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Opec under siege as Isil threatens world’s oil lifeline

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Opec under siege as Isil threatens world’s oil lifeline

By Andrew Critchlow: 30 May 2015

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Screen Shot 2015-05-30 at 23.22.28Thick black smoke rising from the Baiji oil refinery could be seen as a dirty smudge on the horizon as far away as Baghdad after fighters from the Islamic State of Iraq and the Levant (Isil) set fire to the enormous processing plant just over 100 miles north of the capital last week.

The decision to torch the refinery, which once produced around a third of Iraq’s domestic fuel supplies, was made as the insurgents prepared to pull out of Baiji, which they captured last June in a victory that sent shock waves across world oil markets.

A year on from the start of the siege and a shaky alliance of the Middle East’s major Arab powers, with the limited support of the reluctant US government, has failed to contain the expansion of Isil.

The problem for the US and the rest of the industrialised world is that the Middle East controls 60pc of proven oil reserves and with it the keys to the global economy. Should Isil capture a major oil field in Iraq, or overwhelming the government, the consequences for energy markets and the financial system would be potentially catastrophic.

Many of the countries most threatened by the onslaught of the extremist group, which has grown out of the chaos of Syria but was initially dismissed as a wider threat to regional stability, will gather at the end of this week in Vienna for the meetings of the Organisation of the Petroleum Exporting Countries (Opec).

Iraq, Saudi Arabia, the Gulf states and Iraq – which together account for two thirds of the cartel’s production – are all now affected by the inexorable march of the Isil jihadists but appear powerless to prevent it due to the widening sectarian schism between the Sunni and Shia Muslims across the region in the wake of the Arab spring uprisings five years ago.

Oil ministers gathering to decide on production levels at Opec’s secretariat building in Vienna will normally stay clear of wider geopolitical issues during their deliberations in the Austrian capital. However, the threat posed by Isil and its brutal brand of Islamist extremism is likely to force politics onto the agenda. It certainly can no longer be ignored.

According to Daniel Yergin, the energy expert and vice-chairman of IHS, the business information provider, the biggest threat to oil prices is the political chaos that threatens to engulf the Middle East, combined with the West’s reluctance to intervene.

Speaking to The Sunday Telegraph, Mr Yergin argued that the price of a barrel of oil could skyrocket to levels above $100 per barrel if Isil is allowed to press deeper into Iraq, the second-largest producer in the cartel after Saudi Arabia.

“Isil presents a whole new reality for the region, which just isn’t reflected in the oil market at the moment,” said Mr Yergin. “It’s an increasingly grave situation for most of Opec and the Middle East. At some point the security issues will start to come back into the price of oil.”

Up to this point, oil markets have shrugged off the risk of a major supply disruption caused by the worsening security situation. Traders have remained focused on the market fundamentals that almost 2m barrels per day (bpd) of excess oil capacity will be more than enough to absorb any supply-driven shock. A rally in the price of Brent crude – a global benchmark – which began in January and saw prices push close to $70 per barrel has lost momentum amid signs that higher prices could revive drilling in the US. Just over six months ago when Opec’s 12 oil ministers last met in Vienna the cartel decided to continue pumping oil at a level of around 30m bpd, which effectively fired the first shots in an oil price war against shale drillers in North America, and Russia.

After almost a decade of oil prices ticking along at above $100 per barrel during which the group ignored the shale revolution taking place in the US, Opec decided to act last November. Under massive pressure from its most powerful member Saudi Arabia, the cartel allowed market forces to drag down oil prices. Initially, the strategy worked.

Within a month, oil prices had fallen to multi-year lows below $50 per barrel, sharply lower than the $115 year-high achieved last June when concern over the civil war in Syria caused a spike in prices. The sudden downturn in prices immediately had the desired effect on oil producers outside the Opec cartel.

In the US, oil companies began to shut down drilling rigs at a record rate. According to Baker Hughes, rig numbers have fallen for 24 straight weeks to 659 rigs as of last week compared with a record 1,609 rigs operating last October. In high-cost production areas such as the North Sea the impact of Opec’s decision to allow oil prices to fall naturally has shaken the industry to its core.

In his last budget of the Coalition government, George Osborne was forced to offer North Sea oil companies tax breaks to soften the blow of lower prices, while hundreds of jobs have been lost in Aberdeen.

“Opec has embarked on a strategy of leaving the oil price to the market and is willing it seems to allow the economics of supply and demand to take effect,” said Mr Yergin. “What is so startling is that geopolitics has been stripped out of the oil price for now but sooner or later it will be factored back in.”

Oil prices have gained roughly 30pc since the beginning of the year to trade at around $65 per barrel, with major banks and trading houses. However, traders have so far ignored the risks posed by Isil now to oil supplies, or the danger of a major terrorist attack on oil facilities in Saudi Arabia. Goldman Sachs has instead forecast that prices could again fall to $45 per barrel by October as US shale drilling picks up.

FULL ARTICLE WITH VIDEO AND NEARLY 2000 COMMENTS

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