Kurdish Crude Bails Out Baghdad

Tough economic times are turning willful enemies into reluctant partners.

When Iraqi Kurdistan's oil minister, Ashti Hawrami, buoyantly announced last week that the Kurds and the federal government in Baghdad had agreed to start pumping Kurdish crude through the Iraqi network for export to Turkey, the global oil industry cheered. Up to that point, a long-running tussle between Baghdad and the Kurdistan regional government (KRG) had all but dashed Kurdish export hopes. After years of stalemate over how to divide power, land, and resources, the oil deal looked like nothing short of a breakthrough.

Perhaps not surprisingly, Baghdad's response was more guarded. At first, the government denied that any such deal existed, only to reluctantly concede later that there was an agreement after all. Baghdad dampened expectations by refusing to say when the oil would start flowing and reiterating its longstanding position that the KRG's some 25 deals with foreign oil companies are illegal. The central government disputes both the principle and the design of the contracts. First, Kurdistan lacks the jurisdiction to sign away extraction rights, the government argues. Second, Kurdistan has signed production-sharing contracts (PSCs) by which companies are paid partly in oil, allowing them to book higher holdings and thus drive up the value of their shares. Paying in oil is seen as an abomination in Iraq, provoking a nationalist backlash against what many perceive as a sellout of the country's natural resources to foreigners.

The KRG has long been seeking to develop the Kurdish region's own resources, despite Baghdad's opposition. It argues that a history of neglect, discrimination and outright destruction at the hands of the central state has given the Kurds ample justification for autonomy in all things, including oil. The export-ready oil comes from exploration begun several years ago by companies working in two fields: Tawke on the Turkish border, developed by DNO, a small Norwegian company, and TaqTaq, a large field in central Kurdistan that is co-operated by Addax of Switzerland and Genel Enerji of Turkey. Jointly, the two fields could produce 250,000 barrels per day. This would boost Iraqi exports, which have lagged at 1.8 million bpd, far below potential and much less than what Iraq was producing before Saddam Hussein dragged the country into a series of disastrous wars.

As much as Baghdad might like to object, economy reality necessitates that it go along with the Kurds - for now. The government drafted its 2009 budget last year as oil was peaking at $147 per barrel. It conservatively based revenue projections on a price of $80 a barrel -- not conservative enough, it turns out. By year's end, the price had plummeted to $40, and today it hovers around $60. Despite budget amendments, Iraq is expecting an $18 billion deficit this year that could grow further if oil exports don't pick up. And even if projected oil revenues of $36.5 billion are realized, these won't cover even the government's day-to-day expenses, mostly salaries for the huge public sector.

Kurdish exports would be a boon for an ailing Iraq since the KRG and Baghdad long ago agreed to share revenues. The KRG gets 17 percent of the federal budget. However, in an important concession that was sure to make the deal more palatable to Baghdad, Kurdistan's Hawrami indicated that proceeds from the new sales would be deposited into the federally managed Development Fund for Iraq rather than an independent offshore escrow account from which both Baghdad and the KRG could draw.

The pragmatism that bred this unlikely compromise will prevail as long as the economic outlook remains dire. If the export deal could form the basis for a much bigger bargain on the division of powers between center and regions, the status of disputed territories such as oil-rich Kirkuk, and a federal hydrocarbons law, then we would truly be looking at a breakthrough. Such a task will require a proactive mediation effort from the Obama administration, which will surely want to leave behind a sustainably stable Iraq when its troops withdraw by the end of 2011. Economically speaking, the time couldn't be more fortuitous to give KRG-Baghdad talks a serious go.