The Next Iraqi Threat to the Oil Industry… It’s Not What You’re Expecting

If you still doubt that geopolitical heat can raise the price of oil, I strongly advise you to carefully watch the events that are about to play out.

At the top of my own list is Iraq. Geopolitical matters there continue to worsen. U.S. Secretary of Defense Ashton Carter has just called out the Iraqi military – during a high-profile TV interview no less – claiming that it lacks the will to fight. ISIS is solidifying positions within marching distance of Baghdad. And the main Iranian general is condemning the U.S. for “not doing a damn thing” to halt the ISIS advance.

These three developments will have an impact on global crude oil stability and are thereby certain to affect oil prices.

But a fourth situation is about to unfold… with the potential to have a more direct effect on oil.

Here’s my take on what’s going on in Iraq… and what it means for energy prices…

First, let’s go over the three known developments.

1) Carter Slams the Iraqi Military

Earlier this month, Ramadi, a Sunni majority city in Iraq’s Anbar Province about 75 miles west of Baghdad, fell to ISIS forces. The town is in a strategic location on the banks of the Euphrates River. It stands on an important trade route connecting to the Mediterranean Sea, as well as being located on the main road from Amman, the capital of Jordan, to Baghdad.

On Sunday, Defense Secretary Carter conducted an interview with CNN’s State of the Union. “What apparently happened was that the Iraqi forces just showed no will to fight,” he said. “They were not outnumbered. In fact, they vastly outnumbered the opposing force, and yet they failed to fight, they withdrew from the sight, and that says to me, and I think to most of us, that we have an issue with the will of the Iraqis to fight [ISIS] and defend themselves.”

And although the U.S. has sped up the delivery of arms to the Iraqi forces, Carter said that the Iraqi military itself needs to ramp up its efforts to defeat ISIS. He also announced that he would not currently consider recommendations from military strategists for relocating U.S. forward air controllers to help better identify targets for coalition airstrikes.

“If there comes a time when we need to change the kinds of support we’re giving to the Iraqi forces, we’ll make that recommendation,” he said. “But what happened in Ramadi was a failure of the Iraqi forces to fight.”

2) ISIS Encroaches on Baghdad

The embarrassing retreat of the numerically superior Iraqi security forces when confronted with an ISIS advance into Ramadi disheartened the American personnel who had trained and declared them fit for combat. (I have worked with the senior command here on various assignments over the last several years.)

ISIS continues to flank the capital city from the north, east, and west. But they will not be able to take and hold Baghdad. Neither the West nor Iran will allow that. And that should provide sufficient support for the Shiite-dominated government.

On the other hand, ISIS’s strategy is to continue putting pressure on the city while it entrenches itself in the area that remains its real objective – the border region connecting Syria and Iraq. This is the “caliphate” of their self-proclaimed “Islamic State.”

3) The U.S. Hasn’t Done a “Damn Thing”

Yesterday, General Qasem Soleimani, the head of the elite Quds forces in Iran’s Revolutionary Guard, leveled a charge of gross inaction against the U.S. following the fall of Ramadi. His apparent comment (it was actually relayed by others in the Guard) was that the U.S. had not done a “damn thing” to stop the advance on Ramadi.

“Does it mean anything else than being an accomplice in the plot?” Soleimani reportedly asked, later saying the U.S. showed “no will” in fighting ISIS. He said Iran and its allies are the only forces that can deal with the threat.

“Today, there is nobody in confrontation with [ISIS] except the Islamic Republic of Iran, as well as nations who are next to Iran or supported by Iran,” he said, according to sources in the Revolutionary Guard.

Most military analysts I know – both in the Persian Gulf region and in Washington – admit Soleimani is the most capable battlefield tactician in the entire Persian Gulf basin. Whether we like it or not, the West has to admit that Shiite militias under Soleimani’s leadership are key to keeping ISIS at bay.

Iran now holds considerable leverage over Iraq. Both nations have Shiite majority populations, Iraq has a Shite-dominant government, and Soleimani commands Shiite military detachments from his headquarters in Baghdad.

Each of these problems is serious enough to weigh on immediate prospects for crude oil prices.

But there’s another event approaching that will affect oil prices even more directly.

4) The Next Iraqi Threat Is Coming

Kurdistan, the semi-autonomous region in northern Iraq, is again threatening to export oil and natural gas without the approval of Baghdad.

I have advised the Ministry of Natural Resources in the provincial capital of Irbil and was involved in putting together the oil law and model production sharing agreements the Kurdistan Regional Government (KRG) has offered to outside companies.

These were met with stiff opposition from the central government who claimed only Baghdad can approve exports. An uneasy accommodation has been struck between the two, but it has been fraying of late.

Under the accord, Baghdad is to pay the KRG for exports of Kurdish oil while meeting payments to operating companies in Kurdistan. But the fees have not been forthcoming, owing to Iraq’s acute budget problems and the internal political strife that these days dictates what officials in Baghdad can accomplish.

All of this sets the stage for a major change in Iraqi oil export capabilities. This will have a global knock-on effect for crude prices.

Why You Need to Watch Kurdistan

The KRG legislation and regulations are more profitable for operators than those offered by the central authorities. Baghdad attempted to pressure Western majors by demanding they stop activities in Kurdistan or risk losing contracts elsewhere in Iraq.

Bur despite the huge fields in the south, international leading companies like Exxon Mobil (NYSE:XOM) opted to take the better terms offered by the KRG.

The stage is now set for the Kurds to act. It may begin over oil proceeds but quickly morph into a full-blown drive for independence. Kurdistan has been biding its time. But the clock on separation is ticking.

The Kurdish population of Kurdistan, eastern Turkey, and northwestern Iran remains the largest indigenous population on Earth without its own country. And Irbil’s fierce militia (the peshmerga) has been defending Kurdish territory from ISIS largely on its own.

The divorce from Baghdad will not be amicable. It will intensify instability and play into the hands of ISIS, the Iranians, and those bent on expanding the unrest regionally.

I’m keeping an eye on all of this and will let you know of any important developments.

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