By Joseph Bentley and Alexander Botashev
In a long-awaited decision, the Tribunal in a Paris-seated ICC arbitration has ordered the Republic of Turkey (Turkey) to pay the Republic of Iraq (Iraq) approximately USD 1.5bn and to suspend the loading and export of crude oil from Kurdistan transported through the Iraq-Turkey Pipeline (ITP).
The Tribunal’s award, handed down nearly nine years after Iraq started the arbitration in May 2014, comes as a further potential blow to Kurdistan’s independent oil and gas sector following the Federal Supreme Court of Iraq’s decision in February 2022, on which we reported here.
In response to the decision, Turkey has now suspended the transportation of all crude oil, both Iraqi and Kurdish, through the ITP, halting the flow of around 450,000 barrels a day (comprising some 0.5% of global oil supply), and putting pressure on both local and global supplies. It follows that, while the Tribunal’s award has resolved the legal dispute between Iraq and Turkey, a number of practical issues arise.
In this briefing, we consider the background to the arbitration, the reasons for the Tribunal’s decision and the wider implications for the Kurdish oil and gas industry and international oil and gas companies (IOCs) with investments in Kurdistan.
Background to the ITP arbitration
As explained in our earlier article, there is a long-standing constitutional disagreement between the Kurdistan Regional Government (KRG) and the Federal Government of Iraq (FGI). In February 2022, the Federal Supreme Court of Iraq resolved that dispute in the FGI’s favour, holding that oil and gas in Iraq is held on behalf of all Iraqi people equally, and revenues from the sale of that oil and gas (wherever it is found in Iraq, including Kurdistan) must be fairly distributed by the FGI (via Iraq’s Ministry of Oil and its State Oil Marketing Organisation (SOMO)).
However, in 1973, long before enactment of the Constitution of the Republic of Iraq in 2005 and the resulting dispute between the FGI and KRG, Turkey and Iraq entered into a Crude Oil Pipeline Agreement, amended and supplemented on a number of occasions since, known as the Iraq-Turkey Pipeline Agreement (the ITP Agreement).
Under the ITP Agreement, Turkey and Iraq agreed to construct two oil pipelines, the first a 40-inch pipeline (coming into operation in 1977) and the second a 46-inch pipeline (coming into operation in 1987), from the Kirkuk oil fields on the border of the semi-autonomous region of Kurdistan to Ceyhan in southern Turkey (which together form the ITP), from where it could be exported overseas. In addition to the ITP itself, storage and loading facilities were built at Ceyhan.
In 2010, Iraq and Turkey agreed an amendment to the ITP Agreement which reaffirmed that the ITP and its associated facilities in Ceyhan would be used exclusively for the transport, storage and loading of Iraq’s crude oil (the 2010 Amendment). At the time, the 40-inch pipeline was not operational because damage suffered in 1997 had yet to be repaired and Iraq had proved unable to meet its minimum guaranteed throughput obligations under the ITP Agreement. The 2010 Amendment therefore (temporarily) relaxed Iraq’s throughput obligations and established a new dispute resolution procedure under the ITP Agreement by providing for disputes to be resolved via ICC arbitration in Paris, governed by French law.
In September 2013, the KRG built a spur linking three of its major fields to the ITP’s 40-inch pipeline, thereby allowing the export of its crude directly to Turkey via Ceyhan and onwards into international markets (primarily, Europe or Asia). The FGI objected to the KRG’s actions on the basis that, in its view, the KRG had no authority to export and market oil from Kurdistan without licence from Iraq’s Ministry of Oil.
Notwithstanding the FGI’s protests, the KRG entered into an energy framework agreement with BOTAŞ which provided for the transportation of oil from Kurdistan through the ITP spur. Since then, the ITP has been used regularly to transport oil from Kurdistan into Turkey where it is stored in the facilities at Ceyhan, loaded onto ships and exported around the world.
In February 2014, the Iraqi Ministry of Oil reacted by instructing BOTAŞ (via SOMO) to cease transportation of Kurdish crude oil and to close the Turkish part of the ITP’s 40-inch pipeline. BOTAŞ’s response was that it had no control over the oil that entered the ITP from the Iraqi side and that SOMO had in any event failed to fulfil Iraq’s guaranteed throughput obligations under the ITP Agreement. On 23 May 2014, two days after oil from Kurdistan transported through the ITP was first loaded onto a tanker at Ceyhan, Iraq lodged a request for arbitration, alleging that Turkey had (through BOTAŞ) breached its obligations under the ITP Agreement by facilitating Kurdish oil exports without its consent. In the arbitration, Iraq ultimately claimed approximately USD 30bn in compensation between 2014 and 2018 (having started a second arbitration under the ITP Agreement in relation to the period from 2018 onwards).
Shortly afterwards, the Islamic State’s incursion in June 2014 led to improving ties between the FGI and KRG, notwithstanding that control of Kirkuk, the super-field which straddles the border between Iraq and Kurdistan, changed hands several times before the FGI took control following Kurdistan’s referendum in 2017. Nonetheless, despite a series of incidents, discussed in our previous article, during which tensions between the FGI and KRG rose and fell, the arbitration between Iraq and Turkey continued in the background.
The ITP Arbitration
The key issue before the Tribunal was whether Turkey’s conduct constituted a breach of the ITP Agreement.
Neither party disputed that: (i) Turkey was required to facilitate the transit, loading and export of crude oil coming from Iraq in accordance with the instructions and requirements of the Iraqi side; and (ii) Turkey had in fact transported, stored and loaded oil from Kurdistan using the ITP facilities on the KRG's instructions, contrary to the Iraqi Ministry of Oil's instructions, since December 2013.
Overview of Iraq's position
Iraq brought five primary claims under the ITP Agreement, as follows.
Iraq claimed that Turkey had breached the ITP Agreement in three distinct ways by: (1) transporting crude oil from Kurdistan; (2) storing that crude oil in the storage facilities in Ceyhan; and (3) loading that crude oil onto tankers docked at Ceyhan, contrary to the Iraqi Ministry of Oil’s express instructions.
In relation to Iraq’s transport and storage claims, the Tribunal found that Turkey had not breached its obligations under the ITP. Although the Iraqi Ministry of Oil had (through SOMO) issued a number of instructions to Turkey to cease transportation and storage of oil from Kurdistan, the Tribunal held that these instructions were neither realistic nor legitimate, not only in a practical sense (once the oil was pumped into the pipeline via the ITP spur outside of Turkey’s borders, it was unclear as to how Turkey could stop it) but also because they were inconsistent with the overarching purpose of the ITP Agreement, namely, the transportation and storage of oil from Iraq.
However, the Tribunal found that Turkey had breached its obligations in relation to the loading and export of the oil. Under the ITP Agreement, the loading and export of “Iraqi oil” (held by the Tribunal to include oil pumped into the ITP by Kurdish authorities) could only take place pursuant to the instructions of the Iraqi Ministry of Oil (through SOMO). Accordingly, loading Iraqi oil (whether delivered by the KRG or FGI) on the instruction of anyone else was a breach of the ITP Agreement, and inconsistent with the Iraqi Ministry of Oil’s instructions to hold all Iraqi oil in the storage facilities to its order and cease the practice of exporting Kurdish oil without instruction from the FGI.
Turkey raised several defences to Iraq’s claims, targeting the validity of Iraq’s instructions, one of which was that the FGI was not the true ‘custodian’ of the oil because the KRG disputed Iraq’s right to sell or dispose of oil from Kurdistan. In response, Iraq argued that the Federal Supreme Court’s decision on February 2022 was fatal to Turkey’s position, because it had (in effect) uprooted the foundation of Kurdistan’s independent oil and gas sector.
The Tribunal declined to comment on Iraq’s constitutional affairs, focusing instead on the fact that the ITP Agreement referred to “all crude oil coming from Iraq” – whoever ‘owned’ the oil in question was irrelevant: it was ‘oil coming from Iraq’ and its loading and export was therefore subject to the instruction of the Iraqi Ministry of Oil.
Iraq made two further claims that Turkey had breached its obligations under the ITP Agreement, namely that: (4) the ITP Agreement conferred ‘exclusive use’ of the ITP on Iraq and Turkey (and, therefore, by implication, not the KRG); and (5) Turkey had prevented access to the port at Ceyhan for Iraqi officials. The Tribunal dismissed Iraq’s claim as to exclusive use on the basis that the ITP Agreement only referred to ‘oil coming from Iraq’, which included oil pumped by the KRG. The Tribunal upheld the access claim in part, finding that Iraqi personnel were denied access for the short period between January and March 2014.
In finding that Turkey had breached its obligations as to loading under the ITP Agreement, the Tribunal held that Turkey was liable to pay Iraq almost USD 2bn.
Overview of Turkey’s position
Turkey raised a number of ‘affirmative defences’, centred on claims that Iraq had acted in breach of the ITP Agreement, entitling Turkey to withhold or suspend performance of its obligations.
Turkey alleged that Iraq had breached its obligations under the ITP Agreement to: (i) operate and maintain its section of the ITP, because the 40-inch pipeline had been damaged in 1997 and was inoperable at the time of the KRG’s spur in 2013; and (ii) meet the minimum guaranteed throughput volumes and related payment obligations. Turkey also argued that an event of force majeure, in the form of damage caused to the ITP due to bombing of the 46-inch pipeline during Islamic State’s incursion, had in effect suspended both parties’ obligations.
Turkey relied on two equivalent doctrines, one under French law and one under international law, referred to respectively as: (i) “exception d’inexecution”; and (ii) “exception non adimpleti contractus”. The essential tenet of both principles is that, where the parties’ obligations are reciprocal, synallagmatic and interdependent, a party may be entitled to withhold performance if the other party fails to perform.
The Tribunal found that the application of either doctrine would lead to the same conclusion. A non-breaching party can only rely on these principles if it comes with ‘clean hands’. As Turkey had repeatedly reassured Iraq that it would not load oil from Kurdistan on the KRG’s instructions, but then did so, it could not in good faith rely on Iraq’s alleged inability to transport oil through the damaged ITP as grounds for not performing its obligations (particularly as Turkey knew of the damage suffered in 1997 and discussed it with Iraq during the 2010 Amendment negotiations).
Moreover, in relation to Iraq’s minimum guaranteed throughput obligations under the ITP Agreement, the 2010 Amendment provided for a specific remedy whereby if Iraq did not pump the specified amount, it would have to pay transportation fees to Turkey. Turkey could not therefore suspend its obligations on account of Iraq’s non-performance because the parties had anticipated the circumstances of and remedy for the breach in question.
The Tribunal also dismissed Turkey’s argument of force majeure as an affirmative defence on the basis that, notwithstanding the damage caused to the 46-inch pipeline in 2014, crude oil from Iraq continued to flow through the ITP during the period in question and performance was therefore evidently possible. The Tribunal did however consider that a situation of force majeure existed in Iraq between 1 March 2003 and 31 July 2007, such that Iraq should be excused from complying with its minimum guaranteed throughput between these dates.
Nonetheless, although the Tribunal dismissed Turkey’s affirmative defences, it upheld Turkey’s counterclaims, finding that Iraq had failed to meet its minimum guaranteed throughput obligations under the ITP Agreement and ordering Iraq to pay around USD 527m (plus interest) in respect of minimum guaranteed throughput fees, transportation charges and costs reimbursement costs, as provided for in the 2010 Amendment.
Implications of the Tribunal’s decision
Both parties have since claimed victory. Fundamentally, the Tribunal found that Turkey is not entitled to load or export oil from Kurdistan in a manner inconsistent with instructions from the Iraqi Ministry of Oil, and the decision therefore represents something of a win for Iraq. For Turkey, however, its successful counterclaims, Iraq’s failure to win three of five of its claims, and the reduction in the amount demanded by Iraq (at one stage around USD 30bn) represents significant success. Moreover, as Turkey’s counterclaims relate to failures in terms of Iraq’s throughout obligations dating from the 1990s, and attract compounded US dollar denominated interest, any payment to Iraq may ultimately be substantially less than the value of the award.
Nonetheless, in terms of immediate impact, the award has prompted the suspension of crude oil exports through the ITP Pipeline, which has in turn put upwards pressure on international oil prices and caused further strains in regional relations. At the time of writing, oil is yet to resume flowing through the ITP, despite the FGI and KRG appearing to reach an agreement that would allow for the resumption of northern oil exports through the ITP, with Turkey citing technical issues for the continue outage.
While the cessation of oil exports through the ITP affects Iraq to some extent, it represents a blow to the Kurdish oil and gas sector, still feeling the impact of the Federal Supreme Court of Iraq’s decision which led to the departure of a number of IOCs last year in the face of pressure from the FGI. The KRG used the ITP spur to export around 375,000 barrels per day, representing a very considerable proportion of the KRG’s total revenues. In addition, because the 2013 energy framework agreement between the KRG and BOTAŞ contains an indemnity clause, Turkey may seek to recover any payment it makes to Iraq in relation to the award from the KRG.
In terms of wider implications, the shutdown and resulting reduction in revenue has caused the KRG difficulties in making repayments to oil traders and has affected relations with those IOCs still operating in Kurdistan (few and far between following the Federal Supreme Court of Iraq’s decision last year and the FGI’s threats of litigation). In addition, the outcome of the arbitration is ultimately likely to increase the risk of investing and operating in Kurdistan because the dynamic between the KRG and its key customer, Turkey, appears to have shifted fundamentally. Although the underlying dispute was between Iraq and Turkey, it is therefore Kurdistan and those operating within it that are likely to suffer the effects.
While there has always been risk surrounding Kurdish PSCs due to question marks over their constitutional validity (now seemingly resolved in Iraq’s favour), the ITP outage puts relations between IOCs and the KRG under additional strain, affecting the revenues of all parties and increasing the risk of disputes between IOCs and the KRG and between IOCs and Turkey (and perhaps Iraq) under applicable investment treaties. It follows that, while the Tribunal has now finally settled the dispute under the ITP Agreement, it remains unclear how regional politics and commercial realities will play out in terms of the vast resources that lie below the border of Iraq and Kurdistan.