Guest Post: Silver Lining to the Financial Crisis

I'm still in full-scale end of semester crisis mode, but I'm delighted to pass along this commentary from a very well-placed observer who prefers to remain anonymous.  It's extracted from a longer paper, which goes into far more detail on the issues in question.   As with all guest posts, this represents his/her personal views with which I might or might not agree but which I certainly find interesting.  

Guest Post
A Silver Lining to the Financial Crisis:   Progress on Kurdish - Arab reconciliation in Iraq?
By "Oil Watcher"

It is certainly cliché, but today’s interconnected world truly works in mysterious ways.  On 11 July the world market price of oil peaked at $147 per barrel and Iraq was forecasting a $38-$50 billion budget surplus.  The ensuing months saw a secret ballot vote in Parliament aimed at imposing power sharing on Kurds in Kirkuk, a tense standoff between Kurdistan Regional Government (KRG) and Government of Iraq (GOI) military forces around the disputed city of Khanaqin, and an increasingly bellicose war of words between Baghdad and Erbil.  The Shiite-Kurdish political alliance which has run post-2003 Iraqi politics appeared to be in the process of disintegrating and being replaced by an ugly and potentially dangerous Arab-Kurdish split.   

However, in late November the GOI reportedly agreed to accept oil production for export from two of the KRG’s international oil contracts.  On the face of it, with Arab-Kurdish relations having reached their post-war nadir, the prospects for agreement on such a contentious issue would seem to be virtually nil.  Indeed, Prime Minister Maliki personally described all Kurdish oil contracts as unconstitutional for the first times only days before the agreement was reached.  This apparent contradiction can be explained by the financial crisis and the cratering of the world oil price to below $50 per barrel earlier in November.  Bottom line? A silver lining to the world-wide financial crisis may be progress towards Iraq’s Oil Law, agreement on which could help to define the place of Arabs and Kurds in Iraq.

An Oil Company

Iraq has been described as being founded as an oil company.  The centrality of oil to the fabric of the Iraqi state is critical to understanding the depth of the issues involved in agreeing upon an Oil Law and the significance of the Iraqi Government’s acceptance of oil for export from selected Kurdish contracts.  These contracts are not simply a technical or commercial matter, but rather are proxies for differing Arab and Kurdish conceptions of the Iraqi state.

The KRG’s leadership has sought a federal system for Iraq with maximum local autonomy and limits on the ability of the central government to exercise power.  Local control of oil is seen as essential to enabling this autonomy, but the decentralization of oil revenues is also a mechanism to check the power of the central government by limiting its ability to finance a large army.  The saliency of this issue is high after the Iraqi Army – peshmerga standoff in Khanaqin, recent reports that Iraq is purchasing weapons with oil monies, and Kurdish leaders publicly recalling how oil has been used to finance military campaigns against Kurds in the past.  The treatment of oil is also existential for Arab Iraqis.  Oil is perceived as intimately related to the territorial integrity of the country, and the manner in which it is handled as the determining factor as to whether the country stays together or breaks apart.  This is not only because Kurdish control over their oil reserves could provide the financial basis for future Kurdish independence, but also because it could set a precedent or model for future oil-rich regions in Iraq’s south.   

The Payroll

If Iraq is an oil company, to borrow a phrase from the post-financial crisis lexicon, what concerns Iraqi leaders in the new oil price environment is their ability to “make payroll”.  Iraq is uniquely dependent upon oil revenues to fund its budget, with IMF statistics indicating that 95% of expenditures being financed by oil monies in the 2008 Budget.  With oil prices declining by two-thirds as of early November, Iraq has already cut its draft 2009 Budget by $10-$15 billion and Iraqi political leaders are voicing concern that if prices remain at the current levels, Iraq may exhaust its financial reserves and be unable to meet certain obligations by mid-2010 or early 2011.

The area of the budget to keep an eye on is the operating budget, Iraq’s “payroll”.  This is because almost the entirety of the Iraqi population relies in some way on government support from the operating budget, which funds salaries, pensions, transfers (including food rations) and subsidies on basic services.  In evaluating the political implications of the financial crisis for Iraq, it should be understood that while reductions in capital expenditures will damage the country’s development prospects, it is the operating budget through which Iraq’s political parties fulfill the patronage function that is key to their power bases.  The political significance of the operating budget is made clear by an examination of what Iraq’s government actually spends money on (as opposed to what it allocates in its budgets).  By one estimate, some 90% of the money spent by the GOI over the past three years has been on operating rather investment expenditures.  With this in mind, it is the prospect of being unable to fund operating budget which currently has Iraq’s political class transfixed.  Quite simply, making the payroll is a matter of political survival.

Allowing Selective Export of Kurdish Oil

During the past few years Iraq has consistently been able to raise crude oil export revenues and deliver record budgets despite average daily oil production only growing modestly.  In this context, the federal government was under little pressure to increase oil production by passing an Oil Law.  The KRG, perceiving the development of the Kurdish oil sector as fundamental to consolidating the long term future of the Kurdistan Region, was far more eager to attract international investment and develop oil production, but not at the cost of sacrificing the principle of regional autonomy to sign oil contracts.  Having instead chosen to proceed in signing contracts on its own, the KRG faces a major strategic quandary.  Namely, it needs access centrally controlled pipeline networks to export its crude oil. 

At the current juncture, with the precipitous drop in oil prices, incentives have changed.  The GOI has an obvious need to increase oil production levels to compensate for falling prices but lacks the immediate means to do so.  Iraq’s Ministry of Oil has announced that it intends to sign long term risk service contracts to rehabilitate five major producing oilfields in June 2009, but these would not have an appreciable impact on production for a further eighteen months.  This leaves the GOI with one way to achieve a near term boost in oil production and limit the damage to its “payroll”: allow those Kurdish oil contracts that are close to production to begin exporting.  The KRG and its investors are similarly eager to resolve the export issue in order to begin obtaining a return on their investment.  Both sides therefore had a compelling interest in the reported agreement to allow exports from Taq Taq and Tawke fields in Erbil and Dahuk respectively.

It remains to be seen whether this agreement represents the first step towards a broader deal or is a short-term marriage of convenience.  There are still deep seated reasons that will make passing an Oil Law challenging, but with the financial crisis there is a sense of urgency to reach some form of accommodation that was previously absent.

Policy Lessons

Is this account of how the worldwide financial crisis has led to the KRG and GOI agreeing to allow exports from certain Kurdish oil contracts merely a curiosity or does it hold a wider policy lesson?  One possible conclusion is that any viable national reconciliation strategy for Iraq has to succeed in reframing key disputes in a way that addresses Iraqi stakeholders’ underlying interests or actually alters those interests themselves.  The financial crisis is an external shock, but it demonstrates how a change in incentives can lead to progress on oil issues against the grain of worsening Arab – Kurdish relations.

With respect to oil, the political strategy of the US-led military Surge does not appear to meet the standard of addressing the parties’ framework of interests.  The rationale of the Surge was to create the political space necessary to enable national reconciliation through stabilizing the security environment.  However, the KRG approaches the oil issue from a perspective of consolidating its autonomy and seeking to limit the central government’s ability to finance its military.  GOI concerns relate to ensuring the territorial integrity of Iraq and safeguarding the financial basis for a viable central government.  Even as the Surge played a role in sharply reducing violence levels in Baghdad, Anbar and elsewhere, it is difficult to see how additional “space” has affected these fundamental interests and translated into incentives for progress on the Oil Law.   

This can perhaps be illustrated through examples of policy choices that could affect the actors’ interests and incentives.  These possibly include conditional US security guarantees to the KRG on the one hand and seeking ways to address the threat to the territorial integrity of Iraq that the GOI perceives to result from regionalization of oil on the other.  One means to accomplish the latter would be to support Iraq’s Constitutional Review Process, and thereby help provide Iraqis an opportunity to re-examine the control over oil which the Constitution would grant newly formed regions in Iraq’s South.  This is all the more pressing following the oil wealthy Basra governorate recently initiating the process to become a region.

The ultimate purpose of this exploration of the policy lessons of the link between the financial crisis and oil negotiations in Iraq is not to advocate for either of these options, each of which require a much more detailed treatment than received here.  Rather this post seeks to highlight the changed playing field for Oil Law negotiations resulting from the financial crisis and to identify the kind of thinking about interest altering interventions that is required if the US and international community want to help build upon the recent developments related to allowing selective Kurdish oil exports.  The fact that an agreement on initial Kurdish oil exporting has happened at all suggests, somewhat counter intuitively, that it is potentially impactful moment to engage in thinking about how to facilitate progress towards a broader Arab - Kurdish agreement on oil that is a necessary part of the foundation of any stable Iraqi state.       

Comments

[Badger]

The writer refers to a "reported agreement", then to "this agreement", and the argument is based on there being an actual agreement. I thought it was clear there were talks but no agreement. Am I missing something? Could you provide a link to any report that says there was actually an agreement?

[motown67]

According to Azzaman, the Baghdad-Kurd export deal is dead. Link:

http://www.azzaman.com/english/index.asp?fname=news\2008-12-06\kurd.htm

Baghdad demanded that the Kurds renounce their independent oil deals and they wouldn't give in. The Kurds also wanted a cut of some of the oil profits and Baghdad refused.

In terms of the Iraqi budget, it looks like some pretty drastic budget cuts and austerity measures are on the way. They based the budget on a $62 a barrel price, and world prices are now down in the $40s, plus an oil official said exports are estimated to drop next year because of deteriorating infrastructure.

I've written several pieces on these events recently as well on my blog if anyone is interested. http://musingsoniraq.blogspot.com/

[gorwell]

As I read it,

On a KRG export of (say) 250.000 bopd, Shahristani wants it all and send 17% to KRG, ie 207.500 for Baghdad, 42.500 to KRG and not one barrel to the "illegal" oil company that made the export possible in the first place. KRG wants (lets say) a 20% cut amounting to 50.000 bopd to the oil company that made the export possible in the first place, a 17% cut of the remaining volume or 34.000 for KRG and the rest for Baghdad, ie 166.000.

As investment may continue and possibly grow, I bet KRG sees the benefit of having a prosperous oil company around. In the meantime we`re talking no revenue on 166.000 bopd to Baghdad because Shahristani wants 207.500 and show the oil company out the door.

I can understand Baghdad wants control with money flows but as per constitution they don`t have it (not that anyone in power could care less). But this is tragic. In real politics such a revenue loss spells political "disaster" even without financial collaps.

When is Shahristani facing his constituents?

I owe it to admit I have stock in an oil company working in a KRG controlled area.

gorwell