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Wall Street warily watching Iraq

Wednesday, June 18 08:43:56

Traders are bracing for more volatility in markets as fighting in Iraq intensifies, with the recent rise in crude oil prices posing risks to the strong rally in U.S. stocks.

Investors worry that the insurgent Islamic State of Iraq and the Levant (ISIL), which threatens to take control of northern Iraq, could extend its reach to the south and cripple oil production in OPEC's second-largest exporter. This week, fighting shut the country's biggest oil refinery.

Concern over Iraq was in part responsible for the S&P 500's largest weekly drop in two months last week, when prices for Brent crude jumped the most since last July.

Prolonged fighting would boost volatility in stocks and in particular hit transportation, shipping and airline companies with a significant portion of their expenses from fuel costs.

Oil production in the north of Iraq has been down since March, but the prospect of supply disruptions in the oil-rich south has pushed the price of Brent crude to a nine-month high in recent days.

Bank of America Merrill Lynch analysts said in a note that $125 per barrel for Brent - near the highs hit in 2011 and 2012 - is on their watch list. Others have said the Brent peak near $150 in mid-2008 could be in play.

The price of U.S. wholesale gasoline also jumped last week, up 4 percent, and brushed against its highest since July. Analysts fear that a steady climb could hit consumer spending.

Investors will likely continue to pile into energy shares. The S&P 500 energy sector, which was down on Tuesday, is up 9.6 percent so far this year. The sharp move has pushed the energy sector into overbought territory, measured using an index of relative strength, leaving it vulnerable if the Iraq situation is resolved.

Oil volatility spiked last week, with the CBOE Crude Oil ETF Volatility Index up more than 30 percent to its highest level since late April. (Reuters)