Comment: Basra's oil drowns out Kurdish complaints

As the KRG cuts exports, high oil prices and capacity insulate Baghdad

Oil exports from the south accounted for almost all of the uplift in exports in March. GETTY IMAGES
Oil exports from the south accounted for almost all of the uplift in exports in March. GETTY IMAGES

As Iraq’s oil ministry was cheering a landmark month in oil exports, the Kurdish regional government was ordering its oil sector to close the taps. The development that may mark the point at which the Maliki administration in Baghdad takes the upper hand in the dysfunctional relationship between Iraq’s parallel oil industries, and the Kurdish oil industry separates itself still further from Baghdad’s oil ministry.

Yesterday the State Oil Marketing Organisation (SOMO) confirmed that it had exported 2.316 million barrels a day (bpd) through March, the highest monthly average since 1990. The news is a huge technical achievement for the companies operating the southern fields and Iraq’s South Oil Company.

The exports give an indication of the ability of southern fields to ramp up Iraq’s exports, which were responsible for almost all of the increase, and corroborate the oil ministry’s claim that a recent dip was due to bad weather, and not any lingering issues with a new single-point mooring system offshore Fao. SOMO says Iraq’s exports dipped 4.5% in February to 2.013 million bpd from an average of 2.107 million bpd through January.

KRG production cut

Meanwhile, the Kurdish regional ministry for natural resources made good on a threat to cut oil exports, ordering oil companies producing in the region to halt flows to the Kirkuk-Ceyhan pipeline by which Kurdish oil makes its way through the central Iraqi export system. The move is the second time the region has shut exports since they began on 1 June 2009.

“After consultation with the producing companies, the Ministry has reluctantly decided to halt exports until further notice,” read an official ministry statement released late yesterday.

The move was confirmed by the region’s largest single exporter, DNO International, which is 40% owned by RAK Petroleum.

“As of 1 April 2012, the Ministry of Natural Resources of the Kurdistan Regional Government (KRG) has instructed DNO International ASA to halt delivery of that portion of crude oil produced from the Tawke oil field that was destined for the Iraqi national pipeline system for eventual export through Turkey,” DNO said in a statement to the Norwegian bourse, while confirming its other crude and refined product deliveries and field operations remain unaffected.

Under clause 16.12 of its production sharing contract with the KRG, DNO - which produced 48,770 bpd in the region through the fourth quarter last year - is likely to be given an extension to its contract to allow it to eventually produce the oil that the KRG’s shutdown prevents it from producing. Other producers enjoy similar provisions in their respective contracts.

“There have been no payments for 10 months, nor any indication from federal authorities that payments are forthcoming,” the ministry for natural resources said, despite a widely reported remark from an Iraqi official in Baghdad that part payment against the $1.5 billion claimed by the KRG is slated to be paid shortly.

"We've allocated 650 billion Iraqi dinars ($559.4 million) in the 2012 budget to pay the companies, which we will release after we receive the audit from the board of supreme audit," finance minister Rafie al-Esawi told reporters on the sideline of the Arab League summit on 27 March, according to a Reuters report.

Baghdad reacts

In an interview with AFP’s Prashant Rao, Iraqi Deputy Prime Minister for Energy Hussain Al-Sharistani said the region needs to “get its act together.”

"I would advise them, before they make any threat, to consider how much oil [revenue] they are getting from other parts of the country, which is much more than the oil that is being produced there," Hussein al-Shahristani said.

The KRG has a commitment to supply 175,000 bpd to the Iraqi export network under the terms of a bilateral deal struck before Iraq’s $100 billion 2012 federal budget, and receives 17% of budget revenue under the terms of the Iraqi constitution. Assuming an export price of $115 a barrel, the KRG’s gross oil revenue contribution to the central budget is therefore $7.34 billion, while it draws $17 billion in central government funding.

For the time being the region is richer in Iraq than out, though that is cold comfort to the ministry of natural resources, which needs to be able to honor the terms of its production sharing contracts to maximize investment in the upstream sector.

That dilemma is irrelevant to Sharistani, who told AFP that the KRG "need to put their act together and hand all the oil that's being produced in the region to the ministry of oil immediately if they would like to see the budget allocation in the 2012 budget... implemented."

Sharistani also said that Exxon had sent the oil ministry a second letter confirming that they have 'frozen' their six production sharing contracts with the KRG, something denied by KRG and undermined by recent reports on the ground of early preparations by the US oil giant.

The central government is riding high after successfully – if, at a readily reckoned $500 million, expensively – hosting the Arab League summit and seeing a reduction in violence throughout the country. The death toll in March was the lowest since the 2003 invasion, in which 78 civilians, 22 police and 12 soldiers died.

The oil ministry is targeting average national exports this year of 3.5 million bpd. Current oil prices more than compensate for the loss of Kurdish crude. The central government’s incentive to bend to the KRG’s demands is diminishing as the south’s exports increase.

At this stage there seems little incentive for Baghdad to honour its reimbursement commitment under the 2012 budget. There is a risk that the KRG’s latest move costs its oil sector $560 million for no benefit.

What next for the KRG?

The problem for the KRG is that it has now played its strongest hand – perhaps too late – without prompting change from Baghdad, which remains committed to both blacklisting the region’s oil industry and developing the Kirkuk field under central oil ministry terms. Assuming the Maliki administration feels as dominant as the south’s oil sector, the KRG has put itself in a serious bind.

Kurdistan has an aggregate oil production capacity thought to exceed 250,000 bpd. With regional refining capacity of only 50,000 bpd (with an increase to 75,000 bpd by the end of the year possible) and total regional crude demand officially estimated at 100,000 bpd, oil companies in the area are able to turn a profit, but much of the value of their 48 production sharing contracts signed in the region are being negated.

Refining the problem

A quirk of the current situation is that the KRG cannot export crude without answering to Baghdad, but can export refined products. The region has a large additional semi-official cottage industry in refining, but relying on this wasteful and rather ersatz sector is not what the KRG has in mind for its future as a major oil exporter.

The KRG currently pays oil companies around $60 a barrel for oil sent to the local market, which given low lifting costs is certainly profitable, but represents a huge opportunity cost given average export prices of $115 a barrel.

Building industrial refining capacity large enough to keep pace with oil field development will take time, though as the KRG loses leverage with Baghdad, it may be a sensible alternative development plan should the prospect of regularisation of Kurdish oil contracts slip further from view.

The plan would, however, be unpopular with oil companies operating in the region and their investors. Share prices in foreign oil companies operating in the region have been depressed by political and legal uncertainty and an inability to realize market prices for every barrel lifted. A domestic refining-first development plant would likely make these depressed valuations permanent.

A kick-start to Kurdistan’s domestic downstream sector may be good for a more diverse industrial sector in the long term. Now, however, building refineries to truck petrol and diesel across the Turkish border it would be an expensive and inefficient fudge of a political problem.

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