Explaining The Kurdistan Oil Outage

The oil markets have interpreted the most recent development in the battle between Baghdad and Erbil rather dramatically. Just when it appeared that the new Iraqi government was easing up on the Kurds over their unilateral oil exports, an international arbitration ruling disrupted developments, leading to the shutdown of the pipeline that transports Iraqi Kurdish oil to Turkey.

The oil market response to this loss of 450,000 bpd–from a purely barrels perspective–appears to have been overblown. Normally, 400,000 bpd–only a fraction of Iraq’s total production–would not move markets to this extent. However, coming off a mad sell-off amid a banking crisis that many feared could dent demand if the contagion spread, the loss of 450,000 bpd was a promising balancer of prices. The thinking was the 450,000 bpd loss would compound Russia’s plans to cut output by 500,000 bpd, possibly through June. However, there is still no data showing this output cut has happened, and it has since been reduced, with Moscow stating that it would be taken from higher February production numbers, rather than January’s–as initially stated.

The loss of this production from Iraqi Kurdistan should not be roiling markets to this extent. The exports in question represent half a percent of global supply. True, there is some concern about the medium-term impact on oil companies operating in the KRG–two of whom have already started cutting production because there simply isn’t enough storage capacity in the region to keep producing and wait for a resolution from Baghdad and Erbil (and Turkey, as well). But neither the KRG nor Iraq proper wants to sustain this shutdown. The KRG will be desperate to be able to pay its salaries.

Exports have now been halted since Saturday, March 25. On Sunday, a KRG delegation arrived in Baghdad to discuss the way forward after the International Chamber of Commerce in Paris ruled last Thursday in favor of Baghdad against Turkey, where KRG crude oil exports were transported through the Ceyhan port. Turkey was found to have breached a contract by directly trading Kurdish oil that bypassed the Iraqi central government. But talks so far between the parties have faltered.

According to some sources in the Middle East, Iraq had sued Turkey for breach of contract in five categories, yet the international ruling only favored Iraq in one category–transportation. Baghdad has been trying to get up to $58 billion from Turkey for breach of contract. The court has only awarded it $1.4 billion, of which Ankara will likely only pay a small part in the end–or perhaps nothing at all. But it’s less about the money than it is about the end game.

All parties lose in this pipeline shutdown, though Iraq also gains major leverage over the KRG to end the battle for control of the region’s oil. Initial sentiment has been that a quick resolution is likely; however, there have been indications that Baghdad is planning to play hardball and hold out for SOMO (the Iraqi national oil marketer) to take over the KRG’s oil marketing before exports are resumed. It could take a week to be resolved, or it could drag on longer if Baghdad thinks the odds are in its favor.