Earlier this week the people of the Kurdistan Region of Iraq (KRI) voted overwhelmingly for independence from federal Iraq. The vote has been widely criticised by local and international players – in particular by neighbours Turkey and Iran (likely fearing a groundswell of nationalistic sentiment from their own large Kurdish populace), and the United States, a stanch ally of the Kurdistan Regional Government (KRG).

Although the results of the referendum clearly demonstrate the will of the people of the KRI, the KRG had no constitutional right to call such a referendum and the result of the vote has no legally binding effect on the federal government. In this respect, certain parallels with the Scottish independence referendum in 2014 have been drawn – neither devolved governments had a constitutional right to self-determination. However, the significant difference between the two plebiscites is that where the Scottish government sought, and was granted, assurances that the Westminster parliament would honour the outcome of the referendum, federal Iraq has vigorously denied the validity of the vote, frequently citing the grave consequences for regional security that the vote will engender. Self-determination could theoretically still occur under international law (the right is enshrined in the UN Charter), but it is unlikely that such self-determination would be granted by federal Iraq. One needs only to look to the history books to find examples (East Timor, Kosovo, South Sudan) of the violence and disorder that can ensue when resisted self-determination is pursued.

However, the KRG has made no secret of the fact that independence would not automatically follow a “Yes” vote, with the Kurdish President, Masoud Barzani, himself conceded that any referendum would be merely symbolic in nature, providing him with a strong mandate to commence discussions with the federal government in Baghdad.

While the political manoeuvring and constitutional challenges that are likely to develop in the coming months and years will make for fascinating viewing for foreign commentators, the uncertainty that may ensure will be particularly troubling to the people of Iraq as a whole and the international investors within the country, particularly the international oil companies (IOCs) with interests in the KRI.

Constitutional issues resolved or will old divides be deepened?

The expectation from the KRG and the Kurdish people appears to be that while independence may not occur immediately (or even at all), the vote will allow Kurdistan a strong mandate to discuss many existing issues with federal Iraq and may bring about a settlement to existing issues of sovereignty, budgets, delineation of borders, oil rights and security. Such renegotiation may not manifest itself in full independence, or even the birth of a confederal system as some have suggested, but if it allows renewed vigour in negotiations on these unresolved issues the vote will have been worthwhile.

The subject of oil and gas rights in Iraq, and more particularly, who has the authority to grant rights to produce oil and gas has been hotly disputed since the enactment of the Iraqi Constitution in 2005, not helped by the unclear drafting which has allowed the KRG some interpretative room to manoeuvre. This scope has seen the KRG grant production sharing contracts (PSCs) to a number of IOCs, despite intense and sometimes litigious objections from the federal government of Iraq.

The constitution is also less than clear on the the marketing of hydrocarbons extracted from within the boundaries of Iraq. Various rights are reserved to the federal government that could be interpreted as reserving marketing of hydrocarbons, in particular: (1) formulating foreign sovereign economic and trade policy; (2) customs policy; and (3) regulating commercial policy across regional and governorate boundaries. The federal government asserts that Iraq’s State Oil Marketing Company has the exclusive right to export and import crude oil, gas and oil products from and to Iraq. In contrast, the KRG argues that direct export of oil produced in Kurdistan is in full conformity with its right to “manage” oil and gas under the Constitution. The KRG’s Oil and Gas Law of 2007, and the PSCs issued pursuant thereto, provide IOCs with the right to take title to and delivery of petroleum which they are, theoretically, free to market to national and international markets.

Neither of the foregoing issues have been resolved in the courts of Iraq or elsewhere, in spite of the federal government brining claims against the KRG in the Iraqi Supreme Court on the validity of the PSCs, and more recently in the U.S. in attempts to block the unloading of Kurdish crude in the U.S.

It seems unlikely that federal Iraq will concede ground on the foregoing issues regardless of the result of the election, but even if it were to come to the negotiating table willing to consider softening its stance and recognise the KRG’s right to issue granting instruments and title to crude, the process of clarifying and amending the constitution to reflect this position would likely be tremendously difficult to achieve. Any amendment to the Iraqi Constitution would require approval of two-thirds of the members of the council of representatives and the approval of the populace of Iraq in a general referendum. It remains to be seen if such a move would be acceptable to the other governorates and regions who may themselves feel that they would be better served by acting independently from the federal government. The possibility of Kurdish independence leading to the break-up of Iraq will be an issue the federal government is all too aware of.

Issues for the Kurdistan Oil Industry

One only needs to look at the number of IOCs present in Iraq (including Rosneft’s recent announcement that it will be investing in new gas pipelines in the KRI) to appreciate that the country is an attractive investment proposition for IOCs. Indeed, the KRI has somewhere in the region of 15-20% of Iraq’s oil which as an independent nation, would rank Kurdistan in the top-10 of OPEC members.

However, Iraq’s ongoing security issues as well as the political uncertainty on the legal validity of the KRG’s PSCs, coupled with historic payment delays by the KRG to IOCs, make the KRI a high-risk province. This high-risk has manifested itself in more favourable terms for investing IOCs in the PSCs compared with the terms offered by the federal government in the Technical Service Contracts, as well as a significant “risk discount” in the price attained for KRI oil sold to international markets. The KRI independence referendum will do nothing in the short term to lessen this risk profile, and is more likely to increase the concerns of IOCs operating in Kurdistan.

It is therefore no great stretch to suggest that one of the biggest risk to the oil industry in the KRI following the independence vote is disruption to the KRI’s primary export route for its oil. Without the pipeline to Ceyhan, landlocked KRG would become reliant on the trucking of crude to national refineries or cross border to Iran, Iraq or Syria – a far more costly, time consuming and riskier endeavour which would inevitably lead to delays or a complete cessation of payments to IOCs under the PSCs. IOCs can take some comfort from the fact that Turkey does not stand to benefit economically from cutting off half a million barrels of oil a day from its own markets, however it is not a risk that can be discounted. Furthermore, Bagdad has declared that it will shut-down the KRI’s airspace, effectively imposing an aerial blockade. A number of airlines have already announced that they will cease flights to the Kurdish capital, and oil industry hub, Erbil. If Turkey follows suit and bars flights from its airports to Erbil, there is likely to be a significant strain placed on the availability of rotational personnel and supplies available to the IOCs

A number of legal issues may surface following such events, for example could the KRG excuse the lack of export route and payment on doctrines of impossibility, could IOCs suspend or terminate PSCs in case of extended non-payment / unavailability of resources? Such issues have faced IOCs in the past and have led to protracted arbitrations and settlement discussions between the KRG and IOCs. Both sides will hope that such steps are not required in the months ahead and that business will continue as usual following Monday’s historic vote.