Since March 2023, several International Oil Companies (IOCs) have been impacted by the halt of the Iraq-Turkey Pipeline (ITP) that transported their oil from Kurdistan to the port of Ceyhan in Turkey. The pipeline stopped operating after the decision by the International Chamber of Commerce’s International Court of Arbitration (ICA) in favor of Baghdad. These companies have not been able to export their production through the ITP pipeline since then. Currently, they have resumed production in some wells, but well below their nominal capacity and with sales exclusively to the domestic market at a huge discount compared to the international prices, just to allow them to breakeven. In this first part, I am going to comment on the origins of the current disagreement between all parties and how the situation could evolve in the next months according to the latest news. There is a second part that includes a comment about some of the IOCs operating there and their value proposition.
Oil production in Kurdistan
The Kurdistan Regional Government (KRG) is highly dependent on the revenue from oil production and export, as they account for most of Kurdistan’s government income. There aren’t official figures, but it is estimated that the region's oil output has already slipped from about 468,000 bpd in 2019 to less than 440,000 by the end of 2022. The three major oil fields in the region are Tawke, Khurmala and Taq Taq. The lack of investment hasn’t been able to make up for the natural decline that is estimated to be between 15% and 20%. In this regard, the Shaikan oil field stands out with a decline as low as 6-10%. The region is in dire need of the investment by IOCs operating its oil and gas fields to maintain the production.
In recent years, IOCs have faced several difficulties while doing business in Iraq. Since 2020, majors like BP, Shell, Lukoil and ExxonMobil have completed their plans to sell most or the totality of their assets in the country. In July and August 2022, the US contractors who were working on the expansion of the Khor Mor gas field operated by Pearl Consortium suffered a series of rocket attacks. These contractors had replaced previous US and Turkish contractors that withdrew due to previous attacks. Most oil and gas fields have suffered attacks during the last decade and the enlarged presence of Iran-backed militias in Iraq represents a bigger threat to these IOCs despite the presence of the US army in the region.
The KRG has been working to increase the local production of natural gas to generate electricity and to end almost daily power blackouts. Of Kurdistan's 13 power stations, five are gas powered and are only working at about 50% to 70% capacity because of shortages. The KRG needed the IOCs to continue investing in new wells and transport and processing infrastructure to secure both revenue and cheap energy. The region sources its refined products from the Kalak and Bazian refineries in Erbil and Sulaymania, respectively. These refineries receive the oil directly from the fields in the region, so they have continued working despite the ITP closure.
The absence of steady revenue streams is also impacting the payments. Many IOCs and trading houses are owed large amounts. The KRG has been in a constant debt crisis for the last 20 years. In early 2023, some estimates put the debt with trading houses at $6 billion. This is not only affecting IOCs but also current and retired employees such as teachers. Public employees have organized several strikes to claim their salaries. The region hasn’t been stable as the different political parties have been fighting over the governance of the region and some of its key policies. For example, the last time Kurdistan region held an election was September 2018. The region has lost significant political strength compared to Baghdad, as the clashes between Kudish factions have occurred at a time when Baghdad has managed to improve its own political stability and security.
The KRG is desperate to obtain a constant inflow of money to satisfy its past and current obligations and the lack of oil exports via Ceyhan is a financial setback that is eroding the region’s welfare. The perspective for the future is also uncertain; the worsened security situation, delayed payments, excessive bureaucracy and a growing Iran-Iraq collaboration are affecting the investment level in the oil and gas sector. This desperation has forced the KRG’s hand and it had to change the approach with regards to the relationship with Baghdad.
Baghdad-Kurdistan Regional Government dispute
The Kurdish Peshmerga were fundamental in the fight against ISIS when both Syrian and Iraqi armies failed to stop it from conquering a considerable amount of territory and large cities like Mosul. After a successful battle against ISIS self-proclaimed caliphate, the Kurds had to fight against Iran-backed militias in Iraq. These militias had replaced the Iraqi military in the fight against ISIS, but turned against the Kurds once that menace was eliminated.
As a result, the tensions grew and the Kurds decided to prepare an independence referendum in 2017. In September 2017, the Kurdistan region of Iraq completed the referendum and claimed independence from Baghdad, which was followed by an offensive by Iraqi security forces that “recovered” loss of 40% of the territory that the KRG had controlled since 2014 and over 250,000 barrels per day in oil production from the fields in Kirkuk. Since then, the KRG and Baghdad have continually been in conflict with Iraqi Kurdistan operating more as an autonomous region belonging to Iraq rather than as an independent state.
As the tension eased during 2023, Baghdad allowed the Kurdistan Democratic Party (KDP) taking back its headquarters in Kirkuk, which was used by the Iraq army’s Joint Operations Command in the region. This decision is seen to serve 2 purposes: undermine the position of the Patriotic Union of Kurdistan (PUK) and the New Generation Movement (NGM) while normalizing the relation between Erbil and Baghdad. This will allow the KDP to prepare the campaign for the next provincial council elections. However, Arab (mainly Iran-backed groups) and Turkish groups have opposed this decision and have organized protests and road blockades, which have caused several deaths. To ease the turmoil, the KDP decided to donate the facilities to the city’s University. The KRG-Baghdad situation is very complex, but the relationship has greatly improved compared to the 2014-2017 period.
Coming back to oil and gas, the region is entitled to a portion of the national budget under the Iraqi constitution, and Baghdad needs the oil and gas production for obtaining the funds for this budget. But this situation collapsed in 2014 when the Kurds seized control of Iraq's main northern oil fields in Kirkuk from ISIS and began controlling them independently from Baghdad. In 2015, IOCs operating in Kurdistan began direct oil sales to world markets under the umbrella of the KRG, who signed new Production Sharing Agreements (PSCs) with them. However, this is not totally new, the KRG has allowed oil and gas production outside of the control and supervision by Baghdad since as early as 2007. The signature of the PSCs undermined the authority of the Iraqi federal government in Baghdad, who was the only public body able to sign such contracts until then. This move by the KRG seriously aggravated the political conflict between Erbil and Baghdad.
Baghdad challenged this decision at a federal court, which declared in February 2022 that the KRG's oil and gas legislation was "unconstitutional" and invalidated all PSCs that the KRG had signed with IOCs. I insist: “invalidated all PSCs that the KRG had signed with IOCs”, this is very important. This ruling was not surprising, many majors and supermajors and most US oil service companies (Schlumberger, Baker Hughes and Halliburton) had already initiated the liquidation of all their contracts in the Kurdistan region in the 2020-2021 period due to a combination of factors including pressure by Iraq’s federal oil ministry. However, most independent IOCs saw this as an opportunity and benefited from the exit of the majors, taking over some of the fields that these companies left behind. For them, the closed pipeline was fundamental for exporting their production.
The Iraq-Turkey Pipeline (ITP)
Let’s briefly take a look at this infrastructure. It is important to consider that the halt of the pipeline is affecting the global oil market. It is estimated that approximately 450,000 barrels per day have been removed from the market. This oil includes both KRG (ca. 370,000 b/d) and federal oil (ca. 75,000 b/d). However, this amount is far from the maximum level. The Turkish side of the ITP consists of two parallel lines, of 48-inch and 40-inch diameter, with a nominal capacity of 1.4-1.6 million barrels per day (depending on the source). The Iraqi section of the pipeline has 2 different routes, the original that was attacked by ISIS and it is still unusable, and the smaller pipeline built in Kurdistan that connects the Tawke and Taq Taq fields with the Turkey-Iraq border where they are connected towards Ceyhan. Other fields in Kurdistan truck their productions to Tawke and Taq Taq where they unloaded it into the pipeline.
The federal government hasn’t yet restored the original section of the pipeline and the new sections laid out by the KRG are still the only alternative. The 40” section of the Kirkuk-Fishkabur pipeline was too severely damaged to be repaired, and the Iraqi federal government has proposed the construction of a new infrastructure to replace it. However, there hasn’t been progress on this project and the production of the oil fields controlled by Baghdad around Kirkuk remain heavily constrained due to the lack of transport capacity.
Hence, the short-term effect of this blockade is affecting the international oil price, but its long-term effect can be much higher once full capacity is restored. The global oil demand is estimated by the International Energy Agency (IEA) at 101.5 MMb/d, and an increase in supply of 1.4% of the total demand will surely impact the international oil prices. Importantly, Iraq must first assure it is allowed to produce and export those volumes under its agreement with OPEC.
ICA Ruling
In parallel to the process in Iraq, Baghdad opened a case at the ICA, claiming that Turkey violated a 1973 pipeline transit agreement by allowing the exports from Kurdistan without Baghdad’s consent. ICA’s decision was announced on 13rd February 2023, and it found Turkey had breached the agreement and had to pay a compensation of over $1.9 Billion to Iraq for exports between 2014 and 2018. At the same time, it awarded Turkey approximately $500 million in fees that Baghdad owed Turkey according to the same agreement. Following the outcome of the arbitrage, Turkey stated that it would not allow shipments carrying crude from Kurdistan to leave Ceyhan without Baghdad's consent. On 25th of March, Turkey's state-owned Botas informed Baghdad that pumping operations were suspended at around 12:30 local time at pumping station 3 (PS3) on the Turkish side of the pipeline.
The Iraqi oil ministry said that the State Oil Marketing Organization (SOMO) is the “only party” that is allowed to manage oil and gas production and exports from Kurdistan, which includes the pipeline to Ceyhan. The ministry said it will discuss “mechanisms for exporting Iraqi oil through [Turkey’s] Ceyhan port with the concerned authorities in the Kurdistan region as well as with the Turkish authorities” in a manner that guarantees exports will be sustained and international commitments met. Other countries like the US have been vocal about a resumption of the exports through Ceyhan. After ICA’s award, a spokesperson of the US State Department said that Washington has “urged the governments of Turkey and Iraq to resume the flow of oil through the Iraq-Turkey pipeline, and disruptions to global energy supply would not serve anyone’s interest”.
The initial reaction from KRG’s prime minister, Masrour Barzani, was to publish a tweet acknowledging ICA’s ruling: “Our recent understandings with Baghdad have laid the groundwork for us to overcome the arbitration ruling today. A team from the KRG will visit Baghdad for talks tomorrow to build on the goodwill of our discussions”. That forced the KRG to sit at the negotiation table with Baghdad’s representatives. Considering both Iraq’s federal 2022 and ICA’s 2023 rulings and the lack of revenue for the KRG from oil and gas production, Baghdad had the stronger position in these talks. As a result, the KRG signed an initial agreement with the federal authorities to exchange any claims over the oil and gas production in Kurdistan for a stake of the federal budget. Finally, with the regained control over the production, Baghdad proceeded to request Turkey to resume the operation of the pipeline, but Ankara has blocked it since then.
The final agreement had to be formalized including all conditions and there has been a constant back and forth between both sides, accusing one another of breaches of the initial agreement and lack of willingness to sign the final agreement. Nevertheless, it is clear that the KRG has renounced its previous ambition to monitor and supervise all oil and gas production in Kurdistan, and this is key as it leaves IOCs that signed their PSC with the support of the LRG.
Following the handing over of oil and gas production to Baghdad, the KRG has supported Baghdad’s pressure on its Turkish counterparts to reopen the pipeline to Ceyhan. As soon as May 2023, the KRG publicly issued a statement requesting Turkey to reopen the pipeline acknowledging that Baghdad was the only voice in the matter in Iraq.
Now Baghdad’s renovated power has allowed it to regain part of the control over the regional institution. The Iraqi Supreme Court has moved to dissolve critical institutions, including the Parliament and provincial councils, which are essential for legislation and decision making, impeding the KRG’s ability to function as a normal government. Baghdad is using KRG’s economic needs to grab part of the lost control over the region, which is in dire need of accessing the funds of the federal budget.
What’s needed to reopen the pipeline?
So, the KRG and Baghdad have achieved a common understanding, but there is a loose link, Turkey. The Turks have played several roles in the process, from being supportive of Baghdad’s claims and showing a willingness to reopen the pipeline to publicly announcing that there was a lack of understanding between both countries. There are 2 key aspect at play:
Current ICA’s ruling: the country has been through a tough economic and financial situation with years of sky-high inflation. Turkish currency reserves are very low and it has required the support of Russian public companies to increase their US-based reserves. The payment of this amount in full would impact the ability of the country to import some goods or satisfy some contracts in foreign currencies. In August, its foreign reserves were estimated at just $2 billion, coming from negative levels. Turkey cannot easily pay the $1.5 billion without harming its own economy. Hence, Turkey needs an agreement with Baghdad regarding this payment. Should Turkey fail to serve its obligations under ICA’s ruling, Iraq could seize some Turkish assets, such as Turkish Airlines’ aircrafts. This may sound weird, but it has recently happened: in December 2022, an Air Tanzanian’s plane was seized in The Netherlands in relation to a compensation awarded to a Swedish company by the World Bank’s International Centre for Settlement of Investment Disputes.
Additional ICA’s ruling: the previous decision covered until 2018, but Turkey has been accepting oil from the KRG until March 2023, so there are c. 5 years of exports that are not included in the current ruling. This is one of the major issues here for Turkey that many overlook, as the amount to be paid to Iraq could double and become an even higher burden for the country. Thus, the amount at stake is not the current $1.5 billion but much more than this, and Ankara is aware of it and has requested that Baghdad suspend this separate case during the conversation with Iraqi officials.
Therefore, any negotiation between Iraq and Turkey is not limited to the current $1.5 billion settlement, and Ankara wants to reach an agreement for the whole 2014-2023 period. Turkey is not publicly signaling its willingness to pay any amount to Baghdad (even if it has the capacity, which I doubt); instead, it insists on just reopening the pipeline without acknowledging the amount owed to Iraq. However, why will Baghdad let Ankara walk away without paying the $3 billion that it could be owed? This is just an opinion, but it seems EXTREMELY unlikely. The Iraqi economy is highly dependent on oil revenues (it does not produce gas due to the lack of processing and transport infrastructure and it is flared), as non-oil industries like agriculture have contracted due to the drought and associated water shortages. Its current multiannual 2023-2025 budget is based on an oil price of US$70/bbl and exports of 3.5 MMb/d, which are inclusive of 400,000 bpd from Kurdistan. Every day of delay in reopening the pipeline is affecting the Iraqi economy, but this negative effect is partially being relieved by the higher oil prices.
It is almost impossible to assess the exact status of the process as both countries have requested the US courts to solve their respective claims in response to ICA’s decision. In April, Iraq went to a US court to force Turkey to pay the compensation. Last September, Turkey completed a court filing in the US claiming Iraq owes it $957 million after the ICA’s ruling, which was responded to by a court filing on 28 September by Iraq arguing for a US court to enter a judgment of $601.9 million in Iraq's favor.
The two countries have also held a series of technical meetings. In August, a delegation led by Iraqi Oil Minister Hayyan Abdulghani met with officials from Turkey’s Energy Ministry, including the Energy Minister, and state pipeline company BOTAS. This visit was followed by a trip by the Turkish Foreign Minister Hakan Fidan to meet with two dozen Iraqi ministers and political chiefs in Baghdad and Erbil. In September, Turkey also stated that the maintenance of the pipeline has been completed, as it needed a complete survey after the earthquakes and floods occurred in the regions where the ITP transits.
On the 2nd October, BOTAS informed SOMO that the turkish section of the pipeline was ready to resume operations after completing a required technical review:
We would like to inform you that the part of the ITP [Iraq-Turkey Pipeline] system in Turkish territory will be ready for the transportation, storage and loading of crude oil coming from Iraq on 04.10.2023.
However, other sources claim that Turkey has yet to officially notify Iraq of the resumption of the operation of the ITP.
The political situation remains unresolved and is preventing the resumption of the operation until both countries resolve the matter. In the meantime, KRG/Baghdad is losing billions in lost oil sales revenue and Turkey is not earning the oil transport and loading fees. Turkey has benefitted by the cheap oil from Russia and Azerbaijan, which has reduced the need to access Iraqi oil. There will be an understanding but how and when remain a mystery.
What’s the outlook for the production in Kurdistan?
Besides the reopening of the pipeline at the current 400,000+ b/d, the normalization of the Ankara-Erbil-Baghdad relations will attract investment to the oil and gas fields in Kurdistan, which can quickly increase production. The opex per barrel in this is among the cheapest in the world, as low as $5/bbl, which attracts the interest by most IOCs despite it not being of the highest quality. Hence, all companies will be willing to ramp up production as fast as possible given the regulation framework is totally clear and the PSCs will be respected by all parties. However, Iraq is an OPEC+ member and the increased production from Kurdistan will help it to reach its quota (ca. 4.4-4.2 MMb/d), which it hasn’t met in the last quarters. Any substantial increase in production by Iraq-Kurdistan must be under the OPEC+ quotas, hence the actual impact would be lower. Nonetheless, this is strong evidence about those predicting sustained $100+ per barrel of oil due to lack of sector-wide investment in the last decade that will affect the supply in the future. Once the region sees the long gone stability and the sector is again operating under the umbrella of SOMO, the return of investment can increase the production in the northern regions of Iraq (conditional on the security situation continuing to improve).
Challenges to the IOCs operating in Kurdistan will not be finished once the ITP resumes operations. They will face heightened competition by western majors but also Turkish (maybe part of the agreement with Baghdad, I speculate) and Chinese (who have increased their presence in projects across Iraq) oil companies chasing these highly profitable barrels. Thus, it is important to analyze the final framework that Baghdad offers to the IOCs and how it affects the existing PSCs and licences, because I assume there will be changes. The pending payments from the KRG to the IOCs are another key aspect to confirm. Is it of interest to Baghdad to service KRG’s debt that was generated while the IOCs were in breach of the Iraqi constitution? To be honest, I doubt it. Hence, I think one aspect that will not be resolved together with the reopening of the ITP is the payment of the high amounts owed to the IOCs by the KRG.
The last position by the Iraqi federal government with regards to IOCs has been that they must sign contracts with SOMO before resuming production:
Iraqi PM Sudani says IOCs operating in Kurdistan informed Baghdad that resuming oil exports via Iraq-Turkey pipeline will be possible within a month if they reach an agreement with federal govt over production costs and their contracts
IOCs in Kurdistan have now lost any assurance that their PSCs will be valid, and Baghdad will set the new conditions. Most of them have managed to partially resume production for the domestic market at huge discounts compared to international oil prices, but the struggle is not yet finished.
Conclusions
I’d recommend not to generalize and jump into simplistic conclusions about the outcome. There are many parties involved and Baghdad is in a position where it can obtain reparations for the humiliations suffered in the last decade. Hence, I believe it will be particularly challenging for the IOCs. However, expelling them from Kurdistan/Iraq is not a viable option, as it would send a negative message to the international community. Seeking reparation for the damages is different from pure vengeance. The main unknown is when Turkey and Iraq will sign the agreement solving the feud over the ICA’s current and future rulings for the whole 2014-2023 period. Such negotiation must be complex as both sides have their own interests and limitations. Both parties have insisted on resolving the matter as soon as possible, but there doesn’t seem to be near signing a final agreement.
I would not dare to make statements like “all IOCs in Kurdistan will resume production as soon as the ITP reopen” or “they will receive all the pending receivables”. The situation is very complex and not all companies may be treated the same way. For example, DNO has been in Baghdad’s spotlight because it supervised and operated the Tawke terminal, where other operators unloaded their oil for transport to Ceyhan. I’m convinced that Baghdad is going to introduce many changes to the new PSCs that will be offered to the IOCs, including giving entry to new players that have been more loyal to SOMO. But this is just an opinion.
The situation is extremely complicated and only experts in the dynamics of both the Iraqi oil and gas sector and the political situation between Ankara, Erbil and Baghdad can make informed assessments. I’d recommend you to follow Ashmed Rasheed on Twitter, who is a journalist for Reuters in the country and is monitoring how the situation evolves.
Part II will be published in a few days, where several companies will be discussed in detail. Please, subscribe in the button below:
Disclaimer: The situation between the Kurdistan Regional Government, the Iraqi Federal Government and the Turkish Government is complex and may change at any moment. There are some aspects that have not been included as this is not intended to be a thorough review of the historical relationship in this heated region. The information presented here comes from publicly available sources and it is not intended to provide a detailed analysis of the geopolitical situation. This post does not reflect the reality of the conflict in depth and has been prepared only for informative purposes.
Wonderful work
Excellent, thank you