Iraqi Deputy Prime Minister for Energy Hussain al-Shahristani accused Iraqi Kurdistan of sabotaging the country's budget by halting its oil exports and said crude from the autonomous region was instead smuggled over the border, mainly to Iran.

The charges threatened to exacerbate a long-running dispute between Baghdad's central government and the Kurdistan regional government over oil rights, political autonomy and land that risks upsetting Iraq fragile sectarian and ethnic balance.

Baghdad's accusations came after Kurdistan on Sunday said it was halting its oil shipments of around 50,000 barrels per day in protest against what it said was the central government's failure to pay oil companies working there.

This will cause a budget deficit, and the government should act to preserve Iraqi resources, Shahristani told reporters, without giving details on what action Baghdad would take.

Most of the crude produced in the region is being smuggled though the borders, and mainly to Iran.

Kurdistan oil exports make up a small fraction of the OPEC nation's 2.3 million bpd shipments, but the payment dispute feeds into a wider conflict between Iraqi Arabs and ethnic Kurds over the region's right to autonomy from the Shi'ite-led central government.

Kurdistan government officials did not immediately respond to a request for comment on the accusations.

Baghdad says only the central government can control oil rights and refuses to fully recognize profit-sharing deals signed by Kurdistan. But the region, autonomous since 1991, says it can develop oilfields in its area, a disagreement that has trimmed payments to oil firms such as Norway's DNO.

EXXON LETTER

The dispute between Baghdad and the Kurdistan capital Arbil also highlights the dilemma facing investors including Exxon Mobil , the only oil major to sign petroleum deals with both Iraq's central government and the Kurdistan region.

Baghdad has warned Exxon it could face sanctions if it continues to develop its oil contracts with Kurdistan, and other majors such as France's Total, are waiting on the sidelines for an outcome of the Exxon case.

Oil Minister Abdul Kareem Luaibi said on Monday Exxon had sent a second letter to the ministry confirming its decision to freeze its oil deals with the Kurdish region.

Exxon Mobil first sent us a message on March 5, which included the decision to freeze contracts in the region, Luaibi told reporters.

Luaibi has said before that Exxon had written to Baghdad. But Kurdish officials deny that Exxon has frozen its work in the region.

With violence easing from its long war, Iraq wants to ramp up oil production and this month reached crude output of 3 million bpd, its highest level since before the 2003 invasion that toppled Sunni dictator Saddam Hussein.

Major companies signed service contracts with the central government to develop oilfields in the south. But Kurdistan's stability, profit-sharing contracts and better security are also drawing the attention of companies struggling with bureaucracy and infrastructure bottlenecks in the south.

(Writing by Patrick Markey; editing by Jane Baird)