Iraq's federal government, whose relations with Turkey are strained and getting worse, is bitterly opposed to such an agreement.
Baghdad, along with U.S. and other diplomats, fear it could lead to Kurdish independence and trigger the breakup of the Iraqi state.
At the very least, an agreement would probably trigger violence in a region where regional conflicts intersect and likely involve Iran, Syria and the Persian Gulf monarchies.
The proposed deal highlights a "sea change in relations between Ankara and Erbil," the northern Iraqi city where the Kurdish Regional government is based, the Financial Times reported.
It "could transform the region," the newspaper declared.
Kurdistan sits on 45 billion barrels of oil and has extensive natural gas reserves.
That's only a fraction of Iraq's proven oil reserves of 143.1 billion barrels but for major oil companies like Exxon Mobil, Chevron and Total of France the returns are more lucrative than they are drilling in Iraq's huge fields in the south.
The arrival of Big Oil in Kurdistan since October 2011, when Exxon led the break with Baghdad to develop Kurdish fields, transformed the Kurds' fledgling energy industry, just as it looks like triggering a geopolitical turnaround in one of the world's most volatile regions.
Oil strikes in Kurdistan have attracted some $10 billion in investment from foreign oil companies, a huge total for a territory of 4.9 million people that was once a tribal backwater.
"It's almost the only place in the Middle East where the private sector can explore virgin territory," said Tony Hayward, former chief executive of BP who now runs British-Turkish explorer Genel Energy.
The company was the first to move into Kurdistan in 2002 and it's now the largest producer.
In May, energy-poor Turkey, which has ambitions to become the pivotal energy hub between East and West, agreed to a broad partnership with the KRG and outlined plans to build pipelines from land-locked Kurdistan to Turkey's export terminals on the Mediterranean.
That will free the KRG from reliance on the state-owned bottleneck-plagued Iraqi pipelines that currently pump oil north from the Kirkuk fields, which the Kurds claim as their territory, through Turkey.
That will make Kurdistan totally independent of Baghdad's Oil Ministry for the first time.
Right now, a trickle of condensates -- a byproduct of natural gas -- is being trucked to Turkey, which sends back refined products to Kurdistan.
But energy development is accelerating rapidly. In 2008, there were three drilling rigs in Kurdistan. Now there are 24. Next year there will be 40. Production, currently 180,000 barrels per day, is set to hit 250,000 bpd by 2013 and 1 million bpd by 2015. By the end of the decade that could reach 3 million bpd.
The proposed deal marks a significant shift in Turkish geopolitics. It has long battled its own secessionist Kurdish minority and mounted several military incursions into northern Iraq to crush rebel sanctuaries in Iraqi Kurdistan.
Ankara, along with Damascus, Baghdad and Tehran, has long been obsessed with blocking the emergence of Kurdish state anywhere in the region where Turkey, Iraq, Iran and Syria meet and 20 million Kurds live.
But under an Islamic government, with ambitions to become a regional power once more, Ankara's geopolitical outlook has changed because of economic developments and the seismic political shifts across the Arab world.
Sunni-majority Turkey's new focus on Kurdistan has been at the expense of its relations with Prime Minister Nouri al-Maliki's Shiite dominated coalition in Baghdad.
Relations have deteriorated sharply over Maliki's growing authoritarianism, with minority Sunnis the main target. This horrifies Ankara.
Turkey currently harbors Iraq's fugitive Sunni vice president, Tarek al-Hashemi, convicted of running death squads against Maliki, a charge he denies.
Baghdad recently threw out Turkey's state oil company from Iraq's southern oil fields and refused to allow the Turkish energy minister's aircraft to land at Erbil Dec.6 for an energy conference.
Meantime, a military confrontation with the KRG in northern Iraq is simmering. An energy agreement between Ankara and Erbil could well mean big trouble's on the way.
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