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The Next Oil Shock: Iraq Attack

Written By Christian DeHaemer

Posted June 12, 2014

Crude oil prices just went up.

The price of WTI hit $105, while Brent rose to $110.

Two years ago, the spread between WTI and Brent was $20. Today, it is down to $5 — the lowest spread in nine weeks.

Here in the United States, the Energy Department reported a drop in supplies at Cushing, OK. Supplies dropped by 198,000 barrels to 21.2 million last week.

That means U.S. prices are going up and the gap with Brent has narrowed.

But it’s not going to last… Not because WTI will get cheaper, but because the price of Brent could launch.

Iraq Civil War

In case you haven’t heard by now, al Qaeda-aligned forces in Iraq have taken over Tikrit as well as Mosul in the northern part of Iraq. Only 17% of Iraqi oil is produced in this area, but it could get worse — the rebels are on the move.

Early reports state that the Iraqi Army forces have fled, tossing off their uniforms and abandoning their weapons.

According to Fox News:

“Two Iraqi security officials confirmed that Tikrit, the capital of Salahuddin province, was under the control of the ISIL, and said the provincial governor was missing. Tikrit is 80 miles north of Baghdad.”

Now the Times is reporting that the Islamists have captured Baiji, home to a large oil refinery, on their way to Baghdad.

The war has already shut down work on the pipeline to Turkey and will likely take more crude off of the international market as the fighting moves south, though the key export hubs remain safe for now.

Force Majeure

This isn’t a surprise. I outlined this scenario in Energy and Capital last August:

But you had better be concerned, because Iraq is a big deal.

The country has the second largest oil reserves in the world. They are currently pumping out 2.9 million barrels a day, with goals of pumping 9 million bpd by 2020.

That, as they say, is a pipe dream. It’s just not going to happen.

Instead of expanding, production has been falling over the last few months.

A bomb attack on a pipeline running from the Kirkuk oil field to Turkey has shut down for three days. It’s not the first attack, and it won’t be the last.

At the time, major oil explorers and producers were selling their leases and getting out. No one’s going to invest the billions of dollars it will take to bring Iraqi oil production up to speed if that investment will simply be destroyed… and if no one will insure it.

Despite the ongoing problems, Iraq did manage to increase its production.

Iraq was able to produce 3.6 million bpd in February, but this fell by 300,000 bpd a month later. The April and May numbers will be worse. There is no way Iraq will reach the predicted 9 mbpd by 2020, much less the 12 mbpd predicted by Bush on the eve of the Second Gulf War.

There is, however, a chance that the 3.3 mbpd produced a few months ago will fall dramatically and cause a global price shock.

Output Falling

These events are transpiring in a world where other global players have seen falling production as well.

Libya’s output has fallen 1.4 mbpd a day. Mexican oil is in decline. The North Sea is facing a 22% decline this year. Nigerian and Venezuelan output is off. There are sanctions on Iran, and Russia is a wildcard.

At the same time, demand is picking up as the U.S. gears up for the summer driving season. Furthermore, the uptick in jobs points to higher oil consumption.

And consumption is growing globally. The IEA currently estimates that the world consumes 92 mbpd, up from 90 mbpd in 2013.

Sharif Don’t Like It

Right now, OPEC is meeting in Vienna to decide on oil output targets. The cartel, which pumps a third of the world’s oil, has said it is happy with global oil prices.

UAE energy minister Suhail Mohammed al-Mazroui said on Tuesday that oil prices are at a suitable level.

And as this goes to print, word is that OPEC has agreed to hold production steady at 30 mbpd for the rest of the year. According to the New York Times, Saudi oil minister Ali al-Naimi said, “Supply is good; demand is good; the price is good.”

This isn’t a surprise. No one knows if Saudi Arabia can make up any shortfall from Iraq even if it wanted to. As we have written extensively, Saudi oil appears to be running out.

The question now is over how far the Iraqi insurgents will go. Because where I’m sitting, the Iraqi Army looks weak, and the Iraqi government is inept. And the U.S. won’t do anything after Obama castrated the military.

This leaves open the very real possibility of a global oil shock.

Global oil shocks can and do happen. Eleven years ago, in the year leading up to Desert Storm, the price of Brent went from $19 to $37 in about a year. That’s a 94% gain.

A similar jump would push Brent to $213 today. That’s a black swan event that would crush the economy and send the shares of non-Middle East producers much, much higher.

All the best,

Christian DeHaemer Signature

Christian DeHaemer

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Christian is the founder of Bull and Bust Report and an editor at Energy and Capital. For more on Christian, see his editor’s page.

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