Will the Iraq crisis trickle down to the pump?

Iraq has the fifth largest oil reserves in the world and is OPEC’s No. 2 exporter. Will global fuel prices go up?

June 19, 2014 12:00PM ET

by Inside Story Team @AJInsideStoryAM

The vast grounds of the Baiji oil refinery in Iraq have been the scene of a big battle between Iraq's national army and the Sunni guerrillas led by the Islamic State of Iraq and the Levant, or ISIL.

Both government military forces and the Sunni militias fighting them have claimed the Baiji refinery during the fighting, and the black flag of the ISIL forces has been seen flying inside the facility.

The refinery is just 130 miles from Baghdad. Baiji supplies a lot of the fuel for electric power in Iraq's western provinces near Syria, and the northern ones, by the Kurdish lands and Turkey.

The battle for Baiji shows the vulnerability of Iraq's central government under Prime Minister Nouri al-Maliki and the vulnerability of one of the world's major oil suppliers. World crude-oil prices have moved higher as Iraq's problems have deepened — and as jittery markets contemplate what threats to 3.5 million barrels a day of capacity could do to the oil business.

Who controls the oil in Iraq?

How does the shutdown of the Baiji refinery affect production and export?

Will worries in the world market translate to higher gas prices in the United States?

We consulted a panel of experts for the Inside Story.

Mihaela Carstei

Mihaela Carstei is deputy director for the energy and environment program at the Atlantic Council. Carstei maintains substantive knowledge and thought leadership in the policy, science and business arenas of a broad range of energy and environment issues, including climate change adaptation, electricity markets, nuclear power, renewable fuels and unconventional resources.

Inside Story: What is the significance of the seizure of the Baiji refinery for global oil markets?

Mihaela Carstei: The size of the destruction vindicates the International Energy Association’s [in Paris] downgrade last week of Iraqi oil production to half of its previous forecast. A lot of people did not think that downgrade was being very reasonable. The disruption that this seizure is causing the global oil markets confirmed that it was a good downgrading. Without a significant increase, let alone a decrease, in Iraqi oil production, we were going to see prices spiking because of rising global demand. The immediate shock has already happened, but we will see major price impacts down the line. If we do not address the insecurity, we will have major price problems in the future.

So this will only really affect Americans a couple of years down the line?

It is starting to affect us now, but it will really affect us later on. Is the capture of the refinery a symbol that the existence of Iraq is in danger altogether? This is a very serious signal for whether we need additional direct action. We are going to suffer short-term disruptions as well, but they are mostly going to be regional. The refinery was mostly providing for Baghdad. Obviously it creates an impact in the global market. We will see some immediate impact, but the biggest concern is that if we don’t manage the situation we are going to face larger issues down the road.

How does ISIL sell this oil on the black market?

It is not as much about selling on the black market as it is slowing supply. There is oil sale on the black market, but it is not very big. They could also use it themselves. I almost see the biggest benefit as for their own logistical needs. But based on reports I have seen, parts of the refinery are on fire and there has been damage to the infrastructure. I do not see them making money off of this as much as causing disruption and security risks.

Feisal Istrabadi

Feisal Istrabadi was the Iraqi ambassador to the United Nations from 2004 to 2007. He is now a professor of practice at the Indiana University School of International Studies. He focuses his research on the processes of building legal and political institutions in countries in transition from dictatorship to democracy.

Inside Story: What is the significance of the seizure of the Baiji refinery?

Feisal Istrabadi: First, it is not clear to me that it has actually been seized. But it is almost a distinction without a difference because Baiji, the largest refinery in Iraq, has been shut down. The Iraqis have been importing refined oil products since the beginning because they have an inadequate refining capacity. There are projects to build a greater refining capacity, but they are not online yet. This means fuel becomes scarcer in Iraq and prices go up. Since it is being shut down, it does not matter whether it is being taken over or not. But it does appear that the area around the refinery has been surrounded.

How much of the involvement of other regional players stems from concerns about petroleum?

From the Iranian perspective you can imagine that it is — the more control they can assert over Iraqi oil, the better it is for them. They have been under sanctions for years, and that has affected their ability to sell oil. If they have greater control over Iraqi oil production, it puts them much more in the driver’s seat than they have been.

Barring a complete destruction of Iraq, I do not imagine that the Iranian army is going to march into Iraq and take over the oil fields. That said, it is a real concern. ISIS [another name for ISIL] already controls oil fields in Syria. On top of the money they stole from the Mosul bank, it means they have self-sustaining revenue sources.

You mentioned ISIL selling the oil. Can you describe how they are able to sell this oil on the black market?

I do not have a clue, but I know they are doing it in Syria.

Luay al-Khatteeb

Luay al-Khatteeb is a visiting fellow at the Brookings Doha Center, focusing on the geopolitics and political economy of the Gulf Cooperation Council and Iraq. He is the founder and director of the Iraq Energy Institute and serves as senior adviser to the parliament of Iraq for energy policy and economic reform. His experiences in the private sector span more than 20 years, and he is a frequent commentator on issues related to energy security, economics and politics in the Gulf region.

Inside Story: What is the significance of the seizure of the Baiji refinery?

Luay Al Khatteeb: What is really significant about this refinery is that it handled 50 percent of Iraq’s oil supply. It is the main national refinery in the country. The shortage of supply right now has caused a tremendous increase in oil price and pushed the government to import more of the product to fill the shortage. This is on the downstream side. On the upstream side of oil development, production and export continues intact far from the fault lines. Most of the main production centers are very much in the south, in the Basra province.

So this will not, in your opinion, damage global oil markets and create price shocks?

In my opinion, the recent reaction that created a price shock is a long speculation by traders on one side, and on the other side to play the market for short-term gains. In reality, any increase in price is just baseless. We have enough oil supplies in the market and the region. I do not understand the price hike other than short-term gains on oil prices.

How does ISIL sell this oil on the black market?

This conflict, although it carries a sectarian image, it is just one of its elements. ISIL learned from the experience in Syria. And the first thing they did is attack banks and producing assets. This could help them in financing their operation. Having said that, such operations are mammoth and very sophisticated. It is not just seizing banks and refineries but a much more sophisticated management and brains behind the management of such an organization. We are talking now about thousands of foreign fighters. I find it very hard to imagine that someone called Al-Baghdadi will overwhelm the intelligence of the U.S. and Russia and other powers like that.