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OPEC's second-biggest producer could possibly split in two — and start an oil war

An oil-rich province in the north of Iraq plans to vote in a referendum on Kurdish independence later this month, prompting fears of regional conflict as tensions escalate over who owns a portion of the country's crude.

Kurdish forces have been in complete control of the province of Kirkuk — as well as other disputed areas — since the summer of 2014, when so-called Islamic State swept across parts of Iraq. In addition to being home to much of Iraq's oil, the northern part of the country forms part of Kurdistan, the unofficial but centuries-old home of the Kurdish people. The Kurds have long sought their own state and began to believe it was near their grasp after American troops overthrew Saddam Hussein's Iraqi government in 2003.

Both Iraqi government troops and Kurdish militia forces have fought to drive ISIS out from most of the country during the past two years, but now the long-running dispute between Baghdad and the Kurdish capital of Erbil over who should claim the spoils is sharpening.

Iraqi Kurds celebrate while urging people to vote in the upcoming independence referendum in Arbil, the capital of the autonomous Kurdish region of northern Iraq, on September 8, 2017.
SAFIN HAMED | AFP | Getty Images
Iraqi Kurds celebrate while urging people to vote in the upcoming independence referendum in Arbil, the capital of the autonomous Kurdish region of northern Iraq, on September 8, 2017.

The Sept. 25 referendum is vehemently opposed by Baghdad, with Prime Minister Haider al-Abadi describing the vote as "unconstitutional and illegitimate."

On Tuesday, Iraq's central government authorized the prime minister to "take all measures" to preserve the country's unity. Iraq's Kurdish leader, Massoud Barzani, rejected the notion that the vote endangered the nation's identity and vowed to press ahead with the referendum.

"In Kirkuk especially, Baghdad will not accept a scenario in which all of the territories are annexed," Ayham Kamel, director for Middle East and North Africa at consulting firm Eurasia Group, told CNBC via phone interview.

Regional tension could 'ignite conflict'

More than 6 million Kurds are estimated to live in Iraq — amounting to around 20 percent of the total population — with most situated in the landlocked northern region.

With the 5 million Kurds who are eligible to vote largely united by dreams of self-determination, the outcome appears in little doubt.

The Kurds have been pursuing an independent state since at least the end of World War I, when colonial powers divided up the Middle East, leaving Kurds largely in Iraq, Iran, Turkey and northeastern Syria.

Western governments, including Germany, oppose the referendum, arguing the vote will undermine the fight against ISIS and escalate tensions with Baghdad. But it does have the support of Israel, which regards the Kurds as a buffer against Iran and Arab nations. The United States also opposes the referendum, though the Kurds have been a critical ally for the U.S. going back at least to the Iraq War.

"Regional interference could serve to raise tensions and potentially ignite conflict, rather than dampen down the chances." -Michael Stephens, Research Fellow at RUSI

Opposition to the vote from Iraq's central government in Baghdad has been accentuated by its regional neighbors. Turkey, Syria and Iran are all staunchly against the referendum as they fear a potential contagion effect from their own Kurdish populations.

Michael Stephens, a research fellow at think tank the Royal United Services Institute, argued that Iraq's relationship with its neighboring countries would be complicated "enormously" in the immediate aftermath of the contested referendum.

"I think the instability of this dynamic is particularly worrying, and regional interference could serve to raise tensions and potentially ignite conflict, rather than dampen down the chances," he said.

'Biggest challenge to oil'

Turkish officials have described Kirkuk's decision to hold a referendum as "dangerous" and a violation of Iraq's constitution. Ankara holds close political and economic ties with the Kurdistan Regional Government and appears to have considerable leverage over the area as it remains the only major outlet for Kurdish oil exports.

The decision to hold a vote is a potential powder keg to an already long-running dispute between Baghdad and Erbil over Kurdish oil exports and revenue sharing.

A security guard is seen at the Tawke oil refinery near the village of Zacho, in the autonomous Iraqi region of Kurdistan, on May 31, 2009.
ALI AL-SAADI | AFP | Getty Images
A security guard is seen at the Tawke oil refinery near the village of Zacho, in the autonomous Iraqi region of Kurdistan, on May 31, 2009.

"The relationship between Baghdad and Erbil is the biggest challenge to oil, with the Kurds using this upcoming referendum as a bargaining chip," Renad Mansour, an Iraq expert at London-based think tank Chatham House, told CNBC via phone interview.

"Do I foresee all out conflict? Probably not. The referendum is a bit of a bluff in that sense because the Kurds need the U.S. and the U.K. and a conflict would mean losing this lifeline. I wouldn't rule out skirmishes, but an all-out war is in no-one's best interests," Mansour added.

Iraq is the second largest OPEC producer and currently pumps 4.32 million barrels of oil a day, according to Iraqi Oil Minister Jabar Al-Luaibi.

However, he conceded the government does not have reliable figures for shipments from the country's Kurdish region, which reportedly accounts for around a 10th of the nation's total production.

"In the current oil price environment, the economic foundations for independence look shaky." -Torbjorn Soltvedt, Principal Analyst for MENA at Verisk Maplecroft

"Independent Kurdish oil exports are still a long way off covering what is a very large and expensive public sector. In the current oil price environment, the economic foundations for independence look shaky," Torbjorn Soltvedt, principal analyst for the Middle East and Northern Africa at risk consulting firm Verisk Maplecroft, told CNBC via email.

"It would be wrong to assume, however, that the issue of independence will be governed by economics alone. … In particular, legal challenges from Iraqi courts against independent (Kurdistan Regional Government) crude are still a significant restraint under the Kurdistan Region's current semi-autonomous status," he added.

U.S. oil giant Chevron has been operating in the Kurdistan region of Iraq since it signed an oil agreement with the semiautonomous government in 2012. Baghdad criticized the decision, suggesting any oil firm operating in the northern region of the country without the approval of the central government could be blacklisted.

A Chevron spokesperson told CNBC that it "seeks to work constructively with all stakeholders in any country in which it operates (and) with regards to any referendum, it is a decision to be made by those directly involved."

CNBC contacted several other oil companies operating in Iraq — including Norwegian gas and oil operator DNO, Austria's OMV group and the U.K.'s Gulf Keystone Petroleum company — regarding the extent to which business operations are likely be impacted by the referendum. However, each oil company either declined to comment or were not immediately available.

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