Exxon Moves on Kurdistan Deal Despite Baghdad Threat

Consultancy firm Wikistrat analyzes the impact of the American oil company’s Iraq operation.

According to sources in the city, supermajor ExxonMobil is establishing a presence in Arbil, the capital of the Kurdistan Autonomous Region.

This is a major development because in November 2011, ExxonMobil signed an oil exploration deal with the Kurdistan Regional Government despite the fact that the different political factions in Iraq had not agreed on a law to distribute oil revenues between the provinces and the central government in Baghdad. The central government maintains that the KRG/ExxonMobil deal is illegal and threatened to nullify Exxon’s other contracts for oilfields in southern Iraq. Exxon announced that it would review the deal but appears to be going forward with implementing it.

ExxonMobil was the first supermajor to ink a contract with the KRG and rumors abound that other supermajors will finalize deals of their own soon. An industry source said that Total, ConocoPhillips, Chevron, Eni and Lukoil are all interested in working with the KRG. Kurdistan has an estimated 45 billion barrels of proven reserves, compared to at least one hundred billion barrels of oil in southern Iraq. However, Kurdistan has proven to be a more attractive target for investors because its security situation and economy are markedly better than the rest of Iraq.

Analysis

ExxonMobil has moved forward with the KRG deal for several reasons. First and most importantly, it saw no credible threat that the Iraqi government would cancel its contracts in the southern oilfields as retaliation for an exploration deal with uncertain returns. The architects of the deal believed that because Baghdad is so dependent on oil revenues, threats to disrupt production in the south by severing ExxonMobil’s contracts there (in the largest oilfield in Iraq, no less) amounted to nothing more than bluffs. After witnessing oil minister Hussain Shahristani’s feeble response to the ExxonMobil deal, other oil companies are more likely to call this bluff as well by pursuing deals with Kurdistan.

Second, the American withdrawal has created substantial uncertainty in the security and regulatory environment of non-Kurdish Iraq and investment there will remain a risky prospect for some time. The dispute between Baghdad and the provinces cuts to the heart of the nature of the post-2011 Iraqi state and it has flared up in the wake of American withdrawal. Salah ad Din and Diyala provinces have formally requested autonomy from the central government, prompting a crackdown by Prime Minister Nouri al-Maliki’s security forces. Until these disputes are resolved and the character and powers of Iraq’s governing bodies are clarified, investors will rightly be hesistant to commit themselves to such a volatile region.

Finally, it is important to remember that this is just an oil exploration deal, not a production contract. Should oil be discovered in significant quantities, it is quite possible that Maliki’s government will not be so tolerant of ExxonMobil operating in Kurdistan without contributing revenues to Baghdad’s coffers.

The distribution of oil revenues is part of a larger ongoing conflict between Iraq’s provinces the central government in Baghdad. The dispute touches on a number of fundamental questions and factional insecurities about the nature of the Iraqi state itself. The Kurds, a stateless people who endured centuries of persecution from governments across the region, have been largely successful since 2003 in achieving their goals of sovereignty, security and economic prosperity with an eye toward eventual independence. Although Kurdistan’s accomplishments have not trickled down to the rest of Iraq, the KRG does provide an appealing model that other Iraqi provinces may seek to emulate.

Both Sunnis in the west and Shiites in the south have expressed interest in local self government with only nominal ties to Baghdad — in other words, Iraqi federalism. This is because Iraq’s national government has largely been deadlocked and unable to effectively distribute resources and services outside of Baghdad. Furthermore, there is great uncertainty as to whether the government will be representative, responsive and free of sectarian influence.

This trend toward federalism poses a problem for Baghdad because most of Iraq’s oil is located in Kurdistan and southern Iraq. If those regions were to become functionally independent without sharing oil revenues with Baghdad, the central government would collapse into bankruptcy (oil accounts for about 75 percent of GDP and 90 percent of government revenues). This basic impasse explains why a national oil law has been stalled since 2005.

Wikistrat Bottom Lines

Opportunities

Kurdistan increasingly looks like the silver lining within the cloud that is Iraq. Reuters describes the ongoing boom in Arbil: “Now the latest Porsches, Maseratis and Range Rovers jostle with the albeit largely new pickup trucks preferred by the masses on the still potholed roads. Five star hotels are swiftly springing up and Kurdish shoppers buy designer brands at swish shopping malls with an air of confidence in the future.” Investment opportunities in Kurdistan should be monitored and pursued particularly closely.

Risks

Iraq is a fragile state and its politicians are playing a particularly nasty game of hardball right now, accusing each other of running death squads and/or autocratic security forces. There are a number of endgames to the current situation, but none of them are particularly pretty. The outcome of the dispute between Prime Minister Maliki and his political rivals will shape the resolution or escalation of the conflict between the central government and the provinces.

Dependencies

The public reaction to Western oil companies will be decidedly mixed. In Baghdad, they may be seen as predatory, whereas in Kurdistan they are more likely to be viewed as partners. A particularly strong reaction one way or the other — for example, attacks on infrastructure/personnel or tax breaks/favorable incentives — could determine how vigorously future investment opportunities are pursued.

Nick Hubbard contributed to this analysis.

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