Iraqi Kurds’ Independence Vote Exposed Risks to Energy Strategy

Iraqi Kurdish leaders have long sought to craft an energy policy independent of the federal government in Baghdad, courting international companies and offering lucrative deals to drill for potentially huge new reserves of oil and gas.

Then in September, Kurdish voters overwhelmingly chose to break free of Baghdad. But instead of stepping closer to nationhood, the Kurds were handed a humiliating setback: Iraqi troops seized the disputed city of Kirkuk and the oil fields around it. That loss of territory comes on top of worsening trends in the local oil sector and continued tensions between Kurdistan, a region in northern Iraq, and its neighbors.

Taken in concert, those factors raise questions about the Kurds’ strategy of achieving political independence through energy, which provides nearly of all the regional government’s revenue.

The consequences of battling over northern Iraq’s riches extend beyond the region’s borders. Kurdistan’s oil sales look unlikely to live up to their early promise, and the uncertainty that followed the referendum only heaps risk on energy markets already unsettled by heated rhetoric between the United States and Iran, and the near-collapse of Venezuela.

“It is going to be incredibly difficult for Kurdistan to move forward with its original plans,” said Ayham Kamel, leader of the Middle East unit at Eurasia Group, a political risk firm. “I don’t think they can do what they want to do.”

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Iraq’s oil industry has recovered markedly since Saddam Hussein was ousted in 2003. Including Kurdish output, the country is the second-largest producer in the OPEC cartel with about 4.5 million barrels of crude per day, but decades of underinvestment mean its vast oil reserves could be squeezed for even more.

Marginalized and brutally oppressed under Saddam, Kurdistan has sought a piece of the global oil action. The energy consultants Wood Mackenzie peg total potential oil and gas holdings in the region at about 13 billion barrels, and Kurdish officials have worked to attract investment from international oil companies. They offered advantageous revenue-sharing agreements to foreign firms, a stark contrast to the low-margin fixed-fee deals offered by Baghdad.

To some global companies, the rewards were attractive. Kurdistan offered easily extractable oil in a politically friendly environment, without the huge costs and environmental risks of drilling in the Arctic or mining the tar sands in Canada. Energy giants like Chevron and Exxon Mobil shrugged off the threats of legal action by the Iraqi government and the displeasure of Washington by signing contracts with the Kurdish region at a time when oil prices were significantly higher than they are now.

The energy companies wanted to see whether large troves of oil lurked below the hills of Kurdistan, as exist elsewhere in Iraq and in neighboring Iran.

But the luster of those prospects has since faded. Drilling has not produced the large finds they had hoped for, leading companies to back off. Chevron said recently that it was suspending operations in Kurdistan. Total of France relinquished its exploration blocks last year, taking a $200 million write-down. Analysts say the poor exploration results, combined with world oil prices that have fallen off from their peak above $100 a barrel, raise doubts about the value of continuing to invest in Kurdistan.

“It is not a play that is working for the majors,” said Ian Thom, head of Middle East analysis at Wood Mackenzie. “They have bigger fish to fry.”

Some of the smaller companies that originally opened up Kurdistan to exploratory drilling have also struggled. Genel Energy — the London-listed company co-founded and led until 2015 by the former BP chief executive Tony Hayward — has in the past two years sharply downgraded its estimates of the volumes in Taq Taq field, one of its two Kurdish mainstays. Output from the field has plummeted to about 14,000 barrels a day compared with 128,000 barrels a day in early 2015.

The region now finds itself exporting around 250,000 barrels of oil a day, just a quarter of what it optimistically estimated a few years ago, according to Ruba Husari, managing director of the consulting firm Iraq Insight.

These disappointments were largely masked by the giant oil fields seized in recent years by Kurdish fighters, known as the pesh merga. As Iraq reeled from the Islamic State’s onslaught in 2014, the pesh merga took control of some of the energy producing areas near Kirkuk. Holding those fields allowed Kurdistan to increase exports to about 550,000 barrels a day, with roughly half of it coming from Kirkuk, according to Ms. Husari. Those advances, however, have largely been reversed.

Beyond the short-term issues resulting from the independence vote, longer-term problems persist.

For one, Massoud Barzani, Kurdistan’s longtime regional president, has said he will leave his post. That could create a power vacuum, threatening the region’s domestic stability and complicating talks with the federal government and neighbors like Turkey. The landlocked region remains dependent on good relations with Ankara, and probably still with Baghdad, to move its oil and gas to market.