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Energy Insights: Energy News: Turmoil in Iraq could engulf global oil market

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Turmoil in Iraq could engulf global oil market


Turmoil in Iraq could engulf global oil market

The safety of Iraq’s oil-producing capacity, and the global energy market as a whole, is under threat from the Isis insurgency 
Isis fighters raise their weapons as they stand on a vehicle mounted with the trademark Jihadists flag in Anbar province

Isis fighters raise their weapons as they stand on a vehicle mounted with the trademark Jihadists flag in Anbar province

Over the last fortnight, the Sunni extremist group Islamic State of Iraq and Syria has made jaw-dropping advances across Iraq Photo: AFP/GETTY

By  Liam Halligan

I’ve been reading A Line in the Sand, a riveting book by James Barr. It’s about the incredible manner in which the British and the French re-made the map of the Middle East during and after the First World War.

Barr tells a sordid tale of hubris and eye-popping political skulduggery, as two colonial powers cooked up the Sykes-Picot Agreement of 1916, dividing Le Moyen Orient along a line drawn from the Mediterranean to the Persian frontier.

This book is vital reading, not only for the author’s gripping portrayal of high politics, intrigue and espionage, involving the likes of Lawrence of Arabia, Churchill and De Gaulle. The story also has deep contemporary relevance. For the Middle East’s colonial boundaries now look under severe threat, as the region is convulsed by a renewed outbreak of intra-Islamic conflict.

Over the last fortnight, the Sunni extremist group Islamic State of Iraq and Syria (Isis) has made jaw-dropping advances across Iraq. Isis now holds large parts of the country’s central and northern regions, including Mosul, the second-biggest city, and Saddam Hussein’s home town of Tikrit.

Since splitting from al-Qaeda in 2011, Isis has operated on both sides of the Syrian-Iraqi border. If the World Cup wasn’t on, and it wasn’t the height of summer, this militia group’s activities would be dominating our news agenda to a far greater extent than they are.

Having fought President Assad’s Alawites, Isis is now focused on Prime Minister Nouri al-Maliki’s Shiite Iraqi government. The stated aim of Isis is to establish an Islamic Caliphate from eastern Syria and across western and central Iraq, wiping what remains of Sykes-Picot off the map.

Perhaps the oil price will force us to confront what’s really happening in the Middle East. Brent crude hit almost $116 a barrel on Thursday, its highest level since September 2013. Prices are up 10pc over the last fortnight, since this new insurgency kicked-off, with crude steadily approaching the $120-$125 danger zone.

At that level, oil starts to impose serious economic damage on the major energy importers. Over the last half century, pretty much every oil price spike has been followed, relatively quickly, by a recession in the Western world.

More recently, a related pattern has emerged. In 2011 and again in 2012, it was the rise of oil to around $125 that triggered a return to “risk off” and a significant downward correction of equity market.

What we’re now seeing is precisely what financial analysts feared during last summer’s Syrian crisis.

The concern then was that a US air strike would cause massive upheaval, with fighting spreading from Syria, which produces a mere 56,000 barrels of oil daily, to Iraq, which back then pumped a very sizeable 3.1m — or 3.7pc of global production.

That’s exactly what has happened — even though the air strike was called off. Last year prices rose from around $108 to $117 and, so far, the current response has been roughly the same. In that sense, the market’s response to these Iraqi fireworks has been relatively subdued. One reason is that the oil exports from the region which has seen most of the fighting, northern Iraq, has anyway been offline since earlier this year, due to a damaged pipeline to Turkey. Those losses to global commodity markets were already priced in.

As the Sunni insurgency heads south, though, towards Baghdad, the vital Basra port complex, outlet to the 2.6m barrels of Iraqi crude exports that leave via the Persian Gulf, comes under threat. Were these supplies to be disrupted, the rest of our World Cup coverage, and maybe even Wimbledon, would be set against the backdrop of a nasty oil price spike and related financial turmoil. Iraq, after all, is now the second-biggest producer in the Opec exporters’ cartel after Saudi Arabia, its total oil output now larger than the Desert Kingdom’s fabled pool of “spare capacity” — the existence of which is designed to keep crude prices relatively stable.

Such an outcome, while certainly possible, is not yet likely. Iraqi government troops are fighting back against Isis, unofficially assisted by Shiite militias.

Iran, too, has unleashed several battalions of its fierce Revolutionary Guard to help its Shiite ally. America, meanwhile, may yet wade in, if not with troops, then with air strikes.

This is no idle threat, for US aircraft carriers and other warships have just moved into the Persian Gulf. It’s also not clear, despite much scaremongering by Washington-based hawks, that Isis is interested in, or even capable of, capturing or disrupting southern Iraq, the site of the country’s major oil infrastructure.

Be in no doubt, though, this Iraqi strife will almost certainly have a significant bearing on global oil markets even if an immediate price spike is avoided. That’s because roughly 60pc of the growth in Opec’s production capacity over the next five years is due to come from Iraq — and this renewed conflict, which is unlikely to abate even if Basra is spared, puts such growth at serious risk.

Earlier this year, Iraqi production hit a 35-year high of 3.6m barrels — up no less than 16pc on the year before. The country’s output is set to grow to no less than 5m barrels by 2019, according to the International Energy Agency, the Western world’s energy think tank.

“Given Iraq’s precarious political and security situation, this forecast is now laden with downside risk,” the IEA warned, in a report published last Tuesday. “This offensive is not only raising concerns about future production from operating and new projects, but is casting a pall on the functioning of the country’s government institutions and even on regional stability”.

Although it’s impossible to know how Isis will fare, I have three observations. The first is that, while I’m in no doubt America’s “shale revolution” is important, I’d still argue an awful lot of nonsense has been written about it to drum up investor interest, while pretending the West is no longer dependent on energy imports from “nasty” places like Russia and the Middle East.

Yes, the exploitation of “tight” oil and gas formations has seen America’s total energy production recover to its seventies peak of 11.3bn barrels a day. Back then, though, the world economy was much smaller, and used a lot less energy. And the reason US energy prices are below those in Europe (particularly gas prices) isn’t because shale energy is cheap.

On the contrary, shale requires the drilling of many more wells than conventional production. American energy prices are low due to a combination of massive shale-focused tax breaks and a near blanket energy export ban – which has produced a glut. Again, shale is important, but it won’t redraw the global energy map.

Secondly, this new threat to Iraqi oil supplies is set against an alarming trend barely mentioned by Western analysts. Last year, the global oil industry discovered just 13,000m barrels of oil, a third less than in 2012 and the lowest discovery rate in 62 years. I know 13,000m barrels still sounds a lot, but consider that 2013 global consumption was almost 33,500m. More wells are being sunk yet discoveries are falling, with field sizes on a long-term downward trend. All this points to much tighter energy markets going forward, not least given relentless demand from the Eastern emerging giants.

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