Oil Prices and the Implications of the Political Unrest in Iraq

Iraq, the world’s fastest-growing oil exporter, has fallen into a state of great political turmoil due to the recent military offensives of the Sunni-led Islamist movement known as the Islamic State in Iraq and the Levant (ISIS). Since early June, ISIS militants have swept throughout Northern Iraq capturing city after city, most notably Mosul – the nation’s second largest city.

The swift successes of the militant forces highlights the weakness of Iraq’s Shia government and its US-trained security forces, and has called into question if the government can regain political stability or succumb to civil war.

This specter of Iraq collapsing into sectarian conflict has had a dramatic effect on the price of oil, which has risen 4% since June 6th. The increase has taken a barrel of crude oil to $107, the first time it has reached such a level since September 2013.

Although militant attacks have shut off most exports from Iraq’s northwestern oil supply, 70% of the country’s oil production is in the south. While these oil deposits are relatively secure currently, the instability of the Iraqi government leaves the oil market with little faith in the continuing production levels of the troubled state.

According to Paul Stevens, a professor and fellow at Chatham House, “the oil price shouldn’t be affected that much unless there’s a major collapse in Baghdad. Fear and uncertainty are playing a part in the price.”

The turmoil in Iraq has coincided with fears of further disruptions in the oil market with the growing instability in Libya. Libyan supplies have collapsed to about 100,000 barrels per day, from 1.4 million a year ago, as rebels have occupied oil fields and major export terminals.

“Given that Libya is pretty much offline … the only country that has spare capacity to meet any rise in demand is Saudi Arabia, which would have to increase production in any case in Q3,” said Amrita Sen, chief oil analyst at Energy Aspects. “If you get any supply disruption in Iraq, that is going to be the challenge for the market — how does it counteract that?”

To meet the increasing demands for fuel this summer traveling season, the major Gulf Arab producers such as Saudi Arabia, Kuwait, and the United Arab Emirate are expected to increase oil production. However, this increase in production by the Gulf States will not be able to fully replace the resources that the oil market has lost in the recent months.

Instability in Iraq has the potential to be a catalyst for greater destabilization in the region. For example, Iran has felt its national interests threatened by the aggressive ISIS offensive, and currently is exploring options to assist the Iraqi Shia government. If Iraq is unable to settle its sectarian strife, then oil prices will continue to be on the rise in the foreseeable future.