Looking Beyond the Gulf and Russia: Kurdish Energy on Europe's Doorsteps

03/04/2012 15:30 BST | Updated 02/06/2012 10:12 BST

Article first appeared in the EUCERS Newsletter, No. 12

By Shwan Zulal

While crude oil is hovering above $100 per barrel, the rhetoric against Iran is ratcheting up, followed by the US and EU sanctions against the regime. With Iranian exports are being halted, global oil spare capacity is being squeezed. The Iraqi oil supply is on the increase and Libya is returning to near pre-war production levels. For the time being, the gap left by the Iranian sanctions has been filled by swing suppliers like Saudi Arabia but any interruption or further unrest in the Arab world, or elsewhere, will send oil prices at even higher level, with foreseen consequences for the world economy.

There are many on-going deep-water drilling projects and shale oil is becoming economically viable to extract. Nevertheless, the lack of Iranian oil will affect the market. Although Iran is finding other buyers and even giving favourable terms and discounts to buyers like Pakistan, EU and US reliance on the Gulf region for oil is also increasing, making the Saudis even more influential in the market.

The Kurdistan Region of Iraq has been described as the last onshore oil and gas frontier in the world; and it is on Europe's doorsteps. While Iraq has the potential to be one of the largest oil producers, or only second to Saudi Arabia in the future, the country and its oil policy is still in turmoil as the ethno-sectarian divide and its consequences hold back the promised rapid development of its energy sector.

Kurdistan has been autonomous and has its own government and parliament separate from Iraq but it is still within Federal Iraq. It receives 17% of the Iraqi annual budget and since 2003, Kurdish authorities have started to grant Production Sharing Contracts (PSCs) for exploration and production. To date, 47 PSCs have been signed with mainly European companies, such as OMV, MOL, Repsol and Genel, resulting in an extensive exploration programme which has yielded large hydrocarbon discoveries, like the Shekhan oilfield by the petroleum giant Gulf Keystone and Heritage's massive Miran gas find.

Kurdish PSCs have attracted a variety of companies. These contracts usually stipulate a five-year-exploration phase and an up to 20 year production period in which the company receives a share of the revenue after recovering the costs. Furthermore, the production cost is minimal apart from some initial infrastructure challenges, but the companies involved can capitalise on high oil prices.

In contrast to the service contracts awarded by the Iraqi Government for the existing oil and gas fields, the Kurdish PSCs offer much more generous terms. While Baghdad contracts on average pay the oil companies around $2 USD a barrel as a royalty, whatever the oil prices are, the Kurdish PSCs allow the IOCs a much higher profit, in return for taking a higher risk.

As Iraq is embroiled in political disagreements and deadlock, the Kurdistan region passed its own oil and gas legislation in 2007 and has since then managed to attract many big names like BP's former Chief Executive Tony Hayward and his investment vehicle, Vallares, which merged with Turkish Genel energy and is now listed in the UK's FTSE100, as well as more recent entrants, like the US supermajor, ExxonMobil.

ExxonMobil's entry has created an intense political atmosphere, with the Iraqi government feeling that it has been undermined. In the past, the central Iraqi government has threatened to blacklist the companies agreeing PSCs with Kurdistan area; therefore, it now assumed that the US oil giant is taking sides and has thus stepped over the Iraqi oil ministry's toes. Meanwhile, the Kurds feel triumphant and many believe that the acquisition of six exploration blocks by ExxonMobil can be a catalyst for more deals and will open up the market for consolidation, putting Kurdistan on the world oil map.

The Kurdish government is eager to develop the infrastructure and its ultimate goal is to become an independent state, although not stating the fact in public. While this will be difficult to achieve at this moment in time as the regional geopolitics and the economics of independence is not aligned. Nevertheless, it is a matter of when rather than if Kurdistan would be an independent oil and gas producer.

Therefore, the EU energy policy makers must surely have a plan as to how to approach this friendly but fledgling democracy which is known to be the most friendly nation towards the west in the whole of middle east region.

Kurdish institutions and infrastructure is still in its early stages of development therefore the EU must not miss this opportunity to adopt the region. Not only to make sure a democratic entity flourishes at Europe's south easterly borders but to participate in developing its oil and gas industry and make it a important strategic energy partner.

According to the US Geological Survey, Kurdistan has an estimated 45bn barrels of conventional oil reserves and around 60 TCF of gas.

The geopolitics of the region and the bitter disagreement over oil policy as well as the power struggle in Iraq over the control of the hydrocarbon sector, has stalled the development pace of the Kurdish oil and gas.

The Kurds are in control of their natural resources but because of Baghdad's opposition to this, many infrastructure and pipeline project have stayed in the sidelines and waiting for the dispute to be resolved. Ashti Hawrami, Kurdistan Natural resources minister, was quoted on the 7th march in Huston CER Week 2012 conference saying that Kurdistan can produce 1m bpd by 2014 and can build a pipeline to facilitate that within 18 month.

Moreover, the EU has a memorandum of understanding with the Iraqi central government committing to only buy hydrocarbon from the Baghdad and not enter any deal with the Kurdish autonomous region of Iraq.

The lack of political consensus over oil policy in Iraq and the Kurdish government not having the legitimacy of a state, therefore, consortiums or countries would find it hard to make any deals with a none state entity like Kurdistan region.

Kurdistan has the energy resources which is easily accessible less than 400 miles to the Mediterranean shores. The region may not been seen as reliable as a Norway for energy supplies but it has the potential to become a reliable EU partner, given the right policies perused. The current Kurdish government has shown eagerness to form such relationship, but so far, the EU has not engaged it directly.

While the plans for the much hyped up NABUCCO project-the trans Caspian gas pipeline connecting Asia to Europe through Turkey- is in turmoil and hope is fading, mainly dues to the politics of the project and partly to the issue of the supply. Kurdistan has shown the wiliness to commit to the project but because of indecision and lack of clear vision by the consortium controlling the project, the plans are on halt.

The Turkish minister for energy recently discussed the possibility of integrating the rival TANAP-alternative Trans Caspian gas project- project with NABUCCO, at the same time the Iraqi ministry of oil has made comments regarding the possibility of supplying NABUCCO.

Details will still needs to be worked out and, the statement from Iraq and the possibility of a merger of the two projects may yet be a lifeline for NABUCCO which many experts and analyst have written it off and see little a chance of becoming a reality.

If the EU policy makers are serious about diversifying supply and breaking the Russian gas monopoly, other unorthodox and new emerging players like Kurdistan region is key to be included in the new energy strategy. The Kurdish region is fast becoming a big player in the energy world and the sooner the EU includes itself in the bonanza the more influence they will exert.

Turkey is a key player and it has foreseen the potential of the region much earlier than Europe and become an important partner to Kurdistan. With its Kurdish population, Turkey is still overcoming its reluctance to accept a more confidant and possibly independent Kurdistan. However, the modern Turkish state realises the importance of the region and see the economic benefits.

However, lack of action by the EU and doing more waiting for events to unfold only further weaken the EU's influence in the region. UK listed companies are taking a lead and Genel is one of the biggest operator while the US supergiant is set to acquire more interest.

Total CEO, Christophe de Margerie, has been quoted saying that the Kurdish deal on offer is much better than those from Baghdad and his company has been tipped to make its first move out of the European major energy players into Kurdistan and their presence on the ground this could lay the foundation for grater EU-Kurdish energy cooperation.

To make sure the EU energy policy of diversification is a successful one, policy makers should not overlook new potential resources and in this case, at its doorsteps. There are challenges and uncertainties, but active engagement with Kurdistan at early stage of its development, would insure a greater European influence and participation in the making of potentially a new major energy producer.