You’ve sunk your wells, started drilling; have extracted tens of millions of barrels of oil for export. But a year down the line, you still haven’t been paid.

This is the predicament faced by several leading European oil companies – including the Genel Energy, run by ex-BP boss Tony Hayward, Norway’s DNO and the UK’s Gulf Keystone – caught in the stand-off between the Iraq’s central administration in Baghdad and the semi-autonomous Kurdish Regional Government (KRG) over how the spoils of Kurdistan’s oil reserves should be shared.

The KRG deposits are huge, amounting to roughly a third of those in Iraq, where one in ten of the world’s accessible barrels are to be found. Kurdistan is among the cheapest places to drill for oil on earth. The total cost per barrel – a measure that includes exploration and extraction spending – is around $12, compared with about $50 for US shale, says Will Forbes, head of Oil and Gas at research advisory Edison in London.

Politically, things are more complex. While the deals the three firms struck with KRG resulted in their blacklisting by Baghdad, they require some of blessing from the Iraqi government to function.

Under the terms of the 2005 Iraqi constitution, KRG is not entitled to sell the oil itself, but must hand it to the Iraqi state oil-marketing organisation (SOMO). Baghdad in turn gives KRG 17 per cent of total Iraqi oil revenues as a budget payment.

But the KRG-Baghdad agreement broke down last March, when Baghdad, claiming KRG was selling oil independently of SOMO, stopped the province’s budget payment. This caused a budget crisis for KRG: Baghdad’s payments account for roughly 95 per cent of KRG revenue, according to Denise Natali, a senior research fellow at the Washington-based Institute for National Strategic Studies.

The payments drought coincided with the toughest stretch in the KRG battle against Isis – by August Isis were closer to the KRG capital Erbil than at any time before or since. The KRG government was looking everywhere for reservists and weapons, impatient with the slow pace of Western aid. By autumn, estimates Natali, unpaid wage bills amounted to $720m and workers were striking in Erbil.

“The bills were racking up and there were a long line of people to be paid,” says Richard Mallinson, Geopolitical Analyst at Energy Aspects in London.

Genel, DNO and Gulf were hardly at the front of that line: despite sales beginning in May, by September none of the firms had seen any money.

KRG’s cashflow was further impeded by Turkey’s shifting relationship with Baghdad. When payments from Baghdad ceased, the KRG had started selling its oil directly through Turkey, aided by a new pipeline that linked the Kurdish oil fields directly to its northern neighbour, allowing exports to proceed despite Baghdad’s opposition.

But by the time Turkish tankers loaded up the oil and set sail, Baghdad had started a US court case with Turkey over the cargo, which it considered stolen from Iraq. For months before, oil experts had tracked thousands of barrels of Kurdish oil as it floated around the Mediterranean on Turkish container ships, waiting for the dispute to be settled.

The map below shows the position of the Turkish container ships.

But even when a spat was averted, Ankara prevented proceeds from cargo’s sale from making their way back to KRG, keeping them in a Turkish bank.

Mallinson reckons roughly 25m-30m barrels were ultimately sold this way. But secrecy of the deals mean the oil drillers may never work out what they are owed: “They didn’t know who the buyers were and what they had paid for it,” he says.

Just when things were looking desperate – “probably September”, says Mallinson – Turkey released the funds.

It wasn’t much, but it was enough for payments from KRG to the oil firms to start. On the quarterly earnings calls in October and November, all three firms reported they had received early instalments or were expecting them. The total of $75m released was much less than they were owed – Genel alone was due $140m – but it still sent share prices in the three drillers on their largest upward tick of the year.

The chart below shows the share prices of the three companies in 2014 and this year, with the orange line representing Gulf Keystone, the green line Genel and the brown line DNO. Not the recovery in price around November last year.

Then in November, Baghdad and KRG put aside their acrimony to strike a new agreement. The final terms pledged a budget payment of $1bn per month from Baghdad and daily delivery of 550,000 barrels of oil from KRG to SOMO.

Things are looking better than at any stage since the three firms started pumping oil out of the ground in January. Nevertheless, Baghdad is wrangling over how many barrels were delivered in January and the KRG has received nothing in the way of payments so far this year.

Beneath a photo showing the Prime Ministers of KRG and Iraq scowling at each other, the KRG government website on February 16 reported that at the previous day’s meeting:

“It became apparent that due to the financial crisis in Iraq and the lack of liquidity, the Iraqi government is unable to pay the Kurdistan Region’s share of January and February from the federal budget.”

The effect for Gulf, DNO and Genel has been immediate. “On the last quarterly earnings calls in January, every firm reported that payments had stopped,” says Mallinson.

How long can the firms survive the payments embargo?
Genel and DNO are on the soundest footing financially. Both have cash reserves roughly equivalent to their borrowings: Genel’s $500m bond doesn’t require repayment until 2019; DNO’s $215m bond expires in April 2016. Genel’s President Mehmet Sepil was in a bullish mood in December, talking up acquisition opportunities in response to the falling oil price.

To his shortlist, he can now add Gulf Keystone, which put itself up for sale this week. Alone, the firm looks the most vulnerable to the unreliable cashflow from the KRG. Its financial reserves are small; they were last reported last June at $225m and have likely halved since then, according to one analyst. At $575m, their bond liabilities are the largest of the three firms. This year it faces roughly $50m of interest payments, with the first due in April.

Until yesterday’s announcement, it had lost three quarters of its market cap since Baghdad first halted payments to the KRG in March. Since then, the prospect of acquisition by a larger firm, that would keep the wolf from the door, has pushed shares up by 50 per cent in value.

As for prospect of sustainable cash flows for the three firms, Natali believes that Turkey may hold the key. KRG and Turkey have struck multiple agreements, including an additional crude pipeline connecting the two and agreements to sell large gas exports to Turkey. For Turkey, these reduce dependence on Russian and Iranian exports and recruits KRG support in Turkey’s 30-year struggle with Kurdistan Workers Party (PKK) the militant separatist group that typically launches its strikes from Kurdistan.

But it puts KRG at the mercy of Turkey’s Iraq policy, which has been characterised increasingly by rapprochement.

“The KRG were mistaken in believing they could rely on Turkey as an alternative source of revenue to Baghdad. It is now more deeply lodged between regional powers and Turkey’s control over Erbil’s energy and political agendas has increased,” Natali says.

Receipts from sales through Turkey – about 30m barrels to date – show no sign of delivering KRG from its budget crisis. The KRG has still received only $2bn since payments from Baghdad ceased early last year, a fraction of the $13bn it received from Baghdad in 2013, and nowhere near what it needs to run its administration, let alone pay the oil firms.

For the time being Gulf, DNO and Genel remain at the end of a long line of creditors to the KRG awaiting payment.

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