Recently there has been much speculation around the prospects for independent oil exports from the Kurdistan Region of Iraq and the easing of international sanctions against Iran. These events continue to cause uncertainty for international companies and complicate their longer-term business planning. Nearly every major energy company is invested in the outcome of these developments, even if only indirectly through the impact this will have on oil markets and competitive opportunities.
This update focuses on several important considerations for companies producing oil in the Kurdistan Region while sanctions on Iran remain in place. This is an important issue for oil producers given the reports of tanker trucks lining up at the Iraq-Iran border to deliver crude oil and refined products to Iran, and potentially onward to other destinations.
For a discussion of the basis for independent oil exports from the Kurdistan Region through Turkey, please see the article by Richard Devine and Patricia Tiller in the upcoming March 2014 issue of Petroleum Economist. A discussion of the easing of sanctions against Iran can be found in our January Update.
Oil Exports to Iran
Reports on the Kurdistan Regional Government’s ("KRG") exports of crude oil to Iran raise several complex sanctions compliance issues for companies operating in the Kurdistan Region.
Press reports in late 2013 revealed that the KRG has been exporting commercially significant quantities of oil, perhaps as much as 30,000 barrels a day, to Iran’s Bandar Imam Khomeini terminal, likely for onward shipment to Asia. Sources claimed that the petroleum is mainly from the three biggest producing fields in the Kurdistan Region – Taq Taq, Tawke and Khurmala. In August 2013, the KRG announced that it had approved a second route for exports to Iran. In so doing, the KRG seemed to acknowledge what had been a long-standing rumor.
At the same time, press reports also quoted unnamed U.S. State Department officials who were critical of the KRG exports and called on the KRG to stop undermining international sanctions against Iran. These unnamed officials did not address the involvement or liability of any oil companies in such exports, nor did they address any intention to investigate or take enforcement measures. The State Department has said both publicly and informally that the U.S. Government intends, as part of the Group of 5+1 process, to increase enforcement of the sanctions that are not being suspended and that it will not hesitate to make an example of companies that violate the sanctions. This is intended to send a message that companies must remain vigilant in their compliance obligations, assuage domestic critics in the U.S., and hold Iran to its commitments under the Joint Plan of Action with the Group of 5 +1. Whether these warnings of increased enforcement will focus on exports from the Kurdistan Region is unclear. Some speculate that the U.S. Government’s response would be influenced by the sensitive nature of the U.S. - KRG - Iraq relationship and the desire to preserve regional stability and good relations. Moreover, the State Department and OFAC1 are unlikely to clarify uncertainties, in the abstract, around the liability of companies for exports by third parties of oil produced in the Kurdistan Region.
U.S. sanctions regulations impose the strictest standards on U.S. persons2 and entities owned or controlled by U.S. persons. The regulations define “entity” and “owns or controls” broadly.
Specifically, section 204 of the Iranian Transactions and Sanctions Regulations (“ITSR”)3 prohibits the export, re-export, sale, or supply, directly or indirectly, of any goods or services to Iran from the United States or by a United States person, wherever located. This also applies to U.S. owned or controlled entities. OFAC has clarified that prohibited indirect sales to Iran (that is, through a foreign person) include not just those situations where the seller has explicit knowledge the goods are specifically intended for Iran, but also situations where the seller had “reason to know” that the goods are specifically intended for Iran.4
The KRG’s announcements of exports of crude oil to or through Iran raise concerns that OFAC may view these reports as creating a “reason to know” beyond the rumors and unsubstantiated reports of the past. A key and highly fact-specific question will be whether the KRG’s acknowledgments of its export activities create enough “reason to know,” to expose a U.S. person to liability for services provided to or investments in Kurdistan Region oil projects that produce oil that a third party exports to or through Iran.
The State Department has not yet taken an official view of the implications of the KRG’s announcement of Iranian exports. However, at some point, the U.S. Government may decide that these activities give operators and service providers “reason to know,” making them complicit in sanctionable activities. Companies should prepare for a more aggressive enforcement attitude toward these exports if the Group of 5+1 process reaches an impasse and the U.S. moves to re-impose sanctions or heighten enforcement measures.
To address the risks discussed above, U.S. producers5 should, among other things, include provisions in their contracts that prohibit counterparties from engaging in actions that would expose a U.S. person to the risk of a sanctions violation. In addition, U.S. producers should adopt procedures to ensure that in their own transactions they are not selling oil to Iran, transshipping oil through Iran, or delivering oil to an intermediary whom the U.S. producer has reason to know may be selling, delivering or transshipping such oil to or through Iran.
Non U.S. Persons
Non-U.S. persons are also subject to certain U.S. sanctions against Iran,6 which could apply to activities to facilitate oil exports from the Kurdistan Region to Iran. These so-called “secondary sanctions” apply to foreign companies which, among other things, provide (or facilitate the provision of) goods and services that contribute to Iran’s ability to import refined petroleum products or Iran’s domestic production of refined petroleum products. These sanctions also apply to foreign companies which engage in transactions with Iranian entities identified on OFAC’s Specially Designated Nationals and Blocked Persons List, including the National Iranian Oil Company, the National Iranian Tanker Company and the Central Bank of Iran.
The U.S. Government has several other authorities for bringing enforcement actions against non-U.S. persons engaged in transactions that run afoul of secondary sanctions. These include prohibiting sanctioned parties from engaging in export or financial transactions in the U.S. and imposing strict conditions on a non-U.S. financial institution from opening or maintaining U.S. accounts where the financial institution is found to have knowingly engaged in sanctionable activities.7
Despite the growing commercial interest in the possibility of greater participation of the Kurdistan Region and Iran in international oil markets, it is critical to note that existing U.S. sanctions and trade controls remain firmly in place. Those who intentionally or unintentionally become part of a petroleum value chain that involves Iran remain at risk of violating U.S. sanctions and subjecting themselves to significant penalties. As the year progresses, it is anticipated that production in the Kurdistan Region will increase. Whether Iran and the Group of 5+1 make further progress toward easing of sanctions is far less foreseeable, and contingency planning should factor in a high probability of diplomatic setbacks and threats to ratchet up sanctions. The unwary and reckless may look for a quick fix to get their crude oil to market, but best practices require a more diligent and cautious approach.
1The Office of Foreign Assets Control of the U.S. Department of the Treasury.
2The term United States person means any United States citizen, permanent resident alien, entity organized under the laws of the United States or any jurisdiction within the United States (including foreign branches), or person in the United States.
331 C.F.R. Part 560.
4Office of Foreign Assets Control, Guidance on Transshipments to Iran (Jul. 22, 2002), available here.
5e.g. U.S. persons producing oil in the Kurdistan Region.
6The Iran Threat Reduction and Syria Human Rights Act (“ITRA”) expands the jurisdictional reach of U.S. sanctions to entities that are owned or controlled by U.S. persons, including foreign subsidiaries of U.S. companies.
7Comprehensive Iran Sanctions, Accountability, and Divestment Act of 2010 (“CISADA”), Section 104. Executive Order 13622, issued by President Obama on July 30, 2012 imposes similar prohibitions available under CISADA for a non-U.S. financial institution’s knowing transactions with the National Iranian Oil Company (“NIOC”) or Naftiran Intertrade Company (“NICO”).