Iraqi forces sought to check the rapid advance of Islamist militants who had seized major cities, as Prime MinisterNouri al-Maliki responded to the greatest threat to his government since taking power.

The military attacked fighters of the Islamic State in Iraq and the Levant in Saddam Hussein’s former hometown of Tikrit, about 80 miles (130 kilometers) north of Baghdad, state-sponsored Iraqiya television reported. In Mosul, the air force struck ISIL positions after they seized the largest city in Iraq’s north earlier this week, Iraqiya said. Al-Sumaria television reported heavy clashes as the army fought for Tikrit backed by air support.

The surge in violence across northern and central Iraq, three years after U.S. troops withdrew, has raised the prospect of a return to sectarian civil war in OPEC’s second-biggest oil producer. Al-Maliki’s Shiite-led government is struggling to retain control of Sunni-majority regions, and his army units in northern Iraq collapsed in the face of the Islamist advance.

“This can’t be looked at as anything other than a comprehensive failure by the Iraqi army,” Crispin Hawes, managing director of the research firm Teneo Intelligence in London, said in a phone interview. “If the army can’t protect Mosul, how are they going to protect other cities?” he said. “Moving southward would be the logical thing to do for ISIL.”

The advance of ISIL fighters has rattled oil futures and markets in both Iraq and Turkey. Brent crude oil rose to the highest since the start of March and West Texas Intermediate to an eight-month high amid the violence.

David Fuller's view

This latest unrest in the Middle East’s second largest oil producer, while not an immediate threat to Iraq’s production, has nevertheless additionally firmed crude oil prices at a time when other factors have also been stirring interest in what is still the world’s most important commodity.   

I think that much of this recent interest is speculative.  Traders have seen some sharp moves in commodity markets and Brent crude’s increasingly narrow range since 2011 (weekly & daily) was an anomaly which could not persist beyond the lengthy medium term.  Also, the recent rally in US 10yr Government Bond yields from 2.4% on 29^th May to back above 2.6% lowered deflationary concerns and prompted expectations of somewhat stronger US GDP growth during the second half of this year.  Stock market gains have encouraged similar expectations for other countries.

The recent rally in US WTI crude (weekly & daily) looks even more speculative to me, since the US is consuming less oil and producing more.  Nevertheless, the push above range highs for the last several months by oil contracts will attract further interest from momentum traders if it is not quickly reversed.  The US could easily lower the WTI contract by releasing more oil from its very large strategic stockpile which was established before the country became virtually self-sufficient in energy.  Similarly, the Saudis could weaken global oil prices by just promising to increase production shortly.  However, they may not want to do this, due to their own budgetary requirements, and increased Saudi production would not be welcomed by other oil exporters. 

Currently, the chart patterns for crude oil can support higher prices, driven by supply concerns and momentum buying.  Downward dynamics, triggered by rumours of increased oil production, are necessary to reduce this risk.  Meanwhile, today’s gains in oil prices are already a headwind for global stock markets and this would increase with every additional dollar move to the upside.