Oil exports from the Middle East Gulf States amounted to 19.6 million barrels per day in 2013 [BP] equivalent to 22.6% of total global oil production and 43% of OECD oil consumption. The importance of the region to the well being of the global economy cannot be overstated. It is therefore pertinent to ask what risk ISIS presents to the stability of the region and its oil supplies. History has some clues.
The response of the oil price to “the crisis” has so far been muted. That is because, so far, oil supplies have not been put at risk. In fact, the pending independence of Iraqi Kurdistan and the opening of new export routes via Turkey has in the interim enhanced oil supplies from the region.
What happens next is of course difficult to predict. Three scenarios are envisaged that may lead to a disruption of oil supplies but only unrest in Saudi Arabia is seen as a risk to oil prices. A fourth scenario is that the ISIS advance peters out and Iraq returns to being the home of chronic sectarian and tribal violence that has little impact on oil exports from the north and south of the country.
Figure 1 Oil exports from the Gulf states in 2013. While most of the exported oil is loaded onto tankers that must then pass through the vulnerable Straits of Hormuz there are alternative export routes marked by arrows and grey numbers. Iraq has for many years had an export route through Turkey for oil from the Kirkuk Field and this is now joined by a second pipeline from Kurdistan. Saudi Arabia has a 5 mbpd export route that crosses the country to the Red Sea and the UAE have recently built a pipeline to the Gulf of Oman. In the unlikely event that Hormuz becomes unpassable, there are therefore options totalling 8.5 million bpd available. There are other pipelines that are all currently out of action.
Figure 2 shows the history of oil exports and the events that sent the oil price soaring to rock the world economy. The 1960s saw the meteoric rise of oil exports from the region to over 20 million barrels per day that in 1973 represented 34% of global oil production. In 1973 came the Yom Kippur War between Israel and Egypt and Syria. The war itself did not threaten oil production, but passage through the Suez Canal was put at risk and it led to a Cold War stand off between the USA and the Soviet Union. In 1974, the Arab World (OPEC) decided to punish the USA for aiding Israel and cut oil supplies (only a little) creating queues at gas stations and sending the oil price spiralling upwards (Figure 2).
Figure 2 Oil exports from the Gulf based mainly on BP 2014 data. BP do not report oil consumption data for Iraq, therefore I have used EIA data for Iraq, 1980 to 2012. Pre-1980, BP production data is used for Iraq and consumption data is extrapolated. The four events marked with white arrows are discussed in the text together with an account of the rise, fall and rise in Middle East oil exports.
1979 saw the Iranian Revolution followed by the Iran – Iraq war that raged from 1980 to 1988. Oil exports from both countries were severely affected (Figure 2) taking the oil price to over $100 / barrel ($2013), fuelling inflation and global recession. At this point it is necessary to closely examine Figure 2. Saudi Arabia, now turned friend of The West, increased production in 1979 through 1981 compensating in part for the lost production from Iran and Iraq. But then Saudi Arabia and OPEC were overtaken by global events with new oil provinces opening up in The North Sea and Alaska. Oil drought turned to oil glut sending prices spiralling down. In 1981 Saudi Arabia exported 10.3 million barrels per day. In 1982 that was cut to 7 and by 1985 to 3.6 million barrels per day. Other OPEC countries made similar cuts in a vain attempt to bolster the slumping oil price.
1985 marked the low point of Gulf oil exports but OPEC quota wars continued through the 1980s contributing directly to Gulf War I. Saddam Hussein had accused Kuwait of over producing its OPEC quota. Worse still, oil was being produced from a field that straddled the Kuwait – Iraq border. In 1990 Iraq invaded Kuwait, sending an international task force to The Gulf, culminating in operation Desert Storm.
The response of the oil price to these tumultuous events was muted. A close examination of Figure 2 shows Kuwaiti and Iraqi oil exports down to zero in 1991. Kuwait’s exports recovered quickly in the following years while Iraq, subject to sanctions, was off line until 1997. This made little difference to the oil price that continued on down as other Gulf States brought on spare capacity created by production cuts two decades before. 1998 saw the oil price dip below $10 / bbl in money of the day creating a crisis for Saudi Arabia and the International Oil Companies (IOCs), and as I found to my cost, small service companies serving the oil industry. The oil industry and the world were all about to change.
The response of the IOCs was corporate mega-mergers. BP-Arco-Amoco, Total-Fina-Elf, ExxonMobil and so forth. And then on September 11th 2001 Islamic terrorists, orginating mainly from Saudi Arabia, flew two jet aircraft into The World Trade Centre and another into The Pentagon, initiating a 13 year long period of conflict between America and her allies and Islamic fundamentalists leading directly to Gulf War II in 2003 and the re-arrangement of politics in Iraq against the will of some of the people.
While 2003 marks the beginning of the recent run up in oil prices it was events elsewhere that now controlled global oil markets. In 2001, China initiated its 10th 5 year plan sending global demand for oil upwards at a rate faster than supply growth could match and the World entered a new era of “permanently” higher oil price. I say permanent because the Saudi State now requires over $100/bbl to sustain its population in peace and the IOCs need well over $100/bbl to make money out of the remaining oil resources that are progressively more difficult, and hence more expensive, to extract.
The final episode of this brief tale comes in 2008. The global economy, fuelled by debt expansion, consumption and economic growth in China and other emerging economies, cracked in spectacular fashion in 2008 sending demand for oil down a mere couple of million barrels per day with disproportionate impact on the oil price (Figure 2). OPEC and the Gulf states reacted by cutting production. But by 2011, normal service was resumed.
Throughout this last decade the amount of spare OPEC production capacity has had a major control on oil prices (Figure 3). The strong run up in price began in 2005 when OPEC spare capacity fell close to zero. Growing demand for oil then met static supply. Estimating spare capacity is notoriously difficult to do and tends to be overstated by OPEC. For example, Saudi Arabia has capacity to produce more heavy oil but the world lacks the refining capacity to refine it. I have not had time to update Figure 3 which plots IEA data up to November 2013. The data needs to be transcribed by hand from the IEA Oil Market Reports which is rather time consuming to do. But my main message would be that OPEC spare capacity is unlikely to be substantially more than 3 million bpd and any event that takes this amount of oil off the market may result in a shock to oil prices and the global economy.
Figure 3 OPEC spare production capacity based on data from the International Energy agency up to November 2013. In 2005 it was evident that everyone was pumping flat out and the existence of over 2 million barrels per day spare capacity back then seems unlikely. It is equally unlikely today that the majority of OPEC countries have spare capacity to bring on line at short notice with the exception of Saudi Arabia and Libya – if peace would only break out.
And so to the three scenarios that may lead to a disruption of oil supplies from The Gulf region.
1) The disintegration of Iraq: Iraq has already disintegrated into Kurdish, Sunni Arab and Shia Arab territories. But there has not yet been a serious fight over control of Iraq’s oil wealth. The Kurds seem to be in control over the northern fields and Turkish export route and the Shia remain in control of the southern fields around Basra and the supergiant East Baghdad field. If there is a fight for control over these fields then western companies may flee and infrastructure may be damaged taking up to 2.4 million bpd of exports off line. This may in part be compensated by growing production and exports from Kurdistan. Disruption at this level may be absorbed by OPEC and is unlikely to severely impact oil prices in the medium term.
2) The involvement of Israel: It is difficult to know the precise objectives of ISIS, but attacking Israel figures in the rhetoric. It does not seem likely that ISIS presents a credible military threat to Israel and so it is only in the event of horrific terrorist attacks and Israeli reprisals that a regional disruption to oil supplies may emerge, with, for example, closure of the Suez Canal. The likelihood and consequences of such events are near impossible to call.
3) The Arab Spring dawns in Saudi Arabia: The spread of religous and tribal dissent within Saudi Arabia itself is what I see as the most significant risk to oil supplies from the region. If the West’s ally and swing producer, who is called upon to make up for production shortfalls else where, descends into chaos then this would be extremely serious. In effect ISIS may emerge in Saudi Arabia without having to go there. In 2006 there was a terrorist attack on the Abqaiq oil processing plant that accounts for about 50% of Saudi production. This event, which had enormous significance, went largely unreported in the West. By all accounts there was a gun battle, security perimeters were breached and the attackers came close to fulfilling their goal. With a population of 28 million, Saudi Arabia is kept stable by the carrot of generous state handouts and the stick of state security agencies. It remains to be seen if events that have unfolded in Egypt, Libya, Syria and Iraq can avoid unfolding in Saudi Arabia. The global economy could not survive the loss of Iraqi and significant amounts of Saudi oil. I think it is safe to assume that should Saudi begin to unravel that the West would intervene.
The small Gulf emirates of Kuwait, Qatar and Abu Dhabi are so fabulously wealthy that it is difficult to foresee unrest in these countries although it is always bubbling just beneath the surface in Bahrain. Iran seems trying to come in from the cold and we could see increased exports from that country in the near future if sanctions are relaxed. It is extremely difficult to foresee the future of the Middle East other than to assume that chronic unrest will continue. I conclude that only if ISIS emerges in Saudi Arabia itself, will the current conflict impact global oil markets and in this regard I concur with Andrew McKillop that this conflict so far amounts to failure of US foreign policy and is not an immediate threat to the price of oil.