Kurdistan gets Russian vote of confidence

The state-controlled Russian oil company Rosneft is advancing and expanding its multi-faceted energy deal with the Kurdistan Regional Government (KRG) - giving the KRG a badly needed geopolitical boost ahead of its controversial independence referendum.

Rosneft is moving forward with plans to invest in Kurdistan's crude oil pipeline to Turkey, and it has announced a new intention to finance a gas export pipeline, according to statements released Monday by Rosneft and the KRG Ministry of Natural Resources (MNR), as well as industry officials.

"We are excited about the future of our pipeline business together with Rosneft," said Baz Karim, CEO of the Iraqi-Kurdish company KAR Group, which built the oil export pipeline and will soon operate it jointly with Rosneft.

The KRG and Rosneft struck a framework agreement in February for upstream, midstream, and downstream energy cooperation - including the development of five oil and gas blocks, investment in the oil export pipeline to Turkey, and purchases of crude exports from the KRG. The oil sales began soon thereafter.

In a statement Monday, Rosneft said it has finished due diligence on the oil pipeline and "will shortly finalize the legally binding documents." The company will partner with KAR to operate the pipeline and raise its capacity from 700,000 barrels per day (bpd) to 1 million bpd by the end of 2017.

Rosneft also announced its intention to finance a gas export pipeline to Turkey - a project that was not directly referenced in the February announcement of the framework deal. Both Rosneft and the MNR said the new pipeline will carry its first gas to domestic consumers in 2019, and exports to Turkey and into Europe by 2020, with volumes ultimately reaching up to 30 billion cubic meters per year (bcma).

"It is expected that the [gas pipeline] agreement will be finalized by the end of 2017," the MNR said in a Monday statement.

The pipeline announcements come at a crucial time for the KRG, which appears to be moving forward with a Sept. 25 non-binding referendum for independence, despite opposition from Baghdad, Ankara, Tehran, and Washington.

Turkey's opposition has been especially forceful, causing many Kurdish leaders to worry privately that Turkish President Recep Tayyip Erdogan might retaliate by shutting down the export pipeline to the Mediterranean port of Ceyhan, which provides the vast majority of the KRG's revenue. On Monday, the Turkish military conducted drills involving tanks in the border town of Silopi, where the KRG-controlled export pipeline enters Turkey.

In February and March 2016, the pipeline was stopped for more than three weeks while the Turkish government said it was conducting military operations against the Kurdistan Workers' Party (PKK), a militant separatist group. The extended outage cost the cash-strapped KRG about $360 million in lost revenue, according to an Iraq Oil Report estimate based on crude pricing and pipeline throughput data.

Russia's investment in the oil pipeline helps ensure that a powerful international player will have a direct financial interest in keeping Kurdistan's crude exports flowing.

Rosneft will put up the money to expand pumping, storage and other parts of the export line that need to be upgraded or expanded, according to an industry official. Rosneft and KAR will split the proceeds of tariffs charged for oil flows; nobody has disclosed what the tariff rate will be or who will bear its cost.

The gas pipeline deal also promises to insert Rosneft as an essential party for implementing a gas sales agreement (GSA) between the KRG and Turkey. The promise of competitively priced gas was a key driver behind Turkey's decision to pursue a broad energy deal, finalized in November 2013, which paved the way for the KRG's autonomous oil exports and de facto economic independence.

A KRG official confirmed Monday that the deal with Rosneft will not affect the terms of the GSA, and that the prices offered to Turkey remain "very competitive" with Turkey's other gas suppliers, the largest of which is Russia.

The contract will be a Build-Own-Operate-Transfer model, with investment "to be recovered through tariff charges and an agreed rate of return basis," the Rosneft statement said.

Bullish on Kurdistan

In addition to a geopolitical vote of confidence, the Rosneft deal represents a bet on the KRG's ability to rekindle the interest of oil and gas investors.

The KRG has billed itself as a potential source of gas for the European market, but so far it has not generated enough production to serve domestic demand let alone exports.

That picture could soon change, now that the KRG has settled a multi-billion-dollar arbitration dispute with the Pearl Petroleum consortium, which stalled development of the Khor Mor and Chemchemal gas fields and gave pause to other potential investors.

Neither Rosneft nor the MNR specified which fields would be providing the export supply, but a KRG official said the pipeline was likely to carry gas from Khor Mor and Chemchemal, Genel Energy's Miran and Bina Bawi fields, Repsol's Topkhana and Kurdamir blocks, and ExxonMobil's Pirmam - all of the major gas assets currently contracted with international oil companies.

Most of those projects are still in exploration phases, and will require billions of dollars in order to generate anything close to a cumulative 30 bcma.

The crude pipeline deal also shows Rosneft's confidence in KRG oil production growth, which has been anemic over the past two years. Not only has the Taq Taq oil field suffered steep declines, but international oil companies (IOCs) were also reluctant to put money into new production because of the KRG's unreliable payment history.

The KRG provided a shot of confidence in August, when it reached an agreement with two of its major IOC partners - Norway's DNO and Genel - to settle outstanding bills by assigning the companies additional equity and modifying payment terms.

Kurdistan's export pipeline carried about 582,000 bpd to Ceyhan in August, according to an official familiar with the export system - well below its current capacity of 700,000 bpd. Domestic refineries are also not working at capacity, meaning the current infrastructure is more than adequate for absorbing incremental production increases.

But Rosneft appears to be planning for the long term - and anticipating nothing less than a KRG oil boom. Its investments also include five exploration blocks, although neither the company nor the MNR has disclosed which ones.

The company is pursuing "cooperation in the entire hydrocarbons production chain, from exploration and production to commerce and logistics," the MNR said.

Ben Lando and Ben Van Heuvelen reported from the United States.