The Washington PostDemocracy Dies in Darkness

Chaos in Iraq is already sending oil prices higher

ISIS fighters patrol on a vehicle in Tikrit, which the group overran, June 11, 2014. Sunni rebels from the al Qaeda splinter group overran the Iraqi city of Tikrit on Wednesday and closed in on the biggest oil refinery in the country, making further gains in their rapid military advance against the Shi'ite-led government. (REUTERS/Stringer)

One of the biggest headlines in the energy world this year has been the revival of Iraqi oil output. In February, Iraq's production surged to an average of 3.6 million barrels a day – the highest level since 1979, the year Saddam Hussein took power. Since Iraq has the world’s fifth largest proven oil reserves, it has the potential to expand output much further.

But while geology has bestowed gifts on Iraq, political strife has repeatedly taken them away.

The swift collapse of the Iraqi army in Mosul and other northern towns and the advance of extremist militants toward Baghdad has shaken the country’s stability just as Iraq, now the second largest producer in the Organization of Petroleum Exporting Countries, was starting to bring stability to oil markets.

Oil prices were virtually unchanged on Wednesday, but on Thursday they climbed. The price of Brent crude oil, the international benchmark grade, for delivery in July rose to $112.61 a barrel, up 2.4 percent, on the London-based commodity exchange.

Oil prices are already at their highest level this year, though they were slightly higher at a couple of points last year, partly in response to supply disruptions in Libya. This is the fourth consecutive year in which crude oil prices have bounced along all-time highs. (In 2011 and 2012, Brent hit peaks of about $125.)

So far, the only oil-related casualty of the fighting has been the pipeline that runs from Kirkuk to Ceyhan in Turkey. The pipeline, which has been out of commission since March because of sabotage, was expected to be repaired and back online and carrying up to 250,000 barrels a day.

That might remain the only petroleum casualty. Iraq’s biggest oil fields are far to the south, closer to Basra than to Baghdad. The Islamic State of Iraq and Syria (ISIS) forces are modest in size, and any attempt to reach the south might stretch their supply lines and put them up against tougher foes. The 2.5 million barrels a day exported via terminals and tankers in the Persian Gulf seem relatively secure.

“While not beyond [ISIS'] geographical reach, an effort to expand operations into southern Iraq would risk overextension and expose the militants to the more determined defenders of southern oil infrastructure as well as Shia militia,” said Robert McNally, president of the Rapidan Group, a consulting firm.

Those big fields in southern Iraq were discovered long before Saddam’s time, and after U.S. and allied forces ousted Saddam, the Iraqi government invited international oil companies to come and use modern drilling techniques to increase production.

In the giant Rumaillah oil field, for example, BP and its partner the Chinese National Petroleum Corp. have boosted crude oil production from about half a million barrels a day to 1.4 million barrels a day.

The other major oil exploration and production area is in the Kurdish region in the north. There too foreign companies are helping. On May 1, Exxon Mobil said in an earnings presentation that it was drilling two exploration wells in the Kurdish region. (It also holds about a 25 percent interest in boosting production on a southern field.) Chevron has agreed to drill new wells in three other fields in the Kurdish region. There are other companies there.

Few companies outside the energy sector do business in Iraq, which through 2011 had imported about $2 billion a year in U.S. goods and services. Companies fear violence and chafe at the difficulty of dealing with the Iraqi government. Many prefer doing business in the Kurdish region.

“The World Bank’s 2013 Ease of Doing Business survey ranks Iraq 165th of 185 economies evaluated, although companies appear to find that doing business in the Iraqi Kurdistan Region, a federated region within Iraq, is significantly easier than in the rest of Iraq,” said the Commerce Department last year.

While the Kurdish region of Iraq is closer to this week’s fighting, it has its own fighting forces and ISIS so far has not ventured into that area.

One side effect of the ISIS advances might be to push the central government in Baghdad and the Kurdish regional authority closer together into an “alliance of convenience,” McNally said. Baghdad has objected to exports of Kurdish oil through Turkey and threatened to sue foreign companies involved.

However the military campaign goes, it is certain to divert attention and resources away from rehabilitating the oil sector. The state-owned oil company still needs to do its share to protect infrastructure and provide its share of investment to keep output rising. Now the mood and focus have changed.

“They’ve just created a whole new environment in Iraq,” said Ayham Kamel, director for the Middle East and North Africa for the Eurasia Group, a consulting firm. “A week ago we were talking about an environment where the long-term challenges of the central government were more or less manageable. Now we’re looking at something much more complicated and where large parts of the country are outside government control.”

Where will it lead? “As military confrontations expand it is possible there will be broader conflict,” Kamel said. “Does it have immediate impact? Not right now. But the long-term implications are not that positive for Iraqi stability as a whole.”