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Kurdistan: Get a National Soccer Team Next Time

Kurdistan is done with the perceived corruption of Baghdad. They have received little to no military support coming from Baghdad in the face of kidnap and worse from ISIS. I’ll not embarrass the Iraqi military by repeating the headlines. There is a perception of “central government” incompetence, if not outright anti-Kurdish prejudice. So the solution is to ditch Baghdad and go it alone. Kurdistan has decided to float a sovereign bond.

The Kurdish militia, the Peshmurga, has been able to successfully eradicate the ISIS infestation as of late. Good for them: ISIS is the most napalm-worthy losers ever born. In all of Iraq, the Kurds have been most able to transcend the divisions of religion and geography and actually work together to create a viable society that has an upper bound on corruption. Kurdistan has the brightest hope because they work together.

Besides, there has been an expectation of Kurdish independence for centuries. Further, the US has been involved for over a decade now. Back when Bush was crafting his plans for a post-Saddam Iraq, the Kurds, played a huge role. The implicit payback for the Kurds was at least a measure of independence from Baghdad, at best full sovereignty (see red circled area on the map for an approximation).

Since the ISIS has been able several times to route the Iraqi army without a shot, the sovereignty option is preferred by the Barzani regime. So the Kurdish government has enlisted Goldman Sachs and Deutsche bank as book-runners for the $5 billion maiden bond sale.

I know this is simplistic and doesn’t capture the unique existential template of the Kurdish language and millennia of history. But I get the bond part well enough: Money is power in circulation. There is nothing more sovereign than a sovereign bond. It says a state is grown-up, so to speak. Ready to take responsibility and keep the book in balance. A bond carries an iron law like the ancient cutting of a covenant.

But there are a couple of problems. This bond, just like Kurdistan, depends on oil revenues. Fair enough, but it is a land-locked sovereign that depends on a Turkish pipeline to get the oil to market. Turkey and Iran are very opposed to Kurdish independence for centuries of reasons that I can’t touch. Iraq opposes it because, well, even unnatural and pathological institutions desire to live. Second, you can’t forget about the military quagmire in its midst. Seldom have a seen a bond built amid such chaos.

The strategy of issuing a bond in the face of this near-permanent struggle could make sense, but it is a razor’s-edge path. Solid finance lies behind the affirmation of force, and is a sign of its power. It could back-fire if the books aren’t fit.

The legal obstacles are nominally taken care of. The Kurdistan regional government started crude exports by pipeline through Turkey in 2014. KRG commitments under the 2015 Federal Budget Law have been met, and oil production has reached record levels. The bond will be linked to oil production in one form or another. Since, there is a commitment by the Kurdish regional government to export 550,000 bpd (barrels per day), the issue will be 1) a revenue bond tied to the cashflows generated by selling rights to tolling fees on the Turkish Ceyhan pipeline or will 2) collateralize a Kurdistani budget entitlement of one billion US dollars per month to be remitted by the Iraqi federal government.

The feeling is that this bond is being placed to do more than fund a war against ISIS amid crashing oil revenues. After all, if oil = cash, why not just fund it from market proceeds from oil sales? Well this isn’t about eradicating ISIS, as wonderful as this is. It is about building a nation-state. The geopolitics is more than what most real money will have the appetite for without huge yield.

There’s no knowing how this paper will price out. Iraq’s $2.7 billion 2028 notes yield over 8%, but this is more of a long-term play on the 5th largest crude reserves in the world. The Kurdish bond is based on near term oil revenues that deliver oil to the Mediterranean via Turkey, and will have high beta connected to spot oil prices. In short: the cheaper the oil, the higher the yield. Crude exhibits 30% volatility annually, with is worth 50 bps in risk premium.

There is no relief in sight on the supply side. Iran is gearing up to re-enter crude markets in a big way. There is no indication of anything more than tepid economic growth. So there is no support for a big pick-up in demand. Presently, the only shocks are to the downside. The market is pricing a rising Fed funds cycle (this hand is crumbling right now, which I think a mistake).

I regret being so skeptical about the financing angle. I think Kurdistan is ready to function as an independent sovereign nation. Dude, I’d be totally stoked if one of my sons fell in love with a Kurdish woman that put a bullet between the eyes of some ISIS scumbag. But for building a nation-state, it seems far easier to field a Kurdish national soccer team instead of servicing a bond that looks to be inevitably north of 9%.

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