His comments on Sunday in the Turkish city of Trabzon came a week after Islamic State of Iraq and the Levant militants made rapid advances in Iraq.
Erdogan told journalists: "This has gone far beyond an encounter with forces affiliated with ISIL.
"Under current circumstances it can evolve into a sectarian conflict, or maybe even a sectarian war."
Vigilante groups formed
Heavy fighting has also been reported in Tel Afar in Iraq, where Islamic State of Iraq and the Levant militants have stepped up attacks using mortar shells.
Turkmen tribesmen, who constitute the majority in the city, formed vigilante groups in the city after ISIL forces seized the provincial capital, Mosul.
Erdogan said: "We cannot underestimate the developments in Tal Afar.
"As you all know, it is a Turkmen majority city. Half of our Turkmen brothers are Sunni Muslims, the other half are Shia Muslims."
The three million-strong Turkmens represent the third-largest ethnic group in Iraq, constituting 13 percent of the population.
`All channels activated`
Referring to 80 Turkish nationals abducted by ISIL fighters on Tuesday and Wednesday, Erdogan said: "Our first priority is to bring our citizens to the homeland safe and sound."
He said the government had activated all channels to ensure Turkish citizens return.
The ISIL, which developed into a formidable force inside Syria, has extended its reach in Iraq since Tuesday, gaining near-complete control of the northern Iraqi city of Tikrit and seizing Mosul, Iraq`s second-largest city.
The group seized large swathes of western Iraq`s Anbar Province in January, including much of Fallujah and parts of Ramadi, flashpoints of the US-led war in 2003.
Iraq has seen a marked increase in sectarian violence between Sunni and Shia Muslims in recent months, which the Iraqi government blames on ISIL.
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