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Must-know implications of the tumult in Iraq for oil prices

Must-know story: Why turmoil in Iraq is affecting energy stocks (Part 3 of 4)

(Continued from Part 2)

Iraq turmoil sent oil prices skyrocketing

The implications of the sectarian violence in Iraq are felt worldwide even as the violence threatens to disrupt Iraq’s oil supply, which has caused oil prices to rally.

After rising 4.1% last week, the benchmark U.S. crude, West Texas Intermediate, or WTI, for July delivery rose 36 cents to $106.74 per barrel—the highest in nine months—on NYMEX (the New York Mercantile Exchange).

Brent crude, a benchmark for international oils, gained 63 cents to $113.62 per barrel.

Both the WTI and Brent benchmarks are at their highest levels since September 2013, even as the threat to global oil supply keeps mounting. Iraq is a member of the Organization of the Petroleum Exporting Countries, or OPEC, second only to Saudi Arabia, and it’s one of the world’s largest producers of crude oil. So the turmoil in Iraq is of consequence to the rest of the world. U.S producers in particular will be keenly watching oil prices, as changes would affect the U.S benchmark, WTI. WTI crude price movements affect producers such as Oasis Petroleum (OAS), Hess Corporation (HES), Chevron (CVX), and ExxonMobil (XOM). Also, oil price movements affect energy sector ETFs such as the SPDR S&P Oil & Gas Exploration and Production ETF (XOP) and the iShares Dow Jones U.S. Energy Sector ETF (IYE).

Oil prices are also supported by a drop in U.S crude oil inventories. As per the inventory report released by the U.S. Energy Information Administration (the EIA) on June 6, crude oil inventories decreased by 2,596 thousand barrels compared to analysts’ expectations of a 1,655 thousand barrel decrease.

A brief background of Iraq’s oil production

Iraq’s civil war in early 2000 had destabilized the country, disrupting the oil supply. Only recently has Iraq’s oil production recovered to pre-war levels. Last year, the EIA declared Iraq to be the seventh-largest oil producer in the world.

In February this year, the country pumped a record 3.6 million barrels of crude per day. Iraq aims to increase its output to 4 million bpd (barrels per day) and, in light of the recent upheaval, it remains to be seen if it can achieve this goal.

Implications for the U.S.

Although the U.S. isn’t immune to the effects of disruption in world markets, the rise in global oil prices is curbed by U.S. production. As per the recent short-term energy outlook released by the EIA, crude oil production in May this year averaged 8.4 million bpd—the highest monthly average production since March 1988.

It would be logical to assume that WTI prices would have been even higher if it weren’t for the U.S. energy renaissance. Currently, the U.S is producing more oil than it imports, so prices, although they have spiked, haven’t risen much on fears about Iraq.

However, this won’t last if the tumult in Iraq worsens and combines with the lack of oil from Libya (see Why unrest in Libya is affecting oil markets). Oil prices will continue to rise even higher.

But the situation hasn’t created as much panic as you would imagine, and this is mostly because the southern zone of Iraq, which is the base of 75% of Iraq’s crude production, remains unscathed, as per the U.S. Energy Information Administration. Southern Iraq is the origination point of major export terminals, leading to no immediate cause for a supply crunch. If the upheaval spreads into the south of Iraq, it might spur real worries for oil players.

The U.S. shale oil boom has helped keep much of the Iraq shock under control. So oil prices aren’t likely to skyrocket in the near term. However, the longer the insurgency lasts, the more difficult it will be for Iraq to approach its potential to sustain production. This will have severe implications for oil markets as production falls worldwide due to intensifying disorder in a growing number of OPEC countries.

The following parts of this series discuss the macroeconomic implication of the Iraq turmoil.

Continue to Part 4

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