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Syria increases upside risk to oil prices

The further deterioration in the Syrian situation adds to the upside risk for oil prices, says Gary Dugan, Chief Investment Officer, Asia and Middle East at Coutts…

Increasingly vocal international allegations that the Syrian government has used chemical weapons, and the start of UN inspections on Monday, may foreshadow a potential international military intervention.

The US had previously cited the use of chemical weapons as a “red line” that, if crossed, would draw a far more robust response from the international community (notably the US, UK and France). If the US were to intervene, it would likely lead to a marked deterioration in its relationship with Iran - just when it appeared to be starting to improve.

Oil supply is already tight. Ongoing labour disputes at four Libyan ports have resulted in the country producing less than half of the 1.6m barrels a day (b/d) it produced before the country’s recent revolution. Although one of the four ports looks likely to come back on line, Libya will probably still produce 600,000 b/d less than it had previously.

Supply has also been inconsistent elsewhere. In Iraq, ongoing terrorist activity has reduced supply by 250,000 b/d while terrorist activity has limited gas supplies in Yemen. Moreover, given the fact that 2.2m b/d pass through the Suez Canal, any closure or disruption as a result of geopolitical uncertainty has the potential to push oil prices toward USD130 a barrel.

Geopolitical risks in the Middle East continue to mount, particularly in Egypt. And with more stable parts of the Middle East, such as Saudi Arabia, Kuwait and the United Arab Emirates, needing to fund their very high levels of government spending, the downside looks limited.

Market expectations for demand have increased given the recent improvement in the outlook for European and, particularly, Chinese economic growth. The latest industrial confidence data for China was much better than expected, suggesting growth is re-accelerating. In Europe, recent data shows that even peripheral countries have seen a meaningful improvement.

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