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Summary

  • Iraq has recently experienced a great deal of violence and yet crude oil prices have not spiked.
  • One reason for this is that ISIS is mainly contained in non oil producing parts of Iraq.
  • Another reason is that contagion is unlikely because ISIS is too extreme.
  • Unless things get a lot worse, crude oil will not rally because of Iraq.

In a world where economical oil is becoming harder and harder to find, Iraq is seen as one of the last great places to drill for oil cheaply. According to the Energy Information Agency, the Middle Eastern country has 141 billion barrels of oil, and the cost to drill is only $2-$5 per barrel.

Given its prodigious reserves of easy oil, many had hoped that Iraq would ramp up production as quickly as possible so that the nation could rebuild and heal. And while Iraq has ramped up production to slightly over 3 million barrels a day, Iraq has unfortunately been struck by a bout of sectarian violence. The rebel extremist group ISIS has taken control over more and more parts of central Iraq and is now threatening Iraqi Kurdistan.

Despite the escalating geopolitical conflict, the market has remained relatively calm. The price of Brent has not rallied like it did for the Jasmine Revolution. There are several reasons for why the market is not that concerned:

One reason is that vast majority of oil fields in Iraq are still producing oil. Even though ISIS has captured a significant part of central Iraq, most of Iraq's major oil fields are in Southern Iraq or Iraqi Kurdistan. In addition, the U.S. has recently begun air strikes in an attempt to prevent ISIS from capturing more territory. As long as ISIS remains relatively contained in central Iraq, disruption to Iraqi oil production is unlikely.

Another reason is that there is little threat of contagion. Even though it did spread from Syria to Iraq, ISIS is unlikely to spread to other countries because the organization is too extreme. Much of the Muslim world, for example, doesn't like ISIS. The organization's goals are not noble ideals like the Jasmine Revolution's goal of less corruption, but are instead to establish an Islamic caliphate to benefit themselves. Because ISIS doesn't have the support of other Muslims, its beliefs won't spread like the Jasmine Revolution did, and consequently it won't be able to disrupt oil production in other parts of the Middle East.

Finally, the market is not that concerned about Iraq because of increasing U.S. tight oil production. Over the past 5 years, the U.S. has ramped up its oil and gas production by leaps and bounds. According to the EIA, the U.S. produced an average of 7.4 million barrels a day in 2013, or 2.4 million barrels more than in 2009. This new U.S. oil production has arguably compensated for and buffered against the modest supply disruption caused by ISIS.

By remaining relatively stable through the Iraq crisis, the market seems to be taking the long term view that even though there may be bumps along the way, Iraq will eventually produce enough crude oil when the world needs it. Unless things get a lot worse, current oil prices will not rally and future production will not shrink because of Iraq's geopolitical troubles.

Given a weakening Chinese economy and increasing U.S. tight oil production, the market is much more concerned about potential short term oversupply instead.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: Why The Market Is Not That Concerned About Iraq