If Iraqs Oil is cut off!!

The ISIS rebels have carved out an impressive swath of territory in northern Iraq. This has enormous implications and risks to the world’s oil supplies. 

Months before the ISIS rebels began their threatening move into Iraq’s southern regions, the International Energy Agency was imploring OEPC to produce and export an additional 1.2 million barrels per day (mbd) more oil by the end of 2014. 

Unlikely allies aid militants in Iraq

Radical Sunni fighters, who seized another northern Iraqi city on Monday, are being aided by local tribes who reject the Islamists' extreme ideology but sympathize with their goal to oust Baghdad's Shiite-led government.

The sad fact is that out of 12 OPEC members, eight of them are collectively in decline. When summed together Algeria, Angola, Ecuador, Iran, Libya, Nigeria, Qatar and Venezuela were producing just over 14.5 million barrels per day in early 2005; but are now producing just 11.25 mbd. 

These countries are losing nearly 500 thousand barrels per day of production per year. 

Of the other four OPEC members not in decline, only Iraq has managed to add significant production. It increased its output from 1.75 mbd in 2005 to 3.25 mbd currently. 

The nearly 2 mbd of incremental Iraqi production were essential to keeping Brent oil within the price range of $100 to $110 per barrel over the past couple of years. 

At best, the ISIS rebellion guarantees that any potential additional Iraqi oil output gains are not going to materialize in the near future. No oil companies are going to invest in Iraq until and unless the situation stabilizes. 

This means that Saudi Arabia will have to account for 100% of the hoped-for additional oil supply that the IEA is calling for. There’s quite a bit of uncertainty among oil analysts as to whether Saudi Arabia can even do this, as that’s over 1 million barrels per day more than the country has ever pumped in its entire history.

Can the Saudis do this on the back of ageing fields on average 50 to 60 years old? It’s an open and very serious question. They say they can, but all we have is their word on the matter; no data or evidence. If they cannot, then the world will have to confront the harsh reality that Saudi Arabia is no longer the go-to swing producer it once was. 

A slightly more dire scenario could see Iraqi oil production decline from current levels due to various insults to its existing oil production systems. Perhaps there will be more voluntary shut-downs of pipelines and refineries, as happened to Iraq’s biggest refiner in Baiji Tuesday morning. A complete loss of Iraqi production would spike the world oil price CLN4 +0.17%  up to $200 per barrel pretty quickly.

Any declines will only add to the pressure on Saudi Arabia. It would not only need to make up for losses in the sliding eight OPEC members’ production, but for any Iraqi losses as well. The loss of a million barrels per day would place a burden on Saudi Arabia that takes it to 100% of its stated production capacity. 

The most dire scenario sees a regional conflict break out that pits the Middle East’s Shiites (Iran) against the Sunnis (Saudi Arabia), leading to a compromise of the Strait of Hormuz. Forty percent of the world’s exported oil flows through this waterway. 

If conflict causes this flow to become restricted, then $200 per barrel would seem positively cheap. While this risk is small, it is a catastrophic potential outcome that cannot be dismissed. Prudent governments and investors need to begin factoring this in.