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China Makes A Move On OPEC's No.2

Simon Watkins

Following a political backlash in Iran over details of its plans to make Iran effectively a client state through various multi-layered oil and gas deals, China has switched its attention – for the time being at least – to Iran’s equally oil and gas-rich neighbor, Iraq. China has the advantage in Iraq that the northern part of the country – the semi-autonomous region of Kurdistan – is already under the control of its increasingly close ally, Russia, with its corporate proxy Rosneft having secured control over Kurdistan’s oil and gas infrastructure in a deal in November 2017.

Bridging this gap beautifully is the new development that in the long-running dispute between the south and the north regarding budget disbursements from Baghdad to Erbil in exchange for oil supplies from Erbil to Baghdad, China is to be appointed by Baghdad as its mediator in negotiations, a senior source who works closely with Iraq’s Oil Ministry told OilPrice.com last week.

As it was, the negotiations between Baghdad and Erbil over the budget-for-oil deal have been going nowhere and have been in a constant state of flux ever since the original deal was struck back in 2014. This deal involved the government of the Kurdistan region of Iraq (the KRG) agreeing to export up to 550,000 barrels per day (bpd) of oil from its own fields and those in and around Kirkuk via Baghdad’s State Oil Marketing Organization (SOMO). In return, Baghdad would send 17 percent of the federal budget after sovereign expenses per month in budget payments to the KRG. This agreement was superseded by another in October 2018 that required Baghdad to transfer sufficient funds from the budget to pay the salaries of KRG employees in exchange for the KRG handing over the export of at least 250,000 bpd of crude oil to SOMO. Since the beginning of this year, Baghdad has purportedly delivered on its side but the KRG has not.

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The sticking point from the KRG side has been the changing metric that Baghdad sought to impose for determining the budget disbursement levels following the independence referendum held in Kurdistan in September 2017. Although from the legal perspective the vote was not mandatory, the overwhelming support for independence – well over 90 percent of the Kurdish population in the north – catalyzed popular support against Baghdad until it was quelled, with the help of Iran. At that point, Baghdad took back on-the-ground control over the Kirkuk and surrounding fields and only held off from further expanding its military footprint across the KRG area because the U.S. signaled that this would not be a welcome development.

The U.S. did this because it had promised that the Kurds in Iraq would be given their independence within the next two to three years as a reward for their being the West’s boots on the ground in the fight against Islamic State: that was the deal. Events in the last week, however, with Trump opening the way for the annihilation of various Kurdish populations by the Turkish Army – which regards them as terrorists – have allowed Baghdad as well to take a less conciliatory tone in its dealings with Erbil.

Consequently, Baghdad has withdrawn even the much worse offer that was on the table – that had already been rejected by Erbil – in favor of allowing the Chinese government, through its own corporate proxy, China National Petroleum Corporation – to act as its intermediary in these budget-for-oil deal negotiations with the KRG. The previous deal on offer was that rather than the previous 17 percent share of Baghdad’s budget in exchange for a full quota of oil coming from the KRG, Baghdad would offer 12.67 percent. Baghdad said this figure was more in line with the percentage population of the KRG area in Iraq as a whole. “Basically, this deal will involve the Chinese doing a deal with the Russians and bribing the Barzanis to accept whatever deal is agreed between Beijing and Moscow,” said the Iraq source.

For China, given that it has temporarily had to shelve its plans for Iran due to a backlash in Tehran over various media revelations about the devil in the details – many of them exclusively appearing on OilPrice.com before they were further syndicated – regards Iraq as a worthy stand-in for the time being, both in terms of its massive oil and gas reserves and its geographical position. “A deal would have had to have been done with Iraq anyway in order for China to put into place the planned Middle East section of its ‘One Belt, One Road’ strategy, so this problem with Iran has just meant that Beijing has had to change the order of the deals,” the Iraq source told OilPrice.com.

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“If you do a deal with Iraq, you are basically signaling your ongoing intentions to Iran as well, given the enormous economic, political, and military power then Tehran wields over Baghdad, and securing Iraq and Iran means that China will have a direct route for its ‘One Belt, One Road’ project into Europe, via both Turkey and the FSU [Former Soviet Union] states and then Russia,” the Iraq source added.

The Iraq deal that China is working on is similar in tone and range to that which had been accepted by Iran as part of the 25-year deal signed between Iran and China recently. In addition to being granted huge reductions on buying Iranian oil and gas, China would have been given the opportunity to build factories in Iran – and build-out infrastructure, such as railways - overseen by its own management staff from Chinese companies, that had the same operational structure and assembly lines as those in China, but utilising the currently cheap labour available in Iran. The deal on the table for Baghdad, according to the Iraq source, is remarkably similar, centered initially on Chinese companies undertaking various projects in Iraq in exchange for China receiving at least 100,000 bpd of oil from Iraq. This amount, when added to the current amount being exported to China, would mean that around 30 percent of Iraq’s total oil production will be going to Beijing.

This ‘oil for construction’ deal was agreed in broad terms last September during a visit by Iraq’s Prime Minister Adel Abdul Mahdi to Beijing, with the purpose of expanding China’s then US$20 billion of investment in Iraq at that point, in addition to the US$30 billion or so in annual trade between the two countries. It also follows the signing in 2015 by Abdul Mahdi - who was then Oil Minister – of Iraq’s agreement to be part of the ‘One Belt, One Road’ initiative. Completing the circle – and the temporal reordering of Iran first, then Iraq – is that many of these Chinese projects will relate to Iraq’s transport infrastructure, including railways, ports, and airports, the Iraq source concluded.

By Simon Watkins for Oilprice.com

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