Are we heading for another oil crisis?

At the start of 2014, investment managers thought oil prices were due to fall, says John Authers in the Financial Times. Prices had been stable for several years, hovering around $110 a barrel (for Brent crude). But shale oil and gas from the US was entering the equation, while tension in the Middle East was easing, thanks to improving relations with Iran. It all pointed to higher supplies in the future, and therefore lower prices.

So much for all that. Oil has jumped to a nine-month high of $114 due to the unforeseen insurrection in Iraq by Islamist fighters. The Islamic State of Iraq and Syria (Isis) militias have overrun much of the north of the country. Now the fear is that potential disruptions to supply could cause a spike in the oil price. That would hurt global growth, as it forces firms and consumers to spend more on energy and less on everything else. That tends to be bad news for the economy. As Andrew Bridgen of Fathom Consulting points out, three of the four global recessions since 1960 and ten of the 11 American recessions since the war were preceded by sharp increases in the oil price.

Prices should stay stable for now

But don’t panic just yet, says Fiona Maharg-Bravo on Breakingviews. “The bulk of Iraq’s production is still secure.” It would take “a cascade of problems to create a big oil-price shock”. The oilfields that account for 90% of Iraq’s production are in the south, which is still peaceful. Security has been stepped up in the south and it’s not thought likely to come under control of the insurgents. Iraqi exports, which are at near-record levels, haven’t yet been interrupted as an attack on a northern pipeline in March had already crimped shipments. So you can see why oil prices haven’t gone far beyond their recent range around $110: nothing much has changed on the supply front.

But over the longer term, plenty still could. If Isis make it to Baghdad, “the question of oil security in southern Iraq and the Kurdish region would pale into insignificance compared with the breakdown of Iraq as a sovereign entity”, says Abhishek Deshpande of oil and gas analyst Natixis. With the country riven by civil war, Iraq’s oil infrastructure could collapse completely and all of Iraq’s exports could be lost. Iraq produces around 3.4 million barrels per day (mpbd), of which 2.7 million are exported.

Oil-spike scenarios

The International Energy Agency (IEA) is probably optimistic in assuming that oil cartel Opec (mostly Saudi Arabia) has 3.3mbpd of spare capacity, as Maharg-Bravo points out. So the West might have to release some of its official strategic reserves to offset any loss of Iraqi output, especially since Syrian and Libyan output have disappointed of late.

But if the fighting continues, investment in Iraq will suffer, threatening the IEA’s projection that Iraq’s production could soar to 6mbpd by 2020. And fighting could easily spread beyond Iraq. In these circumstances, says Capital Economics, it’s not hard to imagine oil reaching $140. Note too, adds Liam Halligan in The Sunday Telegraph, that this threat to Iraqi supplies is happening against a backdrop of dwindling global oil discovery rates. Last year just 13 billion barrels were discovered, the lowest rate for 62 years. Global consumption was 33.5 billion.

As a rough rule, every $10 rise in the oil price trims global growth by 0.2%, says Capital Economics. There is no magic number at which oil becomes a problem, but remember that growth has been weak ever since oil exceeded $100 and “activity has tended to slow sharply” above $120 in recent years. That is the sort of level we might see if Iraqi fighting continues much like the civil war in Syria – ebbing and flowing, but not quite spinning out of control. Of course, the violence could dwindle and better relations between Iran and the West would then imply lower prices. Fingers crossed.