In recent months, heating oil prices have been moving in the right direction i.e. downwards. A trend that started uncharacteristically early in January 2014 largely because of the extremely mild winter. As we have moved into the warmer months, prices have continued to fall with average prices in the UK hitting levels not seen since 2011. All of that changed abruptly last week with the growing unrest in Iraq spooking the commodity markets and resulting in a spike in crude oil prices.
Why is Iraq so Important to Crude Oil Prices?
Like the unrest in Syria at the end of August 2013, the current march of the ISIS forces in Iraq is a serious concern to world oil markets. Despite the fact Syria was not an oil producing country, it did have critical oil supply pipelines under its control and, as a result, prices shot up by approximately $10 a barrel. Iraq, on the other hand, is OPEC’s second largest oil producer and exports approximately 3.3million barrels of crude oil a day. That’s approximately 4% of global oil supply. On the scale of things, 3.3 million barrels doesn’t sound like a lot until you realise that, if Iraq supplies went offline completely, this would potentially wipe out any spare capacity OPEC has and would inevitably lead to large price rises.
Equally as important as existing supplies of crude oil are future supplies. It is estimated that Iraq is sitting on the world’s 5th largest proven reserves of crude oil so the potential to increase production and provide a large percentage of world oil supplies is there. Iraq have, up until now, been focused on developing oil exports with production growth up by 22% since 2011. The main driving force being that oil provides more than 90% of all government revenue and 75% of GDP. It is believed that by 2019 production could be at 4.6m barrels a day and, beyond this some estimate Iraq could be producing between 6 and 8 million barrels a day. That’s a lot of oil and, as world economies continue to grow, the world is going to need the extra capacity to cope with increasing demand.
Where are Prices Going?
At the moment, the continuing march of ISIS towards Baghdad has driven prices up by approximately 5% to a 9 month high of $115 a barrel. We haven’t yet reached the levels seen in the Syrian crisis last summer but analysts are predicting that if oil exports from Iraq fail, prices could exceed $120 a barrel. Victor Shum, vice president of IHS Energy Insight told Bloomberg that he expects to see a rise of at least $10-$15 a barrel.
Whether prices will hit new highs is largely down to whether ISIS are able to disrupt exports by either physically attacking and taking over the oil fields in the South of the country that account for 75% of all production or, as is more likely, disrupt supplies by targeting infrastructure that supports the regime in Baghdad. There is already evidence of this happening with attacks on the main Baiji refinery near Mosul that produces 310000 barrels a day for internal use. Baiji also happens to be a primary power provider to Baghdad. There are also reports that ISIS have taken over the dam at Haditha which could lead to disruption of electricity supplies to the main grid.
Of course, unrest in Iraq is not the only cause for concern in terms of escalating crude oil prices. Ongoing disruption to supplies in Libya due to unrest, the increasing tensions between Russia and Ukraine and political instability in Venezuela and Nigeria are all potential trigger points for further price increases.
What Does this Mean for Heating Oil Prices in the UK?
We have been relatively lucky over recent months in that the weather has worked in our favour and kept prices of heating oil down. Other factors that have supressed prices include the recent strength of the pound (we buy crude oil in dollars so when the pound is stronger, imports in dollars are cheaper) and the fact that growth in China has slowed meaning demand for oil is not as strong. However, if the unrest and, perhaps more importantly, the uncertainty over Iraq continues, it is highly likely heating oil prices will rise.
Prices rose rapidly shortly after news of the progress of ISIS in Iraq largely because UK heating oil users immediately saw the potential threat to prices, perhaps being reminded of last years’ hikes when Syria kicked off in late August. At BoilerJuice we saw a large spike in volumes over the weekend of 13th June as people rushed to top up their tanks just in case prices started to rise. Largely as a result of this, prices did actually rise as demand increased and have now dropped back slightly. However, as higher crude oil prices filter down to heating oil the price will inevitably be affected, but by how much is harder to predict. The Syrian conflict, which saw a $10 increase in crude oil prices resulted in a little over 2 pence per litre increase in heating oil. So far, the Iraq conflict has seen a $5 increase in crude oil which as caused heating oil prices to rise by just over 1 pence per litre. So heating oil price increases do appear to be proportional to crude oil prices.
What we don’t know is how long the uncertainty in Iraq is likely to last. It appears that the Americans aren’t in any hurry to step in and try and secure the situation which could mean, as it has in Syria, that the conflict could drag on for many months. With Syria, once the initial crude oil price rises had happened, they held for a very short space of time (approximately 3-4 weeks) before falling to pre-crisis levels once oil speculators realised that the US was not going to bomb Syria. This could well happen with Iraq and there are already indications that this may be happening as oil prices have started to stabilise, albeit around the higher $115 per barrel. However, if the conflict does drag on towards autumn and winter, other price pressures caused by increasing demand for heating oil will start to drive prices higher, perhaps higher than they would have been without the conflict.