All Eyes Are on Iraq

Last week terrorist group Islamic State of Iraq and al-Sham (ISIS) swept out of Syria and into northwestern Iraq, moving southwest and through several major population centers—capturing cities of Mosul, Tikrit and Tal Afar as of Sunday. The Kurds mobilized their army (they have one). The Iranians are reportedly involved. The Iraqi army is fighting back as well. And the US moved the USS George HW Bush into the Persian Gulf to put it in range for air strikes, if needed. (For a play-by-play of the latest developments—which are moving at high speed—click here.) The situation seems like a real mess, and the end-game to the conflict is an open question. But some have raised another question: What does the conflict mean for stocks and the economy? The answer, in our view, is it likely doesn’t much matter unless it spreads far and wide, as the present regional conflict lacks the size and surprise power to materially affect stocks.

Iraq is only a sliver of the global economy. With annual GDP of about $229.327 billion in 2013, Iraq’s economy is slightly larger than Louisiana’s and slightly smaller than Connecticut’s—all three roughly 0.3% of the world’s economy. And its trade ties with other countries are minimal. In 2013, Iraq trade made up only 0.3% of EU exports and 0.6% of EU imports. And it made up only 0.1% of US exports and 0.5% of US imports.^[i] Countries do business with Iraq but on a pretty darn small scale—the conflict is unlikely to ripple into the global economy.

Much of that trade, however, is in oil—and unrest in the Middle East nearly always spells oil fears (today’s concerns aren’t anything new). Iraq, with output of 3.1 million barrels per day (mb/d), is OPEC’s second-largest producer and the world’s eighth biggest. Its oil production amounts to about 3.4% of total world production—a figure most analysts expected to grow, as Iraq sits atop the world’s fifth-largest reserves, and additional development and infrastructure builds were projected to push output up over the 4 million barrel mark this year. That (already lofty) goal may be in jeopardy now. We say, “may be in jeopardy,” because so far Iraqi oil output has been largely unaffected. Most of Iraq’s oil infrastructure and production are centered in areas further to the south and east, near the city of Basra. The only piece of major oil infrastructure presently in the conflict zone is a pipeline that runs from Kirkuk to Ceyhan, Turkey. But that was already offline due to terrorist sabotage.

The likelihood a global oil shortage occurs because of Iraq is tiny. If Iraq’s oil supply goes partially or even completely offline, OPEC, led by Saudi Arabia, has 3.5 million barrels per day of spare capacity to offset the dip—more than Iraq’s total output. And it isn’t unprecedented for OPEC to respond to strife with increased production. In 2011, when the Libyan Civil War ousting Muammar Gaddafi took most of its production offline (which has only just begun to ramp back up), Saudi Arabia increased output and covered the lost supply. An OPEC statement responding to the Iraqi conflict noted the bloc would, “if required, take steps to ensure the market balance.”

What’s more, non-OPEC oil production, led by the US, has grown far faster than OPEC output. According to the US Energy Information Administration, the US produced 8.2 mb/d in March 2014—which is about 3 mb/d higher than the average from 2005-2010, before the shale oil boom began in earnest. That’s just shy of an Iraq! It has been well reported that US oil imports have fallen as a result. Now, the US still does import a fairly significant amount of oil. But not much comes from Iraq. Iraqi oil exports amount to around 2% of US total oil consumption.

What’s happening in Iraq can best be summarized as a regional conflict. And regional conflicts have historically had little lasting impact on global stocks. Especially regional conflict in the Middle East. Take the two official Iraq wars. In 1991, global stocks were up 18.3%. And in 2003, stocks were up 33.1%.^[ii] Both featured oil production interruptions, with the former reducing Iraqi output for years (associated with sanctions). The Israel-Hezbollah conflict in 2006. The Syrian conflict. Egypt’s revolution. The many and varied conflicts in Lebanon. We could, tragically, go on. The specifics of who is doing the invading of Iraq today may be surprising, but that there is turmoil in Iraq and the broader Middle East is not. These types of localized tensions are neither new nor unusual for stocks. There just isn’t much surprise power here.

That is not to say there is no impact—it’s just that the impact is very unlikely to be market-wide. Some global energy firms have projects in Iraq that are theoretically now at risk. And it’s fair to say that if the conflict impacts Iraq’s oil production directly and/or damages these global Energy firms’ facilities, it is a negative for them. But it also isn’t as though these companies operated on the notion Iraq was just like Texas, populated only by folks with a different twang. These firms are well aware of the risks and rewards of operating in the Middle East, and many insure themselves against loss. In fact, this Energy insurance firm was founded with a “primary focus on the war and terrorism market.”

In our view, the Iraqi scenario is worthy of consideration, but unless it materially and broadly escalates from here, it’s unlikely to carry much lasting market impact.