What could Kurdistan independence mean for FDI?

The Kurdistan Regional Government (KRG) is facing mounting pressure from Baghdad and neighbouring governments after it carried out a referendum that widely confirmed the independence ambitions of northern Iraq’s Kurds.

The Iraqi federal government reacted by declaring an air embargo over the region. Turkey and Iran are also raising the stakes, threatening retaliation should Erbil – the capital of the Kurdistan region – not rein in the current independence push. They consider such claims a destabilising force for the whole region, given their own large Kurdish communities. At the same time, the international community is refraining from endorsing the referendum’s outcome.

Oil resources a factor

With all parties involved preparing for a new, challenging round of negotiations, the future of multibillion-dollar investment commitments in the development of the region’s abundant oil resources is a factor. The contracts the KRG autonomously signed with international oil companies made its quest for independence more legitimate over the years. But they also widened the fracture between Erbil and Baghdad. Any future negotiations will have to overcome divisions over ownership and revenue-sharing mechanisms for oil resources in Iraqi Kurdistan and contested areas such as Kirkuk. Their outcome will eventually determine the continuity of ongoing investment in the region.

Existing as a largely autonomous region within Iraq since the first military campaign by the US against Saddam Hussein, Iraqi Kurdistan endorsed Iraq’s 2005 constitution, which formalised the area as an autonomous region within federal Iraq and thus recognised the authority of the KRG and the Kurdish parliament. 

But Iraq’s continual sectarian violence, combined with the Islamic State crisis (which at its height even threatened Erbil), as well as repeated failures to agree on the distribution of oil revenues and the future of disputed areas such as Kirkuk, weakened the hand of the federal government in Baghdad and added fuel to the fire of Kurdish independence.

The KRG eventually built the case for a non-binding independence referendum on Iraq’s “extensive violations” of the 2005 constitution. Despite repeated calls from the UN, but also, among others, the US and the UK, to forgo the vote, the KRG stuck to its initial plan and held the referendum on September 25. As expected, a vast majority (about 93%) of the voters backed independence. 

As Iraqi Kurds cheered in the streets, Iraqi prime minister Haider Al-Abadi’s government announced a ban on domestic and international flights in and out the region until the KRG hands over the control of the airports in Erbil and Sulaymaniyah. Turkish president Recep Erdoğan immediately backed Mr Al-Abadi, calling for the unity of Iraq against the “illegitimate” referendum in a televised press conference on September 29. But the KRG is not budging and is gearing up to sit at the negotiating table with a strong hand, given the overwhelming support for independence obtained in the referendum.

The last oil frontier

“The reactions of the likes of Turkey, Iran and Iraq [is] all about creating a strengthened hand in negotiations. It’s very much about leverage,” says Torbjorn Soltvedt, principal analyst for the Middle East and north Africa region at risk and strategic consulting firm Maplecroft.

“From the Kurdish side, the referendum itself was a way of creating leverage in negotiations in Baghdad. They can still extract a lot of concessions within the current constitutional framework. Even though independence remains their ambition in the long run, in the mid-term they can still try to strike a better revenue-sharing agreement, and make some progress on Kirkuk.”

The KRG’s power has increased since the discovery of abundant oil reserves in the region under its authority. Largely unexplored during the rule of former Iraqi president Saddam Hussein, the region’s oil potential for abundant, shallow oil reserves quickly surfaced in the past decade, even prompting former BP chief Tony Hayward to hail the region as one of the industry’s last great frontiers.

The KRG has estimated oil reserves at some 45 billion barrels, and has long set a production target of 1 million barrels per day (bpd), which would represent a major achievement for a small region of 8.3 million people. However, it has struggled to deliver on these ambitions because major oil companies have proceeded with caution for fear of compromising other much bigger interests in the giant oil fields under Baghdad’s control.

Some smaller players, such as Oslo-based DNO International or Genel Energy (a company Mr Hayward launched in 2011), have taken the gamble, however, and bigger players such as Kremlin-controlled Rosneft are now following suit. Today, the region still exports fewer than 600,000bpd, from barely any a decade ago. However, with oil prices far from their peak, and disagreements continuing between Erbil and Baghdad over a national oil revenue-sharing mechanism, the legitimacy of these deals remains matter of debate. The KRG has also been increasingly struggling to pay its bills and finance a growing fiscal deficit.

“Everyone wants to see a more permanent and stable agreement in place,” says Mr Soltvedt. “At the moment they understand that the current agreement [between Erbil and Baghdad over oil revenue sharing] is vulnerable to either side using it as a bargaining chip whenever there is a crisis.”

Cultural claims

Oil-rich Kirkuk embodies the different aspects of the conflict between Erbil and Baghdad. The city was subject to a deep Arabisation process during the Saddam Hussein years, but Kurds still consider it to be one of their cultural capitals. Peshmerga Kurdish militia took control of the city in 2014, stepping in to fill what they referred to as a “security vacuum”. The KRG is now exporting the production of Kirkuk’s ageing giant oil fields through a pipeline running all the way to the Turkish port of Ceyhan and is in advanced talks with Rosneft to develop these contested fields. But Turkey will also have an influence on any future agreement, as it holds the keys to the Kirkuk-Ceyhan pipeline and is the region’s largest trading partner beyond the oil sector.

Turkey is home of about 15 million Kurds, and the Kurdistan Workers’ Party’s calls for Kurdish independence have always been considered in Ankara as the main threat to internal stability. Turkish president Mr Erdogan is committed to avoiding a dangerous precedent.

On paper, all parties have a major interest in finding common ground and preventing an ethnic and territorial conflict from escalating. But they will have to move fast before matters escalate and possibly run out of control, sending shockwaves through the entire region.