Federalism in Iraq Could Be a Gusher for Oil

The new Hunt Oil deal suggests de facto regionalism is the reality on the ground.
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Sen. Joe Biden (D., Del.) has been hocking his federalist solution to Iraq on the campaign trail, in the media and among his Senate colleagues. The nonbinding resolution calls for an Iraq policy that supports stronger regional governments along sectarian lines, limiting the role of a central government to defense and division of oil revenue, and abiding the constitution already in place. The plan, which the Bush administration has rejected, may be voted on as early as today.

Several factors suggest federalism may be the natural course of events in Iraq regardless of a change in policy in Washington. The most intriguing is a new oil deal between the Kurdistan Regional Government, or KRG, and Texas-based Hunt Oil. The environment for investing appears to have improved in the Kurdish northern regions, but questions remain unanswered in the south -- where most Iraqi oil reserves are.

Oil-sharing legislation is the lynchpin that all sides have been awaiting to facilitate Iraqi political reconciliation. Hussain Ibrahim Saleh al-Shahristani, Iraq's oil minister, negotiated an accord and announced it in August with much fanfare. It was briefly hailed as "positive" news in the run-up to Gen. David Petraeus' recent report to Congress regarding the state of affairs in Iraq. The Iraqi National Assembly, however, seems unlikely to pass any legislation and rarely can manage even a quorum.

Recent events in Kurdistan further undermine the national accord. The KRG passed its own version of the oil bill earlier this year showing symbolic independence. The KRG predicated its agreement with Hunt Oil on the new law and has expressed its displeasure with the gridlock in Baghdad. Ashti Hawrami, KRG's minister of natural resources, said in a statement that the deal demonstrates "a supportive and transparent business environment which promotes investment by international oil companies in our region for the benefit of all."

One of a Kind

The Hunt deal is the first of its kind. According to both parties, it was negotiated in secret without the knowledge of Iraqi or the U.S. government. The deal involves drilling in only a portion of the Jabal Kand area of the Dihok region. Although it is a relatively small deal, analysts at

Energy Intelligence -- a private publisher of energy reports such as the Energy Compass -- expect other independents to follow suit. Rumors surround

Pioneer Natural Resources

(PXD) - Get Report

, which denies interest in a deal. Al-Shahristani, however, has stated unequivocally that the Hunt contract is null and void because it lacks the central government's approval.

The Bush administration has vocally supported the central government and Prime Minister Nuri al-Maliki. But the White House and State Department have made no public comment on the Hunt oil deal or its political implications. The State Department has an official policy to discourage such agreements. For example,

Marathon Oil's

(MRO) - Get Report

deal to acquire

Western Oil Sands

(WTOIF)

remains contingent on the spinoff of Western's Kurdish division in order to conform with the State Department's policy.

Hunt Oil is the most intriguing piece in this puzzle. Hunt is an independent oil company based in Texas that has a history of taking risks, with its first foreign success coming in Yemen in 1984.

Its CEO, Ray L. Hunt, has ties to President Bush. According to the

Center for Responsive Politics database, Hunt has made significant contributions to both the Republican National Committee and Bush's presidential runs in 2000 and 2004. He was named to the president's Foreign Advisory Board after 9/11.

The logical assumption is that Hunt Oil has not naively rushed into a bad deal. Greg Priddy, an analyst on transnational oil with the

Eurasia Group, says the accord "reflects the reality on the ground in Kurdistan." Priddy noted: "There's a 70,000-strong militia force, a stable political environment and opportunities for the smaller players."

The most important point Priddy makes is that the industry no longer feels a "dilemma of offending the central government in Baghdad." This is a good sign for economic development in the north for the Kurds. The environment, however, in Baghdad and southern Iraq preclude the major players. Energy Intelligence analysts Paul Merolli and Ruba Husari say companies such as

Chevron

(CVX) - Get Report

,

Conoco

(COP) - Get Report

and

ExxonMobil

(XOM) - Get Report

, nevertheless, look to big opportunities in the south. But security remains a big concern for corporations operating in Iraq, and lack of a federal oil law has held up contracts.

Sectarian Head Winds

Other factors also lead to a federalist reality. Sectarian violence forces

100,000 Iraqis from their homes each month. Baghdad has seen incredible population shifts in the last several years. Before the U.S. invasion, the capital was 65% Sunni and was an integrated city of both Sunnis and Shia. But after 4 1/2 years of violence, 75% of Baghdad's population are Shia. A

recent analysis by the National Intelligence Estimate suggests the recent downtick in violence reflects the reality of this trend and segregated neighborhoods.

Some reports suggest violence hasn't been reduced in Iraq.

The Bush administration has embraced a more regional solution to security during the recent "surge." Much has been made of our joining forces with Sunni militias to try and reduce the influence of Al-Qaeda in Iraq -- AQI. According to the administration, success against AQI has been made, but it is not clear if this regional model of security can be replicated in other areas.

Finally, Iraqis have a national identity. The unity has been tested by sectarian violence and a winner-take-all mentality. The Shias saw themselves as winners following the fall of Saddam Hussein, who was a Sunni. The problem clearly lies in getting all sides to come together and agree without one of the factions perceiving it has lost. Perhaps a looser federalist state will accomplish this goal.

Biden's prescience on Iraq shows he understands the reality on the ground. The Bush administration has high hopes for a regional solution to security, but the greater question is how long it will be before the administration wises up and works toward U.S. withdrawal from Iraq.