Brent crude and West Texas Intermediate (WTI) prices rose to nine-month highs early today as sectarian violence erupted in northern Iraq, while global equity markets turned red following reports that the US Military may be sent in to curb violence in the war-torn Middle Eastern country. Iraq is the second-largest crude oil producer among OPEC nations, having surpassed Iran in 2012.
Front month contracts of Brent crude, a global benchmark for oil prices which is traded on the International Commodity Exchange (ICE), have resultantly jumped $1.38 to $114.40 per barrel as of 3:26 am EDT today. It had gained more than $3 per barrel yesterday. Likewise, prices of WTI futures, the benchmark for US crude oil, rose 93 cents to $107.44 a barrel after gaining $2.13 in trading yesterday. Futures contracts of both benchmarks are currently at a nine-month high.
The increase in WTI prices will have a direct impact on retail prices of gasoline, which averaged $3.674 per gallon in the week ended Monday according to the U.S. Energy Information Administration (EIA). If the increase in gasoline prices is significant, it will have major repercussions for the US economy’s growth. The US GDP contracted 1% during the first quarter of the ongoing year.
Markets across Europe and the US fell following the developments in Iraq. The S&P 500 index dropped 0.7% or 13.78 points yesterday to close at 1,930.11, while the Dow Jones Industrial Average (DJIA) fell 109.69 points, or 0.65%, to close at 16,734.19. As of 3:30 am EDT, the FTSE 100 is in the red, registering a 0.3% decline to reach 6,821.81. Gold, considered a safe haven in times of instability, has turned around and is currently trading at $1,274.60 per ounce. Spot gold prices had been declining ever since tensions between Ukraine and Russia cooled off.
Islamist militants calling themselves the Islamic State in Iraq and Syria (ISIS) have reportedly overrun three important cities – Tikrit, Mosul, and Baiji – in northern Iraq. Mosul is Iraq’s second-largest city, and Baiji is home to the country’s largest oil refinery which, till now, had never been compromised, as Iraqi special forces were responsible for its protection.
Instability in Iraq can worsen if ISIS starts moving south toward the capital. The movement can threaten operations of oil refineries and also cut oil production from oilfields that fall under its control. This will add to speculative activity and result in crude oil futures rising again. Iraqi oil production has become ever so important with Libyan production set to remain off the grid and production restricted in Iran due to sanctions.
PetroChina Company Limited (ADR) (PTR), a Chinese oil and gas company, has a significant stake in the West Qurna oil field situated in southern Iraq. China’s heavy reliance on crude oil from the Middle East is reminiscent of the situation in 1973, when the US had been heavily reliant on Middle Eastern oil producers and an embargo at the time, which saw crude price rise from $3 per barrel to nearly $12, resulted in an international crisis. Any significant increase in crude oil prices can go a long way in similarly hurting China, resulting in cost-push inflation for Chinese products.
Kurdistan, an autonomous region in Iraq, is considered to have 45 billion barrels of crude oil reserves. To prevent ISIS from taking control of important oilfields, Kurdish armed forces, known locally as the “peshmerga,” have taken Kirkuk, the city with the largest oilfields in Iraq, under their domain. The region has received special attention from numerous oil companies, including Exxon Mobil Corporation (XOM), Chevron Corporation (CVX), and Total SA (ADR) (TOT).
Crude oil production from Iraq reached a three-and-a-half decade high to 3.4 million barrels per day (bpd) earlier this year, and the country has ambitiously been planning to reach the 4 million bpd mark by the end of 2014. According to government officials, Iraq has the potential to eventually produce as much as 9 million bpd. Currently, Iraq exports 2.5 million bpd, of which approximately 300,000 bpd reaches the US.
According to International Monetary Fund (IMF) estimates, the Iraqi economy is expected to grow 6.3% in 2014, and 8.25% by 2016 to become the fastest-growing economy among the 22 countries in the Middle East. However, the rise of Islamic militancy can limit the country’s growth.
Iraqi energy infrastructure in the northern region has faced attacks from militants on several occasions. The 600,000 bpd capacity Kirkuk-Ceyhan pipeline has been attacked multiple times and is not far from the ISIS-controlled Anbar province.
In the equity market, the price performance of WTI and Brent crude futures are replicated by two exchange traded funds (ETFs), namely the United States Oil Fund LP (ETF) (USO), and the United States Brent Oil Fund, LP (BNO). Investors can bet on these ETFs to gain exposure to future movements in Brent and WTI futures.