Iraq crisis: Why Baiji refinery matters for Iraq – and beyond

Sunni jihadists battled with Iraqi government forces for control of the country's largest refinery. Loss of the Baiji refinery wouldn't directly impact global oil markets, but it would exacerbate the Iraq crisis and further destabilize a fragile regional situation. 

The conflict in Iraq converged upon the country's largest refinery Thursday, as government forces clashed with militants looking to seize a critical source of transportation fuel and electricity. 

It remains unclear who controls the Baiji refinery, about 130 miles north of Baghdad, but the attack by Islamic militants has already dealt a significant blow to Iraq's energy sector. A complete loss of Baiji would deal a double whammy against regional security by giving insurgents a potential long-term source of revenue while undermining economic stability in Iraq and beyond. Just the threat of broader destabilization across Iraq has unnerved global oil markets.

"[D]omestic gasoline shortages could undermine Iraq's fragile stability," James Hamilton, economics professor at the University of California, San Diego, writes via e-mail. "[I]f this spills over into disruptions from Iraq's southern oil-producing and exporting facilities it would have a significant effect on world oil prices ... and we will find out whether Saudi Arabia's promises to stabilize the markets hold any substance."

An Iraqi government spokesman told Reuters midday Thursday that the refinery was in their "complete control," but other reports cite witnesses and refinery employees as saying Sunni rebels remain in command. The jihadists, led by the Islamic State of Iraq and the Levant (ISIS), likely aim long term to use revenue from fuel sales to finance terror operations across the region. 

The Baiji refinery supplies motor fuel for northern Iraq and can process around 310,000 barrels a day, fed by oil fields in the autonomous Kurdistan region. It also fuels a nearby power plant that provides electricity for Baghdad, which already suffers from outages.

"Power generation in Iraq has been a mess for years," Simon Henderson, director of the Gulf and Energy Policy Program at the Washington Institute, writes in an e-mail. "Despite purchases of equipment, not much has been installed. Many people in Baghdad use personal generators."

The flow of oil to the refinery is already off-line, according to Thamir Uqaili, an oil and gas consultant who worked in Iraq for the Iraq National Oil Co. and Iraq's Ministry of Oil for over 40 years. If it remains damaged or off-line, it will create a shortage of products that cannot be replaced quickly, Mr. Uqaili writes via e-mail.

"I do not think that the Ministry of Oil or the Government has an emergency plan to remedy the situation," writes Uqaili, who is now based in Canada. "Equally it is not clear if the Government Forces can stabilise the remaining part of the country in a short time."

Fears of that happening have already put upward pressure on global oil prices. Brent crude oil, an international benchmark, was up 80 cents to $115.06 per barrel Thursday, a nine-month high.

Combined with rising global demand, the loss of even a third of total Iraqi oil production would generate an oil price increase of up to $40 per barrel, according to a report issued this week by Securing America’s Future Energy, a Washington-based group that advocates for decreased US oil dependency. That would be a tremendous blow to a global economy slowly rebounding from the Great Recession. 

"It is in our national security interests not to see an all-out civil war inside of Iraq, not just for humanitarian reasons, but because that ultimately can be destabilizing throughout the region," President Obama said in a press conference Thursday. "And in addition to having strong allies there that we are committed to protecting, obviously issues like energy and global energy markets continue to be important." 

Iraq accounted for 4 percent of the world's oil production in 2013, according to the Paris-based International Energy Agency (IEA), and the country is home to the fifth-largest proven crude oil reserves in the world. Production had picked up in recent years, but the unfolding crisis threatens to derail progress on Iraq's postwar oil development.