Oil prices gained more than two per cent after a militant group made its presence felt by taking over Iraq's largest oil-producing city and moving on the capital.

The world woke on Thursday to news that a Sunni rebel group called the Islamic State of Iraq and the Levant has taken over Mosul, the country's second-largest city, and Tikrit, the birthplace of Saddam Hussein and a key cog in the oil industry in the north part of the country.

The group has reportedly overrun its largest refinery at Baiji, and has set its sights on the capital of Baghdad, which has a strong Shia majority.

That sent oil prices higher, with all the world's major oil blends gaining between one and two per cent. Brent crude gained $1.95 to $111.90 US a barrel in London, while the North American benchmark WTI gained $1.50 to $105.90 US a barrel, the highest level since September.

Canadian oil (which trades at a discount to others because it has a different chemical composition and must be sent far afield to be refined) was trading at $86.69 a barrel, up $1.40 on the day.

"I would entirely ascribe this move to the insurrection in the north of Iraq," Christopher Bellew of oil trading firm Jefferies Bache said. "The fear is that it will cause a threat to Iraqi oil exports … If this conflict knocked out Iraq as an exporter, that would have significant impact on prices."

The effect on prices will be a lot more if the insurrection spreads south to the area around Kuwait, where the majority of Iraq's three million barrels of oil exported per day comes from.

"For now, the conflict is located in the north of the country, but it seems that the market may be concerned that it could spread toward the producing fields in the south," research firm JBC Energy said in a note.

Prolonged supply issues in Iraq would eventually play out in higher prices, as OPEC lacks the capacity to make up Iraq's shortfall. World demand for oil has grown from 88.5 million barrels a day in 2010 to an estimated 92.8 million barrels a day this year. All of Lybia's oil has effectively been removed from the system since the ouster of Gadhafi in 2012 has dropped that country's oil industry into disarray.

Increased output from non-OPEC countries like Canada and the U.S. has kept prices lower than they would otherwise be, as a boom in U.S. shale oil has caused America's oil output to rise by four million barrels per day over the last four years. That's more than the entire output of Canada, the world's 5th largest producer.

Global oil markets have been unusually steady since 2010. Dramatic changes in oil production around the globe have offset each other instead of wreaking havoc. That has helped keep world oil prices high enough to provide OPEC countries with robust income, but not so high that they scare customers away from buying more oil.

The stable oil prices have helped o bolster the current economic recovery and there are fears a price shock could upset that balance, and halt growth before it takes hold in the U.S. and EU.

If the situation with ISIL in Iraq escalates to include more oil-producing regions, oil prices would likely move higher still.

"A $2 move is nothing in historical terms," BNP Paribas oil analyst Gareth Lewes-Davis. "A lot would have to happen before we saw a serious disruption to exports."