Earlier this month, the price of Brent crude oil jumped to a nine-month high of $115.71 a barrel on fears that violence in Iraq could disrupt the nation's oil production. While that fear premium has since faded, as markets have largely brushed off the risk that Iraq's oil production will be affected, this sense of complacency may be unfounded.
In fact, there is good reason to believe that Iraq, unlike other recent geopolitical events, is more than just a temporary risk to global markets – and one that could keep oil prices elevated for years to come.
Iraq in perspective
Iraq is hugely important to the global oil markets. It is OPEC's second-largest producer after Saudi Arabia, with daily oil production of 3.3 million barrels per day last month, of which around 80% is exported. Western oil companies including ExxonMobil (NYSE:XOM), BP (NYSE:BP), and Occidental Petroleum (NYSE:OXY), among others, are all active in the country.
Exxon is currently developing the West Qurna oil field in southern Iraq and also holds interests in Kurdistan. BP maintains a 38% working interest in the Rumaila field, one of the world's largest oilfields, which contributed net production of 39,000 barrels of oil equivalent per day, or boe/d, last year. And Occidental is developing the Zubair field and relies on Iraq for about 17,000 boe/d of its output.
While Exxon and BP recently evacuated some of their staff from Iraq, their operations -- and Iraqi production -- have so far been unaffected. This is because the vast majority of Iraqi oilfields and export facilities are concentrated in the south of the country, while the fighting is mainly in the north. Indeed, exports of Basrah Light crude, Iraq's main crude benchmark, could reach a record 2.7 million barrels per day in July, according to experts.
But if Iraq's security situation worsens and results in the loss of just a third of its oil production, it could be enough to send the price of Brent crude higher by as much as $40 a barrel, according to estimates by Securing America's Future Energy, a nonpartisan energy policy group. The long-term impact of widespread violence could be equally severe.
That's because the world depends heavily on Iraqi production growth at a rapid clip over the rest of the decade to maintain oil market stability, especially since some 3 million barrels per day of supply have been lost in key oil-producing nations like Libya, Nigeria, and Iran since 2011. Indeed, the International Energy Agency expects Iraq to account for 60% of OPEC production capacity growth through 2019.
But given Iraq's "precarious political and security situation, the forecast is laden with downside risk," the agency said. It now expects Iraq to produce just 4.5 million barrels a day by 2019, a downward revision of nearly half a million barrels a day. The only OPEC member that could potentially make up for a shortfall in Iraqi supply is Saudi Arabia, but the Kingdom's ability and motivation to do so is debatable.
Implications for oil prices
Given Iraq's huge importance to the global oil market, maintaining relative political and social stability in the country will be crucial for the large Western oil majors and services companies to continue operating there. Given these companies' integral role in Iraq's oil industry, their departure could seriously jeopardize the nation's long-term production growth potential.
While the markets appear to have largely shrugged off the risk of a supply disruption in Iraq, major near- and long-term threats remain. Even if the ISIS rebels are silenced, Iraq's highly polarized political and social environment is likely to remain a persistent issue. The spread of extremist ideology and the mobilization of groups like ISIS to neighboring countries is an even bigger threat.
These pervasive issues elevate the threat of more violence in the Middle East, raising the risk of supply disruptions in key OPEC-producing countries. While Iraqi production may very well remain unaffected in the short term, the region's troubled geopolitical environment suggests the risk to long-term oil prices is skewed to the upside.