Intentionally or not, ExxonMobil has set itself up to catalyze either prosperity or instability in Iraq, with far reaching regional and global implications. At stake is at least a third of the world’s additional crude supply this decade.

Basically, the world’s biggest oil company is forcing Iraq’s central government to come to terms with its rival Kurdish autonomous region over the control of the country’s oil wealth. The eight year standoff must now be resolved in a matter of weeks before American forces withdraw by the end of 2011 taking with them the only buffer separating the two warring sides.

If the two work out their differences and regulatory stability settles in, Iraq could easily exceed the International Energy Agency’s expectations of more than doubling output to 5.4 million bpd by 2020 from the current 2.8 million bpd, on its way to at least triple output to 9 million bpd.

If not, civil war could be around the corner and all bets will be off, again.

Let’s backtrack. The two main disagreements are over a national oil law to divvy control of the oil wealth, and the jurisdiction over the disputed Kirkuk region, which not surprisingly sits over a huge oil field.

Kurds have waged war with Iraqi Arabs for centuries and suffered chemical warfare under Saddam Hussein, only to reach de facto self-rule in 1992 as the Kurdish Regional Government following the first US war against Iraq.

After the 2003 US invasion, two Iraqs emerged: a prosperous KRG-ruled territory with its own army, laws and parliament, and the remaining anarchic two thirds split between warring Shiites and Sunnis and an American occupier.

Once Baghdad managed to regain control with the help of US forces, oil understandably became a spoil of war. Shiites and Sunnis sided against the Kurds in energy issues. And when it comes to crude oil, Iraq has by far more potential to increase production quicker than any other country.

The KRG can offer an estimated fifth of Iraq’s reserves of 143 billion, but Baghdad controls all export pipelines, literally land locking Kurdish wealth. In fact, regional production is below 200,000 bpd currently and Baghdad does not fully pay companies for their work as it doesn’t recognize their contracts.

In the dangerous tug of war over resources, Baghdad has blacklisted companies that sign deals with the Kurds. Accordingly global oil majors went to bed with Baghdad and over three dozen smaller companies drifted toward more attractive Kurdish production sharing terms.

Indeed, the biggest bottleneck for Iraq’s oil industry into the future is the standoff between the central government and the KRG. “Iraq’s oil production potential is immense, but exploiting it depends on consolidating the progress made in peace and stability in the country, including resolution of the debate about the legal status of contracts awarded by the KRG.”

And that is where Exxon comes in. The KRG leaked news last week that the company defied the status quo when it signed an agreement on October 18 to explore six blocks in the Kurdish region. Baghdad threatened Exxon and denied the news, while Exxon kept quiet, but KRG officials again confirmed it this weekend.

Not only is Exxon the first oil major to sign a deal with Kurds. It’s the first to try to have it both ways, with the KRG and Baghdad, even before the two settle their differences. Exxon has an 80 percent share in developing West Qurna 1, which by the end of the decade will produce 2.3 million bpd after a $50 billion investment.

Baghdad must now either risk the political and economic consequences of blacklisting Exxon from West Qurna or in effect recognize all contracts that the KRG has signed in the past, adding fire to the sectarian tensions in the country.

The timing of the disclosure of Exxon’s deal points to a KRG ploy to pressure Baghdad to resolve the issue, especially after months of rising tensions that included exported cuts-offs. Both sides are reportedly nearing an agreement following high-level negotiations, at least in terms of the oil law, although the Kirkuk issue remains unresolved.

Iraq needs to address the standoff to attract foreign investment and to reach its oil production targets. Without it, security and a stable legal framework will remain elusive, especially without the US acting as a guarantor.

The clock is ticking and pressure is growing daily on Iraq’s central government to signal whether this will be a boom or a bust of its oil industry, indeed of oil markets globally. The ideal scenario is that Exxon’s deal catalyzes an understanding between both sides, but a lot could go wrong.

If Baghdad flinches, oil majors will follow Exxon and flock to the Kurdish region in search of the much better terms that the land-locked region offers, severely heightening political and military tensions in Iraq and dragging its neighbors Turkey, Syria, and Iran, all with big Kurdish populations and insurgencies.

If on the other hand Baghdad confronts Exxon, investments in Iraq’s oil industry –especially in the Kurdish region- will be delayed and output goals will be unachievable without a stable environment.

Whatever happens, there’s no turning back from this crossroads. Iraqi leaders must choose yet again whether war or prosperity lies in their future.