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Energy Insights: Energy News: Iraq Foretells Oil's Dystopian Future

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Iraq Foretells Oil's Dystopian Future



By Liam Denning

When things go down in the Middle East, oil prices go up. Even axioms have their nuances though.

Amid what may be the unraveling of Iraq, oil prices have characteristically risen, with Brent crude breaking back above $112 a barrel.

Yet Iraq's real significance for oil may have less to do with what transpires this summer and more over the rest of this decade. The direct threat to the country's oil exports is actually not yet acute. For now, the insurgency is focused in central Iraq, away from the main oil producing and exporting areas in the south and the largely Kurdish-controlled north.

The bigger issue is what the sudden advance of the Islamic State of Iraq and al-Sham means for Iraq's oil-production growth prospects.

In its latest medium-term forecast, released Tuesday, the International Energy Agency trimmed its supply growth outlook for Iraq. It now expects it to be able to produce 4.29 million barrels a day by 2018, almost half a million barrels a day less than last year's forecast.

Despite that, Iraq still accounts for 61% of expected growth in production capacity controlled by the Organization of the Petroleum Exporting Countries. So even if the near-term threat to oil supply from ISIS isn't catastrophic, the wider context potentially is.

Iraq's borders now look more like dotted lines, potentially portending a situation like Libya's, where rival regional groups vie for power or separation with a weak central government.

In Libya, that instability has caused production to yo-yo between virtually zero and about 1.75 million barrels a day in recent years. Now, it is back down to about a quarter of a million barrels a day. In 2010, before Libya blew up, the IEA forecast that country to produce more than two million barrels a day in 2015. Now, it isn't seen getting anywhere near that even by 2019.

In Iraq's case, even if Baghdad doesn't fall, ISIS may establish itself in a large swath of the country, remaining a force for instability. Worse, Iraq is now an arena for wider rivalries between Sunni and Shia Muslims backed by their regional patrons, Saudi Arabia and Iran.

Such instability means even the IEA's reduced forecasts look questionable, as the investment needed to develop Iraq's oil could be deterred or blocked outright.

That is bullish for longer-dated oil prices. Yet these haven't reacted as much as near-term prices, suggesting gains to be made. For example, whereas average Brent prices for the rest of 2014 have risen by 3.3% in the past week, average 2018 prices are up by less than 1%. Moreover, those 2018 prices are roughly where they were at the end of 2010 just before Libya blew up—yet this crisis could be potentially much worse.

As longer-dated oil prices rise on intensifying instability in the Middle East—the center of the conventional oil industry—this should benefit companies operating in unconventional areas. Chief among these are North American exploration and production firms developing shale resources and the like.

The IEA forecasts global oil demand to rise by 6.58 million barrels a day by 2018, of which 61% is to be met by extra North American supply. That actually represents a slowdown in production growth. But if Iraqi growth slows sharply, that would raise oil prices and likely spur even greater investment in North American production. E&P firms rely on the futures market to lock in prices, providing certainty on cash flow to underpin drilling. So any rise in longer-dated oil futures would reinforce this.

Ultimately, though, all this is bearish for oil in the longer term. Iraq joins a litany of countries like Libya, Nigeria and Venezuela—all OPEC members—that cannot necessarily be relied upon as stable suppliers.

The high oil prices and geopolitical shocks that ensue are slowly but surely pushing oil-consuming countries to redouble efforts to reduce demand. They are also raising the energy burden on consumers in vulnerable regions such as the euro zone, slowing economic growth that underpins the oil market's continued health.

The periodic conflagrations of the Middle East, so often lighting a fire under oil markets, eventually will burn them down.

Write to Liam Denning at

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