Turkey: Oil Sales Tension Between Iraq And KRG In The Light Of Constitutional Debates And The Background Of The Recent ICC Ruling Against Türkiye

Oil Sales Tension Between Iraq and KRG in the Light of Constitutional Debates and the Background of the Recent ICC Ruling Against Türkiye

Why did The International Chamber of Commerce's International Court of Arbitration order Türkiye to pay compensation to the Iraqi Central Government?

International Chamber of Commerce (ICC) International Court of Arbitration is an institution to resolve international commercial disputes between institutions. The oil and gas sector mainly invokes arbitration mechanisms in price dealing clauses within their contracts when disagreements occur between the parties. However beyond being oil and gas sector issue, it is vital to underline that the relevant ICC decision is in fact related to a commercial dispute between two governments namely; Iraqi Central Government (ICG) and the Kurdistan Regional Government (KRG).

Moreover, Türkiye had been indirectly involved as a party of the case due to a constitutional disagreement between ICG and KRG. In line with this, the ICC order confirms that "Iraqi national oil company SOMO is the only entity authorized to manage oil export operations through the Turkish port of Ceyhan." referring to the 1973 Turkey-Iraq pipeline transit agreement. It is essential to point out that the current ICC decision relates to oil transport between 2014 and 2018 and does not cover the period after 2018 and onwards.

What is the historical background of the ICC judgement?

In March 2023, ICC fined Türkiye c. US1.5 billion dollars in compensation for its oil transport through Ceyhan Port in cooperation with KRG that occured between 2014 and 2018. ICC announced its compensation decision of Türkiye as a resolution to the ICG's application to the ICC in May 2014. According to various sources, it is claimed that Türkiye will also pay interest retrospectively for the amount calculated by the ICC. However, the calculation process of the interest rate is not shared in open sources.

The compensation is based on the ICG's allegation that Türkiye violated the 1973 Turkey-Iraq pipeline transit (TIPT) agreement by allowing crude oil exports from the KRG without ICG's consent. The legal argument for the lack of ICG's consent is built on the TIPT agreement. This agreement authorized the national oil companies of both sides on operational matters in accordance with their assigments defined in the agreement. In line with this, Türkiye's national oil company Petroleum Pipeline Corporation (BOTAS), and Iraq's national oil company State Organization for Marketing of Oil (SOMO) have the authority to manage Kirkuk Ceyhan Oil Pipeline (KCOP).

Further, in light of the agreement discretion, the primary basis for the arbitration decision was the violation of the agreement between Türkiye and Iraq that originated from the transportation of KRG oil through Türkiye without the approval of SOMO to the international markets via Ceyhan Port. As a consequence of this transportation, ICC decided to fine Türkiye due to its oil transportation in different modes independently from the SOMO. Following the court's decision, Türkiye's Ministry of Energy and Natural Resources (MENR) stated that the current case on ICC reflects the oil management rights dispute between the ICG and the KRG rather than a disagreement between Türkiye – Iraq, which the report delves further.

The ICC also sentenced ICG to pay 600 million dollars in compensation to Türkiye for not complying with the terms of the agreement regarding unpaid transport charges between 2014 – 2018. For this reason, it is expected that the relevant compensation that Türkiye will receive from ICG will be reduced from the amount of Türkiye's compensation payment to ICG. Moreover, private sector sources argued that Türkiye has the right to recourse its current compensations to the KRG in scope of the close ties between Türkiye's Government and the KRG. Türkiye's MENR also underlined that they amicably contribute to the diplomacy between parties and relevant countries to solve disagreements without mentioning the details.

Why did the arbitration rule only cover the period between 2014 and 2018?

The origination of the current arbitration result could be related to the new oil pipeline between Türkiye and KRG. Before the court's relevant decision, Iraq pumped 370,000 barrels of KRG crude and 75,000 barrels of IGC's crude per day. At this point, it is crucial to understand the logic of the calculated amount of compensation which totaled c. US1.5 billion dollars, where ICG expected much higher as to receive around 33 billion USD from the ICC as a compensation. For this reason, analyzing Iraq's geopolitical balances and changes within its region, is critical in questioning the oil transportation and Türkiye's compensation.

Iraq's geopolitical position comes with many economic and political uncertainties. In line with the changing dynamics affected by the internal and external instabilities, directly reflect the circumstances in the region. Back in the summer of 2014, terrorist organization Islamic State of Iraq and the Levant (ISIS) began its activities in Iraq - as well as Syria that caused a high level of instability for individuals and companies operating in KRG, including other parts of Iraq. As a results of the terrorist threats and attacks to the pipeline and oilfields within the region, KCOP that sets the essence of TIPT was physically targetted for several times, mostly by terrorist organizations Islamic State of Iraq and the Levant (ISIS) and Al-Qaeda which rendered the TIPT inoperable in March 2014. Sources indicated that TIPT remained inoperable until 2018 due to sabotages. Therefore, after March 2014 there was an emergent need in the region for another operational pipeline to sustain the oil transfers to the international markets.

After the technical obstacles emerged in the KCOP, KRG laid an additional pipeline link to the previous oil pipeline from Hurmala to Fishkhabour and connected it with the main Kirkuk-Ceyhan line at the border. The oil pipeline with its new link cost 600 million USD and is now being operated under Russian company Rosneft (%60) and KRG-based KAR Oil Refining Limited (%40) within the scope of capacity expansion investments for pipeline in 2017.

In line with the new link that was added to the KCOP, Istanbul-based energy consultancy company Gazday Head has assumed that Türkiye's compensation fee could be related to the calculation of oil exports from the oil fields (Bai Hassan and Avana) which were integrated into the pipeline system by the time that ISIS became active in the region. At this point, it should be mentioned that the control of Bai Hassan and Avana oil fields was transferred from the ICG to ISIS, then from ISIS to the KRG and lastly from KRG back to ICG. ICG retook its oil fields after the KRG's independence referendum in 2017. After ISIS took control of various oil fields in Iraq, KRG's military forces (-also known as Peshmerga) began their repelling operations of ISIS elements from the oil fields. Reffering to KRG's control of the oilfields, ICG argued that KRG operated Bai Hassan and Avana oil fields independently from the Iraq's state company North Oil Company (NOC) until March 2018.

Constitutional Source of Oil Tension Between ICG and KRG

Disputes between the ICG and the KRG over oil and gas sales mainly originated from the Iraqi Constitution stating: "Oil and gas are owned by all the people of Iraq in all the regions and governorates." Furthermore, the petroleum law of the ICG rules that "Allocation of oil production revenues is based on population proportion of all Iraq." which determines the proportion of oil & gas distribution shares between ICG and KRG. There are many disagreements between the parties due to the differentiating interpretation of the constitution at the micro and macro levels, but this report categorizes disputes under four main headings that are interrelated to each other.

Matter 1: Iraq's census cause tensions between the IGC and KRG

Disagreements between the ICG and the KRG over the census directly affect the transfer of budget revenues, including energy incomes, from central government to the local government. The ICG has been claimed to utilize the censuses to create political pressure on the KRG. For instance, ICG decreased KRG's population count from 17% to 12.67% following its independence referendum, which impacted KRG's budget negatively and increased its financial fragility. In this vein, the first matter stems from the differences in numbers from the census provided by the IGC and KRG.

Matter 2: Collection of Oil Revenues in a Joint Bank Account

The second matter arises from a disagreement on where the oil revenues should be deposited. ICG's preference was to have a joint bank account for KRG and SOMO in order to be able to track KRG's oil share and transfer it from this account to KRG. On the other hand, KRG preferred its own oil revenues account citing that KRG-based oil fields' revenues belongs to them and ICG didn't have any contribution in the exploration and production processing of the KRG based oil fields'. However, in the joint account operations, ICG had delayed payments to the KRG from the relevant ratio at various times, which strained the KRG's institutional capacity and financial sustainability and led to the establishment of escrow account in Türkiye.

Matter 3: KRG's Production Sharing Contract with International Companies

The main source of the previous matter stems from the legal conflict between KRG's oil law (Law No. 22) that was promulgated in 2007 and the ICG's Article 112 (1) within its constitution. Article 112 (1) of the Constitution states that "The Federal Government shall, in co-operation with the Regional Governments and the provinces, manage oil and natural gas extracted from existing deposits." In line with 112 (1), KRG passed its own petroleum law in the Kurdistan Region Parliament in 2007 that authorized KRG to give production-sharing contracts (PSC)¹ to international oil and gas companies (IOGCs).

The ICG opposes the KRG's PSC approach that enables KRG to give shares from production incomes to IOGCs by referring to Article 111. Nevertheless, it is important to underline that KRG does not directly sell the shares of oil or gas fields to companies in contrast to ICG's claim by gathering strict rules on IOGCs' production licenses. The KRG side argues that the PSCs given to IOGCs are in accordance with Article 111 of the Constitution. On the other hand, the ICG demands that IOGCs be granted service contracts² that do not include production sharing with the companies and authorize companies for just operational matters of the oil or gas field.

Matter 4: Lack of Unified Oil and Gas Law in Iraq

One of the central matter sources between the ICG and the KRG is that the two regions do not have a unified oil and gas law to mediate the implementation of legal processes in a coordinated manner. This situation brings differences in the approach of ICG and KRG in their governance of contract negotiation with IOGCs which paves the way to constitutional disagreement. ICG has been authorizing IOGCs through service contracts. Meanwhile, the KRG signed various PSCs with IOGCs, under its own petroleum law. The ICG which did not have a complete petroleum law until 2018 opposed KRG's PSCs. Hence, ICG's not having an oil-specific law for a long time has introduced serious matters in oil-sharing issues with the KRG.

Footnotes

1. "Host country's government awards to an oil company (or group of companies, typically called the Contractor) the rights to explore in a specified area and following discovery of hydrocarbons in such area the right to produce such discovered resources."

(Shamaran Petroleum Corp., How Oil Production Sharing Contracts Work, 2023)

2. "Pure service contracts are agreements for the provision of specific oilfield services, such as the acquisition of seismic data, drilling and construction. They are between an oilfield operator, who is usually an oil company, and the service contractor, who provides its technical service in exchange for a prescribed fee."

(Brooks and Knights Legal Consultants (BKLC), An Overview of Service Contracts in the Oil and Gas Industry, 2020)

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