Last week I was in Boston. There I met the man who would be the foreign minister of Kurdistan, if Kurdistan had a foreign ministry. I asked him about the ongoing battle between Kurdistan and the central government over the region’s oil sales.
He responded simply. “It is a matter of principle. We want to sell our own oil.”
Oh boy. Not that I blame the Kurds, but oh boy. Given that the Kurds do not consider the dispute a simple deal to be negotiated, I do not expect yesterday’s settlement between Baghdad and Erbil to hold for long. Kurdistan will be declare independence within two years.
Under the Iraqi constitution, Kurdistan is due 17% of all Iraqi oil revenues. That is a lot; rather more than what the region can earn from its own production. The deal requires Kurdistan, however, to give up all control over its internal oil production to the central government.
That never happened. Rather, until January the post-occupation status quo (hammered out and guaranteed by the Americans) was that Kurdistan could sign production contracts with foreign companies in contravention of Iraqi law. Any oil produced under those contracts, however, would be turned over to the central government, which would sell it. Kurdistan would receive its 17% of total national oil revenues, from which it would pay the oil companies according to their contracts with the Kurdish government.
In January, though, Kurdistan started selling its oil directly. It promised to deduct those revenues from bill due it from Baghdad. One problem with that is that the government take in Kurdistan is much lower than in the rest of Iraq, which in effect meant less revenue for the central government. The other problem was that it violated Iraqi law. So Baghdad cut off all revenues to Kurdistan and threatened to sue anyone who bought Kurdish oil.
The U.S. played a passive-aggressive role towards Baghdad. It supported Iraq verbally, but when the Iraqis tried to enforce their rights in American courts it did nothing. The Justice Department could have weighed in ... but no. Radio silence. And so, the Texas judge ruled that the dispute was outside his jurisdiction. (By the way, this was the right thing for Washington to do. We owe the Kurds but we cannot be seen to be abetting violations of Iraqi law. Difference, split!) A good legal analysis from some Baker Botts lawyers can be found here.
Kurdistan succeeded at selling a lot of oil, but at a 20% discount. From January to last week, the Ministry of Natural Resources reported selling 34.5 million barrels. Of that, 21.5 million went through the new pipeline to Turkey and the rest went on trucks. Kurdistan earned $2.87 billion from the sales; $2.1 billion in cash and $775 million in swaps of crude for refined products. ($1.3 million of the cash is being held in escrow in Turkey.) That means that Kurdistan earned $83 per barrel on its exports at a time when Brent traded (on average) for $104 per barrel. And that is before deducting the $400 million that the country had to pay the truckers to move the stuff. (Some of the $400 million went to upstream producers, but Kurdistan has understandably mostly not been paying them. $31 per barrel is not an unreasonable trucking cost considering as trucking runs about $20 per barrel in the United States.)
Might the discount on Kurdish oil be due to low quality? After all, crude oil comes in different flavor. Heavier and more sulfur-ridden crudes are harder to refine and command lower prices per barrel than lighter “sweeter” crudes. Kurdish oil, however, is neither particularly heavy nor particularly sour. Oil from the Taq Taq is very light. Other grades from Kurdistan are relatively sour, but overall the quality resembles the Urals blend from Russia. Urals trades at around a $1-$2 discount against Brent, much less than $20. (The link will take you a historical time series; the discount has occasionally touched $3 for short periods; it has also occasionally fallen to zero.) Maya is heavier and more sour than Kurdish production, and its spread below WTI is only around $10. In other words, the Kurdish discount appears to be somewhere between $10 and $18 per barrel.
Kurdistan is earning less than it would under its deal with Iraq. Between January and September, Iraq exported $66.0 billion worth of crude. (We will avoid asking why Iraq cannot field a decent army with such revenues.) Add Kurdish production minus an $18 per-barrel-discount and Iraq as a whole exported more than $69.4 billion. 17% of that is $11.8 billion. Even the smaller 11% that the Kurds were actually receiving would have come to $7.6 billion. That is a whole lot more than the $2.5 billion the country actually got net of price discounts and transportation costs. And even that figure is deceptive, since Kurdistan will eventually need to start paying the oil companies their share of the revenue.
The rub is that Kurdistan expects its exports to grow. Right now, the place has been exporting about 126,000 barrels per day. The country hopes to hit 1m barrels per day by the end of 2015. At that level, Kurdistan is likely better off on its own unless oil production in the south also explodes. Which is likely in the long run (to a level of 7m bpd or more) but not by 2015 ... maybe around 2020.
- Kurdish independence makes no economic sense right now. Nor does it make sense in the long run. But it will make sense for a brief shining period between 2o15 and 2020;
- But Kurdistan has shown that it is willing to pay the economic cost of independence (and say so publicly to American academics);
- The United States has only half-heartedly backed the Iraq central government in its legal fight against Kurdish oil exports;
- Iraq has taken Kurdistan to international arbitration but that is a long slow process; and
- Kurdistan is stepping up to the plate against the Islamic State.
Conclusion: the recent revenue-sharing deal will not last. Kurdistan will declare independence within two years.