The outbreak of violence in Iraq by Sunni rebels belonging to Islamic State of Iraq and the Levant (ISIL) has introduced a new event risk for global oil markets. So far the escalation in geopolitical risk in Iraq has so far been confined to the north of the country with the only oil related casualty being the 250,000 b/d Kirkuk-Ceyhan pipeline – out of action since March.
Geopolitical risk does not yet pose a significant threat to the country’s oil production since the northern region represents only a small proportion of total Iraqi oil production.
Current options market pricing reflects this sanguine view with oil markets attaching a low probability of an oil price spike over the coming 12-months ~ less than 20% probability of Brent Oil rising over $120 per barrel. Brent crude futures rose $3 per barrel over the past week to around $113 per barrel, a nine month high.
The last time oil prices were this high it was the threat of military action against Syria and the risk of wider conflict in the region that the oil market was focused on.
But what if Iraq’s infrastructure is compromised and the 2.5 million b/d currently exported is shut-in? In the short-term the oil market could call on the 2.75 million b/d of spare Saudi capacity. However it is very doubtful whether Saudi Arabia could sustain anywhere near this level of output for any sustained period.
The only other oil producer capable of putting significant additional volumes of crude onto the world market is Iran.
According to the country’s oil minister Iran could boost its oil exports by 500,000 b/d immediately if sanctions were lifted and by a further 200,000 b/d within two months of sanctions being lifted.
Meanwhile over the weekend Iran’s president has given the clearest hint yet that Tehran is prepared to cast aside 35 years of hostility in an alliance of convenience with the US to combat Sunni militants in Iraq. Even more incentive to conclude negotiations over nuclear facilities with Iran ahead of the 20 July deadline.
The US and the IEA could also release oil from its strategic stocks into the market. The IEA has coordinated a global stock release on only three occasions before. In the early stages of the Gulf War in 1991, after Hurricanes Katrina and Rita struck the US in 2005 and in response to the prolonged disruption of oil supplies from during the conflict with Libya in June 2011.
The US could threaten to release oil to dampen further price hikes, a move it made during tensions with Syria during the summer of 2013.