Iraq and Global Oil Markets

June 18, 2014

Q1: How is the recent escalation of violence in Iraq impacting global oil markets?

A1: Last week’s attack on and seizure of Mosul (Iraq’s second largest city) by armed groups affiliated with the Islamic State of Iraq and the Levant (ISIL), an extreme jihadist group, represents a major expansion of the group’s previously held control of areas near the Syria/Iraqi border and escalated security concerns within Iraq. Unable to stem the tide of the incursion thus far, the Maliki government asked Parliament to declare a state of emergency and requested assistance from the U.S. military as well. The U.S. Embassy is already evacuating certain employees and sending in additional troops to bolster security at the Embassy, recent press reports indicate that several energy companies operating in southern Iraq have done the same, and indications are that the ISIL forces have recently take over a major refinery in Baiji, a town north of Baghdad (though the refinery provides products to the domestic market). The deteriorating security situation in Iraq and the prospect of an even broader humanitarian and regional political crisis is at the forefront of an already tense geopolitical landscape this week with Russia cutting natural gas supplies to Ukraine and ongoing territorial posturing between China and Japan in Asia.  Given the complexity of the ethnic, national, and regional disputes and alliances within in the Middle East, however, the current situation in Iraq has clear potential to follow a rapid and dangerous trajectory.

As a consequence, the prospect of threats to Iraqi oil production, infrastructure and exports - beyond the north - has already helped push Brent prices to over $113/barrel.  Since the majority of exports from Kirkuk were already suspended due to shut down of the Kirkuk-Ceyhan pipeline earlier this spring, the larger fear now is focused on the prospect of expanded and continued violence in the north as well as the potential for violence and infrastructure attacks on the southern oil fields, the main source of Iraqi exports, as well as on the government in Baghdad.

While the situation in Iraq remains fluid, for now the most immediate focus for the Iraqi government is to concurrently attempt to contain the ISIL threat in the north, while securing the area around Baghdad and the oil facilities and infrastructure in the south. 

Last month (May), Iraq produced some 3.4 million barrels per day (mmb/d), at least 75 percent of which came from the Shia-dominated south (Rumaila, West Qurna, Zubair, etc.).  An additional 200,000 to 250,000 barrels per day are reportedly still accessible out of Kirkuk (primarily transported by pipe and truck) to neighboring Turkey, although sabotage and security threats are likely to limit that volume as the earlier pipeline repairs (see above) are unlikely to be undertaken/completed anytime soon. 

Beyond the obvious, the current situation poses a number of risks and challenges, but also some opportunities (most notably for the Kurds – see below).  At present, the combination of the loss of Libyan, Nigerian, Venezuelan and Iranian oil production for various reasons, the uncertainty surrounding Russia’s gambit in Ukraine and the prospects for further reductions (seasonal maintenance, hurricanes, etc.) as we enter the second half of the year point to potentially tighter markets and higher prices (EIA’s Short term energy outlook for  June identified some 2.6 mmb/d of unplanned supply disruptions from OPEC sources and an additional 720 mmb/d of non-OPEC volumes).   Further, since Iraq was expected to contribute a large portion of near term incremental OPEC increases, sustained or enhanced violence would undoubtedly limit investment and volumes going forward.   And while Saudi Arabia still maintains over a million barrels per day of spare capacity and could offset some of the loss of larger Iraqi volumes, a complete loss of Iraqi exports would require more drastic measures – like the release of strategic stocks – in order to prevent prices from spiking.

Q2: What other scenarios might arise that could impact energy markets?

A2: The Iraqi central government has clearly had to rely on Kurdish forces to provide security in the north and that has given the Kurdistan Regional Government (KRG) an opportunity to consolidate control over key regions in the north including Kirkuk. If the Maliki government requires additional funding streams and stronger allegiance with the Kurdish region in the north then the impetus for a deal on oil related investment and export could be in the offing. It should be noted that this scenario says nothing about the political arrangements or security situation in the oil important south. The idea of Iraq partitioning itself into three or more ethnic regions/blocks has also gained credence in the last few days but, again, a path toward that outcome or a clear line of sight on how that type of arrangement would be structured is far from clear.

Second, the crisis provides an interesting opportunity for new formulations of regional alliances and coalitions interested in shoring up regional stability.  For example, to the extent that Iran, or even perhaps Saudi Arabia, see it in their interest to contribute positively to the resolution, the U.S. and other major countries may find themselves dealing with Iran on a new strategic plane that could add a new dimension to nuclear negotiations and a pathway to broader reconciliations – which would inevitably lead to reduced sanctions and ease oil market concerns. Both of these scenarios seem overly optimistic if not far-fetched given the current state of the situation, and, as Jon Alterman argued in his latest piece – resolution of the current simmering conflict may not be in anyone’s core interest other than citizens affected by the ongoing violence and turmoil. 

Of course, in an alternative (worst case) future, the conflict could spread to the south as well as into neighboring oil rich states and upend any prospects of regional stability/security and a global economic return to normalcy. Even if the insurgency (so far limited in numbers) is beaten back or at least contained –the energy world may revert to the geopolitical range of uncertainties that predominated the previous months (significant as they were) yielding somewhat higher but stabilized prices and prospects for a tighter second half of the year but a more complex and troubling security outlook for companies with investments, infrastructure and operations in the country.  

Frank A. Verrastro is senior vice president and James R. Schlesinger Chair for Energy & Geopolitics at the Center for Strategic and International Studies in Washington, D.C. Sarah Ladislaw is director of the CSIS Energy and National Security Program.

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