* Former BP CEO Hayward working with KRG as head Genel
* Iraq wants to raise output to 600,000 bpd from 280,000
* KRG also seeks to raise output on its side of field
By Peg Mackey and Andrew Callus
BAGHDAD/LONDON, Jan 17 (Reuters) - BP's deal to develop an Iraqi oilfield that straddles the border with the autonomous Kurdish region puts it in the front line of a sectarian stand-off, in which rivals and its former CEO have chosen the other side.
Under the draft agreement revealed by Reuters on Wednesday, BP will undertake work to arrest declining production at the Kirkuk oilfield.
Kirkuk's oil riches are at the centre of a crisis within the national government of Sunni, Shi'ite and Kurdish parties over how to share power amid increasing worries the country may relapse into wide-scale sectarian bloodshed.
At least 25 people died on Wednesday in a Kirkuk suicide bombing.
BP will be working on the Baghdad-administered side of the border on the Baba and Avana geological formations. Kirkuk's third formation, Khurmala, is controlled by the Kurdistan Regional Government (KRG).
"From a political perspective, this would move BP close to the fault line. But there are also very solid technical reasons for the oil ministry to have BP at Kirkuk," a western oil executive working in Iraq said on Thursday.
Kirkuk output has slumped to 280,000 bpd from 900,000 bpd in 2001 after years of injecting water and dumping unwanted crude and products into the field. Iraqi officials have said they would like BP to raise production capacity at this 77-year old workhorse to around 600,000 bpd in five years.
BP's former chief executive Tony Hayward, now heading a new company, and a number of rivals including Exxon Mobil and Chevron have cast their lot with the Kurdish side of the dispute.
In an interview with Reuters in September, Kurdistan Energy Minister Ashti Hawrami said he wanted to deploy oil companies on a project to raise Khurmala's output to as much as 300,000 barrels a day (bpd) from its current 85,000 bpd.
Hawrami also said the KRG, with autonomy and its own armed forces since 1991, would also be interested in capturing the gas that is now being flared from the Avana dome.
At the start of its project, BP will make a "special allocation" of $100 million to help stop Kirkuk's decline and carry out surveys to get a clear picture of the field.
"We have made a proposal for short-term assistance, which they appear to like and we're progressing on from that," Michael Townshend, president of BP in Iraq, said on Wednesday. "It's early days."
BP has arguably the best relationship with Baghdad among the world's top international oil companies through its contract at the huge Rumaila field in the south of the country, far from the disputed Kurdish north.
The KRG's oil exports and contracts are at the heart of a wider dispute with Baghdad's Arab-led government over territory, oilfields and political autonomy.
Iraq's government insists it alone has the sole authority to export crude oil and sign deals, but Kurdistan says the constitution allows it to agree to contracts and ship oil independently of Baghdad.
Iraq Energy minister Abdul Kareem Luaibi has said Baghdad intends to sue Genel Energy - the first company to export oil directly from Kurdistan - and may slash the government's allocated budget to the region unless it halts what he rejected as smuggling.
Genel is led and part-owned by Hayward, the former head of BP who quit the company after the U.S. Gulf oil spill of 2010.
BP's rivals Exxon, Chevron, Total and others have angered and alienated Baghdad by signing lucrative production-sharing contracts with the KRG on better operating conditions than in the south.
Baghdad issued Exxon an us-or-them ultimatum a year ago. The result was the U.S. major opted to sell its 60 percent stake in the West Qurna-1 oilfield in southern Iraq. China National Petroleum Corp (CNPC) has emerged as the front-runner to buy it.