BAGHDAD—An oil-sales deal between Iraq and the semiautonomous Kurdistan Regional Government is close to collapse about six months after it was signed, undermining the country’s unity as it struggles to fight Islamic State and contain an escalating financial crisis.
Months of acrimony between Baghdad and Erbil, the KRG’s capital, came to a head in June, when the Kurdish side reduced the amount of oil it sold through Iraq’s state-owned Oil Marketing Company, known as SOMO, and began ramping up its independent sales of oil through the Turkish port at Ceyhan.
The sales undercut an agreement struck in December that gave Iraq’s central government access to revenue from Kurdish oil, which accounts for about 15% of the 3.8 million barrels the country pumps each day on average. In exchange, the Kurds were to get 17% of federal expenditure—an amount KRG officials say hasn’t materialized.
“The oil deal between Baghdad and KRG has reached a deadlock,” said Kawa Mohammed, a Kurdish member of the Oil and Energy Committee in the Iraqi parliament. The accord “was built on uncertain foundation, very weak foundations, with a lack of trust on both sides.”
If the deal does collapse, it could rupture the fragile unity that Iraq relies on to fight Islamic State, which took over more than a quarter of the country in a startling blitz last summer. The KRG’s economy is facing a fiscal crunch that threatens its ability to support the Kurdish fighters who have taken a leading role in combating the extremist insurgency.
A failed deal would also thwart one of the signature achievements of Iraqi Prime Minister Haider al-Abadi, nearly a year into a premiership that many Iraqi and foreign policy makers had hoped would usher in a new era of Iraqi unity to confront Islamic State.
That fight has largely stalled nearly two months after the extremist insurgent group took over the provincial capital of Ramadi in a major defeat for Iraqi forces. Without the presence of U.S. troops, Iraq’s government is shouldering most of the ground fighting, straining a budget that relies heavily on oil revenue.
The situation underscores the uncertainty surrounding Iraq’s oil industry as it pumps record amounts of crude, in part to pay for the conflict with Islamic State. With oil trading at prices 45% below last year’s highs, Iraq’s government coffers rely on its ability to fight for buyers in the export market with rivals like Saudi Arabia and Kuwait.
Under the December agreement, the Kurds were to market 550,000 barrels of oil each day through Iraq’s SOMO. The Kurds say they instead exported most of their oil independently in June, because Baghdad was giving them less than their share of the budget. They also cited a need to make good on deals with oil traders who gave the Kurds cash up front for oil to be delivered later.
Those sales “kept the region financially afloat at a crucial time for the security and stability of Kurdistan and Iraq,” the KRG said Thursday.
Iraqi Arab policy makers fault the Kurds for failing to provide their agreed-upon share of the oil.
“Baghdad didn't pay what Kurdistan was asking for because Kurdistan didn't give Baghdad what it was supposed to,” said Jabbar Abdul Khaliq, an Arab member of parliament’s finance committee, who held out hope that the December 2014 deal might prevail.
Richard Mallinson, geopolitical analyst at Energy Aspects, who closely follows the Iraqi oil sector, said the oil deal was “crumbling.”
“It feels like it will probably limp along for a while longer, but in practical terms the deal is probably on its last legs,” he said.
The risk is particularly acute for the Kurds, whose balance sheets are squeezed by an escalating financial crisis, the influx of millions of displaced people from Iraq and Syria, and the burden of fighting Islamic State militants.
The KRG’s front line with Islamic State extends for more than 1,000 kilometers (620 miles) and the province hosts more than 2 million displaced people—challenges that add up to a $1.4 billion burden on the semiautonomous state, said Mr. Mohammed.
Kurdish state employees, who make up a majority of the region’s workforce, haven’t been paid since April and many are protesting. Oil companies such as Genel Energy GENL -2.55 % PLC, Gulf Keystone GFKSY -6.80 % PLC and Norway’s DNO AS DNO -2.01 % A have gone unpaid for much of the crude oil they have exported via the pipeline to Ceyhan for the KRG. Last month, Erbil sought international investors in a proposed bond issue to mend a nearly $5 billion budget deficit.
“The fight against ISIS...cannot happen if you don’t have the economic means to do it,” Ashti Hawrami, the KRG’s minister for natural resources, told a London conference in June.
Selina Williams and Sarah Kent contributed to this article.
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