Iraqi oil production and exports at stake

SEB - Prognoser på råvaror - Commodity

The Brent crude oil price spiked 3.6% on Friday to $68.6/bl on the back of the US killing of the Iranian general Qassem Soleimani. This morning it jumps 2.3% to $70.2/bl. Though so far not a single drop of oil supply has been lost.

Iranian retaliation and then US re-retaliation are however imminent. The US has already pre-selected 52 Iranian targets. Eventual loss of supply in the Middle East may however be in Iraq down the road and not so much due to near term retaliations.

Bjarne Schieldrop, Chief analyst commodities at SEB
Bjarne Schieldrop, Chief analyst commodities, SEB

US forces in Iraq now seem likely to be kicked out of the country and Iraq will then most likely “fall into the arms of Iran”. As former acting head of the CIA, Michael Morell, put it: “I think we’ve now ended any hope of keeping Iraq out of Iran’s arms.”

If Iran and Iraq become one large Shia Muslim centre of gravity in the Middle East, then US sanctions towards Iran would naturally be extended also to Iraq leading to a decline in Iraqi oil production and exports. This now looks very much like the way it is moving. The U.S. president on Sunday threatened to impose sanctions on Iraq if the Iraqi parliament voted to expel US troops from the country.

It is very clear that if it wasn’t for the fact that the oil market lost more than 3 m bl/d of crude oil supply from Iran and Venezuela since the end of 2016 it would not have been possible for the US to grow its crude oil production by more than 4 m bl/d over the same period and thus become oil independent and still have an oil price today of more than $60/bl. It is also quite clear that the lost supply from Iran and Venezuela to a large degree is the result of US sanctions towards these two nations and that these sanctions basically have paved the way for US oil production growth and oil independence.

It would of course be very bearish for the oil market if supplies from Iran and Venezuela came back into the market. That will probably happen at some point in time. However, we do not think that this will happen any time soon (years). Production and exports from these two countries will most likely be kept out of the market as long as the US needs room to grow its oil production and exports. The more correct focus may instead be to ask who is next in line to be kicked out of the oil market in order to make room for growing US oil production and exports? Right now, it seems likely to be Iraq.

It might be a tall order to accuse Donald Trump of such simple mercantile motives. But we need look no further than to the Russian gas pipeline Nord Stream 2 which stretches from Ust-Luga in Russia through the Baltic Sea and to Greifswald in Germany. In December the U.S. Senate imposed sanctions on companies working on the pipeline in order to prevent it from being completed. Their explanation was that they did it to protect Europe from becoming too dependent on Russian gas exports. But the sanctions are against the will of the EU. As such this looks bluntly as a move by the U.S. to prevent Russian gas flowing to the EU thus making room for growing U.S. gas exports to Europe instead.

The situation for Iran is of course extremely difficult. Donald Trump basically killed on of its highest-ranking generals with a precision drone high in the sky while he was playing golf at his resort in Florida (or at least he was at his resort there). The feeling of helplessness must be pervasive. If Iran now retaliates and kills U.S. armed forces (which seems likely) they will just see more devastating retaliations in return. The only real hope for Iran it seems is if they could get China fully over to their side and ramp up oil exports to China. While China wants its oil it most likely won’t go in the face of the U.S. doing so in large volumes. But if Iranian sanctions are extended also to Iraq it could be different.

Our general view for 2020 is that there will be involuntary losses of supply in the middle east in the year to come. Either through military action like the one in September when Saudi Arabian oil production was cut in half by the drone strike at its Abqaiq oil reprocessing plant or increased U.S. sanctions for example towards Iraq. The Iranian situation was probably the key source of the disruptive events in the middle east in 2019. This “source problem” has now just become much worse. The consequence of these “most likely losses of supply to come” in the middle east will be that the oil price will be elevated, global oil surplus will be avoided, and U.S. oil production growth and exports can re-accelerate again.

Ch1: Cumulative oil production change in the U.S. versus Iran + Venezuela. U.S. production growth would not have been possible without the losses of supplies from Iran and Venezuela and those losses were largely due to sanctions from the U.S.

Cumulative oil production change in the U.S. versus Iran + Venezuela

Ch2: Crude oil production in m bl/d in the US, Iran, Iraq and Venezuela

Crude oil production in m bl/d in the US, Iran, Iraq and Venezuela

Ch3: Iraq and Iran might be a large Shia Muslim force if Iraq now votes to expel U.S. troops. The U.S. on Sunday threatened Iraq with sanctions if U.S. troops are expelled.

Distribution of Shia and Sunni muslims in the middle east

Ch4: The EU wants gas from Russia via the new Nord Stream 2 pipeline. The U.S. doesn’t want it. It want’s to export gas to the EU

Nord Stream from Russia

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