With a projected capacity of about 40,000 bbl. a day, the new oil refinery inaugurated on July 18 by the Kurdish regional government of northern Iraq is modest even by the standards of Iraq’s dilapidated oil industry.

But its significance shouldn’t be underestimated: in Kurdish minds, the region’s ability to refine the oil it pumps is a vital step toward deepening its autonomy from the Arab-majority remainder of Iraq.

Until recently, Iraqi Kurdistan had no refineries of its own, and though the area is sitting on a huge pool of oil, it had to rely on gasoline supplies from elsewhere in Iraq, Turkey or Iran.

Fearful of giving Iraq’s ethnic Kurdish minority any control over the country’s most precious resource, Saddam Hussein had not only declined to build refineries in the region; he made sure Iraq’s oil pipelines bypassed Kurdish areas, and his army forcibly removed much of the Kurdish population from Kirkuk — the most important oil-producing area in the north — and repopulated the city with Arabs from the south.

Since Saddam’s demise, however, the autonomous Kurdistan Regional Government (KRG) is steadily developing an independent oil industry in northern Iraq.

It has discovered and begun to develop new oil fields inside its boundaries, and has entered production-sharing deals with foreign oil companies that were made without the consent of the federal government in Baghdad.

Those deals have raised suspicions among Iraq’s Arab-dominated government that KRG is not simply taking on more of the prerogatives of sovereign statehood but is actually laying the economic infrastructure for independence.

For their part, Kurdish officials suspect that Baghdad’s failure to pass a national oil law (which would give Iraq’s provincial governments greater control over the industry in their territory) and its failure to press ahead with a referendum to settle Kurdish claims to Kirkuk and other disputed areas are signs that the Arab majority plans to settle matters in its favor
Such is the enmity, in fact, that KRG’s president, Massoud Barzani, and Iraqi Prime Minister Nouri al-Maliki haven’t spoken in over a year. Recently, KRG Prime Minister Nechirwan Barzani said that Arab-Kurdish relations in Iraq are at their lowest point since Saddam was in power.

With Iraq’s Sunni-Shi’ite sectarian violence largely in check, the Kurdish-Arab dispute has become the most worrisome fault line in Iraq.

Ever since the U.S. invasion, the Kurds of northern Iraq have enjoyed many of the trappings of sovereignty. Kurds have their own parliament and executive government, plus an 80,000-strong army (the Pesh Merga militia) and control over their borders, which Baghdad-controlled security forces are not allowed to enter.

Despite the fact that the vast majority of Kurds want independence from Iraq, their leaders have proceeded with caution, mindful of the risks. Their small, landlocked region is surrounded by neighbors — Turkey, Syria, Iran — whose own restive Kurdish minorities make them hostile to the prospect of an independent Kurdish state emerging in Iraq.

While the rest of Iraq was in the grip of insurgency and sectarian civil war, the Kurds quietly advanced their economic-development policies, building an international airport, business hotels and hydro-electric dams and — most important — doing oil deals.

They explained this autonomous engagement with international oil markets on the grounds that they couldn’t wait for the barely functional Iraqi state to get its house in order. Indeed, such is the dismal state of Iraq’s oil production (not yet back at pre-invasion levels, which were a fraction of its full potential) that in June, the Iraqi government allowed the Kurds to begin pumping oil extracted from newly developed Kurdish oil fields through federal pipelines for export sale to Turkey.

(Currently, only Iraqi government companies can sell oil, the revenue from which is shared among the regions.)
Kurds have also grown impatient with Baghdad’s stance on disputed territories.

According to the Iraqi constitution, the central government should hold a referendum in the Kurdish-populated areas of four Iraqi governorates in northern Iraq (including Kirkuk) to determine whether they should remain under Baghdad’s control or become part of the KRG. But even before that takes place, the constitution commits the Iraqi government to a potentially explosive reversing of Saddam’s "Arabization” policies in these areas, moving Arabs out and Kurds in.

The Iraqi government has postponed the referendum several times from its original date in 2007, citing the understandable excuse that it could spark a new civil war between Kurds and Arabs.

But now that Iraq’s government is increasingly stable, Kurdish leaders fear that Baghdad is merely playing for time, allowing the Iraqi military to grow in strength and capability as the U.S. moves to draw down, allowing the Iraqi government eventually to settle the issue the old-fashioned way: with tanks.

Already, Kurdish and Iraqi forces have nearly clashed on several occasions in the disputed territories.

Last month, Kurdish lawmakers passed a regional constitution that unilaterally laid claim to the disputed territories and the oil resources in them.

Though some Iraqi officials have said that the constitution amounts to a Kurdish declaration of independence, Kurdish leaders are pushing for a referendum to be held on the constitution as early as August.

Meanwhile, the domestic politics of both the Kurdish region and the wider Arab Iraq are pushing the two sides toward confrontation.

In Kurdistan, where parliamentary elections will be held on June 25, a new party called Change is mounting the first significant challenge to the duopoly of Barzani’s Kurdistan Democratic Party and the Patriotic Union of Kurdistan, led by Iraqi President Jalal Talabani.

The new party is gaining ground by tapping into growing dissatisfaction with government corruption and nepotism. Although the parties credited with delivering today’s de facto independence are likely to win, they have moved to strengthen their position by sharpening their tone toward Baghdad as the election approaches.

Baghdad has troubles of its own, which creates an incentive for Kurd-bashing. Most Iraqi Arabs have even less faith in their corrupt leadership class than Kurds have in theirs.

And as al-Maliki consolidates his grip on power and styles himself as Iraq’s new strongman, he may find that promising to push back against Kurdish efforts to dismember Iraq could help rally Arab Iraqis, both Sunni and Shi’ite, behind him. Hey, it worked for Saddam.

TIME