(Bloomberg) -- The struggle between Kurds and Arabs for control of the city of Kirkuk and its oil amounts to a "ticking time bomb" in northern Iraq, according to the new United Nations envoy trying to broker a settlement.

Mediator Staffan de Mistura said in an interview that he has about four months left to solve "the mother of all crises" in Iraq. "If that takes place, we will have contributed substantially to avoiding a new conflict at the worst possible time," he said.

Turkey's military incursion into Iraq last week to fight Kurdish rebels may remind Iraqi Kurds that their designs on more territory and oil have limits. Turkey is concerned that the Kurdish regional government would use Kirkuk and its oil to seek independence, displace minorities in the city and embolden breakaway Kurds on Turkish soil.

The dispute over the estimated 10 billion barrels of crude in the region pits the Kurds' expansion drive against Arab demands to keep central authority over oil -- and Kurds within Iraq. Kurdish leaders have embraced UN involvement as their best, perhaps last, opportunity to secure the legal right to sign oil-exploration contracts in the area.

"The issue of oil jurisdiction is very much alive, and companies deciding whether to sign contracts for exploration are focused on what is happening," said Alex Munton of Wood Mackenzie Ltd., an Edinburgh, Scotland-based oil-company consultant. "It's a very complex challenge because the Kurds have awarded contracts that overlap disputed boundaries."

Contracts Awarded

The Kurdistan Regional Government in November awarded exploration and production contracts to Bermuda-based Gulf Keystone Ltd., Hungary's Mol Nyrt., Austria's OMV AG and India's Reliance Energy Ltd.

De Mistura, in his quest for a political settlement backed by the UN, "has the stature to be very convincing," said Qubad Talibani, the KRG's representative in Washington. His government is determined to overcome Saddam Hussein's campaign to quash Kurdish claims on Kirkuk, a city of about 700,000, through the forced removal of Kurds and settlement of Sunni Arabs throughout the 1980s and 1990s.

Resistance is coming from many sides. In Baghdad, Sunni and Shiite parliamentarians have formed an alliance to safeguard the national government's hold on the oil. Turkomans and Assyrians, who together make up about half of Kirkuk's population, have claims on the city that date back centuries.

A Cautionary Message

The Turkish military operation, while not directly related to the Kirkuk issue, sends a cautionary message to the Kurds, according to Ian Lesser, an analyst for the Washington-based German Marshall Fund.

"There may be those in Turkey who would be pleased to see what they are doing in Iraq as putting pressure on the Kurds not to solidify their control over Kirkuk," Lesser said. "But it cuts both ways. Turkey needs a relationship with the Kurds to help control the rebels."

The U.S. persuaded the UN last year to take on the Arab- Kurdish dispute as American officials focused on quelling intra- Arab violence in Baghdad with military reinforcements.

"It is important to get progress on reconciliation, which means agreement among the major players on key issues, one of which is Kirkuk," Zalmay Khalilzad, the U.S. ambassador to the UN and a former envoy to Iraq, said in an interview.

Drawing a Border

De Mistura wants to use results of the 2005 provincial elections to draw a border between contested Kurdish and Arab lands. The 61-year-old Swede said any formula also must protect the rights of the Assyrians and Turkomans in Kirkuk, and factor in the impact of Hussein's forced Arabization.

After forging an agreement in December to delay a referendum on the status of Kirkuk until June, de Mistura sees mid-year as his deadline to get all the parties to reach agreement.

While Turkish officials support UN mediation, they are concerned that the Kurds have rigged the outcome of any referendum.

"What the Kurdish elements in the area have done in the last two years or three years is to change the demographic composition of Kirkuk," Nabi Sensoy, Turkey's ambassador to the U.S., said in an interview. "There have been more than 600,000 people who have come and settled in the area." All told, about 1 million people live in Kirkuk and its surrounding area.

The problem with de Mistura's plan for Kirkuk is that he doesn't know Iraq well enough to end such a complicated dispute, according to Feisal al-Istrabadi, a former Iraqi ambassador to the UN.

`He Is Crazy'

"He is crazy if the thinks he will create an internationally recognized border that will calm the situation," he said. "It is not clear that the results of the 2005 elections should tell you anything about what the boundary ought to be, and you have to ask how free and fair those elections were."

Iraq's UN envoy, Hamid Al Bayati, said the timing of a Kurdish-Arab accord is critical because the U.S. presidential election in November might send a Democrat to the White House with a mandate to withdraw American troops in 2009. That would raise the risk of war over the northern oil fields, he said.

De Mistura "is credible and the government supports him, but when he comes with a plan it may be a different story," he said.

By Bill Varner