The ongoing tit for tat between Baghdad and Erbil over oil-export rights and revenues has escalated over the past two weeks, leading to the Kurdistan Regional Government's (KRG) most serious banking crisis since 1991. In the absence of an agreement, Baghdad has withheld part of the KRG’s revenues, resulting in non-payment of some civil servant salaries for two to three months, including the Peshmerga forces and the Oil Protection Force that guards international oil company (IOC) installations. KRG President Massoud Barzani has responded harshly by equating Baghdad’s actions to a “declaration of war on the people of Kurdistan” while claiming the ability to pay salaries from KRG funds.

Despite employing nationalist rhetoric, staging anti-Maliki protests, blaming the United States for a lack of support and pressing IOCs for payments, the KRG’s efforts to leverage Baghdad and independently export oil remain ineffective. Alongside ongoing legal, political and technical obstacles, the KRG’s key ally and energy partner, Turkish Prime Minister Recep Tayyip Erdogan, is facing his own domestic crisis and an uncertain political future. In the absence of a legal transit route or viable alternative revenue source, and with mounting criticism by local populations and investor confidence to sustain, Erbil will be hard-pressed to compromise with Baghdad. If not, the landlocked region risks undermining the economic and political gains it has made thus far while leaving its population and key institutions vulnerable to social, political and financial instability.

Until now, few believed that Baghdad would go so far as to withhold the KRG budget as a retaliatory measure. Although the Iraqi government and KRG have been disputing payments since 2005, the KRG has continued to receive its expanding annual budget from Baghdad. In 2013, the region was allocated about $13 billion to administer three provinces, relatively more than other oil-producing provinces in Iraq. Nor did Baghdad effectively thwart the KRG’s energy sector development. Its “blacklist” against IOCs working in the Kurdistan Region has hardly deterred oil majors from signing contracts with the KRG and exploiting hydrocarbons.

It was only when the KRG crossed Baghdad’s red line by attempting to circumvent state sovereignty and export oil unofficially to Turkey that Iraqi officials fully utilized their revenue card. The current crisis also imploded in response to Baghdad’s 2014 draft budget, competing claims by other oil-producing provinces for greater decentralization and revenues and the KRG’s opaque financial demands. It has now become part of campaign politics as both Barzani and Iraqi Prime Minister Nouri al-Maliki use the oil and budget issues to affirm their authority and nationalist credentials and cut the best deal possible before the April elections.