maliki government are now being heeded by the Iraqi government. Until further details are clarified, however, this might just be another one of Iraqi Kurdistan's false oil export starts.