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Iraq violence could throw world oil market out of balance, threaten 4 years of steady prices

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NEW YORK, N.Y. - The upheaval in Iraq could throw the world's remarkably stable oil market out of balance, threatening a delicate equilibrium that has kept prices steady for much of the last four years.

Iraqi oil production is at risk because of the outbreak of violence involving militant groups who seized two cities this week and have pledged to march on Baghdad.

For now, the fighting is mostly in Iraq's north, away from important oil-producing regions in the south. But the turmoil sent the price of Brent crude, the key international benchmark, up 2.8 per cent Thursday to $113.02, its biggest gain since August.

More important, it raised questions about Iraq's ability to continue to rebuild its oil infrastructure and increase production to meet rising global demand.

Global oil markets have been unusually steady since mid-2011. Dramatic changes in oil production around the globe have offset each other instead of wreaking havoc. That has helped keep world oil prices high enough to provide OPEC countries with robust income, but not so high that they scare customers away from buying more oil.

"Everybody's happy," Secretary General Abdullah Al-Badry said Wednesday in Vienna after the Organization of Petroleum Exporting Countries concluded a semiannual meeting.

Brent has hovered in the range of $110 per barrel over much of the last four years, with only occasional volatility. That has also led to stable gasoline prices for U.S. drivers, who have been paying in the neighbourhood of $3.50 per gallon.

"It's comfortable for everyone," said Judith Dwarkin, chief energy economist at ITG Investment Research. "The global economy has recovered, oil demand is growing at trend, and prices are high and stable."

But the comfortable market masks some difficult realities that OPEC has so far been lucky to avoid. There have been production booms in some areas of the world that could have sent prices plummeting. And there have been shortages in other areas, including in OPEC countries, that could have sent prices rocketing higher.

OPEC has been fortunate, experts say, because the organization would be hard-pressed to adjust if this precarious balance were upended. OPEC members have a limited ability to either raise or lower production to steady the market, they say.

Instead, "OPEC hasn't had to make difficult decisions," said Michael Levi, Director of the Program on Energy Security at the Council on Foreign Relations.

Production from non-OPEC countries, driven especially by a boom in U.S. shale oil, has risen by 4 million barrels per day over the last four years. That's more than the entire output of Canada, the world's fifth-largest producer, and more than enough to push oil prices lower.

At the same time, Iraqi output has risen 22 per cent since 2011 to 3.3 million barrels per day, further adding to supplies. That too could have pushed oil prices lower.

But prices haven't fallen, in part because production from other OPEC members has fallen — though not because of a concerted effort by OPEC. Libyan production has been almost completely held out of the market due to political and labour unrest. Western sanctions against Iran, once the world's second-largest exporter, have reduced Iranian output by about one-fifth. And production from Venezuela and Nigeria has slipped because of economic and political difficulties.

The rise in production in the U.S. and elsewhere has matched almost exactly the rise in world demand, from 88.5 million barrels a day in 2010 to an estimated 92.8 million barrels a day this year. It also helped cushion the market somewhat from unexpected disruptions.

In early 2011, when Libya descended into violence, Brent crude experienced the kind of spike that has become rare, to nearly $126 per barrel. While Iraq's violence this week isn't as widespread, the oil market's reaction — a rise of 2 per cent — is probably much more modest than it would have been years earlier.

Changes to this scenario would put OPEC in a difficult spot. Analysts believe OPEC nations, other than Saudi Arabia, are producing as much as they possibly can, so they aren't in a position to boost output substantially to meet a spike in demand or avert another unexpected production outage.

Nor would OPEC member countries be likely to make production cuts because they are especially desperate for cash to run social programs and fund national defence.

"OPEC rarely if ever constrains or influences the oil production rate of its member states," writes Jeff Colgan, a professor at the School of International Service at American University in a study soon to be published in the journal International Organization. "A cartel needs to set tough goals and meet them; OPEC sets easy goals and fails to meet even those."

Recently, the little balancing the market has needed has come from Saudi Arabia, the world's largest exporter. As the one OPEC nation with a healthy oil industry, enormous reserves and a relatively stable economy, it has acted on its own to keep the market in balance despite official OPEC production levels.

For example, forecasters expect OPEC production to rise later this year by about 500,000 barrels per day over the official quota of 30 million barrels per day it set at the meeting in Vienna. Nearly all of that will likely come from Saudi Arabia.

And while experts don't expect much disruption of Iraqi oil, if any, from the recent violence, they say if output is slowed, Saudi Arabia will step in with even more crude to keep the market in balance.

The question, they say, is whether Saudi Arabia can continue, by itself, to do what OPEC as a whole was organized to do. Iraq's insurgency may make that more difficult.

"The most significant impact from the insurgency is likely to be the disruption to Iraq's already ambitious targets for oil production," wrote Tom Pugh, a commodities economist at Capital Economics.

___

Jonathan Fahey can be reached at http://twitter.com/JonathanFahey .

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