What ISIS’ "Blood Oil" Really Means for Oil Markets

Money Morning Contributor
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As recently as 18 months ago, terrorist attacks like those in Paris last Friday night would have caused an immediate (and sizeable) spike in oil prices. That’s because, as we can all remember, destabilizing or violent actions on the international stage have increased the uncertainty factor, fueled volatility, and prompted short-covering.

But on Monday, the markets saw a mere 2.5% increase in benchmarks West Texas Intermediate and Dated Brent in New York and London. On Tuesday, both benchmarks moved back down only to rise a few pennies yesterday.

That action says something about the way investors felt the impact of the Paris attacks: Western markets simply won’t be dictated to by terrorists.

That’s not to say ISIS isn’t a “player” in the global oil market. It certainly is, but its role – and impact – is more complicated and insidious than the traditional “geopolitical factor.”

Let me explain…

Prices Today Are All About Supply

We exist in a very different environment today than we did in 2013, and oil is no exception.

Moves in either direction on the demand side have an impact in oil prices, of course. Worldwide consumption is increasing again, so much so that projections show the highest daily levels on record by the end of the year.

But these days, price increases are dependent primarily upon what occurs on the supply side of the equation. And that’s what is keeping prices restrained.

As I have observed in Oil & Energy Investor on multiple occasions, the global oil glut is largely a result of huge shale and tight (unconventional) production, along with mushrooming extractable reserve volumes.

That means the only geopolitical factor likely to push prices up is one that calls the sourcing and supply of oil into question. As horrific and terrifying as Friday’s outrages were, there’s no oil to be had in Paris’ 11th arrondissement.

As a result, Monday’s brief pricing pop reversed itself. But there are some supply developments underway, and ISIS is driving them.

ISIS Needs Oil Revenue… And Lots of It

First, ISIS needs its own oil revenue to fund its agenda and its estimated 53,000 to 238,000 fighters.

In a report I wrote a decade ago, I calculated that a terrorist organization needed at least $14,000 to support each fighter. And that was without the cost of equipment, armaments, or other expenses directly related to the operational side. That figure is no doubt even higher today.

Now, ISIS has a huge war chest, provided by everything from gold and currency stolen from bank vaults in the cities and towns it has overrun, to the black market sale of antiquities it has looted from dozens of ancient archaeological and tourist sites in the territory under its control.

ISIS also relies on the more “traditional” terrorist revenue streams from kidnapping, extortion, smuggling, and blackmail.

Nonetheless, the organization requires a considerable daily revenue flow from the sale of oil harvested from occupied fields.

ISIS gets what it requires, too. In early 2015, when U.S. commandos raided the home of senior ISIS bagman Abu Sayyaf, computer records and intelligence extracted from his widow (Abu Sayyaf didn’t survive the raid) showed that ISIS may clear as much as $10 million a month on oil.

Now, these murdering thugs are hardly savvy oil traders. They dump what oil they have available without regard to market conditions at a significant discount to normal trading prices. In fact, some of the oil is now going for as little as $25 a barrel. That they pull in such high revenue serves to illustrate the sheer volume of “blood oil.”

ISIS’ oil volume, in turn, is creating an immediate glut on a regional market.

Most of the blood oil is being moved into Turkey, and for some time it has restrained prices in trading hubs like Dubai, where futures pricing actually includes a factor reflecting the smuggled oil.

Attacking ISIS’ wellheads is one option that the West has here, although the ability to eliminate production rather than simply damage it is a very difficult thing to accomplish in practice.

Their real Achilles’ heel is found in the transport of that oil. This is accomplished by trucks, since ISIS has no pipelines or ocean tankers (at least, not yet). Each of these could be interdicted easily at the reception point anyway. And the trucks have become a primary target for U.S. and Allied airstrikes.

And it’s that interdiction effort that will have an effect on oil prices.

Stopping the “Blood Oil” Flow

Pressure is also being applied against Ankara, obliging Turkish authorities to patrol their own borders. Until recently, there was pushback. Turkey has been reluctant to enter the fray in neighboring Syria even when that has included fighting in border towns. That is now changing.

With a treasury estimated in the billions (maybe trillions), ISIS will not go away if it cannot move oil. But it will be hampered in funding foreign attacks. It already needs to resort to inefficient ways of moving money since it has no international banking system of any consequence.

The interruption of the “blood oil” flow will have a modest impact on improving overall oil prices.

The second consideration is more direct: The Saudis will need to ease production levels.

As ISIS continues to solidify its presence in the Persian Gulf, bringing Iran into the contest in opposition, the Saudi position is now under siege. Riyadh requires further assurances from the West and regards the atrocities in Paris and the downing of the Russian passenger plane over Sinai as providing the opportunity.

On the other hand, this is likely to require Saudi easing of OPEC’s current high production levels, which I’ve noted is to maintain the cartel’s market share.

There is some movement already under way on this front, with a more direct influence on global prices. In fact, in three weeks and after a trip to Brazil, I’ll be headed to the Persian Gulf – and I’m bringing my Oil & Energy Investor readers along for the ride.

In addition to gathering market intelligence, I’ll be looking at some juicy new opportunities there in the epicenter of the global oil industry.

Don’t miss a minute of Kent’s trip: You can get all of his Oil & Energy Investor research and updates when you click here.

Follow Kent on Twitter and Facebook, too.

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