Two interesting articles on Kurdistan.  The first, via Geopolitical Monitor, is a detailed examination of Iraqi Kurdistan’s rise as an independent energy player .  The second, courtesy of Daily Beast, looks at threat that Kurdistan’s weakening economy may have upon the region:

Iraqi Kurdistan and the governing Kurdistan Regional Government (KRG) is in the midst of a major shift toward autonomy in the northeastern enclave of Iraq. Since the 1970s, the Iraqi Kurds have been struggling for autonomy having faced many internal and external hurdles.

Recently, the main external issue with Iraqi Kurdistan’s autonomy has been its ability to independently export and collect crude oil revenues – the backbone of its economy. A majority of Iraqi Kurdistan oil is exported to Turkey through the Turkey Ceyhan pipeline connecting Iraqi Kurdistan’s northern border and Ceyhan, Turkey, leading to the Mediterranean Sea. The pipeline has total capacity of 1.5 million barrels per day (MMbbls/d) with twining 46 and 40 inch pipelines. The 40 inch pipeline is the only pipeline in operation with 0.5 million barrels per day of usable capacity.

 

The Turkey Ceyhan pipeline is the only source of export for Iraqi Kurdish oil and has seen dramatic fluctuations. In February 2016, the Ceyhan pipeline was the target of a bombing by the suspected Kurdistan Workers’ Party (PKK) in Turkey. The pipeline was temporarily shut down for repairs and cost the KRG $250 million in lost revenues over February/March 2016. The pipeline was repaired, and Turkey provided the KRG with $200 million to deal with the lack of revenue for the 3-week closure of the Ceyhan pipeline.

The KRG’s dwindling revenue due to low oil prices has become an issue that continues to affect the Iraqi Kurdish economy, but the KRG continues to transition its crude oil exports through its owned and operated infrastructure. With its transition to independently exporting and collecting crude oil revenues as of May 2015 – Iraqi Kurdistan has essentially become economically independent.

Direct oil exports and revenue collection has become an important step for the KRG as it continues to take steps to further legitimize its independence from the central government of Iraq. Instead of facing resistance to its independent oil sales to Turkey, Iraq has resorted to a desperate plea to the autonomous Kurdish region. In February 2016, Iraq’s Prime Minister, Haider al-Abadi, offered to pay the salaries of all Iraqi Kurdish employees if the KRG stops independent oil exports to Turkey.

Investment in an Autonomous Iraqi Kurdistan

Even as the KRG struggles with making payments to its employees, partners, and continues to accumulate mounting deficits, investment continues in the Iraqi Kurdish oil industry. In March 2016, Glencore (GLEN.L) paid the KRG a $300 million advancement to market its crude oil and compete with transportation trading houses like Vitol (VITOL.UL) and Petraco.

Interestingly, the most important potential contributor to the future of the KRG’s independence from the Iraqi government is Iran. In the summer of 2015, Iran had made several visits to Iraqi Kurdistan for security and economic reasons. On 28 July 2015, Iran’s Supreme National Security Council (SNSC) Assistant Secretary General visited Iraqi Kurdistan to show support for the current President Masoud Barzani. On 26 August 2015, Iran Foreign Minister Mohammad Javad Zarif met with the KRG to strengthen ties between the two regions.

Iraqi Kurdistan is hoping for a flood of foreign direct investment into the region by Iran as sanctions related to Iran’s nuclear program are lifted. Iran is already Kurdistan’s second-largest trading partner behind Turkey, with close to $4 billion in annual trade, and Iran is looking to develop Iraqi Kurdistan’s infrastructure, particularly, its oil & gas infrastructure. In March 2016 it was announced that Iran was in talks to bring Iraqi Kurdistan’s oil to the Persian Gulf through Iran. Talks resumed after the Nowruz holidays on 5 April 2016, and the KRG and Iran have reached an agreement which is a month away from being finalized in Erbil, Iraq. Additionally, Iran has proposed that the KRG could send crude oil to the Persian Gulf in exchange for finished fuel products and natural gas to protect Iraqi Kurdistan from energy shortages. Making a deal with the Iranians would diversify Iraqi Kurdistan’s oil routes and result in less volatile revenues and less dependence on Turkey.

Almost a third of Iraqi Kurdistan’s oil production capacity comes from its eastern fields Taq Taq, Swara Tika, and Chiya Khere which are located close to the Iranian border and are operated by Genel Energy (GENL.L), HKN Energy, and TAQA respectively.

As Iran sees sanctions lifted and Iraqi Kurdistan sees more investment by foreign countries looking to secure energy supplies – the KRG is moving closer to legitimizing their autonomy in Iraq. Companies that operate Iraqi Kurdistan’s oil fields benefit the most from outside countries providing much needed infrastructure to the regions petroleum sector. Companies have built up production capacity that has yet to be realized due to lagging infrastructure necessary to bring production to market.

 

The Iran and Iraqi Kurdistan Historical Connection

Iran and Iraqi Kurdistan have a long history dating back to Iran’s support of Iraqi Kurds in the early 1970s against the Iraqi government. In 1975, in accordance to the Algiers Pact, Iran withdrew its military support for Iraqi Kurdistan and the Kurds laid victim to expulsion and forced “Arabization” in their oil-rich region. Then, throughout the 1980s Iran-Iraq War, the Kurdish Peshmerga managed to use Iraq’s weakening and preoccupied military to regain small sections of its territory with the help of Iranian intelligence and weapons support.

After gaining virtual autonomy in 1991, Iraqi Kurdistan was split between the northern region’s Kurdistan Democratic Party (KDP) and the southern Patriotic Union of Kurdistan (PUK) that began an Iraqi Kurdish civil war in 1996. The PUK, headed by Jalal Talabani, was supported by Iran and forced Masoud Barzani’s KDP to ally themselves with Iraq. This created uneasiness in the region with the return of Iraq’s occupation of Iraqi Kurdistan. When the Iraqi military executed 700 PUK Peshmerga, the U.S., allied with Iraqi Kurdistan, had to take action in intimidating Saddam Hussein to withdraw troops from the region.

Then, in 1997, the Kurdistan Workers’ Party (PKK) based in Turkey joined the fight with the PUK against the KDP in Iraqi Kurdistan. Turkey found an opportunity to suppress the PKK movement – considered a terrorist group by Turkey – by allying with the KDP. In late 1997 the KDP and PUK agreed on a ceasefire agreement and subsequent peace treaty supported by the U.S. through the 1998 Washington Agreement. Iraqi Kurdistan was formally unified under the KRG and it would benefit from US military protection. The KRG would later benefit from its US allies during the 2003 Iraqi invasion and Masoud Barzani would become President of Iraqi Kurdistan in 2005.

Ten years later (2014/2015), the Iraqi Kurds are facing a different threat in Daesh (ISIS). Daesh’s genocide of various Muslims and ethnic minorities throughout Iraq and Syria put Iraqi Kurdistan in a vulnerable situation. Acknowledging the weakness of the Iraqi army – Iran provided weapons support to the Kurdish Peshmerga to fend of Daesh. Iraqi Kurds have managed to keep Daesh’s offensive at bay with Iranian, Iraqi, and US military support.

Iraqi Kurdistan and Iran Going Forward

This has brought about a key understanding between Iraqi Kurdistan and Iran. The KRG acknowledged that the help of Iran was a major factor in protecting its people, economy, and autonomy. Additionally, Iran sees the KRG as a strategic ally to mutually benefit from military and economic cooperation and would portray Iran as a diplomatic leader in its respective region post-sanctions.

Iran’s proposed pipeline bringing Iraqi Kurdistan oil to the Persian Gulf is a major step in acknowledging the unofficial autonomy of Iraqi Kurdistan from an Iranian-allied Iraqi central government. Although Iran would like to see a unified Iraq – Iran understands that proposed investment and cooperation in northern Iraq would need to be passed through the KRG directly. The KRG understands that this pipeline and many other proposed infrastructure projects by Iran will contribute to its economic and political autonomy. Iran will help the KRG diversify and provide options for the core supporting factor of its autonomy: Iraqi Kurdistan’s oil & gas sector.

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Iraqi Kurdistan’s fight against ISIS has for many Kurds been an existential battle central to their survival and that of their autonomous region in Iraq. However, with ISIS prevented from embarking upon Kurdistan’s major towns and cities, thanks to the efforts of the Kurdish Peshmerga forces and the U.S.-led military coalition against the jihadists, the Kurds face what their Deputy Prime Minister, Qubad Talabani, describes as the “real existential threat”—the region’s economic crisis. If this situation does not improve soon, ISIS will be the least of its problems. Indeed, it is often overlooked that, as a result of the crisis, Iraqi Kurds are now found among the deluge of refugees and economic migrants from the Middle-East into Europe.

Sitting in an office in Sulaymaniah, and armed with a pen and whiteboard, Talabani, who is overseeing major economic reforms, explained to us how the Kurdistan Regional Government (KRG) faces an economic challenge of staggering proportions. Beginning in 2014, he describes how “we were hit with an economic tsunami which came in four waves.” The first of these came in February 2014, when the Iraqi government in Baghdad, which has been in dispute with the Kurds over a number of issues, unilaterally cut the KRG’s share of the federal budget.

This was followed by the emergence of ISIS and its foray into Iraq in June 2014, which led to increased security and military spending and was followed by a massive influx of two million refugees and internally displaced persons into Kurdistan.The final hit was the global drop in oil prices that began in mid-2014, which the KRG failed to plan for during its boom years of 2006-2014 when the price of oil hovered at around $100 a barrel.

Before recent reforms began to take hold the KRG was grappling with a monthly deficit of around $406 million per month. Government employees have suffered pay cuts and civilian staff are only paid every five months, while those working in the security services receive theirs every four. A senior Kurdish intelligence official involved with all aspects of the war on ISIS, from recruiting informants to covert special operations, told us that the crisis threatens to “stall the successful momentum against ISIS” that the Kurds and the international community have recently enjoyed.

The crisis, as most politicians in the region would admit, could have been less severe. Kurdistan’s two ruling parties, the Kurdistan Democratic Party (KDP) and the Patriotic Union of Kurdistan (PUK), sustained a system of patronage that, among other things, involved providing superfluous jobs in exchange for political support. This form of artificial job creation—a small village school or hospital, for example, may have up to 40 government paid guards — has had a devastating impact on the economy.

The KRG also appears to be paying so-called “ghost-employees,” whereby certain arms of the state claim more staff than they have so as to inflate their budgets. Of a population of 5.2 million, 1.4 million are on the government payroll, a clearly unsustainable wage bill. Last year, this amounted to $795 million per month. In addition, the KRG has for too long provided its oil industry with massive fuel subsidies and has relied on expensive diesel for power generation.

What will it take, then, to recover the situation? As a sub-state entity, the KRG does not have the advantages that states have when trying to rescue their economies. It has no track record in debt and is therefore not able to borrow its way out of this crisis. Furthermore, no international fund can come to its aid and provide the sort of bailout packages that have saved countries like Greece. Instead, the KRG has had to rely solely on fiscal management and reform.

Only a tiny proportion of the population pay taxes in the KRG, so among the first steps to offset the loss of oil revenue was to begin a push to collect, rather than raise, taxes. Additionally, all civilian government pay scales have been hit, with junior staff facing pay reductions of 15%, going up to 75% for senior positions. Beyond the pay cuts and freezes, fuel subsidies have also been reduced and power production is gradually being shifted from diesel to natural gas, with parts of the power grid also beginning to be farmed out to independent companies. The measures have yielded some positive results. By January of this year, the wage bill was reduced by 39% to around $480 million a month. The monthly deficit, according to Talabani, has also already been reduced to around $108.4 million.

It is hard to imagine many other populations in the world that would put up with months without pay, and some analysts point out that if this were to happen in Baghdad, the government there would have faced overwhelming social unrest and may have even collapsed. Baghdad, in comparison, is currently on edge as demonstrators have mobilized against the state to protest the lack of services and jobs. This mobilization has taken place at the behest of radical cleric Muqtada al-Sadr, who has threatened armed confrontation against the Iraqi government unless things improve.

Kurdistan, however, has proven to be far more resilient. The experience of generations of repression and struggle and a strong collective memory and history are certainly reasons for the maintenance of relative social stability in the region so far. The undoubted effectiveness of the reforms has also led to a feeling of cautious optimism that has begun to allay fears and reduce tensions.

The KRG still has a long way to go before it recovers, and the crisis has been a wake-up call that is spurring structural reforms which have been a long-time coming, even if these will take a while to fully take hold. In the meantime, there is plenty the West can do and Kurdistan is too important to fail. It shares a roughly 1,000-kilometer border with ISIS and is fighting an enemy that otherwise would likely be turning even more of its attention and resources to international terrorism.

In other words, the KRG’s war on ISIS is also the international community’s war and the state of its economy will have a direct impact on the national interests of Western nations. That means that it must consider providing the KRG with more of the financial support it desperately needs to stabilize its economy so that it can fund this fight and prosper. This does not have to come at the expense of reform. As the US and the European Union have done before, funds can be provided on a conditional basis. That will further incentivize reform, generate economic growth and ultimately position Kurdistan so it can sustain itself in the longer-run.