What History Tell Us About Markets And Middle East Crises

The turmoil and violence in Iraq continued unabated on Monday as ISIL (Islamic State of Iraq and the Levant) militants continued on their quest to acquire additional strongholds in northern Iraq.

From the market's perspective, the question is whether the situation in Iraq is likely to turn into a global geopolitical/economic crisis or remain a local conflict. As human beings, anyone who understands what is happening is likely to have a great deal of empathy for the citizens of Iraq. However, for investors, the focus is more cold-hearted and involves some math.

The mathematics of this crisis are fairly easy to get one's head around. This crisis, as with almost all crises in the Middle East revolves around oil.

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Doing the Math on Iraq

For starters, investors need to recognize that Iraq is a major oil producer--it is the second largest oil producer in OPEC (after Saudi Arabia). According to the Energy Information Agency (EIA), Iraq produces 2.9 million barrels of oil per day, which is the same amount of production seen in Mexico and about 300K more barrels per day than Brazil produces.

Another fun fact to know is the geography of Iraq oil production and export. Approximately 25 percent of production is in the northern section of the country - where all the military action is at the present time - while 75 percent of the country's oil production occurs in the south.

Next, Iraq exports roughly 2.3 million barrels of oil per day. It is important to note that 2.1 million, or approximately 91 percent, of the exports are to the south via the Persian Gulf while 100,000 - 200,000 barrels per day is exported to the north through Turkey.

Related Link: The Markets' Continued Climb On The 'Wall Of Worry'

Therefore, the first conclusion that can be drawn is that southern Iraq is where the action is in terms of oil being produced, stored and exported.

Because the military action in Iraq is primarily in the north, the vast majority of analysts believe there is no immediate danger to Iraq's southern oil fields. Perhaps this geography explains why there does not appear to be any panic seen currently in other financial markets, even while the price of oil has been moving higher.

For example, stocks in the U.S. actually finished a bit higher Monday, gold finished down, bonds yields moved down a bit but not dramatically and the CBOE Volatility Index moved only modestly higher.

Adding The "Risk Premium"

Despite the relative calm in most asset classes, oil has continued to move higher. Take a look at the chart below.

U.S. Oil Fund ETF (USO) - Daily

Although the flow of oil has not been interrupted and there does not appear to be any real threat to supplies in the foreseeable future, it appears that a "risk premium" is being applied to oil right now. The sellers of oil are asking buyers to pay a little more for their oil each day due to the worries about what might happen in the near-term.

What Have Past Middle East Crises Taught Us?

Those who have been in the stock market game for any length of time are definitely familiar with the never ending crises that tend to occur in the Middle East. There have been 18 so-called "crisis events" in the Middle East since 2000 alone. That's 18 crises in 14.5 years.

So, what has happened to the price of oil around the crises seen just in the last four years?

U.S. Oil Fund ETF (USO) - Weekly

The arrows on the chart above illustrate the starting point to the following:

• December 2010: Arab Spring (Tunisia)
• January - April 2011: Egyptian Revolution, Bahrain Uprising, Libya Tension, Syrian Civil War
• October 2011: Gaddafi Overthrow
• January 2012: Mali Conflict
• July 2013: Islamic Unrest in Egypt
• December 2013: Anbar Clash

In looking at the price action in Brent Crude Oil one month after each event began, history shows prices rose seven out of nine times, and by 7.3 percent on average.

Three months after the crisis event, Brent Crude was also higher seven out of nine times (prices fell after Gaddafi was overthrown and the Anbar Clash), by an average of nearly nine percent.

Looking back to the crisis events since 1990 (there have been 21 total), oil prices have been higher 5.4 percent on average three months after the event began and 9.25 percent higher three months later.

The Takeaways

History shows that crisis events in the Middle East tend to last a while and that prices have usually moved up in earnest after the events began. So, given that the so-called crisis in Iraq began about a week ago, the odds are pretty good that oil prices are headed higher over the next few months.

The key question however, is if the liquidity provided by the central banks of the world will be able to keep the party in the stock market hopping.

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