Iraq’s latest energy auction was a flop, and while major international companies balked at everything from unattractive contract terms to security concerns, the failure of the auction highlights how the struggle for power between north and south is shaping the future of energy in the region and beyond.

Earlier this week, Iraq held its fourth round of energy auctions with disappointing results that reflect the global gas glut, the rise of unconventional oil and gas and some very particular geopolitical maneuverings.

During the two-day auction which closed on 31 May, Iraq managed to seal a deal for only three contracts out of 12 gas and oil exploration blocks on auction. More specifically, eight of those exploration block offers were not even bid on as Baghdad stuck to its guns over some important financing questions.

Major international companies had already set the stage with Baghdad before the auction, warning that they would not accept Baghdad’s offer of a maximum price of $6.24 per barrel of oil produced. Baghdad refused to budge and has clearly lost the gamble.

In partnership with Japan’s Inpex Corp, Russia’s Lukoil won the bid for a 5,500-sq-km block in the southern Muthanna and Dhi Qar provinces. The second block, in the eastern Diyala and Wasit provinces, was won by Pakistan Petroleum, while the third was won by Kuwait Energy in partnership with Turkey's TPAO and the UAE's Dragon Oil, for exploration of a 900-sq-km block in southern Basra.

Ambiguous energy regulations, political instability, security concerns and Baghdad’s refusal to heed the financial demands of international companies all contributed to the auction’s failure. A number of developments on the global scene have also contributed to declining interest in Iraq, from unconventional oil and gas discoveries in North America and the US’ own swelling gas reserves to discoveries in East Africa and China.

Also stifling interest from oil majors was Baghdad’s unattractive service agreements, refusing to offer traditional production-sharing deals that would allow for joint profit-sharing, and instead putting forward only an exploration fee. But so far, Baghdad has indicated that the terms of the contracts will not be revised. Instead, it is hoping that the addition in the next auction of new exploration blocks, presumably containing more attractive hydrocarbons for which major internationals are more willing to take risks, will meet with more success.

In terms of political stability, the Iraqi parliament is highly divisive and important issues such as revenue-sharing remain contentious and uncertain. At the same time, these divisions have kept Iraq from approving a hydrocarbons law that would regulate the energy industry.

Internal politics get even trickier when you add to the mix in-fighting over oil with the country’s Kurdish north. Baghdad went as far as to slip a clause in the contracts on auction forbidding international companies from signing any deals with the semiautonomous Kurdish north. The addition of this clause was a direct response to a skirmish with Exxon Mobil, which had the audacity to sign a contract with the Kurdistan Regional Government (KRG) in October last year for six exploration blocks. From Baghdad’s perspective, this was an illegal deal that threatens Iraq’s sovereignty. The clause also comes amid rumblings that other oil giants, including Shell and Total, are considering similar deals with the Kurdish north that would bypass Baghdad.

Security is also a major issue, as the exploration blocks on auction are all in remote undeveloped areas—areas threatened by minority Sunni militant attacks.

The general consensus seems to be that Iraqi oil is not as important as it once seemed, at least not its southern oil. The Kurdish north remains much more attractive, with around 45 million barrels of oil and a local government that is apparently more flexible to work with than Baghdad.

Baghdad must see which way the winds are blowing. The deal with Exxon for six exploration blocks signed solely with the KRG goes a long way towards establishing the Kurdish north’s sovereignty from Baghdad. On a wider geopolitical level it also has some serious implications in the form of the eventual establishment of a homeland for Kurds.

For Iraq, the increasing power, in part due to oil, of the KRG threatens to snowball into other attempts to carve up Iraq into autonomous territories, specifically the southern province of Basra with its Shi’ite majority, as well as some western and central Iraqi provinces dominated by Sunnis. Significantly, Basra is home to at least 60 percent of Iraq’s oil reserves.

As such, the auction was rather foreboding and Baghdad is taking a gamble it cannot afford. A successful auction was to be the backbone of the country’s desperate goals of rebuilding, without which it cannot lure the investment it needs. More importantly, a successful auction would give it more ammunition to subdue attempts to empower the KRG at the expense of Baghdad.

Adding to Baghdad’s distress was an announcement in late May by the KRG’s oil minister and Turkey’s energy minister that the two planned to build a pipeline connecting Ceyhan, Turkey, with northern Iraq and that this pipeline could carry one million barrels of oil per day and could be completed as early as August 2013. Even more distressing, the pipeline would then be expanded by a second addition that would connect it directly to the existing Kirkuk-Ceyhan pipeline in 2014.

The implications of this for Baghdad are immense. Turkey’s Ceyhan is already the key terminal for the Baku-Tbilisi-Ceyhan pipeline, which also has the capability of transporting one million barrels of oil daily.

From Baghdad’s perspective (and it is not an erroneous perspective), major powers are lining up to gang up on its embryonic government to empower the already autonomous Kurds in northern Iraq. From the airplane view, it appears that Iraq is being carved up sloppily, with Baghdad going to Iran while Western forces, plus Turkey, take up position around the KRG.

Shi’ite Baghdad was already irked with Turkey’s projection of “soft power” in the favor of Sunnis across the Middle East, but now the enemy lines have been more clearly drawn. Baghdad, of course, will do everything in its power to ensure that the pipeline, which it views as illegal, does not become a reality. That does not mean that Baghdad is entirely left out of the deal, the Kurds have promised to take only a 17 percent cut of the profits from this pipeline, with the rest going to Baghdad’s central government. But the unilateral announcement still riles Baghdad, which was not consulted at all in the deal.

One might find Turkey’s “Iraq policy” confusing in light of its decades-old bloody struggle against Kurdish militants in the former of the Kurdistan Workers Party (PKK), which operates these days out of northern Iraq. But Ankara has tried everything else in its power against the PKK, so why not try turning enemies into stakeholders through the use of the KRG and its oil? In turn, so the logic appears to go, Iraq’s Kurds could help subdue Kurds in Turkey.

But this is also a gamble on the part of the KRG. It is fair enough to say that the KRG is sitting on some of Iraq’s most attractive oil reserves. But if Iraq manages to boost production significantly in the southern Basra province, which has more reserves, it will be able to wield more control over the KRG. And it will be easier for Baghdad to keep Shi’ite Basra under control, though calls for autonomy over Basra’s own energy deals are growing and threaten to complicate matters for Baghdad. The KRG will also find it challenging to supply its new Turkey-inspired pipeline with one million barrels of oil per day without Baghdad’s consent and contribution.

Of course, Europe and the US will throw their full weight behind the Turkey-KRG pipeline goal, which is a fortuitous development for both as it would provide another way for Turkey to get oil and gas to the European market and bypass Russia at the same time.

A fifth round of bidding is now in the plans, likely to be held by the end of the summer, but this time around Baghdad will have to offer some serious incentives. In the meantime, expect increased Iranian movements in southern Iraq, while the US and its entourage line up around the north.

By. Jen Alic of Oilprice.com

Jen Alic is a geopolitical analyst, co-founder of ISA Intel in Sarajevo and Tel Aviv, and the former editor-in-chief of ISN Security Watch in Zurich.