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Iraq violence lights fuse for oil price spike

LONDON — It is difficult to overstate the importance of Iraq for the global oil industry. It is the world’s seventh-largest producer, with proven reserves of 140 billion to 150 billion barrels of crude oil that analysts have said are among the cheapest to develop.

LONDON — It is difficult to overstate the importance of Iraq for the global oil industry. It is the world’s seventh-largest producer, with proven reserves of 140 billion to 150 billion barrels of crude oil that analysts have said are among the cheapest to develop.

But that is not all. Iraq is also the Organization of the Petroleum Exporting Countries’ (OPEC) second-biggest producer with production of 3.3 million barrels a day. Between now and 2019, the International Energy Agency (IEA), a leading energy forecaster, expects the country to provide almost two-thirds of the growth in the oil cartel’s production capacity.

Yet as the country slides towards civil war, Brent, the international oil marker, has risen only modestly, gaining only over US$5 (S$6.24) a barrel to a nine-month high of US$115 since the onslaught began two weeks ago.

It is a reaction that has surprised many market observers given that the insurgents are less than 65km from Baghdad. “Looking at previous supply disruptions and even threats in the Middle East, this should have taken the price to US$120,” said Mr Tom Nelson, co-portfolio manager at Investec Asset Management.

The explanation for the restrained price action is quite simple, said oil traders. Not a single barrel of crude exports has been lost since the Islamic State of Iraq and Syria (ISIS) routed Iraqi security forces in the north of the country. There are several reasons.

First, Iraq has not exported any oil from the north since March, when the insurgents bombed the pipeline that runs from Kirkuk to the Mediterranean Sea. Second, Iraq’s main production and export facilities are in the south, which has been untouched by the violence. In fact, exports of Basrah Light crude, the country’s main grade, could hit a record 2.7 million barrels per day (b/d) next month, showed preliminary loading plans seen by large trading houses.

But if Baghdad falls to the insurgents, the picture could quickly look different — and not only because more than 75 per cent of Iraqi oil production comes from the giant structures in a basin about 150km south-east of the capital. “If ISIS were to advance into Baghdad, the question of oil security in southern Iraq and the Kurdish region would pale into insignificance compared with the question of the potential breakdown of Iraq as a sovereign entity,” said Mr Abhishek Deshpande, an analyst at Natixis.

Mr Richard Fenning, CEO of Control Risks, a consulting firm, agreed. “It’s not about the production as such, but about whether the mechanics are in place for payment systems to continue. Can the oil financial infrastructure remain in place in that scenario?”

Should the world lose all of Iraq’s exports, traders and analysts reckon it could push the price above US$140 and trigger a coordinated release of strategic reserves from the IEA and additional supplies from Saudi Arabia. “The loss of this supply alone would not be disastrous, but offsetting it would use up most of the spare capacity in Saudi Arabia,” said Mr Julian Jessop of Capital Economics.

But even a partial reduction would be keenly felt. It would come at a time when seasonal summer demand is about to pick up and fighting has cut exports from Libya to almost zero, theft has reduced the flow of Nigerian barrels and international sanctions continue to crimp exports from Iran.

An outage in Iraq would place even more pressure on OPEC’s Gulf states, particularly Saudi Arabia, the only major oil producing country with significant spare capacity, to increase production to balance the market. Even without more problems in Iraq, the IEA has said OPEC needs to pump 30.9 million b/d in the second half of the year to keep prices in check, over 900,000 b/d more than the current output.

But for many, the bigger issue is not what happens today or tomorrow, but what the lightning advance of ISIS means for the country’s oil industry in the longer term. Mr Nelson said it was evident on a recent trip to the Middle East that large United States oil service firms, whose expertise is desperately needed if Iraq is to achieve its potential as an oil producer, are reluctant to commit capital and people to southern Iraq.

There have been around 8,000 civilian deaths in Iraq this year. In response to the fighting, oil companies have started evacuating staff. This may not affect production in the near term, but it will affect development activity and future production growth.

“These developments show that even without the Sunni insurgency reaching the southern oilfields and export facilities, the current security crisis is already threatening Iraq’s long-term growth potential,” said analyst Richard Mallinson of Energy Aspects.

Indeed, the IEA has already trimmed its supply growth outlook for Iraq. It reckons the country will be able to produce 4.54 million b/d by 2019, almost half a million barrels less than its previous forecast and half of what Iraq is expecting.

Concerns about future Iraqi supplies are also being reflected in long-dated oil prices. For example, the ICE Brent December 2019 futures contract has risen almost 4.1 per cent this month to US$97.78 a barrel.

“Regardless of what happens in the short term, there are very damaging knock-on effects to Iraq’s oil industry from the recent escalation in violence,” said Mr Nelson.

That impact is only just starting to be felt. The Financial Times

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