ISIS and Oil Prices

During the past few months, Iraq has been destabilized anew by the rapid incursion of a Sunni militant group known as the Islamic State in Iraq and Syria (ISIS). The risk of a significant disruption to Iraqi production could have a significant impact for stocks in the energy sector, and beyond.

While turmoil in oil-producing countries is nothing new, this situation is different for several reasons. First, the vulnerability of the global economy to disruptions varies over time, and there is currently very little excess global oil production capacity to provide a cushion in the event that Iraq’s exports are cut off. During the past few years, Iraq has become the second-largest oil producer in OPEC, partly because of international sanctions against Iran and instability in Libya. In June 2014, Iraq produced 3.17 million barrels per day, while OPEC’s effective spare capacity is estimated at 3.25 million barrels per day (see chart below). If Iraq’s production were to stop, there would be no spare capacity, and rising oil prices likely would slow global growth and energy consumption.

Longer term, Iraq has been expected to account for roughly 60% of the growth in OPEC production capacity until 2019 (see chart below), and the threat of disruption calls into question the nation’s ability to meet those production targets. While no one can predict how the conflict will end, the possibility exists that Iraq’s production will halt or slow, causing a spike in oil prices that impairs the global economy.

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Source (left): The Organisation for Economic Co-operation and Development (OECD) and the International Energy Agency (IEA), Oil Market Report, July 11, 2014. Source (right): Energy Intelligence Group, Bloomberg Finance L.P., Fidelity Investments, as of May 31, 2014.

Investment implications

It’s hard to view current developments in Iraq as positive for global supply growth, and markets are beginning to price in expectations for higher crude oil prices at the longer end of the curve. This could be beneficial for U.S. and Canadian energy producers, as they are buffered from the turmoil.

The North American shale oil and gas boom has been made possible by new techniques—hydraulic fracturing and horizontal drilling—that help producers extract oil and gas from shale rock. Adoption of these methods has fueled significant production growth during the past two years in the United States and Canada, which are now driving virtually all non-OPEC production growth.

Mideast turmoil further tilts the playing field toward higher-quality North American companies—those with limited debt, declining production cost structures, and the ability to grow production in the prime shale areas. These companies have been growing production volumes in the United States and increasing capital spending despite a relatively flat commodity price. Investors may be rewarded for owning the best-positioned companies, those with the ability to grow production and earnings independent of oil price fluctuation.

Learn more

• John Dowd manages Fidelity® Energy Portfolio (FSENX | Get Prospectus)
• Find more investments in the energy sector.
• Find more commentary from Fidelity Viewpoints

Views expressed are as of the date indicated, based on the information available at that time, and may change based on market or other conditions. Unless otherwise noted, the opinions provided are those of the author and not necessarily those of Fidelity Investments or its affiliates. Fidelity does not assume any duty to update any of the information.Investment decisions should be based on an individual’s own goals, time horizon, and tolerance for risk.

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