Kurdish oil export carries a cost for OPEC

The first barrel of crude to be sold may be a victory for a region with a thinly veiled desire for full independence from Baghdad.

The first barrel of oil to be exported from Iraq's semi-autonomous Kurdish north, which looks increasingly likely to be next month, may be a victory for a region with a thinly veiled desire for full independence from Baghdad. The shipment of oil, produced under disputed deals signed by the Kurdish regional government, is an implicit validation of these production sharing contracts, and a major setback to the interests of a federal Iraq and, by extension, all resource holders in the Gulf.

Baghdad has long resisted the idea of Kurdistan exporting oil under the contracts it signed with a handful of small western oil prospectors. The federal government argued that the deals lacked the seal of national approval, were awarded outside any openly competitive process and that they signed away ownership of sovereign resources without the necessary legal authority. This disagreement is couched within a wider dispute over the Kurds' territorial claims over the city of Kirkuk, and a deep-seated desire by many Kurds for an independent state.

If Kurdish oil begins to flow through Iraq's pipeline next month this will be a major climbdown by Baghdad. The federal government appears to have been swayed by its desire for more cash at a time when output from the south of the country is falling and weak prices have already forced unpopular spending cuts. The Kurdish crude will be sold by the Iraqi state oil company and the proceeds routed through the federal revenue system under which Kurdistan gets 17 per cent of the national oil pie.

But the deal means that the federal government has accepted the production-sharing deals signed by the Kurds, undermining Baghdad's ability to impose a unitary legal framework over the country's economic mainstay. For the Kurds, allowing Iraq's state oil company to market the oil is a small price to pay for the recognition of its contractual regime, which is fundamental to its ambitions for more autonomy.

The deal with Baghdad is a reward for companies that aligned themselves with the regional government in Erbil, even at the cost of incurring the wrath of the Iraqi oil minister, who has barred them from participating in licences for much larger fields in Iraq proper. Kurdistan's generous oil regime has certainly brought in the investors, who have spotted a breach in the nation's commercial defences.

Despite the vociferous protests of the federal government, 20 independent oil companies, among them Canadian, British, American and Norwegian firms, have signed up for drilling rights. The Kurdish regional government now expects to export 100,000 barrels per day (bpd) next month, rising quickly to 250,000 bpd. And the plans do not stop there. Heritage, a small Canadian oil company, said last week that it had found up to four billion barrels, giving added credibility to the region's aspiration of producing 2 million bpd in as little as five years.

Production-sharing agreements, which call for the foreign investor to shoulder all the upfront costs in return for a lion's share of the early oil and a dominant role in decision-making, are viewed with scepticism by many in OPEC. They offer incentives to maximise production even when oil prices are low, which goes contrary to the tenets of OPEC, whose only policy tool is to control production. The deals threaten to undercut the terms being offered by the Iraqi government for access to its reserves and, by extension, they lower the bar for other Gulf nations and OPEC in general.

Lower barriers to entry into Middle-Eastern oil reserves give more room to consuming nations to capture a bigger share of the pump price through taxes, at the expense of producers. Necessity has forced the two sides together, but the deal to ship Kurdish oil to Europe fails to resolve differences in contractual terms with Baghdad, which are not sustainable within a single sovereign entity. Kurdistan's ability to monetise its oil resources could accelerate its departure from the federation by giving the region a more solid economic basis on which to build an independent future.

The bad news is that the tools of Kurdish freedom have also strengthened the hand of foreign investors and opened a breach in the commercial defences of the wider Gulf. [e-mail]