Political and Legal Risk in Kurdistan: Business As Usual?
Companies investing and operating in developing countries are accustomed to dealing with the risks associated with uncertain and sometimes arbitrary political and legal systems. This is true across all industry sectors, but perhaps none more so than in the international mining and upstream oil and gas sectors. In recent years, increases in commodity prices have led to several high-profile illustrations of these risks as countries such as Russia, Venezuela and the Democratic Republic of Congo have sought to renegotiate or impose terms with or on companies to improve their share of the rents from exploitation of their national resources. Perhaps nowhere are such political and legal risks so evident as in the Kurdistan Region of Iraq. Here, according to the Kurdistan Regional Government (KRG), some 38 companies from 17 countries are parties to Production Sharing Contracts (PSCs) with the KRG, notwithstanding that the federal government of Iraq has been outspoken in branding these PSCs as invalid. Is this just "business as usual" for companies and their investors used to operating in high-risk jurisdictions? Or does Kurdistan represent a qualitatively different gamble?
At the time of writing, Iraq’s main political groups continue to strive towards the formation of a new government following the national elections on March 7th. As they do so, there is little prospect of progress being made in resolving the legal uncertainties relating to Iraq’s hydrocarbon sector. The 2007 package of draft federal laws relating to the institutional and operational framework governing the sector and the sharing of oil and gas sales revenue remains unsettled and in limbo. The well-publicized dispute between the Iraqi federal government and the KRG over the validity of PSCs entered into by the KRG has been ongoing since early 2007, and it shows little outward sign of resolution despite conciliatory statements made in early 2010 by Iraqi Prime Minister Nouri al-Maliki and the KRG’s Minister for Natural Resources, Ashti Hawrami.
The dispute between the KRG and the federal government over the PSCs encapsulates the three principal strands of the debate in Iraq over the future organization of the hydrocarbon sector and the monetization of Iraq’s hydrocarbon resources. First, the dispute over the PSCs is an illustration of the struggle for power between the federal government and Kurdistan, the as-yet only formally recognized region. Second, the dispute highlights the differences between resource nationalists who want to assert and maintain control over Iraq’s resources through a "national" model and those who support "private" participation under an appropriate regulatory framework. The former see PSCs as an arrangement in which control over a sovereign resource is surrendered to contractors. This is compared to the service contracts entered into under the federal bidding rounds, which provide no entitlement to reserves to the contractors. Third, the dispute is, at its heart, a dispute about the allocation of government revenue between the federal government, the regions and governorates. Revenues from oil sales amount to approximately 90 per cent of Iraqi government revenue.
The KRG’s defence of the validity of its PSCs rests on its interpretation of certain relevant provisions under the Iraqi Constitution.1 The key components of the KRG’s interpretation are as follows (references are to Articles of the Constitution):
- Iraq is a federal state (Article 1) and the federal region of Kurdistan is expressly acknowledged in the Constitution (Article, 117, First).
- Federal regions have the power to exercise executive, legislative and judicial powers except if stipulated by the Constitution to be within the exclusive competence of the federal government (Article 121, First and Article 115).
- In the case of powers shared between the regions and federal government, priority shall be given to the laws of the regions (Article 115), and in the case of conflict between regional and national legislation in relation to something outside the exclusive authority of the federal government, regional legislation shall prevail (Articles 115 and 121, Second).
- Jurisdiction over the hydrocarbon sector is not a matter that is within the exclusive competence of the federal government (Article 110). While the Constitution does provide some express reference to federal powers in relation to oil and gas elsewhere (Article 112) this power is substantially circumscribed:
- it relates only to the "management of oil and gas extracted from present fields" and the formulation of strategic policies;
- it’s not a power that can be exercised unilaterally but rather with the governorates and regional governments; and
- its powers of management are subject to the distribution of revenues in a fair manner.
- The reference to "present fields" is narrowly interpreted by the KRG as meaning those fields in production at the date of the Constitution, i.e., none. The KRG argues that the power to formulate strategic policies jointly with the regions does not confer any exclusive legislative competence on the federal government in relation to oil and gas — and that therefore, under the general principles enumerated above, the regional governments have legislative authority in this area.
On this basis, the KRG argues that it had the constitutional power to pass the Oil and Gas Law of the Kurdistan Region in August 2007 and that the PSCs it has entered into with contractors pursuant to that law are valid. In addition, the Constitution expressly grandfathers contracts entered into by the KRG between 1992 and the date of the Constitution (Article 141). This grandfathering provision captures the PSCs entered into in relation to the Taq Taq and Tawke blocks, which contain the only currently producing fields in Kurdistan.
Although the KRG’s reading of the applicable constitutional provisions is persuasive, its arguments are not without flaws, as various commentators and critics have noted.2 Criticisms are broadly focused on the KRG’s narrow reading of the general powers granted exclusively to the federal government in Article 110, the downplaying or ignoring of what is argued to be the primary role granted to the federal government in the management of present oil and gas fields in Article 112, the ambiguity in the meaning of "present fields" and the significance of the declaration in Article 111 that Iraq’s "oil and gas are owned by all the people of Iraq in all the regions and governorates." Within Iraq, these interpretative differences will not be resolved by the niceties of legal argument and, whatever the merits of the respective legal analyses and arguments, the political reality is that there is little prospect that a resolution of the stand-off between the KRG and federal government with regard to jurisdiction over the development of Kurdistan’s oil and gas resources is imminent.
For the three companies with interests in the producing Taq Taq and Tawke fields, the impact of the continuing stand-off between the KRG and federal government is significant. Their failure to reach a compromise on revenue sharing means there is no framework for the companies to be paid the compensation due to them under their PSCs from revenue arising from international oil sales. Since the federal government controls the export pipelines, the majority of production remains effectively shut in. In comparison, for the majority of companies with interests in Kurdistan, a continuation of the legal status quo has no immediate negative impact. Most are engaged in preliminary exploration work, and the issues relating to commercial production remain relatively far off.
Nonetheless, once the political horse-trading over the formation of a new government is out of the way, all of these companies will be hoping for a pragmatic resolution of the dispute. They have all taken a bet that, ultimately, an agreement between Erbil and Baghdad will result in acceptance of the KRG PSCs broadly on their existing terms. If this does not happen, companies will be faced with the unpalatable choice of negotiating whatever alternative terms are on offer, walking away from their investments, and/or pursuing remedies against the KRG pursuant to the stabilization and dispute resolution provisions of the PSCs. Given the experiences of both major and independent international oil and gas companies in an era of increased resource nationalism, it is not clear that the risks inherent in this bet are so different from those taken by such companies in the many other uncertain jurisdictions around the world.
1 In support of this interpretation, the KRG obtained an opinion from Professor James Crawford; it is published on the KRG’s website.
2 See, for example, Rex J. Zedalis in the Journal of Energy & Natural Resources Law, Vol. 26, No. 2, 2008.