Realpolitik: How the Crisis in Iraq Will Affect Your Pocketbook

Iraq is the world’s largest oil exporter after Russia and Saudi Arabia, and closed refineries mean higher prices.

Dafna Maor
Dafna Maor
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No drilling is taking place at the Baiji oil refinery in Iraq.
No drilling is taking place at the Baiji oil refinery in Iraq. Credit: Reuters
Dafna Maor
Dafna Maor

Historians and specialists in geopolitical issues will say that there is a greater desire for peace in the world now than ever before. There are many fewer wars and conflicts – ethnic, national or otherwise – than in the past. But try to tell that to the residents of Homs in Syria. More recently, of course, there is the case of the yeshiva students abducted in the West Bank. And on a wider geographic scale, the latest new flash point is Iraq, where the Iraqi government is battling with Islamist forces for control of the country.

The Islamist rebel group, the Islamic State of Iraq and Syria, is leading the sweep toward Baghdad through the northern Iraqi cities of Mosul, Tikrit and Baiji and no oil drilling is being carried out in these areas. Baiji is home to the country’s largest refinery, which had been said to be protected by Iraqi government special forces. On Wednesday, however, there were reports that the refinery had also fallen to ISIS forces, but the rebels have not yet pushed into the south of the country, where most of the oil production takes place. All this prompts the question as to how the near-breakup of Iraq could affect the global economy and Israel’s as well.

Of course, the major influence on world markets from the situation involves oil. Even the Western involvement in the country around the time of the first Gulf War in 1991 was connected to Iraqi oil, and oil remains the world’s most important source of energy, despite efforts to develop renewable energy sources. As the summer driving season begins in the United States, and as China shows signs of fitful economic revival, the concern is that oil supplies from Iraq will now be disrupted, leading to higher prices.

World consumption of oil is now 92.8 million barrels a day, compared to 88.5 million as recently as 2010. Iraq is now the second most important producer in OPEC, the 12-member Organization of the Petroleum Exporting Countries. Iraqi production has surged by 22% since 2011 and is now 3.3 million barrels a day.

World oil prices have been climbing steadily recently. On Wednesday morning, Brent crude, the most widely traded, was selling at over $113 a barrel compared to $91 in January. The price increases are tied not only to the situation in Iraq but also to the instability in Libya and the Russian invasion of Crimea, which threatens European oil supplies.

Volatility in oil prices has been dampened somewhat by economic weakness among major oil-consuming nations, notably China, and the transformation of the American energy sector, where efforts to derive oil and natural gas from fracking threatens to flood global markets. Oil production from non-OPEC countries, particularly the United States, increased by a substantial 4 million barrels a day over the past four years. When it comes to Iraq, foreign oil companies flocked to the country as the regime stabilized there after the overthrow of President Saddam Hussein, and major investments were made in developing the country’s oil fields. It is thought that Iraq could potentially produce 6 million barrels a day. For purposes of comparison, the world’s largest producers, Russia and Saudi Arabia, each have daily production of 10 million barrels.

The fighting in northern Iraq may not affect the oil fields in the country’s south, but it would put off foreign investors and could lead to the scrapping or at least deferral of additional development plans for the Iraqi oil sector. This is all coming at a time when oil production has been hurt in Libya and Syria, albeit on a very small scale. In addition, two other oil producing countries, Venezuela and Nigeria, are facing political instability.

Memories of past damage inflicted on the global economy by oil shortages and oil price increases over the second half of the 20th century and into the current century are not forgotten. The oil crisis of the 1970s nearly wrecked the American economy.

Oil price rises are frequently an inseparable part of the cycle of global recession. When the price of oil goes up, it is accommodated around the world by cutting back on other things – investment in manufacturing facilities, infrastructure and individual consumption. And we should also bear in mind that the world economy is in a more vulnerable state at the moment than it has been. Consumers are already cutting back on spending, governments are enacting austerity measures and few people have spare funds lying around to spend on gasoline or heating oil.

Even if the oil price has not skyrocketed recently, an expectation of such an event is enough to rattle the markets and send investors scurrying to safer havens. In the short run, therefore, it’s possible that demand for highly-rated government bonds will climb, even though prices in the sector are already high. And the biggest losers will be shares of stock and other investments that are dependent on economic growth. Investor flight to safer investment options also shores up the price of gold. But so far, the markets have not panicked over the situation.

For the Israeli consumer, a jump in the price of global oil prices will of course boost gasoline prices too. Israel remains an energy importer, despite the large reservoirs of natural gas discovered off the country’s Mediterranean coast in recent years. And in any event, most of the gas remains under the seabed for the time being. Beyond that, a downturn on the world’s securities markets could affect share prices on the Tel Aviv Stock Exchange as well as bond yields here.

Major OPEC producers such as Saudi Arabia, Kuwait and the United Arab Emirates have the greatest capacity to tame price shocks from the disruption of the oil supply from Iraq. In recent years, OPEC members have benefited from the fact that oil prices have not declined and, even more importantly, that they have not shot up so quickly as to harm the economies of their client countries. Oil price levels have been maintained in part by a cut in production from Iran due to international sanctions against the country over its nuclear program.

At an OPEC meeting in Vienna this month, the organization decided to leave its production levels unchanged at a collective 30 million barrels a day. Abdalla el-Badri, the organization’s secretary general, claimed that everyone was satisfied by the decision but analysts claim OPEC will have a hard time adjusting to major changes in the oil market, whether on the supply side or the demand side. OPEC member states don’t seem to have major flexibility in either raising or cutting oil production.

Saudi Arabia is the major country capable of throwing a lifeline if necessary to offset the decline of oil supplies from Iraq. According to estimates, the country is capable of increasing oil production by 500,000 barrels a day in the second half of 2014. That, however, is the sum total of the increase that OPEC has to offer.

Observers think that the current Islamist offensive from the north of Iraq spells the end of optimism, if there ever was any, when it comes to Iraq. Earlier the International Monetary Fund predicted that the Iraqi economy would grow by 6.3% in 2014 and by even 8.25% in 2016, which would make it the fastest-growing economy in the Persian Gulf region. At this point, however, all of those optimistic forecasts have to be rethought. The fear of experts in geopolitics is that Iraq will actually be split apart by tribal and religious warfare.

Even if ISIS doesn’t manage to capture southern Iraq, it can harm efforts to develop the resources in the north of the country. The potential benefactor in such a situation is the government in the autonomous Kurdish region in the north, which recently developed an oil pipeline from the oil fields there to Turkey. Although it is thought that oil exports via Turkey could grow to 400,000 barrels per day, the government in Baghdad has foiled some of the Kurdish plans on the argument that oil from the north must be sold through Iraq’s central government. Observers, however, have a sense that the Kurds’ bargaining power has been boosted by the Islamist offensive from the north, with the thought that the Baghdad government would now demonstrate flexibility to get in on a piece of the revenues.

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