In the weeks before Iraqi Kurdistan revealed that Exxon Mobil had signed up to explore for oil there, executives at rival Shell faced a dilemma over whether or not to join the U.S. oil major in its foray north and risk angering Baghdad.
The fields in the autonomous region offered rich potential, an easier working environment, better security and attractive contracts. That seemed a winning combination for smaller oil companies already working there, such as Norway's DNO, even though they struggled to collect profits.
But at the 11th hour, industry sources say, Royal Dutch Shell backed out and decided to focus on a $17 billion gas deal in the south rather than sign exploration contracts with the Kurdish Regional Government, which the central government could dismiss as illegal and could prompt reprisals.
Shell's caution, Exxon's silence on its deals and this week's renewed dispute between Baghdad and Kurdistan over export payments reveal how delicate is the balance companies must manage between a central government and a Kurdish authority locked in a struggle over who controls Iraq's vast oil wealth.
The dispute over oil is at the heart of a wider disagreement between Iraq's central government in Baghdad and the Kurdish region, which are also increasingly at odds over regional autonomy, land and political influence.
Iraq has ambitious plans to develop its huge southern oilfields - potentially the world's biggest source of new oil over the next few years - and few oil firms dare risk being barred from such a bonanza by angering Baghdad.
But increasingly, some executives say, Kurdistan's potential is also coming up in boardroom discussions, as sluggish output, red tape and infrastructure bottlenecks in the south take some of the shine off the central government's oil program.
Oil majors are now waiting on the sidelines, watching the outcome of Exxon's balancing act between Baghdad and Arbil, the northern capital. France's Total is the latest company to provoke Baghdad's ire by acknowledging interest in Kurdistan.
"What companies are trying to do is get to the point where they are investing in the north and the south," said one industry source working in Iraq. "But at the moment they cannot do that. And that is what you have to build in when you decide whether to move in or not. You balance the risks."
After decades of war and sanctions, Iraq has signed multi-billion dollar agreements with Exxon, Shell and BP to develop fields in the south where most of its crude is pumped, hoping to become a major global oil exporter with output targets of around 8-8.5 million bpd.
But two years on, only modest gains have so far been notched up in production by companies frustrated by infrastructure constraints, payment disputes and logistical hurdles. Output last year averaged 2.7 million barrels per day versus about 2.4 million bpd in 2009, the year of Iraq's oil tenders.
The government in Baghdad has driven a tough bargain with foreign companies, offering fee-for-service contracts with tightly controlled profit margins and little chance to benefit from high energy prices.
Firms have experienced problems getting visas for contractors and security staff, delays in bringing in armored vehicles and holdups securing operating licenses. Such hassles make Kurdistan's offerings look more tempting by comparison.
"Every delay we face cuts off a significant part of the internal rate of return," said one oil company source. "Sometimes I wonder if we picked the wrong region."
This year Norway's Statoil became the first major company to abandon one of Iraq's lucrative new oil deals, selling its stake in West Qurna Phase-2 field to Lukoil.
The renewed stand-off between Baghdad and Arbil over oil is playing out against the background of a political crisis in Baghdad that jeopardized the shaky power-sharing agreement intended to prevent a return to ethnic and sectarian warfare.
Prime Minister Nuri al-Maliki, a Shi'ite, heads a coalition that also includes Kurds and Sunnis. Just as the last U.S. troops left the country in December, Maliki's government issued an arrest warrant for the country's most senior Sunni Arab politician, Vice President Tareq al-Hashemi.
Hashemi fled to the Kurdish region, and Kurdish regional President Masoud Barzani refused to turn him over for trial, infuriating Baghdad.
Barzani has since given speeches increasingly antagonistic to a central government he says is trying to undermine Kurdish autonomy. He has accused Maliki of concentrating power in his own hands, and has warned in vague terms that Kurdistan may reconsider its relations with Baghdad.
Iraq's central government is also being challenged by other regions like oil hub Basra in the south and Sunni-dominated Anbar who see Kurdistan's autonomous status as a model for their own drives for more freedom from Baghdad's control.
Autonomous since 1991, Iraqi Kurdistan runs its own internal government and armed forces, and escaped the sectarian warfare that saw the rest of Iraq hit by suicide attacks and car bombs since the 2003 U.S.-led invasion.
Kurdistan's stability proved an attractive draw to oil explorers, and its government has offered production-sharing deals, which allow firms to profit directly from oil sales rather than just taking a negotiated fee for their work.
Small and medium-sized companies like DNO, British oil company Afren, Gulf Keystone Petroleum and Canada's Talisman Energy, are pushing ahead with exploration in Kurdish oilfields.
Peter Wells of geological consultancy Neftex Petroleum said Baghdad's service contracts make sense for developing existing, discovered oilfields with only small technical risk attached. Arbil's production-sharing contracts encourage exploration, by offering greater potential gains for greater risk.
Big Oil prefers the production sharing deals, which let firms count reserves on their books, make more money per barrel and gain if the oil price rises. They get operational control and an easily tradeable asset.
"Put it this way: they want us in Kurdistan," says one oil executive. "But it doesn't feel that way in the south."
CATALYST FOR ACCORD
But however attractive Kurdistan may seem, companies operating there face one fundamental challenge: getting paid.
The Kurds receive 17 percent of Iraq's total oil export revenue - a huge sum that has fuelled an economic boom in the region - but in return, Kurdish oil can be legally exported only by the central government.
As long as the legal status of Kurdish oil deals is disputed in Baghdad, companies operating in Kurdistan have had no way to bring oil to market and collect a profit.
Under the Iraqi constitution, the central and regional governments should work together on ways to manage oil and gas reserves and distribute revenues. But Kurdish and Arab lawmakers in Baghdad have been at loggerheads for years over an oil and gas law to sort those issues out.
Exports from the north to a pipeline through Turkey began flowing last year under an interim agreement. Baghdad promised to collect revenue and pay companies their costs, leaving the question of firms' profits to be decided later.
But Baghdad and Arbil argued from the outset over how much oil was being pumped and how much money was owed.
This week, Kurdistan said it had halted those exports because Baghdad had failed to pay the companies for their oil. Iraqi government officials said Kurdistan was failing to meet its export obligations and illegally smuggling oil abroad.
Oil firms may have hoped that Exxon's push into Kurdistan would act as a catalyst to force the two sides to work together and enact an oil law. But for now, the increasingly shrill rhetoric on both sides hardly inspires confidence that a solution is growing closer.
When Kurdistan's government announced last year that Exxon had agreed to exploration deals for six Kurdish fields, Baghdad responded with outrage. Deputy Prime Minister Hussain al-Shahristani - architect of Baghdad's oil program - said the U.S. firm could forfeit the contract on its huge West Qurna-1 oilfield in the south if it did not halt work with the Kurds.
Baghdad has since barred Exxon from bidding in the next round of oil deals, although it says the decision is not final. Exxon was also removed from its lead role in a water injection project in the south, although Iraqi officials denied the move was linked to the Kurdish deal.
The central government now says that Exxon has written to it twice since early March to say that its deals with the Kurds have been suspended. The Kurds say Exxon has not halted work in Kurdistan and have challenged Baghdad to publish Exxon's letters.
Total has become the second supermajor to say it is considering investing in Kurdistan, although it has not yet announced deals there. Chief executive Christophe de Margerie, long a critic of Iraq's service contracts, said Total will not seek deals in the central government's next bidding round.
The conditions on offer from Baghdad, he says, are not attractive enough.
(Editing by Peter Graff)