Kurdistan Region of Iraq – Land of Opportunity

With over 50B barrels of oil and gas (according to the U.S. Geological Society), under explored acreage and a success rate of over 70%, it is no wonder that the Kurdistan Region of Iraq is attracting oil and gas investor interest.  Indeed the region has less than 2% of all wells drilled in the North Sea.

Add in attractive production sharing contracts and a reasonably low cost environment and the investment case seems compelling.  Companies such as Afren, Maersk, Repsol, ExxonMobil, Marathon, Petroceltic and Chevron have joined long timers in the region such as DNO, Genel Energy, Gulf Keystone and Western Zagros, and the case for further regional consolidation seems strong.

Detractors often site the political risk in Iraq which is driven in part by the fact that the draft Petroleum Law has yet to be ratified by parliament.  These people are concerned that the production sharing contracts signed by the Kurdistan Regional Government (KRG) may be invalid.  In the meantime it is said that investors are yet to receive full payment for exports.

The legal and political risk associated with oil and gas investments in the Kurdistan Region of Iraq is little understood by those working outside the region.  This article attempts to shed some light on the legal risk and is based on a legal opinion given by James Crawford, Professor of International Law at the University of Cambridge*.

Under the Iraq constitution of 2005 the federal government has exclusive responsibility in a number of areas, including foreign policy and defence.  In other areas responsibility falls to the regions.

Also, the constitution suggests that the federal government does not have exclusive power over matters to do with oil and gas.  It recognises that oil and gas resources belong to all the people of Iraq but that management of the resource is shared with the regions.  It also requires federal government and the regions to agree strategic policies to develop oil and gas to the highest benefit of the Iraqi people.  If there is a conflict between regional and federal laws under the constitution then the regional law prevails.

The 2005 constitution identifies the concept of “present fields”, i.e. those already in production at the time the constitution was agreed.  Oil and gas already extracted from these fields should be jointly managed by the federal government and regional governments, with fair distribution of revenues to be regulated by law.

However, for non-producing and future fields the federal government has no right to play a part in management and there is no requirement for a federally regulated distribution of revenues.  However, regional management still has to respect firstly the strategic policies made by the federal government jointly with the KRG and, secondly, that oil and gas is owned by all the people of Iraq.  In 2005 all fields in the Kurdistan region fell into this category.

Under the 2005 constitution a revenue sharing law does not need to be in place before oil and gas management activities begin, whether oil and gas is extracted from “present fields” or otherwise.  The federal government has a right to initiate a revenue sharing law, provided it works with the regions.  However, federal government must propose arrangements for the management of oil and gas extracted from “present fields”, but this has not been done.

If it had any, KRG could not unilaterally manage any “present fields” in the absence of  revenue sharing arrangements.  However, KRG is entitled to manage future fields, in the continued absence of agreed strategic policies.

To provide clarity the federal government has been working with the regions to formulate policy and to develop a hydrocarbon law for the whole of Iraq.  This law has been some time in the making with a draft law proposed in February 2007 which has still to be passed by parliament.  Legal opinion* suggests that the new hydrocarbon law seeks to maximise federal control over oil and gas activity and does not comply with the 2005 constitution.

In the meantime the KRG passed its own law in 2007 in order to expedite the development of the oil and gas industry there.  It is this law that governs the production sharing contracts (PSC) that are in place in the region.  Again, legal opinion* confirms the constitutional authority of KRG to manage the oil and gas resources of the Kurdistan region under its 2007 law, which is in full conformity with the constitution of Iraq.  Therefore KRG has the unqualified authority to agree and implement new contracts, pending agreement with the federal government on strategic policies.  Existing contracts made since 1992 are valid so long as they are consistent with the 2005 constitution.

Given the uncertainty over the proposed Iraq hydrocarbon law and its constitutional underpinning, KRG put in place a temporary arrangement with the federal government whereby all oil export revenues are remitted to the federal government and these are then redistributed to the various regions of Iraq.

However, this informal arrangement has broken down with KRG claiming it is owed $1.5B by the central government which it needs, amongst other things, to recompense foreign investors under their PSCs.  In April 2012 KRG stopped all oil exports, reducing production to around 65,000 barrels per day, all of which is consumed in refineries in the region.

Investors in the Kurdistan Region of Iraq may consider that this legal opinion substantially reduces their legal risk – the politics of the situation, however, is another matter.

*Professor of International Law James Crawford of Cambridge University legal opinion provided in a paper “The Authority of the Kurdistan Regional Government over Oil and Gas under the Constitution of Iraq”, 28 January 2008.

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