Will an Escalation in Iraq Cause an Oil Shock?
On June 9, the Islamic State of Iraq and Syria (ISIS) began an offensive within Iraq to take control of a large area of land from the Iraqi government led by Shiite Prime Minister al-Maliki. Iraq is the sixth largest oil producer, and oil markets subsequently shot up 4% as the gravity of the situation became evident. Additionally, concerns of an oil shock to the economy led equity markets to sell off, albeit briefly, and gold markets to rally. History has taught us that unrest in the Middle East typically leads to higher prices at the pump. However, some prices have even fallen in some of the traditionally more expensive markets like San Francisco.
Back in 2011, we faced a large-scale unrest in the Middle East due to the Libya uprising and pushed the average price of U.S. gasoline up 17 cents in just the first 10 days. Libya produces less than 1% of the world’s energy and Iraq accounts for approximately 4%, yet the Libya crisis caused a far more dramatic move in prices at the pump. Three key reasons can explain why gasoline prices have been less impacted despite Iraq being over 4x more important to the energy market.
- Geography: The fighting is currently isolated to northern Iraq, and more than 80% of Iraq’s production and export facilities are located in the south. Sunni rebels are not expected to invade oil-producing regions since these locations are so far away and well-fortified.
- Fracking: The U.S. has become less dependent on imported oil since 2011 due to fracking, which is a technology that has exposed vast amounts of oil below our feet. In fact, U.S. production has risen over 55% since 2011 due to advances made in fracking.
- Seasonal Timing: Gasoline prices normally rise in the spring because refineries shut down to prepare for summer driving demand, which causes supply to drop. Prices then fall in June because although refineries are already producing, families still have kids in school. The timing of Iraq’s unrest just happens to be during this lull in demand.
Due to the dramatic rise in domestic oil and gas production, we are now back down to import levels not seen since the mid 1990s. Our Investment Committee strongly believes that this trend will continue, and the U.S. will become energy independent by 2016.
In summary, any investment manager that holds an allocation of energy stocks must assume that unrest in the Middle East will cause energy prices to be volatile at some point every year. We have seen turmoil be a factor in this region since oil was first discovered, and we expect it to continue into the foreseeable future. However, since the U.S. is moving closer towards energy independence, we expect domestic energy prices to become less responsive to these types of events over time.
Read this week’s Thought of the Week to learn more about the current unrest in the Middle East and how it affects oil prices in the U.S.
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