Iraqi Kurds in talks to cede control of oil fields to Baghdad amid budget crunch

Dubai — The Kurdistan regional government in Iraq is considering transferring its oil assets to the federal government in Baghdad in exchange for it to paying its public sector salary bill, two sources with knowledge of the situation told S&P Global Platts.

Discussions between the two governments and their oil ministries are active, and both sides aim to reach a decision by the end of the year, one source said.

The KRG, its Ministry of Natural Resources and the Iraqi Oil Ministry did not respond to requests for comment.

The hydrocarbon-dependent Kurdistan region is buckling under the strain of low oil prices. The semi-autonomous region has a deficit of about $68 billion, based on its 2020 budget published this month. The region is several months behind on paying its public sector salaries. Some three out of every four workers in Kurdistan receive their salary from the state, and failure to pay them could have security ramifications for the region.

Federal Iraq is currently paying $270 million to the KRG as a contribution toward its budget, a reduction from a previous agreement under which it sent $400 million a month. Baghdad and the KRG have tussled over budget contributions since the region began to export its oil independently. In exchange for this, Kurdistan pledged to hand over 250,000 b/d, about half of its exports, to the federally controlled oil marketing company (SOMO).

"KRG really needs the money, but Iraq is not a good option," the second source said. "It's still not stable, there are a lot of people that want to squeeze the KRG. The consensus is that a deal needs to be made, but on the details, there is no agreement."

The Iraqi federal government and the KRG have been in dispute for years over oil revenue sharing, with the KRG controlling crude production on its territory in northern Iraq. The KRG exports its crude via pipeline to the Turkish port of Ceyhan.

Kurdistan holds proven reserves of some 45 billion barrels of oil and is estimated to have up to 5.7 Tcf of natural gas. The region pumped on average more than 468,400 b/d in 2019, according to a Deloitte audit. The net cash balance received by the KRG for sales and related activities was $4.515 billion last year, it said.

However, the potential asset transfer is fraught with complications, both sources said.

"KRG is rife with corruption," the first source said. "Iraq is technically bankrupt, so its ability to spend is limited. They also don't have an alternative economic plan and can't survive without federal Iraq."

Political risk

Security is another concern. One complication is the tribal leaders in Kurdistan will have to agree to cede control of the territories surrounding the assets to Federal Iraq. Kurdistan also wants Federal Iraq's support in securing its territory against the self-styled Islamic State, the source added.

Taking control of KRG's oil assets would also mean taking on the debt attached to them, which would be a huge draw-back for Baghdad, the sources said.

"However, if you take the oil, you have to take the liabilities, too, which means paying for the loans KRG took out from the traders [in 2015]," the second source said. "With oil prices where they are, the repayments are barely covering the interest of those loans. KRG is in a very tight spot at the moment. It also has debts with Turkey, which has been taking oil as a regular payment."

Also, there's the question of the value of the assets.

"KRG has exaggerated the size of its assets for decades," said the first source. "Kurdish production is also naturally declining."

There are also fundamental differences between the upstream contracts awarded to international oil companies by both Erbil and Baghdad, which presents an issue. KRG contracts are unfavorable to the central Iraqi government and are seen as colonial because they allow foreign companies equity in the oil blocks, both sources said.

Should the asset transfer go ahead, Kurdistan's position as a semi-autonomous entity would be under threat, the sources added.

"If they go through with the plans, it means they are saying the project of the KRG didn't work," a Middle East-focused political risk analyst said. "From an Iraq perspective, if Prime Minister [Mustafa] al-Kadhimi delivers this, it would increase the overall likelihood of the elections being held next year. He wanted to bring the elections forward by a year."

However, a deal, in some form, urgently needs to be done, sources said.

"The KRG are caught out," a global oil and gas consultant said. "Their best bet right now is to make up with the Iraqi government, get them to bail them out and to work out a new structure going forward. I don't think it's the end of KRG, but yes, they're desperate. They need to come up with a new agreement with Iraq itself."