Despite a torrent of threats from neighbors and appeals from world powers, the Kurds of Iraq went through with their independence referendum on September 25, and they’ve paid a high price ever since. To the surprise of no one, voters overwhelmingly favored independence. And although the vote was non-binding—meaning a formal declaration of independence never materialized—the response from Kurdistan’s neighbors was swift and painful.
Months later, the independence vote looks like a disaster.
Months later, the vote looks like a disaster. It exposed how vulnerable the semi-autonomous Kurdistan Regional Government (KRG) was—as a landlocked, oil-dependent territory surrounded by hostile powers. Over the last decade, KRG President Massoud Barzani had positioned himself as the future godfather of an independent Kurdistan. He resigned in October. Today, the Kurds find themselves in a terrible position with zero leverage.
Before the referendum, KRG pipeline exports via Turkey stood at about 600 thousand b/d. All told, crude exports during the first half of 2017 were valued at $4 billion, according to an external audit published by the KRG’s Ministry of Natural Resources. But those volumes included oil from Kirkuk-area fields which were previously controlled by Baghdad. The Kurds only took them over in 2014, after federal forces retreated in the face of ISIS.
With ISIS on the run and nearby Mosul liberated last summer, the Iraqi army was free to pressure the Kurds again. Deployments and ultimatums followed the September referendum. On October 16, Kurdish forces melted away and the Iraqi army recaptured Kirkuk and its oil, re-establishing federal control of Bai Hassan and the Avana Dome of the Kirkuk field. The result? “Kurdish” oil exports were slashed by almost half overnight.
The KRG’s economy was teetering before the September vote. With exports halved now, a bad situation has turned dire. FT put the total KRG debt burden at $17 billion the week of the vote. By December, there were riots over backpay and corruption. Complicating the revenue situation even more is that the Kurds pre-sold much of their oil to traders, meaning today’s diminished volumes are spoken for—and the revenues have already been spent. At this point, Kurdistan simply can’t afford to pay down debt, keep the lights on, and pay salaries.
Politically speaking, Kurdistan is more divided now than at any time since the two major Kurdish parties fought a civil war in the mid-1990s.
Besides taking back oil-rich territory, federal authorities in Baghdad blacklisted Kurdish banks and shut Kurdish airspace to international travel. They also coordinated with Turkey and Iran to squeeze the Kurds. In late October, the Turks and Iraqis announced their intention for Baghdad to take control of key border crossings; their status remains confused. However, the Turks never followed through with their threat to cut off Kurdish oil exports. The Kurds owe Ankara maybe $2-3 billion in overdue oil transit fees and loans. Cutting the KRG off completely would send a message, but it would also be counterproductive if Turkey hopes to collect at some point. Iran, for its part, shut border crossings with the KRG for months after the referendum.
The aftershocks haven’t run their course yet. Politically speaking, Kurdistan is more divided now than at any time since the two major Kurdish parties (the KDP and PUK) fought a civil war in the mid-1990s. Moreover, today’s divisions have national implications for Iraq because, as a unified bloc, the Kurds have the potential to be kingmakers in May, when Iraq holds its next national election. Together, the Kurds could help pick the next prime minister; divided they may be a much less potent force in parliament.
The oil which Baghdad recaptured in October is now stranded in the north.
Beyond Iraq, there are big implications for global oil markets. The oil which Baghdad recaptured in October is now stranded in the north. The federal government may have captured the tap but the Kurds still control the bottleneck which connects those fields to the Iraq-Turkey pipeline leading to the Mediterranean Sea. Despite the disruption of 300 thousand b/d, Iraq has taken the Kirkuk losses in stride. Such resilience would be cause for celebration and congratulations if Iraq—OPEC’s number two producer behind Saudi Arabia—had not fallen short of its commitments to curb production under the 2016 Vienna agreement.
In an effort to lift sagging prices, Iraq joined two dozen OPEC and non-OPEC oil producers to restrict production starting January 1, 2017. The agreement has been successful thus far thanks to historically high overall compliance rates. However, Iraq has been an exception. It pledged to cut output by 210 thousand b/d. According to OPEC’s secondary sources, it failed to meet its commitments last year, cutting output by only about half of what it promised over the first 12 months of the deal. The referendum crisis and the ensuing disruptions in the north promised to improve Iraqi compliance. But any improvement was short lived. Instead, Iraq defied the odds and boosted production from other fields to compensate for at least some of the lost barrels. Total Iraqi production (including the KRG) was 4.405 million b/d in December—54 thousand b/d above the level agreed to in Vienna.
Iraq’s lagging compliance is a headache for OPEC and its partners.
Iraq’s lagging compliance is a headache for OPEC and its partners. But with prices surging above $60 per barrel to start 2018, the Vienna framework is succeeding, and Iraq’s non-compliance is a complication rather than a real handicap. That would change, of course, if Baghdad and Erbil agree to fully restore Kirkuk-area oil fields. 300 thousand b/d could be unleashed thereafter and Iraqi production could jump to 4.8 million b/d or more. The Vienna deal would be seriously compromised and Iraq’s relations with its oil-rich neighbors, especially Saudi Arabia, would likely suffer.
Yet, OPEC’s worst nightmare and Iraq’s dream of pumping 5 million b/d is only possible if Baghdad and Erbil reach a deal on exports and revenue-sharing. Other such deals have broken down before and so far there’s little reason to be optimistic. Without a doubt, oil is the most sensitive issue at hand. Instead of tackling it head-on, Baghdad and Erbil are discussing less controversial—but still thorny—issues like customs administration and public wages. Even those talks haven’t made much progress since the referendum.
Baghdad hasn’t shown much urgency up to now. This is hardly surprising. Federal oil exports from the south could be the highest ever this month and today’s prices are the highest in three years. The simple fact is Baghdad can pay its bills so it’s in no rush. Meanwhile, the Kurds’ past due notices are piling up.