Declining oil Prices Could Strain Baghdad-Erbil Relations Further

31/08/2011 12:51 BST | Updated 09/10/2011 10:12 BST

Oil prices are falling and set to go even lower as the global uncertainty over EU debt crises and US downgrade continues. It is hard to predict oil prices in the coming six month, but it is becoming clear that the global economy is not able to sustain $100 USD plus price for very long.

It is somewhat good news for the developed and developing economies like the US and China and BRIC countries as it will contribute to their efforts in taming inflation. Nevertheless, it will have a negative impact on the oil producing nations like Iraq.

After decades of war, Iraq and Kurdistan Region are recovering and the production of oil has finally been boosted and large part of 2011 budget, in tune of $25 Billion has been allocated for much-needed investments in the infrastructure. However, the downward spiral of oil prices are set to wipe out all the extra production capacity -in terms of revenue-the KRG (Kurdistan Regional Government) and Iraq federal government have been working on.

Iraq depends on oil for over 90 per cent of its national income and the federal government budget. Last week oil prices fell by 10 per cent and Monday the prices have fallen over 4 per cent so far. Considering that, Kurdistan Region's share of the federal Iraqi budget is 17 per cent and 90 per cent of that is oil based, it becomes clear that the Iraqi budget will take a big knock. As a consequence; projects and contracts which has been awarded part of the investment programs may be affected.

The implication beyond the budgets shortcomings and cutting back on spending would be that the fragile Iraqi PM, Nuri Al-Maliki's government would come under more pressure from the public and the political blocs while the cuts bite in to the already meagre public services.

As the Iraqi Budget decreases, the issue of the revenue sharing and budget share of Kurdistan Region may come to the forefront of the political agenda once again. Although this issue has been very contentious in the past - in par with the legality of the oil contracts and Article 140- the rising oil prices and an increase in Iraqi production capacity contributing to higher revenue has made the disagreements less of an issue. However, once the budget come under pressure due to lower oil prices, the issue could flare again and add to the already strained relationship between Baghdad and Erbil over the oil contracts and Article 140 of the Iraqi constitution (determining the future of the disputed territories).

This latest declines in oil prices and market turmoil is a reminder for the KRG, and the Iraqi Government, that relaying on oil revenue alone, would make the country very vulnerable to oil price fluctuations.

The last Iraqi Budget approved last February was estimated at $82.6 billion based on average of $76.50 per barrel. It is needless to say that crude prices are still above the estimated price and capacity has increased in the last six month since the budget was passed. However, October oil future contracts are already down to mid $70 range and more declines are possible as the global economic uncertainty continues.