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15 January 2018

Russia might lose billions of dollars in Iraq

Rosneft’s contracts with Iraqi authorities in Baghdad — and an investment deal with secessionist authorities in Iraqi Kurdistan — are both in jeopardy. Billions are at stake.

Moscow runs a serious risk of undermining its relations with Iraq because of its actions last year in the autonomous region of Kurdistan. In particular, that means Russian investments in the area now in jeopardy.

It all traces back to Iraqi Kurdistan’s bid for independence. Erbil, the prospective capital, held an independence referendum on September 25 — which authorities in Baghdad immediately declared as illegal. The majority of citizens of Iraqi Kurdistan pressed on, and voted for secession. On October 18, in a gesture of recognition, the management of Rosneft signed contracts with the leadership of Iraqi Kurdistan to invest up to $4 billion in the energy sector.

Turkey did not protest. Perhaps this was because the parties initially agreed that hydrocarbons extracted in the autonomous region would be supplied by Russia to Turkey.

Both economic and political motives (Moscow’s growing interest in the Kurdish issue, against the backdrop of the fight against ISIS and participation in the intervention in Syria) are behind the contract.

In this case, the Russian party clearly tried to anticipate developments in an attempt to establish early contacts with the Iraqi Kurds and win a first mover advantage. This would be risking a backlash from the Iraqi authorities in Baghdad, who are also involved in multi-billion-dollar energy contracts and military-technical cooperation with Russia. Moreover, the Iraqi authorities say all energy deals concluded by Erbil without the consent of Baghdad are illegal. That includes Rosneft’s.

Meanwhile, at least $1.3 billion has already been transferred to the Kurdish authorities under the contract. This money was supposed to be used to repay Erbil’s debts to foreign oil and gas companies and purchase oil. Later on, the oil was supposed to be re-sold to Turkey, which has traditionally been the partner that transports the region’s black gold to the port of Ceyhan by pipeline and road. The remaining amount was supposed to finance the construction of a gas pipeline from Iraqi Kurdistan to Turkey, as well as development by Rosneft of five blocks in local fields.

While the US and most major global players were critical of the vote in Iraqi Kurdistan, Moscow, on the contrary, did not expressly disavow the results. This was bound to have a detrimental effect on relations between the Kremlin and Baghdad, which are also involved in a number of oil contracts. Turkey was also far from delighted, since its leaders strongly opposed the decision to hold the referendum.

Moscow was not put off and chose to support Erbil instead, although in a disguised form (this dubious approach allowed the government to avoid angry reactions from Ankara and Baghdad). Thus, Russian Foreign Minister Sergey Lavrov called the referendum an expression of “the legitimate aspirations of the Kurds” that nevertheless “need to be fulfilled within the framework of existing international legal norms.”

At the same time, Moscow probably expected that given their difficult political situation, neither Iraq nor Turkey would take decisive action against Russian interests in the region in general, or the Kurdish autonomous region in particular. Especially since oil and gas extracted in Kurdish-controlled territories have traditionally been sold to one buyer: Ankara.

After the referendum, Iraqi forces retaliated and seized the “disputed” provinces of Kirkuk and Sinjar in October. The Kurds lost 40% of their territory, and nearly two-thirds of their oil and gas reserves. Only two of the five blocks where Rosneft was supposed to drill are still controlled by the Iraqi Kurds. Theoretically, the company could start exploiting these deposits. But the loss of Kirkuk province has led to a severe crisis; oil exports from the autonomous region dropped from 600,000 to 216,000 barrels per day in November. It is noteworthy that Kirkuk oil is considered to be the best in Iraq, serving as the benchmark crude oil for the country.

Moreover, three of the five gas blocks that Rosneft was supposed to exploit are now controlled by Iraq. Therefore, representatives of the Iraqi government have repeatedly pointed out that Russia should carry out negotiations with them. Still, the company said in November it had embarked on the implementation of its contracts with the Kurds, and so far has not re-negotiated the agreements with Baghdad.

From Rosneft’s point of view, the difficulty is that the funds allocated have been almost completely spent by Erbil, without improving the generally unsound economic situation in Iraqi Kurdistan. The autonomous region faced serious financial difficulties even before losing Kirkuk and Sinjar provinces; civil servants including law enforcement have not been paid for months. Erbil’s situation is aggravated by a de facto transport ban (including flights) imposed by its neighbors. Finally, Baghdad has in fact issued an ultimatum: The authorities of the autonomous region must give up all the attributes of independence, abide by Iraqi laws and put the economy under Iraq’s control. This also applies to oil and gas deals. In particular, Erbil must abandon autonomous exports of hydrocarbons and put them fully under Baghdad’s control.

The Kurdish authorities are still trying to resist the pressure, seeking to negotiate an honorable surrender. In particular, they are seeking the return of the expelled Kurdish population to Kirkuk and Sinjar provinces and compensation from Iraq. Additionally, Erbil insists that Baghdad assume full responsibility for its economic problems and allocate it 17% of the Iraqi state budget each year.

At the same time, the Iraqi authorities expect the Kurds to completely fulfil all the conditions set by them up front, and say the demands for financial support are excessive. 

In other words, a political impasse. So far, there is no painless solution to the problem, including for Rosneft. Three options for developments in Iraqi Kurdistan and Moscow’s reaction can be outlined.

The first option is that, given the loss of financial and economic leverages, Erbil will succumb to Baghdad and accept its conditions (although some concessions can be allowed).

In the second scenario, the autonomous region will continue to resist Iraq’s pressure given financial assistance from abroad (e.g. from its traditional American ally, or Russia).

Finally, the third scenario is related to the second one: if Erbil doesn’t surrender, Baghdad may resort to force, and hostilities break out on the territory of the autonomous region. Given the acute nature of regional conflicts, such armed conflict may to a greater or lesser extent involve not only neighboring countries such as Turkey and Iran, but also the US.

Any of these options means a failure for Russia, which has already spent some of the resources allocated to assist the autonomous region in its further confrontation with Baghdad. Consequently, Russia will have to take up the burden of Iraqi Kurdistan at a high cost yet again, with an uncertain return on investment.

In the first option, Rosneft’s deal with the Kurds will naturally die out; the same goes for the scenario of an armed conflict. If the Russian company were to continue working with Kurdistan, it would have to reestablish contacts with Baghdad, which would most probably entail additional payments.

As for the prospects of reaching agreements with Baghdad, they are realistic: The Iraqi authorities have repeatedly “given unambiguous hints” that this is possible, having actually suggested direct negotiations.

However, the price Moscow has to pay will inevitably change as events unfold.

If Baghdad is able to bring Erbil to heel, Russia will have to make additional efforts in order to maintain its previous standing, which entails even greater costs. This raises the question of whether it’s worth going ahead with the contract.

It should be mentioned that the Iraqi authorities have serious leverage at hand to impact Moscow’s position. First, there are the interests of Rosneft, which is investing in Iraq. The interests of other Russian energy companies, such as Lukoil, are also at stake.

Nevertheless, the Iraqi authorities are unlikely to completely sever ties with Russia given their advanced level of cooperation. For instance, arms supplied by Russia played a decisive role in the recent successes of the Iraqi army, not only against Islamic radicals but against the Kurds themselves.

In any case, the current uncertain situation surrounding Russian investments should be treated as a lesson that more accurate assessments of political risks are needed when international projects are at stake.

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