Futures prices for both crude and gasoline were down yesterday. Unfortunately, that barely tells the real story.
So, enjoy the respite while it lasts.
Thanks to the growing Sunni insurrection and the rapid unraveling of the Shiite government in Baghdad, you can bet that prices for both crude and gasoline will be making the headlines over the next two months.
In fact, when it comes to oil, some bankers are now openly questioning the ability of the market to meet global demand a year out. Now prices further out on the futures curve are rising much more quickly than anticipated.
Here's why yesterday's drop in prices is just the pause before the storm…
If Iraq Unravels, Oil Production Will Be Crippled
There's a reason why Iraq figures so prominently in this discussion. Everybody's estimates now suggest that global oil demand will accelerate to 94 million barrels a day by the end of this year.
That will place a greater reliance on expanding the existing sources of supply.
Previously, when in the same situation, the Saudis would bail us out since they have the ability to put 12 to 12.5 million barrels a day on line in a matter of a few hours. In the past, that provided a reliable cushion, restraining a real breakout in prices to the upside.
Well, this time that's just not so. The projected demand spike will flat out exceed the ability of Saudi Aramco to deliver. That means relying even more on other OPEC members. The problem is that consistent overall production increases have been muted, with Iran and Venezuela actually posting declines.
However, the singular exception in all of these estimates has been Iraq, where the government has ambitious plans to ratchet up production at major fields in the south from the about 3.1 million barrels a day to more than 6 million barrels a day with further expansion planned beyond that.
In this position, Iraq has become the new "balancer" in the international oil equation.
Now, keep in mind that the ongoing crisis has not hit the oil fields directly. And there is little indication that the Islamic State of Iraq and the Levant (ISIL) has the ability (or intent) to capture these fields. While they have effectively immobilized the nation's largest refinery at Baiji, near Tikrit and north of Baghdad, their forces are far too small to capture and control the critical fields and pipelines.
Unfortunately, the ISIL can accomplish the same result without occupying a single square inch. All they need to do is immobilize the current government and allow the fragmentation already underway to render the new Parliament (supposedly sitting by the end of this week) powerless to act. After all, even without a major insurrection, it usually takes that body months to come up with an ineffective patchwork administration.
Needless to say, that would only make a bad situation even worse.
Here's why: Losing centralized governmental regulation of the oil sector freezes field development and will prompt international majors to start moving personnel out of the south, even though insurrectionists are 200 kilometers away.
In fact, some of these companies have already begun to make their exits. And that's what is prompting a rise in prices further out on the curve. The problem is, even more bad news is right on the horizon.
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.