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What do Iraq tensions mean for oil markets?

An Iraqi flag is seen on a military vehicle at an oil field in Dibis area on the outskirts of Kirkuk, Iraq October 17, 2017. REUTERS/Alaa Al-Marjani
An Iraqi flag is seen on a military vehicle at an oil field in Dibis area on the outskirts of Kirkuk, Iraq October 17, 2017. REUTERS/Alaa Al-Marjani

Tensions in Iraq’s main oil-producing areas have restored a risk premium to oil prices. How disruptive is the uncertainty over the contested oilfields of Kirkuk, particularly for Mediterranean refiners?

After Iraq’s autonomous region of Kurdistan held a referendum on independence, government forces responded with lightning force to seize back key installations in the oil rich province of Kirkuk.

The Iraqi government considered the 25 September referendum illegal, especially as it was held not just in the autonomous region, but in Kirkuk and other adjacent areas that Kurdish Peshmerga forces occupied after driving out Islamic State militants in 2014.

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As Iraqi forces advanced, Kurdish operators briefly shut some 350,000 barrels per day (bpd) of oil output at two large Kirkuk fields, Bai Hassan and Avana, citing security concerns. Production has partially resumed following an Iraqi threat to seize the field under Kurdish management if they did not do so. The Khurmala field is still under KRG control and is only producing at 75,000 bpd.

Iraq oil pipelines

The short suspension in production helped push up world oil prices as the shutdown represented more than half of total Kurdish output.

It also raised fears that fighting between Baghdad and the Kurds could open a new front in Iraq’s 14-year-old civil war and potentially draw in regional powers such as Turkey and Iran.

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Turkish pipeline

Turkey, which had developed a good working relationship with the Iraqi Kurds and let the landlocked region export oil through its pipes, has swung behind Baghdad, furious at a secession move that might ignite similar demands from its own Kurds.

Rising Kirkuk exports as a proportion of total Iraqi seaborne exports
Rising Kirkuk exports as a proportion of total Iraqi seaborne exports

It is currently uncertain whether the Iraqi government will seek to retake control of all Kirkuk oilfields, a vital source of revenue for the autonomous Kurdistan Regional Government (KRG).

KRG oil exports are shipped from Ceyhan Port where the crude has been transported via the Kirkuk-Ceyhan oil pipeline, which goes through Turkey.

In the case that Turkey decides to suspend Kirkuk loadings from Ceyhan, this will have a huge impact on the KRG, as oil revenues are the main source of income for the federal region.

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The alternative options for the KRG are very limited.

The only other pipeline, starting from Haditha in the north of Iraq spreading to Basrah, supporting Iraq’s seaborne exports at a capacity of 2.25 million bpd is not a feasible option due to ongoing conflicts between Baghdad and Erbil.

Storage capacity limitations

Since March 2017, Kirkuk-grade seaborne exports have started to increase in terms of volume.

Comparing January-September of 2017 with the same period last year, there was a 29% increase in seaborne exported volumes.

Table of Total Iraqi Seaborne Exports by Grade 2017 YTD (mmbbl)
Table of Total Iraqi Seaborne Exports by Grade 2017 YTD (mmbbl)

Kirkuk blend accounted for only 6% of total Iraqi oil exports between January-April 2017; however, from May 2017 onwards the share of Kirkuk exports increased to 12.3%.

In the scenario that Turkey decides to close the Kirkuk-Ceyhan pipeline given ongoing conflict in the area, the fields cannot continue producing due to storage capacity limitations.

The storage capacity in Erbil and Kirkuk is estimated to be around 5.9 mmbbl according to Thomson Reuters Oil Research.

The storage capacity would be filled in 11 days at current production levels and is likely to force the KRG to suspend its production operations.

Mediterranean refining

Kirkuk grade is one of the major crude grades for Mediterranean refineries with an average share of 7.4% in total imports in August-September.

In the event that Kirkuk blend exports are removed from the market, this would cause a supply gap of 15 mmbbl in the medium grade oil segment in the Mediterranean region.

Urals loadings from the Black Sea port of Novorossiysk could be a potential substitute.

Russia has both the capacity to increase its production levels and Urals loadings from Novorossiysk, which would have similar transportation costs to that of Kirkuk for the Mediterranean market.

Mediterranean crude differentials in Eikon
Mediterranean crude differentials in Eikon

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Arab gulf grades like Basrah Light and Arab Light could be potential substitutes for Kirkuk oil, but in terms of CIF MED prices, these grades would be a more expensive alternative with added freight costs.

Kirkuk has been sold at premium compared to Basrah Light in August under CIF incoterms. For the first five months of the year, the grades were being sold almost at the same price.

From June until September this year, Kirkuk was sold with a slight premium against Basrah Light, with the calculated average at $0.27/bbl.

Kirkuk crude will be priced by Iraq’s Oil Marketing Company (SOMO) following the take-over of KRG fields, reducing the discount for Kirkuk FOB Ceyhan and impacting negatively on refinery margins.

Alterations in pricing may adjust Kirkuk grade’s market share in the Mediterranean refinery market, while blending some Kirkuk production with Basrah grades will result in greater volumes for export from southern ports to Asian buyers.

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