Update on the Conflict in Iraq

Iraq Update

Iraq has deteriorated a bit this week and the inability of the Iraqi Parliament to choose a new PM weighed a bit on stocks late yesterday.  Before reading the particulars, keep in mind there are two negative scenarios in Iraq for the markets.  The first is that ISIS gets south of Baghdad and gains control of major oil export terminals in Basra in southern Iraq.  That would send oil materially higher.  The second is this Iraq conflict sparks a Sunni/Shiite civil was that spreads across the Middle East and pulls in Iran, Saudi Arabia, etc.  Obviously, that would send oil  higher.  Given the events of the last few days, the worry is for the later and the moment more so than the former, as ISIS remains well north of Baghdad.

Now, the reason things have deteriorated a bit this week are two fold.  First, ISIS (which is comprised of Sunni Muslims) attached a Shite shrine in Samarra earlier this week.  The last time that happened was ’06, and it sparked a nasty mini-civil war in Iraq.

Second (and more importantly) it was expected that the Iraqi parliament would pick a new Shiite Prime Minister to replace current PM Nouri al-Maliki, who is accused of largely ignoring Sunnis.  It was hoped that a new PM would be viewed as more inclusive, and ISIS would lose support among regular Iraqi Sunnis.

But, as Baghdad dithers, Iraq burns.  And, while militarily it seems a bit of a stalemate at the moment, any real solution will only come from a more inclusive government that saps ISIS’s ability to rally regular Sunnis.  Then the government can beat them back militarily.  But, the longer that doesn’t happen, the more support ISIS can gather among regular Sunnis, increasing the probability of a broader civil war.

Oil is down this morning so clearly the market isn’t worried about this yet.  But, the situation has gotten a bit and I wanted to make you aware.  A major positive in this scenario remains the appointment of a new Iraqi PM, while oil (specifically Brent Crude) remains the indicator to watch as to whether things are materially getting worse.