Increasing violence in Iraq, Opec’s second-largest oil
producer, has spooked many markets, including oil. It has also elicited loud
punditry about an emerging oil crisis, a need for the US to release
strategic petroleum reserves and significantly higher prices throwing a monkey
wrench into plans for global economic growth. But what are markets actually
So far, the oil market’s reaction has been fairly benign. At most, there is a
$5 premium in spot prices and perhaps a risk premium half that size in forward
prices. Spot prices of Brent crude oil jumped 4.5 per cent (about $5 a barrel)
on the fall of Mosul and the spreading
territorial control of the Islamic State of Iraq and the Levant (known as Isis)
over central Iraq.
Deferred (five-year) prices also jumped, albeit by a more modest 3 per cent
($3, to about $98) on the heels of consumer hedging. Prices barely budged after
military conflict emerged around the Baiji refinery that provides diesel and
gasoline for Baghdad.
No disruption yet
There has been no impact on Iraqi exports so far. The only disruption took
place in March, the last time the pipeline delivering crude from the Kirkuk field in the north to Ceyhan in Turkey was
Exports from the south are set to reach 2.8m b/d next month, a 30-year high,
and could grow further now that new export infrastructure is in place. Exports
from the northern Kurdistan Regional Government (KRG) area are about 120,000b/d
and remain well out of harm’s way.
Pending an agreement on revenue sharing, which looks more likely given Baghdad’s need for cash,
production could rise by another 100,000b/d for the KRG by year-end.
At stake is the
650,000b/d of other northern production in the so-called Sunni triangle
That is already down to about 400,000b/d given the closing of Kirkuk production, now under KRG control. But
no additional export flows are threatened.
Perhaps misleadingly, the International Energy Agency has indicated that its
estimated call on Opec for 2014 will be 30.1m b/d, versus recent Opec
production of about 30m b/d, indicating that markets might already be tight.
But the agency is positing US oil production growth this year of 850,000b/d
versus year-to-date growth of 1.35m b/d.
The IEA also projects US natural gas liquids production rising by 276,000b/d
this year, but already in the first quarter it rose by 178,000b/d. Add up
surprising growth in other places, including Colombia and Argentina, and the
world looks better supplied this year than the IEA indicates.
That does not make the events unfolding in Iraq significantly less worrying
for oil markets. Before the Libyan crisis the level of oil flows disrupted by
civil unrest or international conflict was normally about 500,000b/d.
Post-Libya, offline oil-flows have increased, first to about 2m b/d and more
recently to more than 3.5m b/d, including the effect of sanctions on Iran.
Surprisingly, oil prices have not changed much and indeed Brent, the global
benchmark, has averaged close to $110 every quarter since the Libyan crisis, as
lost supplies have been made up by Saudi Arabia using spare capacity and the US
increasing its production by about 1m b/d annually. But with the possibility of
political fragmentation in Iraq,
and with civil unrest emerging elsewhere, there are valid concerns about
reliance on supply from Opec in future.
Other potential consequences must also be considered. Iraq is still sticking to
a production target of more than 8m b/d by 2020, which would involve southern
production ramping up to 6.75m b/d.
The longer term
But for many the bigger issue is not what happens this week or next month but
what Isis’s rapid advance means for the country’s oil industry in the longer
But even under the best case scenario, Iraqi export capacity in the Gulf looks
likely to be capped at 4m b/d. If use of the north-south pipeline is in effect
lost through permanent political fragmentation, global balances would suffer.
Use of pipelines through Turkey
would be required to export more than 4m b/d.
On the other hand, the outlook for production growth in the KRG region has
improved considerably. Ironically, this could result in Iraqi production
actually increasing significantly this year if an agreement is reached on
revenue collection and sharing between Baghdad
With the KRG’s militia having taken the Kirkuk
field, the possibility exists for interrupted Kirkuk
flows to be brought to market through the KRG’s pipeline to and through Turkey. With
pipeline capacity of 400,000b/d, those flows could increase by as much as
280,000b/d by year-end. In the longer-term, the KRG region could attract more
capital for further development of its oil resources as well. Meanwhile, the
price premium is justified: global markets do not have much more wiggle room
for another supply disruption.
Ed Morse is global head of commodities research at Citi