Iraqi Kurdistan: Construction Over Energy

BMI View: The Iraqi semi-autonomous Kurdistan region will outshine the rest of the country in terms of investment potential over the next few years. The construction sector will outperform the energy industry, as the ongoing dispute over oil revenues with Baghdad increases risks for oil companies.

The Iraqi semi-autonomous Kurdistan region will continue to attract significant investment over the coming years, outperforming the rest of the country. There are currently approximately USD46bn worth of projects planned or under way, particularly in the energy, construction, tourism and infrastructure sectors, making the region one of the most dynamic projects markets in the Middle east and North Africa.

A host of factors make Iraqi Kurdistan attractive to investment. For one, the legal framework is friendlier to foreign companies compared to the rest of Iraq. Under the Kurdistan Regional Government's (KRG) 2006 investment law, foreigners are allowed to own land for the purpose of housing projects, which is not permitted in the area administered by the federal government. Legislation also ensures equal treatment of foreign and local investors, and no restrictions on capital movement. Finally, the KRG guarantees a 10-year tax break for new investors. Although we expect Baghdad to attempt to improve the business environment in areas it directly administers over the next few years, bureaucratic bottlenecks and the slow political process will in our view impede a catch up with the KRG.

Outperforming The Rest
Iraq - Governorates, Iraqi Kurdistan in Darker Shade

Iraqi Kurdistan: Construction Over Energy

BMI View: The Iraqi semi-autonomous Kurdistan region will outshine the rest of the country in terms of investment potential over the next few years. The construction sector will outperform the energy industry, as the ongoing dispute over oil revenues with Baghdad increases risks for oil companies.

The Iraqi semi-autonomous Kurdistan region will continue to attract significant investment over the coming years, outperforming the rest of the country. There are currently approximately USD46bn worth of projects planned or under way, particularly in the energy, construction, tourism and infrastructure sectors, making the region one of the most dynamic projects markets in the Middle east and North Africa.

Outperforming The Rest
Iraq - Governorates, Iraqi Kurdistan in Darker Shade

A host of factors make Iraqi Kurdistan attractive to investment. For one, the legal framework is friendlier to foreign companies compared to the rest of Iraq. Under the Kurdistan Regional Government's (KRG) 2006 investment law, foreigners are allowed to own land for the purpose of housing projects, which is not permitted in the area administered by the federal government. Legislation also ensures equal treatment of foreign and local investors, and no restrictions on capital movement. Finally, the KRG guarantees a 10-year tax break for new investors. Although we expect Baghdad to attempt to improve the business environment in areas it directly administers over the next few years, bureaucratic bottlenecks and the slow political process will in our view impede a catch up with the KRG.

The security situation in the semi-autonomous Kurdistan is also significantly more stable compared to the rest of the country, largely because sectarian divisions are much less pronounced. Close to 4,500 US soldiers were killed in non-Kurdish areas of Iraq between 2003 and 2011, while no Western coalition soldier died in the KRG. The Kurdish security forces' headquarters in the regional capital Erbil was the target of a successful suicide attack in September 2013. However, this was the first major attack in the region since 2007, which stands in contrast with near-daily violence in Baghdad, Mosul, Kirkuk and the Anbar province.

Finally, effective institutions have shielded investors from an ongoing political stalemate in the region, with no government having yet been formed despite regional elections having taken place in September 2013. Conversely, the slow political process will continue to damage investment in areas administered by the federal government.

Growth Robust Over the Medium Term
Iraq - Components Of GDP, IQDtrn & Real GDP Growth, % chg y-o-y

In terms of the economy, real GDP growth reportedly expanded by 12.0% in 2012, compared to growth of 8.4% in the entire country. The KRG's Ministry of Planning is targeting 8% annual GDP growth through 2016, a target which we believe to be realistic (and largely in line with our forecasts for Iraq). Importantly, Iraqi Kurdistan has a population of approximately 6.5mn people, much smaller compared to a Kurdish Diaspora estimated at approximately 35mn people. Since the KRG is the political entity with the highest degree of stability and independence among those populated in majority by Kurds in the world, the diaspora will remain a key source of investment and tourism over the next decade. This will provide a significant cushion against the potential for increasing political risks in Iraq over the next few years.

Foreign Investment To Increase Further

There are reportedly 2,724 foreign companies and 17,160 Kurdish companies in total operating in the autonomous enclave, with major local companies such as Faruk Group, KAR Group, Falcon Group and Qaiwan Group are undertaking some of the region's largest projects. That said, foreign direct investment inflows (FDI) have been on the rise over the past decade, and we expect the share of foreign investment as a percentage of total investment to increase in the next five years. Opportunities in the region vary significantly between different sectors.

Construction And Industry Are King
KRG - Investment By Sector, % of Total

Oil Sector: Baghdad-Erbil Row Remains Key Risk

Tensions between the federal government and the KRG over oil revenues sharing will remain a key risk for companies investing in the Kurdish energy sector. Due to considerable below-ground potential and attractive contracts, a number of majors including ExxonMobil, Chevron and Total have been tempted by the KRG, and have joined higher-risk taking independents such as Genel and WesternZagros in exploring the region. However, the KRG is looking for more autonomy with its exports, preferring to sell separately to that of the State Oil Marketing Company (SOMO). Baghdad remains vehemently against such a loss of control, outlining any exports outside the auspices of its control as illegal.

Growth Robust, Below Potential
Iraq Oil Production, Consumption and Net Exports (000b/d), 2013-2023

The ongoing stalemate between Erbil and Baghdad with regards to oil exports will continue this year and over the first part of 2015 in our view. Uncertainty also lingers over the possibility of a resolution to the dispute over oil revenues in the next five years, given the large gulf dividing Erbil and Baghdad. This political dynamic will negatively impact on oil and gas operators in the KRG. Companies such as DNO and Genel are in a position where they can produce oil, but have limited export options. A 300,000b/d pipeline to Turkey is currently the only outlet, however sales have been impeded by Baghdad's opposition. While demand from the local market will provide partial respite, we see continued challenges for those companies to monetise their oil.

We also expect companies exploring in the Kurdistan region to continue seismic acquisition and drilling programmes to shore up the region's resource potential. However, we do not expect any final investment decisions to be taken on major new upstream production projects in the Kurdistan region while there is no export agreement in place. The progress of exploration projects will therefore be delayed from moving to the development phase until an agreement between Baghdad and Erbil is finalised.

Infrastructure: Outlook Bright...

We have long been of the view that the Kurdistan's construction sector is to outperform the rest of Iraq, for which we see real growth averaging 7.2% y-o-y over our 10-year forecast period. The view is premised on the KRG's success in attracting large sums of foreign direct investment (FDI) into the region, leveraging off the huge potential of its oil industry and relative peace and security. With numerous major projects now under construction, particularly in the tourism and residential real-estate sectors, the view continues to play out and we see further potential growth in other areas of construction like industrial real estate.

Kurdish Region To Outperform
Iraq Construction Industry Value (USDbn) and Real Growth (% change y-o-y)

We expect Erbil to push industrial construction projects forward over the coming years, both to limit the region's economic reliance on the troubled hydrocarbon sector and to better supply the regional construction market. We note that Kurdistan's first steel plant was opened in 2007, after being delayed by inadequate supply of electricity, and now meets 40% to 50% of the region's steel demand. To further meet demand, Duhok, Erbil and Slemani municipalities are all readying financially attractive industrial zones for new projects in the industrial sectors, and we expect that building materials will be a key focus. The development of this local capacity should aid in the realisations of the hugely ambitious mega-projects currently under development, such as the USD2bn Dukan Lake tourist development, or the Downtown Erbil project - both being developed by UAE-based Emaar Properties.

KRG - Key Projects
Project Name Main Sector Sector Value (US$mn) Capacity/Length Companies Timeframe Status
Arbat Industrial Town Construction Commercial Construction 3000 12.14mn square metres Announced (January 2012 - Plans announced by Sulaymaniyah Investment Directorate)
Sulaymaniyah Gas Power Station Energy & Utilities Power Plants & transmission grids 1500 MW Enka Insaat, GE, Mass Global Investment Company 2013-2016 Under construction (The project started on 15 July 2013 )
Dhouk Combined Cycle Project Energy & Utilities Power Plants & transmission grids 1000 MW Enka Insaat, GE, Mass Global Investment Company 2013-2016 Under construction (The project started on 20 October 2013 )
Dukan Lake Resort Construction Commercial Construction 2000 Emaar Properties, Falcon Group 2013 Announced
Downtown Erbil Construction Commercial Construction 3000 541000 square meters Emaar Properties 2013 Under construction
Source: BMI

...Despite Underlying Risks

Although we hold an optimistic view on the construction industry in the KRG, some key risks for investors remain. For one, inadequate infrastructure has meant the cost of importing materials - in terms of both delays and financial costs incurred - has been high. Imports are needed because of a fundamental lack of building materials in the region. Also, risks pertinent to the energy sector will partly influence the construction industry. Construction activity is partly based on the premise that a prosperous oil sector would boost wealth and allow the KRG to heavily invest in developing the region. However, the ongoing dispute between Erbil and Baghdad could threaten the Kurdistan region's ability to fund construction projects, as Baghdad is withholding the KRG's share of the national budget.

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