JUN
13

Iraq Could “Send Economic Forecasters Back to the Drawing Board”

 
One month ago, Iraq—OPEC’s second largest oil producer—was seeing steady gains production prompting hope that the country would finally begin to realize the its potential as the holder of the world’s fifth largest oil reserves. Iraq’s output was easing comfortably above 3 million barrels per day (mbd), and seeing sustained upward momentum. Now, internal violence threatens to disrupt its operations, creating what is undoubtedly the most severe vulnerability in the oil market.

Oil prices spiked yesterday and today: Brent crude has jumped from below $110 per barrel to jumping above $114, while West Texas Intermediate has risen from below $105 per barrel to above $107. Tensions are driven by the rapid progress of ISIS/ISIL: Islamic State in Iraq and Syria, alternately named the Islamic State in Iraq and the Levant. The organization, originally formed as part of al-Qaeda in 2004 has reportedly been rejected as “too brutal and extreme” by its origin group, has a very clear goal—to form a Sunni caliphate in Syria and Iraq. ISIS is led Abu Bakr al-Baghdadi, who is currently being described as the world’s most aggressive and powerful jihadist leader, while its forces are directed by high ranking leaders from the former army of Saddam Hussein. A void of leadership throughout Iraq and Syria has enabled ISIS to grow in power, and its estimated forces of 10,000 men have reportedly trained in the conflict in Syria. In addition to unabashed violence and extremism, the group exploits a growing perception among many Sunnis that they were being persecuted by the Shia-dominated government led by Prime Minister Nuri al-Maliki, starved of resources and excluded from a share of power. A few weeks ago, ISIS took Fallujah, signaling their seizure of Iraq’s western Anbar province. Now, they have seized territory across Iraq’s north and east, and are pressing rapidly towards Baghdad. At the moment, oil supplies have not been impacted, with two exceptions. First, ISIS has taken Iraq’s massive Baiji refinery near Mosul, which processes up to 300,000 barrels per day and is a major supplies to Baghdad. This critical resource may influence how they attack Baghdad, creating the possibility that ISIS will cut off supplies to weaken the capitol. Second, while Iraq’s central government is profoundly weakened, Iraqi Kurds have taken the opportunity and seized the oil rich city of Kirkuk. The Kurds have been working to export oil independently of Baghdad for years, and have had some recent success selling their oil directly to Turkey. Their ability to continue doing so is questionable, and effectively all oil installations in Iraq’s north are in serious jeopardy. So while Iraq’s oil is still flowing, oil prices have responded to the growing fears that a severe supply disruption will result from ISIS’s rampage through Iraq, particularly as it approaches Baghdad, and the country’s many super-giant fields and export terminals in the south near Basra. However, despite their rapid progress, ISIS’s complete takeover of Iraq is not a foregone conclusion at this point. First, so far, ISIS has taken predominantly Sunni territory and faced little resistance. They will undoubtedly face greater challenges if they press into the Shia south and west. Iran has also made clear its intentions to step in and assist its perceived Shia allies in Baghdad, the west, and the south. From Vox:
As the map above shows, ISIS isn't close to any of the massive oil fields in the southern regions of Iraq, which produce 75 percent of the country's oil. And ISIS has yet to enter the Kurdish regions in the north, another major oil-producing area. But the fighting has threatened some of Iraq's other oil infrastructure, including a pipeline that can deliver 600,000 barrels of oil per day from Kirkuk to the Turkish port city of Ceyhan. (That pipeline had been damaged by a 2013 attack and was offline receiving repairs — that work has now been halted.) There's also potential for things to get a lot worse. If the conflict spreads further into the Kurdish regions, that could disrupt operations in the large Kirkuk oil field near the city of Mosul, which now produces around 260,000 barrels of oil per day — and accounts for one-sixth of the country's proven reserves. Iraq had plans to invest heavily in that oil field in the years ahead, and that's a lot harder now.

Meanwhile, many believe that ISIS simply doesn’t have the manpower to extend their reach all the way south to Basra. At least not yet. But given the situation on the ground. A serious disruption is very possible, and could have devastating implications for the economy. Can we count on other members of OPEC to make up the shortfall? Unlikely. Spare capacity is stretched dangerously thin, given the loss of supplies from Iran and Libya.

 

In the Wall Street Journal, oil traders described the threat as a “clear and present danger,” and warned of disastrous consequences for the U.S. economy. Thina Saltvedt, chief analyst Macro/Oil at Nordea Bank said: “If Iraqi oil production would fall back to the low levels seen during the invasion of Iraq in 2003, oil prices could easily rise by up to $30 a barrel as this would push the global spare capacity back to the lows when oil prices reached $150 a barrel in July 2008. High oil prices would put the world economic recovery at risk.” David Hufton, managing director of PVM Oil Associates expressed similar sentiments, stating, “The deteriorating situation in Iraq could be the source of an oil price and therefore a financial shock and it should be sending economic-growth forecasters back to the drawing board” The threat isn’t just in the near term. Iraq’s oil production is slated to increase to 7-9 million barrels per day over the next ten years—a critical contribution to growing global demand. A stable Iraq now is necessary to meet those goals, but right now, its long-term stability is looking less likely by the day.