Sizing Up Oil's Geopolitical Risk

 | Jun 12, 2014 | 2:28 PM EDT  | Comments
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Two very big stories this week require that I address both briefly. First, Iraq. 

While it is incredibly disheartening to see Mosul fall so quickly to a very small, very extreme group of Islamic militants, especially considering the tragic loss of life, limb and resources this country expended in the last 10 years, it is also likely to have little immediate effect on the oil markets.

Yes, there will be the standard rally of crude prices based on the risks of reduced production going forward, as we have seen in the Egypt, Syria and Libya squabbles, but there is rather little risk of much reduced production in the near term. Let's examine:

The group calling themselves the Iraq/Syria Islamic state (ISIS) is an extreme Sunni group of insurgents with little popular Iraqi support. The cities that they have so spectacularly claimed are in diverse areas of religious populations. This implies that the success that they have gained could only occur in those deeply divided regions such as Mosul and Tikrit.

The vast majority of Iraq's 3.5 million barrels a day oil production lies in the South, amid the extreme Shiite majority, while only 17% of production remains in the north, with by far the largest center being the Kirkuk "superfield" nearer the border to Turkey -- that 600,000-barrel-a-day field is located in an area of superior Kurdish majorities. Both areas are highly unlikely to suffer a similar fate as Mosul, should the ISIS troops attempt a raid there.

What is a very sharp risk from these latest events in Iraq is a continued destabilization of the Al-Maliki government and its economic progress. In the global oil market, the 3.5 million barrels of production from Iraq had become a critically needed supply source. Moreover, OPEC and even global oil markets were counting on the potential for continued production growth from Iraq, with hopes of 5 million or even 6 million barrels a day of production in the next several years. The risk of threatened new production growth is the real threat to global oil prices.

And it is here that we have to wait and see just how long and how far the destabilization gets. Is Iraq descending into a full-scale civil war? I certainly doubt it. I even doubt that this small group of rebels can continue to hold the towns they have recently taken. But the prospect of continued violence in Iraq will certainly lessen the appetite of Western oil companies to invest in new production infrastructure in Iraq. And that is where the price of oil is at risk of seeing $130 in 2015.

And that's precisely what I think is going to happen.

Now, quickly to Anadarko (APC), a stock I was an advocate of in March, only weeks before the Tronox settlement saw shares explode. Recent options activity in the shares was accompanied by a rumor that Exxon Mobil (XOM) was sizing up Anadarko for a takeover bid. It's not going to happen.

But it doesn't have to. I liked Anadarko before the settlement, and I like it still after it. It still has the best asset mix in the patch, and it is still undervalued compared with its peers, I said in March that Anadarko was worth $130 without the overhang of Tronox.

I still believe that and still am holding shares.

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