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Why Oil Isn't Spiking as Militant Group Tears Apart Iraq

Stocks in this article: XOM CVX RDS.A BP HES

NEW YORK (TheStreet) -- There's a premium in crude oil markets since violence in Iraq escalated the middle of last week, but fear is likely to remain absent from the trade unless a significant change in the altercation on one side or the other.

Islamist militant group ISIS (for Islamic State in Iraq and Syria) has seized a large portion of Iraq's northern territory and claims control of some part of Syria, but analysts said their hostilities don't yet threaten Iraq's oil-rich southern region. Additionally, ISIS militants haven't sabotaged northern oil fields.

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"It still doesn't matter; psychology is what dominates the market at this point," Dennis Gartman, editor of The Gartman Letter, said in a phone interview.

Since June 12 when crude spiked on news of widespread attacks by ISIS, West Texas Intermediate crude oil is up about 2.3% and Brent crude is higher by 3.2%. But the largest portion of those gains occurred during one trading day.

Crude prices haven't spiked further for a couple of reasons. Where most of the fighting last week in northern Iraq transpired, production and exports of Iraqi crude there have been shut down since early March, when rebels bombed a pipeline to Turkey.

"In short, the 250 kilobarrels of Kirkuk oil exports that would have otherwise been most immediately at risk last week was lost months ago, and the oil markets had already adjusted," Michael Wittner, oil and products analyst at Societe Generale, wrote Monday in a note to investors.

The other reason oil prices haven't spiked more is because the major oil producing regions in southern Iraq -- namely the city of Basrah -- remain untouched and as of the moment unthreatened.

"The oil is a reasonably long way from where this particular action is taking place," John Browne, former BP  (BP) CEO said in an interview. "There isn't a sense of panic, and I don't think there should be a sense of panic because there is a reasonable amount of oil to go around."

Should ISIS create a stronghold in territories it currently occupies and choose not to march to Baghdad and the southern areas of the country, prices aren't likely to spike higher.

Bank of America Merrill Lynch suggests the "highly unlikely" scenario that ISIS temporarily enters the capital, Brent crude could jump by another $10 to $15 a barrel from the current price of about $112. The worst case scenario, the bank writes in a note to investors, would be if ISIS disrupts some 2.6 million barrels a day of Iraqi production (the country averages 3.2 million), which would trigger a $40 to $50 jump.

A massive price jump like that would come on the back of much more aggressive action by the militant group into Baghdad and major oil-producing cities, and it assumes ISIS would choose to cut off production, which it hasn't yet done to northern pipelines.

Current market action in Brent and WTI show the increased Iraq violence priced in, but an ISIS surge further in the country or military action by the United States (President Obama is considering possible airstrikes) or neighboring Iran could add greater price volatility.

ISIS previously has stated that its goal is to establish an Islamic Caliphate from eastern Syria to central Iraq -- an area very close to what it currently occupies.

While there is very real uncertainty as to what happens next, ISIS is a well-trained militant group that may not be targeting shutting down the country's oil infrastructure. Additionally, ISIS opposition will also come from within the country, including the ethnic Kurds.

"I think they're wise enough to know not to do that," Gartman said. "They also know: don't f*** with the Kurds."

-- Written by Joe Deaux in New York.

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