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Ahead of Wall Street

Friday, June 13, 2014

The wholesale inflation and consumer sentiment data today will likely not be enough to distract the market from the unsettling headlines out of Iraq. The heightened uncertainty is pushing oil prices higher, though I don’t believe there are any immediate threats to oil supplies out of Iraq.

The Iraq situation is no doubt unsettling, with developments on the ground pointing towards a three-way split for the country – the Kurds in the north, the incumbent Maliki-led Shiite government in the south, and the new extreme Sunni insurgents-led growing pocket in the center. But as we all know, Iraq is no ordinary Middle Eastern country; it has the 5th largest oil reserves in the world that it had only recently started tapping after years of war and sanctions. No doubt global oil prices have responded the way they have to the news flow out of that country.

But the oil market’s reaction appears to be more emotional and knee-jerk rather than reflective of ground realities. There is literally no threat to Iraqi oil supplies even if the extremist forces (Islamic State of Iraq & Syria or ISIS) are allowed to entrench their positions and carve out Sunni state out of Iraq and Syria.

The reason for that is 3/4th of Iraqi oil reserves and volumes are in the Shiite majority south of the country that get exported through the Persian Gulf port of Basra. The Shiite-dominated Iraqi army’s embarrassing performance in Mosul and other Sunni regions thus far notwithstanding, they are unlikely to do the same if the fight ever came to their doorstep in the Shiite parts of the country. Assuming the ISIS forces are rational, they will keep the pressure on Baghdad and the Shiite region, but are unlikely to mount an actual attack on the region. Meaning that he bulk of Iraqi oil will continue to flow through to international markets from southern port of Basra.

The rest of Iraq’s oil is in the autonomous Kurdish region, which only pays lip service to being part of Iraq and the Shiite Maliki-led national government in Baghdad. The town of Kirkuk on the edge of the Kurdish region is the main legacy oil-producing area and it remains firmly under Kurdish control. In fact, the Kurds already have independent pipeline infrastructure to export their oil through Turkey. Importantly, unlike the bumbling and flighty Iraqi national army, the Kurds have a reliable fighting force in the Peshmerga army, which the Sunni extremists will try their best to avoid.

Bottom line, there is no immediate threat to oil supplies from Iraq as result of the three-way split of the country. That said, the carve out of an extremist-led Jihadi haven out of Iraq and Syria, kind of a pre-911 Afghanistan in the Middle Eastern tinderbox, is very destabilizing. Why it happened and what can be done about it is beyond the scope of this piece, but suffice it to say that this is an immensely complex situation that doesn’t lend itself to easy fixes.

What this means is that there may not be an immediate threat to global oil supplies. But the Iraqi developments of recent days represent the most ominous threat to the Middle Eastern status quo. It is this resulting uncertainty that the global oil markets are currently reflecting.

Sheraz Mian

Director of Research
 

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