Oil markets have turned their attention squarely to Iraq and the fast-moving attacks of the Islamic State in Iraq and Syria, ISIS, though also known as ISIL, with Levant replacing Syria, according a latest report of HIS Inc.
The report is jointly written by IHS Energy experts Jamie Webster, Senior Director, IHS Energy; Raad Alkadiri, Managing Director, IHS Energy and Jeff Meyer, Associate Director, IHS Energy.
Global oil prices have increased by several dollars per barrel in the past few days, with Brent front-month futures rising above $114 in trading on Friday. Prices will remain elevated during this crisis, all else equal, as even if there are no disruptions of supplies, just the risk of such outages will add to the geopolitical “premium” on prices. So far, the ISIS offensive has been largely confined to the north and west of Iraq—still some distance away from most of the country’s oil production in the south. In recent months, production in federal Iraq has averaged around 2.6 million barrels per day (mbd) in the south and 500,000 barrels per day (bd) in the north. Output from the Kurdistan Regional Government (KRG) is estimated at around 250,000 bd.
We assume that Iraq’s main producing fields in the south will remain secure for now. However, ISIS could cause outages in other infrastructure links in the oil supply chain. We do not consider this a high threat at present, but such infrastructure, as well as producing assets; will be a tempting target if the ISIS offensive moves into higher gear. An increasing risk of supply outages in Iraq comes against a backdrop of an already tight global demand/ supply balance that has markets already on edge. OPEC spare capacity, currently estimated at around 3 mbd, is at the lower end of the market’s comfort zone of 2.5 to 4.5 mbd, as the market balancers Saudi Arabia, Kuwait, and the United Arab Emirates continue producing at high levels in part to offset some 3.5 mbd of supply offline globally. The global balance is expected to tighten further this summer as the demand picks up seasonally—even as production from North America continues to surge. Given expected high Saudi Arabian production this summer, any additional outage could take the tight summer market and push prices sharply higher. By way of comparison, Iraqi crude exports averaged about 2.6 mbd in May, nearly equal to all of the world’s spare production capacity.
Further increases in global oil prices could spur discussions of releasing oil from strategic reserves. New supply outages in Iraq would likely push global oil prices higher still—possibly toward $120, a level that could trigger discussions among consuming countries of tapping strategic stocks. The United States, for its part, has suggested that other producers could make up for shortfalls if Iraqi production is reduced.
Repeated insurgent attacks have already disabled the Kirkuk- Ceyhan pipeline, which runs from Kirkuk in northern Iraq to the Turkish port of Ceyhan. ISIS may respond to any counteroffensive by Iraqi Security Forces by destroying pipelines and other infrastructure, which would extend present export outages into the medium term.
ISIS operations have occurred in the primarily Sunni provinces of north and west Iraq with only limited attacks south of Baghdad in the Shia heartland, where opposition to the group is intense and security forces are backed up by local militias. However, either an increase in the tempo and scale of attacks south of Baghdad or any sign that ISIS could target oil infrastructure—including oil fields—in these areas would represent a much more escalated risk to oil production and exports.
Iraqi oil production has averaged 3.2 mbd from January to May, including 3.3 mbd in May. Our current expectation is for output to reach an average of 3.6 mbd by the end of 2015. Such a rise would represent a valuable source of supply growth in a global market suffering from so many outages.
For now it seems the most likely near-term outcome is an interruption in local petroleum supplies. Domestic demand is near 700,000 bd, peaking in the summer as fuel is used in smaller neighborhood generators for air conditioning and other power needs. There have already been electricity protests in Basra, and these could spread, potentially adding another layer to the growing instability in the country.
Moreover, oil and gas infrastructure in ISIS-controlled areas—including the northern crude export route and its downstream assets—will be vulnerable to repeated attack, and the risk of disruptions to domestic product supply is high. ISIS will also pose a continued threat to operations in some Kurdish-awarded blocks that lie in disputed territories. The risk to operations will rise further if ISIS’s operations prompt external intervention, possibly by Turkey or Iran, which would exacerbate internal tensions even further. However, southern production and exports are unlikely to be directly affected.
ISIS’s new offensive comes in the wake of the Iraqi Army’s efforts to dislodge the group from the western province of Anbar, which has stretched the security forces’ resources and capabilities. Nevertheless, the speed of Ninawah’s fall and the determined move by ISIS south along the Tigris River valley illustrate the potency of the insurgent group and the extent to which the civil war in Syria has spilled over into Iraq. It is also testament to the degree to which Iraq’s ongoing political disputes and the consequent sense of alienation and frustration that the Sunni population feels have created a fertile ground for extremists. Iraq’s mainstream Sunni political leaders are divided, opportunistic, impotent, and incapable of protecting the interests of their constituency in a political environment characterized increasingly by sectarian and ethnic agendas. Moreover, these leaders have been reluctant to support government efforts to confront extremists. As a result, large parts of the Sunni population are now increasingly tolerant, if not outright supportive, of ISIS and other extremist groups.
The immediate reaction of Iraq’s Sunni and Kurdish leaders suggests that the ISIS advance is unlikely to alter their narrow parochialism. The former have sought to lay the blame for ISIS’s success firmly at the door of Iraqi Prime Minister Nouri al-Maliki as a means of weakening his claim to a third term; Kurdish leaders are using the security crisis to extend their political control directly into disputed territories, under the guise of providing protection for Kurdish communities outside of Kurdistan’s current borders. Thus, rather than rallying Iraq’s political elite to a common purpose, it is exposing their divisions even further. This will limit the effectiveness of the government’s response, and in the longer term poses an increased threat to Iraq’s territorial integrity and may pave the way for the KRG to take a more assertive stance on the autonomy of its oil exports.
In the medium term, should Iraq’s sectarian and regional tensions worsen—and the security environment weaken further—it would likely slow investment flows and blunt the expected steady growth of Iraqi output.