(EnergyAsia, December 28 2011, Wednesday) — The following is an edited commentary by law firm Herbert Smith.

Disagreement between Iraq’s Federal Government and the Kurdish Regional Government over control of oil and gas reserves in the semi-autonomous region is yet to be finally resolved but that has not stopped an increasing number of major international oil companies from choosing to invest in Iraqi Kurdistan.

Kurdistan, which the Federal government claims holds 200 billion barrels of oil, may control anything from 20% to over 33% share of Iraq’s oil reserves.

Pursuant to regional legislation passed in 2007, the Kurdistan Regional Government (the KRG) has signed more than 35 oil production sharing contracts (PSCs) with foreign companies. Officials representing the Federal government, including Deputy Prime Minister for Energy and former Oil Minister Hussain al-Shahristani, have challenged the validity of both the KRG’s petroleum legislation and PSCs.

Some companies that have signed PSCs with the KRG have been excluded from participating in the tender rounds for oil and gas service contracts conducted by the Federal Government, including the current fourth round tender for exploration blocks.

A dispute over the treatment of oil produced from two blocks subject to PSCs signed by the KRG, Tawke and Taq Taq, which began in June 2009, led to production being halted in October 2009.

Following lengthy negotiations, Iraq’s federal State Oil Marketing Organisation resumed exports of crude from KRG controlled fields in February 2011 through the Kirkuk-Ceyhan pipeline. The details of the current revenue sharing arrangements and timing of payments relating to these exports are unclear but it appears to allow producing companies (Genel Energy, Sinopec and DNO) to recover their costs, at least, pending a more comprehensive agreement.

The KRG’s Minister of Natural Resources, Ashti Hawrami, has estimated that Kurdish oil production could reach 200,000 b/d by end-2011, and one million b/d between 2013 and 2015.

While the arguments between Baghdad and the KRG over Iraq’s northern oil reserves could be described as primarily political, the legal debate centres on the interpretation of the Federal Constitution. This document allocates power between the Federal and regional governments, the KRG being the only regional government currently recognised (other areas within the federation being governorates).

Articles 115 and 121 overlap to give regional governments the authority to legislate in all areas of law not exclusively reserved for the jurisdiction of the Federal government. They also give regional legislation priority over any conflicting federal legislation in such areas.

Article 110 sets out the scope of Baghdad’s exclusive powers while Article 114 identifies powers which are to be shared by Baghdad and regional governments, but neither includes any reference to oil and gas.

The law relating to oil and gas is specifically addressed by Articles 111 and 112. Article 111 is limited to the general principle that oil and gas are owned by the people of Iraq as a whole, but Article 112 provides the most guidance and cause for debate.

The first limb of Article 112 provides that the Federal government may “undertake the management of oil and gas extracted from present fields” with the relevant governorates and regional governments, subject to an obligation to distribute revenues fairly by reference to population and taking into account any historical revenues withheld from the governorate or region.

The second limb provides that the Federal government may “formulate the necessary strategic policies to develop oil and gas wealth” with the relevant governorates and regional governments, subject to an obligation to maximise the Iraqi people’s benefit from such wealth.

The most relevant legislation currently in force is the Oil and Gas Law of the Kurdistan Region – Iraq (Law No. 22 of 2007), which, as noted above, underpins the PSCs signed by the KRG. This law is expressed to be consistent with the constitutional provisions outlined above and excludes the application of all other laws seeking to regulate the petroleum sector in Kurdistan.

Federal legislation to reform and govern the petroleum sector has been stalled in Iraq’s Council of Representatives since 2007 for a number of reasons, including disagreement over its provisions for the balance of power between Baghdad and the governorates and regions.

Revised drafts circulated by the relevant parliamentary committee and then the Council of Ministers in August 2011 have remained ambiguous or silent on this point. It remains to be seen if and when a new law will be passed.

Baghdad and the KRG have a longstanding agreement that all petroleum exported from Iraq should be marketed through the federal State Oil Marketing Organisation and the KRG should receive 17% of the resulting revenues. Their disagreement is over the extent of the KRG’s rights to regulate the petroleum sector in Kurdistan and, in particular, to enter into contracts relating to the exploitation of oil and gas in the region.

Baghdad argues that, by unilaterally passing regional legislation and signing PSCs, the KRG has breached its constitutional obligation to act in concert with the Federal government, rendering the legislation and the contracts void.

The KRG’s position is that first, the general provisions of the constitution allow the KRG autonomy in relation oil and gas law as it is not reserved for the Federal government, and that the specific provisions of Article 112 do not apply for a number of reasons.

The KRG says there were no producing fields in Kurdistan when the constitution came into force in 2006; Article 112(1) relates only to management of petroleum after it is extracted (i.e. in relation to transportation and export); and that Article 112(2) is limited to policy formation in areas such as agreeing production levels in the context of OPEC quotas, rather than regulation and contracting.