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The relationship between Baghdad and Erbil has been strained ever since Iraq managed to eliminate the threat of the Islamic State. Both sides perceive the others endeavors with anxiety but are too cautious to entirely shut the door on a future amicable settlement. Today, as both sides struggle to survive the economic impact of COVID having been forced to postpone important projects, a conflict between the two seems increasingly likely. At the same time, finding a mutually agreeable solution to the Iraqi-Kurdish division would massively benefit both parties. For the two sides to come to an agreement, there are multiple hurdles that must be overcome. First and foremost, Iraq desperately needs money as the fiscal breakeven level stipulated in its 2021 federal budget stands at 63 USD per barrel of oil. The Kurdish government, which is even more dependent on crude revenues than the notoriously oil-reliant Iraq, employs roughly half of the entire workforce in the region and has failed to pay out public sector salaries in a timely and adequate fashion. Thus, neither side has the freedom to act magnanimously and let go of funds that the populace might perceive as political misallocation.

Closely intertwined with the issue of budget revenues, compliance with the OPEC+ output quotas that Iraq has committed itself to has been a source of bad blood between the two sides. The Iraqi Oil Minister Ihsan Ismael stated that the production split was not done correctly, lamenting that Basrah production had decreased by 1mbpd (and another 0.1mbpd was allegedly cut in the Kirkuk area), whilst Kurdistan has barely made any changes to its usual upstream routine. It needs to be noted that following Iraqs wild overproduction during the first round of OPEC+ production cuts, Iraq has effectively started to comply with its commitments from June 2020 onwards and has kept its production around the 3.8mbpd mark (although its current quota stands at 3.65mbpd).

Graph 1. Monthly Volumes of Kurdistani Exports via Kirkuk in 2017-2020 (million barrels per day).

Source: Thomson Reuters.

Although companies active in the region of Iraqi Kurdistan have not cut production as part of a coordinated effort, they have still suffered from this years demand slump. Development drilling was arguably the most compromised element the number of drilling rigs at the Tawke field, for example, was reduced from four to one, Genels Qara Dagh appraisal program was delayed indeterminately, and Oryxs Hawler drilling program was also postponed. Thus, whilst Kurdish production has been well beyond the 370kbpd suggested/mandated by the Iraqi federal government, its prospects of a prospective production ramp-up have been tangibly hit by the coronavirus pandemic and its collateral effects.

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Iraq has also seen its fair share of project delays, but due to its much larger resource pool, it can increase production fairly easily if needed. Rumaila is producing almost 200kbpd less now than before the COVID-induced slump, West Qurna-2 is underperforming by some 120kbpd; Zubair, Halfaya, and West Qurna-1 have roughly 100kbpd of additional production capacity that could be brought onstream relatively quickly. Needless to say, these are all currently producing fields as several big projects are looming in the near-term horizon the LUKOIL-operated 2.5 BBbls Eridu field alone is capable of boosting Iraqi oil output by 300kbpd from 2023 onwards. The Achilles heel of Iraqs oil industry lies in its water supply the COVID pandemic has put the Common Seawater Supply Project (CSSP) on hold, an indispensable element of any future production surge in Basrah.

The (re)creation of an overarching national oil company might be one elegant way to dovetail the interests of the federal authorities with those of the Kurdish regional government. INOC ceased to exist more than 30 years ago, Saddam Hussein broke it up in 1987 into several regional companies. Now, with Ihsan Ismael at the helm of the Iraqi oil ministry (he used to be the director-general of the Basrah Oil Company, the largest of regional oil-producing companies) the government consensus is that INOC should be reinstated by Q3 2021 or Q1 2022. The drive to reconstitute INOC is not new, Baghdad has tried to use it to pressurize Erbil into a deal although the federal law was voted by parliament in March 2018, it was later scrapped by the Iraqi supreme court as several of the articles were deemed unconstitutional.

The sense of shared travails and risks might actually be the one element that has been missing between Baghdad and Erbil. Quarreling now, when both sides are suffering to such a degree, seems like a self-defeating strategy. With that in mind, the first contours of a deal may already be brewing. As opposed to previous years, Baghdad has agreed to wire some $250-260 million per month to the Kurdish Regional Government to cover half of its public sector salary expenditures. Although Kurdish authorities continue to bargain for more, even a return to last years agreement (12.67% of the federal budget in return for 250kbpd worth of crude production) seems a mutually acceptable way out. Now the key is not to overdo the bargaining.

By Viktor Katona for Oilprice.com

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Low Oil Prices Could Finally Bring Iraq And Kurdistan Together - OilPrice.com