by Sara Vakhshouri
On Saturday June 21, Iraq’s largest refinery at Baiji finally succumbed to the forces of the radical Sunni militant group, the Islamic State in Iraq and the Levant (ISIL, often referred to as the Islamic State in Iraq and Syria, or ISIS), after being under siege for nearly two weeks. The Baiji refinery has a capacity of 320 thousand barrels of oil per day and supplies one third of Iraq’s domestic fuel use. Even though the refinery is used to help supply an Iraqi domestic demand of 700 thousand barrels per day, its seizure has already pushed Brent oil prices to a nine-month high, and has raised serious questions about the flow of energy exports from Iraq.
According to the Energy Information Administration (EIA), Iraq has the fifth largest proven oil reserves in the world. Yet 90 percent of its resources are unexplored, mainly due to years of war and sanctions. Production costs in Iraq might be some of the lowest in the world, yet its production has never exceeded 4 million barrels a day (mb/d).
The expansion of ISIL’s attacks in Iraq could affect short-term Iraqi supplies, and might also significantly alter its long-term production plans. Before the current turmoil, Iraq’s production was forecast to double in the near future, reaching 9 mb/d by 2035. However most major oil investors, have already pulled their staff out of Iraq. Any further political instability, or worse yet, an attack on its infrastructure, could disrupt such rosy projections.
Supply disruption in the market
Iraqi oil production has already fallen by 300,000-400,000 barrels per day, mostly due to production cuts in Kirkuk. Overall, Iraq produced 3.4 mb/d of oil in May. In addition to the Iraqi supply drop, the broader oil market is facing an unplanned supply disruption from other major oil-producing countries. EIA’s short-term energy outlook forecasts almost 2.6 mb/d of unplanned crude oil supply disruptions from OPEC producers, mainly from Iran, Libya, Nigeria, Venezuela and Iraq. The estimated supply disruption from non-OPEC countries, by contrast, was 720,000 barrels per day in May 2014, up from 660,000 barrels per day in April. Syria, South Sudan and Yemen account for 75 percent of non-OPEC supply disruption; the remaining drop is from Colombia, Mexico and Brazil.
In addition to these actual supply disruptions, there are psychological factors at work. The general fear of potential threats to major Iraqi oil fields, refineries, pipelines and export facilities have all coalesced to increase panic in the global oil market. Last week, the price of Brent crude future contracts on the InterContinental Exchange (ICE) increased 0.3 percent, or about 34 cents to reach $114 per barrel. Currently, the major concerns over Iraqi oil supplies are focused on its southern oil fields. This is mainly due to the higher production volumes from the south, combined with the suspension of most oil exports from Kirkuk, due to repairs on the Kirkuk-Ceyhan pipeline to Turkey. About 75 percent of Iraqi oil production comes from the Shia-dominated southern cities, which are still under control of the central government. West Qurna, Zubair and Rumaila are the major oil producing fields in southern Iraq and, thus far, are far from ISIL controlled areas.
The current turmoil in Iraq could affect how much oil it can bring to the market in both the short and long terms. The partial supply interruption of Iraqi oil could, in theory, be offset by activating Saudi Arabia’s spare production capacity of above 1 mb/d. Larger supply disruptions, or a complete loss of Iraqi oil in the market, would require more excessive supply releases. Global strategic petroleum reserves could also provide a short-term solution for mitigating price shocks in the market. Nevertheless, protracted Iraqi supply reductions, along with the festering Russia-Ukraine crisis, could greatly affect aggregate supplies, demand, and long-term investment prospects for major oil companies.
Perhaps even more focus will be given to North America’s unconventional oil production. One game changer in the market could be a possible warming between Iran and the U.S, and a general thaw in relations between Tehran and the West. Iranian oil production and exports have been hit hard by sanctions. Any positive strategy toward Iran could bring investors back to Iran. That could, potentially, allow the market to count on Iranian resources to offset any supply interruption both in the short and the long term.
Photo: U.S. Secretary of State John Kerry with Iraqi Foreign Minister Hoshyar Zebari in Baghdad, June 23, 2014, Credit: State Department photo/ Public Domain