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Jul 21, 2014 | 10:09 GMT

7 mins read

Iraqi Kurdistan's Financial Trap

Iraqi Kurdistan's Financial Trap
(SAFIN HAMED/AFP/Getty Images)

The Kurdistan Regional Government's recent stream of announcements make it appear that Iraqi Kurdistan, now endowed with the prize of Kirkuk oil, is on the verge of political and economic independence. But behind the Kurdish hubris is a government in an increasingly desperate financial situation, with only its old adversary Turkey to rely on for its survival. This situation will create deeper divisions among Iraq's Kurdish factions, providing neighboring Iran with an opportunity to counter Turkey's moves in Iraqi Kurdistan.

Now that the Kurds have established control over the Kirkuk oil fields, the Kurdistan Regional Government is working rapidly to connect the fields to its own energy infrastructure. Multiple sources have confirmed that the Avana Dome has been connected to the Kurdish-controlled Khurmala Dome. The next step will be to connect the Baba Dome and nearby Bai Hassan field to the Avana Dome, which altogether would add (in theory) some 415,000 barrels to Kurdish production capacity, though these fields currently produce around 160,000 barrels per day of sour light crude. Kirkuk crude can be blended with light Taq Taq crude to channel more oil for export, but that would irritate potential buyers, who are looking for consistency in output and would be reluctant to buy crude from a disputed territory. More likely, Kirkuk crude will be diverted to local refineries for domestic Kurdish consumption.

Peshmerga and Islamic State Areas

Still, the Kurdish acquisition of Kirkuk does little at the moment to alleviate the Kurdistan Regional Government's deepening financial crisis. For the past six months, it has gone without a roughly $1.2 billion monthly budget allocation from Baghdad, since the Iraqi government sought to punish Kurdish attempts to attain energy and political independence. That is about the same amount the Kurdistan Regional Government spends monthly for public sector employee salaries, operational expenses and investment projects. Critically, 60 percent of the Kurdistan Regional Government's monthly expenditures go toward the salaries of a bloated 700,000-strong bureaucracy, including 200,000 peshmerga soldiers.

The government has had to delay paying some public sector employees, especially teachers. With security threats rising, paying peshmerga forces seems to be a priority, even if those salaries are not paid in time. After its financial obligations to its employees, the Kurdistan Regional Government also has to answer to more than 50 international oil companies and contractors operating in Iraqi Kurdistan that also face repeated delays in payments. The government tried to extract fees from these firms to alleviate its current financial problems, demanding immediate payments for the services of its oil protection units. But the patience of international oil companies wears thin with such demands the longer they go without pay. The Kurdistan Regional Government's total debts to international oil companies and contractors are estimated to be roughly $5 billion and counting.

Without reserves to draw from, the Kurdistan Regional Government in Arbil has had to borrow from a limited menu of lenders. Several of Iraqi Kurdistan's business tycoons, including the heads of KAR Group and Asiacell, have been called on to issue loans and maintain liquidity in public banks. Most foreign banks are reluctant to lend to the Kurdistan Regional Government, but Arbil appears to have secured around $1 billion total in regional loans from Turkey's Asya Bank and VakifBank, in addition to funds from Lebanese banks IBL, Byblos and BBAC. After securing a $2 billion to $3 billion loan from Turkey in March, the Kurdistan Regional Government has requested additional loans from Ankara, but the terms and exact amount remain unclear.

Overcoming Obstacles

With a growing deficit of more than $6 billion and no resolution with Baghdad in sight, the Kurdistan Regional Government is desperate to generate enough revenue on its own from oil sales to cover basic expenses. But that is easier said than done. The Kurdish government has already been trying to convince the market that any oil exported out of Iraqi Kurdistan constitutes a legal sale, even as Baghdad has threatened to fine and sue any company that bypasses the central government in such commercial transactions. The legality of Kurdish crude exports has only been compounded by the Kurds' seizure of fields in disputed territory.

Arbil has assumed that all it has to do is establish precedence in selling its oil to drown out Baghdad's threat. Unfortunately, only one of four tankers — carrying roughly 100,000 barrels of Kurdish crude — has been sold so far to a buyer out of Israel, while traders such as Glencore, Vitol and Trafigura have kept their distance. Turkey meanwhile announced July 18 that it is halting the flow of Kurdish oil through its pipeline to the port of Ceyhan because its storage tanks are already full with unsold Kurdish crude.

Iraq's Northern Energy Export Rules

Kurdish officials have lobbied firms throughout Europe in the hope of selling the remaining oil, but the Kurdistan Regional Government would then face the challenge of securing the funds from those sales. Fearing that firms would buy the oil but deposit the funds with Baghdad to avoid a legal morass, the Kurdistan Regional Government has put out messages threatening legal action against its own potential buyers since Baghdad will withhold those funds and deny the Kurdistan Regional Government its revenue. The key to Arbil's funds lies in Turkey's hands. Some $93 million from the first Kurdistan Regional Government crude sale by tanker is sitting in a Turkish Halkbank account. Arbil recently sent a delegation to try to secure those funds, but Ankara can be expected to proceed cautiously in releasing these funds as it tries to avoid incurring further wrath from Baghdad and Washington.

Turkey understands the enormous financial leverage it holds over the Kurdistan Regional Government as Arbil struggles to make its monthly payments. Turkey will selectively — and stringently — provide enough aid to allow Arbil to scrape by but will also demand that Kurdistan Regional Government President Massoud Barzani and his Kurdistan Democratic Party lay off their calls for independence. A nearly bankrupt Kurdistan Regional Government will have no choice but to heed these demands, but it is also not comfortable with its deep dependence on Turkey.

This sentiment appears to be growing within Jalal Talabani's Patriotic Union of Kurdistan. Factions of the party have already vocalized their unease with the policies of Barzani's party that have led Iraqi Kurdistan into a tight dependence with Turkey and an increasingly hostile relationship with Baghdad, Washington and Tehran. This intra-Kurdish tension grew deeper following the Kurdish Democratic Party's ousting of National Oil Co. officials from the Kirkuk fields. The Kurdish Democratic Party made it a point to use its own peshmerga forces and oil protection units to take control of Kirkuk's oil fields, largely edging the Patriotic Union of Kurdistan out. Also, local Arab and Turkomen resistance to Kurdish control over Kirkuk province is rising and will further complicate the regional government's hold over Kirkuk in the long term.

Informal networks and Turkish aid will enable the Kurdistan Regional Government to avoid financial collapse, but growing economic tensions will only exacerbate frictions among Iraq's Kurdish factions as the Patriotic Union of Kurdistan sees its own interests compromised by Kurdistan Democratic Party policy. The longer Arbil holds out on a deal with Baghdad, the more financially dependent the Kurdistan Regional Government will be on Turkey and the more difficulty Kurdish parties will have in maintaining their patronage networks while under financial duress.

This provides Iran with an opportunity to further its already strong ties with the Patriotic Union of Kurdistan and Gorran to counterbalance Turkey's sponsorship of Barzani's Kurdistan Democratic Party. Iran has already threatened to close its border with Iraqi Kurdistan to trade should Barzani proceed with his calls for independence, a move that would have significant economic repercussions for the regional government as a whole, but the Patriotic Union of Kurdistan in particular. Through a carrot-and-stick approach, Iran will try to sow divisions among Kurdish parties, potentially offering financial and military assistance to the Patriotic Union of Kurdistan while using its influence among the Iraqi Shia to grant political concessions and positions to cooperative Kurds in forming a new government. This may well be the subject of conversation when a Patriotic Union of Kurdistan delegation visits Iran in the coming days.

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