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Editor's Note: Yesterday Iraq descended into full-blown civil war.
At the same time, Russian oil interests - specifically those of the Russian parastatal Gazprom - are hitting Western-placed hurdles to their coveted South Stream natural gas pipeline project to the West. That's right when Putin and the Kremlin need it most.
These two events are hundreds - in some cases thousands - of miles apart, but they will have major, immediate impacts on energy prices. And understandably, investors are worried.
Yesterday, we caught up with Dr. Kent Moors for his unique insight, just as he finished speaking to the country in a Fox News interview. Kent had a very different take on events, saying, "We're in an unusually advantageous situation for American investors."
Money Morning: Yesterday Iraq blew up into civil war, with a complicated mix of warring factions. What's your take on the situation as it unfolds, and what are the impacts to Iraq's energy reliability?
Dr. Kent Moors: The impact on Iraqi oil is going to get worse the longer the crisis continues. Which means the price of oil will be up again today. The market is taking a worst-case view so oil prices were up to almost $107/barrel here in the U.S. yesterday and over $113 in London, and that's going to be added to today.
In terms of how far this goes, it's going to depend on several factors.
If it looks like Iraqi production may be adversely impacted by what's occurring over there, then that's when the price increase is going to accelerate.
If the fighting centers around Baghdad, which is not a high oil-producing region, and does not move south into the Basra area, then we may see a tempering of the prices. However, we aren't going to see prices going down anytime soon.
The other factor that people ought to be concerned about with Iraq is northern production.
That's about 20% of the oil that comes out of Iraq daily. That's centered in and around the city of Kirkuk. The Kurds have taken over control of Kirkuk, and they've essentially assimilated the city into Kurdistan, which is a semi-autonomous region in northern Iraq.
That means the oil flow going to Ceyhan in southeastern Turkey will probably be protected.
If the United States goes in, in any military capacity whatsoever, it'll go in first to defend the Kurds.
MM: Was the takeover of Kirkuk by the Kurds quick to develop?
Kent: That essentially happened overnight, and it happened because the Iraqi army just left Kirkuk. They completely withdrew, and the Peshmerga, the very capable Kurdish militia, took over control of the city.
MM: Getting to your earlier point, what's the likelihood of an American military intervention in Iraq?
Kent: I doubt seriously there's going to be any American boots on the ground. We'll be providing assistance and maybe even some air cover, but we'd have to be very careful. Moving back into this region simply sends the wrong message, and then people start reacting to the next American incursion, rather than what's going on domestically.
Military intervention will probably be dictated indirectly by NATO, because Turkey has a border there. Turkey has called for an emergency NATO session on the situation that's taking place in Iraq. So I wouldn't be surprised at all to see a combined Turkish/Kurdish response to this.
MM: How would the Turks and Kurds coordinate, and what would be the impact to investors, if any?
Kent: Well, there's a couple of things that will happen that will be of interest to investors.
Kurds have been trying to move their oil out to Turkey, independently from the central government in Baghdad - and Baghdad has opposed that.
Now we have a situation where the Kurds' ability to move their own oil and gas pretty much is going to be unimpeded from this point forward. So whether Baghdad likes this or not, I think it's a fait accompli: The Kurds now have their own export strategy.
MM: So looking at northern Iraq, it would be fair to say it's less likely to have impacted production.
That's correct, I think it's the more secure of the two primary sources of Iraqi oil.
MM: With Baghdad not in a major oil-producing region, what are your feelings as we turn to the south as far as oil production?
Kent: This is the great unknown. This is where most of the Iraqi oil is produced. The Iraqi Ministry of Oil set out three series of bids over the last several years, so Western major oil companies could come in and increase production at already existing wells.
These are huge fields, some of the largest fields in the world. So these major Western companies came in to bring up the overall production of Iraqi oil and thereby the exports. And it had been increasing on a regular basis.
The real key is whether or not this insurgency moves that far south. If the security situation deteriorates, and the coordination does not take place from the central government in Baghdad, you may well have some of these major companies suspending their activities in the south. If they suspend their activities, production goes down.
Now the disturbing thing we were getting yesterday, and in fact, some of this news was hitting while we were on the air on Fox News last night, is concerning Western oil companies.
We have some major Western oil companies that are now making provisional plans to start moving their staff out of Iraq. If that's the case, these fields stop producing. And now we've got a major problem.
Forget about the overall amount of oil being produced in Iraq; it's about 3% of the entire world oil production. The real problem is with oil prices and the integrated international market; if you have a problem anyplace, the price determinants tend to overemphasize that.
So if you have any suspension of production at all in southern Iraq, no matter how minor in terms of overall daily volume, that's going to have a magnifying impact when it comes to what occurs for international oil prices.
Another factor is China's state oil company, China National Petroleum Corporation, that I spoke about on Chinese television last night.
CNPC yesterday was laying out contingency plans for moving people out and suspending production. They haven't done either. But as things become more unsettled in Baghdad, even if it's two hundred miles away [from Basra's oil fields], you no longer have a Central Administration regulating what you're doing in the field. That's the problem, and it has companies unsettled.
MM: So it's not just how much production might get suspended, it's the perception and the ripple effect on pricing.
Kent: The International Energy Agency just issued a report indicating that they were once again concerned about the ability to provide the supply necessary to meet rising global demand. So any decrease whatsoever in supply is going to have an adverse impact [i.e. increase] on prices.
MM: Switching to the South Stream pipeline project for a moment, although they're not related, they're integrated in terms of international energy prices. What do you see as the scale of interruption of further construction in Bulgaria and the impact on energy pricing?
Kent: All of the particulars on that you can see more fully in the last two issues of Oil & Energy Investor. Remember that this is a natural gas play; this is not an oil play. South Stream is a natural gas pipeline. And it is crucial for the Russians to offset the difficulty in Ukraine by coming up with alternative ways of using and moving natural gas into Europe.
The problem is they've peeved Europe. And both the European Union and NATO are now really looking at further Russian inroads into the European market as problematic at best.
This has been going on for some time. If you go back to Tuesday's Oil & Energy Investor, I've been involved with this, but I couldn't sit around and talk about it until it got released somehow.
Well, when the Bulgarians finally decided Monday that they were going to suspend their operations on building their onshore component of the South Stream, that was enough to allow me to come out and start talking about this. This has been the real economic sanction that the U.S. government and the EU has been preparing against Russia.
I mean, if you want to hit Russia, you have to hit Gazprom. If you want to make it hurt, the exports of gas from Gazprom out of Russia to other places in the world - that's the single biggest component of the Russian "simple" budget.
Unless Gazprom increases its overall exports, Gazprom - which is a very poorly run company - and the central budget in Russia are going to experience difficulties. The suspension of South Stream hits them where they're weakest.
Right now, it's a nonexistent pipeline; they're building it. It's the most expensive pipeline project in the history of man. Depending on whom you believe, I think it's in excess of $32 billion and counting. It's a huge project. It does not adversely impact Europe at all, because Europe is not yet receiving any natural gas from this pipeline.
MM: So the impact on energy prices is really in the diminished future ability for Russia to deliver.
Kent: Yes, and it hits the Russian budget where it's weakest. Their reaction was immediate. They were screaming bloody murder over there; "Bulgaria has violated contracts," they said. Let's face it. Bulgaria is a member of the EU. And it's a member of NATO. The only other option that the Russians have that we talked about in Oil & Energy Investor is that they also need offshore access.
Another outlet for Russia is Romania. Romania is part of the EU and part of NATO. So this is not going to happen, folks; it just isn't going to happen. The third component of that is Turkey, which is part of NATO, so everywhere they look they've kind of painted themselves into a corner.
Look, you don't want to kill Gazprom because that adversely impacts economic interests that it's associated with all of Europe. That's not going to help. What you have to do is make a very concerted effort to force Russia to come to the bargaining table with meaningful terms. After they jump up and down and scream and flap their wings and so on and so forth, then they'll sit down and start talking. That's what we're attempting to get done.
Nobody's interested in killing Gazprom, but we are interested in using Gazprom as a way of forcing Putin to back off a little. And the Ukrainians think they have the upper hand because the Ukrainians just walked away from the gas pricing discussions with the Russians this Thursday.
MM: So again, two events are not necessarily related in Russia and Iraq, but they're going to amplify the impact on energy prices, and it's not going to be a good impact.
Kent: Oh yes. But... we're sitting very pretty with domestic oil and gas plays in the U.S. If this sort of thing were occurring five years ago, we'd have all kinds of problems here. There would be real concerns over price and refineries having adequate supplies and so forth. And that's no longer the case. So this allows us to optimize some domestic plays over which we can control a better amount of the market variables.
Notice that the energy sector went up today. The market went down again triple digits, but the energy sector went up. And most of the components going up are the most secured domestic components in the United States.
Remember two other things about this that people get confused about all the time. One issue is: How much will it cost? How much will my oil cost, and how much will my gasoline cost?
The other thing is, do we have enough supply of it? Are we reliant on untrustworthy foreign sources and so on? Well, with all this domestic oil and gas we have now, we don't have to worry that much about that second security issue. We have plenty of domestic sources.
People shouldn't conclude from that that oil prices will suddenly go down. The price of oil will continue to go up. Which means what? We're in an unusually advantageous situation for American investors, so now you know where the supply is, and you know the profit margins aren't going to constrict.
More from Dr. Kent Moors: June's mammoth gas deal between Russia and China has been described as "historic." That may be true. But there are big problems with the deal that can't be overlooked...
About the Author
Dr. Kent Moors is an internationally recognized expert in oil and natural gas policy, risk assessment, and emerging market economic development. He serves as an advisor to many U.S. governors and foreign governments. Kent details his latest global travels in his free Oil & Energy Investor e-letter. He makes specific investment recommendations in his newsletter, the Energy Advantage. For more active investors, he issues shorter-term trades in his Energy Inner Circle.