The increasing likelihood of some form of limited US led military action in Syria is compounding concerns about the stability of the world’s key oil producing region and Barclays warns that it will likely exert upward pressure on prices until the nature of the possible military intervention becomes apparent. But the bigger risk for the oil market is the potential for the Syrian conflict to spread to neighboring producing countries and imperil regional output, as the Syrian conflict is fueling broader sectarian tensions across the entire Middle East and has become something of a proxy war. The problem for global oil prices is that all of this Middle East volatility is taking place against the backdrop of a recent rise in unplanned outages in the oil market outside Syria. In sum, Barclays is concerned that with geopolitical tension and physical outages on the rise, crude oil markets are at an inflection point.
Syria: No supplies at immediate risk, but spillover effects bear watching
The possible military action, which media reports (e.g., Reuters) indicate could take the form of cruise missile strikes targeting select Syrian military installations, is unlikely to put any additional crude supplies directly at risk. Although not a large producer, Syrian oil production has declined to a trickle of 50 kb/d compared with 350 kb/d in March 2011. Syrian oil minister Suleiman al-Abbas was recently quoted as saying that production was only 39 kb/d during H1 13. It remains unclear if this reflects only production from assets in government-controlled areas. Iran is now supplying Syria with a $3.6mn line of credit for oil and oil product purchases, supporting the thesis that Syria’s domestic upstream and downstream infrastructure is in dire straits.
But the bigger risk for the oil market is the potential for the Syrian conflict to spread to neighboring producing countries and imperil regional output. Iraq, currently OPEC’s second largest producer, has already seen its security situation significantly deteriorate because of Syria. Violence is running at the highest level in five years because of a renewed round of bombings and shootings. Last month, the head of the UN mission in Baghdad warned that the Syrian civilian war had spilled over into Iraq and that the “battlefields are merging into one conflict.” Syria has deepened Iraq’s sectarian fault lines, with Prime Minister Maliki’s mainly Shiite government widely seen as siding with the Assad regime and Iraq’s Sunni opposition leaders with the Syrian rebels. Syria has also emerged as a key base for Al Qaeda extremists to launch attacks in Iraq. Iraq’s oil has emerged as a casualty of the renewed unrest, with Sunni insurgents repeatedly bombing the Kirkuk-Ceyhan pipeline.
Moreover, the Syrian conflict is fueling broader sectarian tensions across the entire Middle East and has become something of a proxy war, in our view, between Saudi Arabia and other Gulf states, who are backing the rebels, and Iran, which remains a stalwart ally of the Assad regime. Likewise, the war has the potential to further exacerbate tensions in large producing countries with significant Shi’a populations such as Saudi Arabia and Kuwait that have a history of troubled relations with the government. For Saudi Arabia in particular, the Syrian conflict places additional strains on the state budget and comes at a time when production levels have reportedly reached close to 10 mb/d in July.
All of this Middle East volatility is taking place against the backdrop of a recent rise in unplanned outages in the oil market outside Syria. EIA recently released estimates of unplanned outages reaching two-year record highs of almost 3 mb/d, a level unseen since at least 2011. Sanctions on Iran and the recent labor and payment problems in Libya have lifted OPEC disruptions to almost 2 mb/d, adding to 0.8 mb/d in unplanned outages in non-OPEC countries. While Libyan output is trickling through, and improvements could be expected in Iraq with the startup of new fields (and maintenance on the export terminal pushed back from September); the return of supplies is likely to be staggered with a high possibility of a relapse in Libya, Nigeria, Iraq and South Sudan. With outages at these levels, it cannot be ruled out that discussions about a possible coordinated stock release among IEA countries may be under way.
Iran’s continued support for Assad could also prevent any significant reset in its bilateral relations with the United States and the return of about 1.5 mb/d of Iranian barrels to the market. Over the weekend, the Iranian Foreign Ministry accused the Syrian rebels of being behind last week’s chemical weapons attack and strongly warned against any Western military action. Hopes had been rising of improved ties following the election of the moderate cleric Hassan Rouhani as president in June. Rouhani had made the revival of the Iranian economy his top priority and pledged to improve Iran’s relations with the international community.
In sum, with geopolitical tension and physical outages on the rise, crude oil markets are at an inflection point. Balances indicate that OECD crude oil inventories in June are close to the five-year average, now moving below last year’s levels. Looking ahead, the outages could come at a time when non-OECD demand increases even further over Q3 levels, further pressuring these inventories in our view. If demand proves even higher than forecast and supplies remain offline longer than the market anticipates, this will support even higher price levels.