Is the Middle East about to deliver another oil shock to the global economy? The U.S. military has targets picked out in Syria and President Obama is trying to convince Congress that America needs to intervene. If the U.S. does go ahead with tactical strikes against the Assad regime, oil markets will be caught in the middle. The size of the repercussions, though, is an open question.
History, both recent and more distant, offers a sense of what to expect when the world’s most important oil producing region destabilizes. Syria’s oil production, in terms of physical supply, is inconsequential. What’s more of a concern is how Syria’s neighbours react to any military intervention by the U.S. The Middle East is home to roughly a third of global oil production. The world depends on a steady stream of cheap crude flowing from the region in order to keep the global economy running smoothly.
Any significant reduction in exports — through a blockage of a key transit choke point such as the Strait of Hormuz or the Suez canal — will be felt in the rest of the world. Likewise, any sabotaged production in Iraq, Saudi Arabia, or elsewhere would stress global supply. Oil markets are also watching Iran, a country that not only produces millions of barrels of oil a day, but also controls shipping lanes vital to global crude flows. If military strikes in Syria draw Iran into the conflict the stakes get even higher. The potential for such disruptive events is why Brent crude is already trading as high as $115 a barrel in recent days. Some analysts warn that instability emanating from Syria could cause Brent to test its all-time high of $147 a barrel reached in 2008.
The market, clearly, has reason enough to be anxious. Syria is devolving into another on the list of failing Middle Eastern states that’s recently expanded to include Libya, Yemen, and arguably even Egypt. The country is also another flashpoint in the region-wide hostility between Sunni and Shiite Muslims. The fault lines of that conflict run through nearby Lebanon, as well as key OPEC players such as Iraq, Kuwait, and global oil kingpin Saudi Arabia.
Regardless of the circumstances, whether it’s Syrian dictator Bashar al-Assad or Libyan strongman Moammar Gadhafi, regime change is never bullish for Middle Eastern oil supply. When leaders are overthrown, as happens in this turbulent region, oil production subsequently falls. How a regime ends, its ideological stripe, or who puts the next government in power doesn’t seem to matter.
Look back to the 1970s when the Iranian Revolution ousted the western-supported Shah. At that time, Iran produced around 6 million barrels a day. More than 30 years later, its daily production is still only around 3.5 million barrels. It could be argued that U.S. sanctions are partially responsible for the diminished output. But that doesn’t change the reality that physical supplies are lower. Oil supply, for that matter, doesn’t fare much better when the U.S. is responsible for putting the new government in place, as happened in Iraq and Libya.
In Iraq, oil fields have been opened up to some of the world’s largest oil companies. Despite the technical sophistication on hand, output is being hampered by sabotage and political instability. Iraq’s oil production has yet to get back to levels from the 1980s when the country was under the brutal authoritarian rule of Saddam Hussein. If the relentless sectarian violence in the country is an indication, Iraq, a key OPEC producer, seems to be getting closer to joining Syria in a civil war between Sunni and Shiite factions.
Libya’s oil industry has fared even worse. Much like Iraq, Libya is the product of 20th century border making by foreign powers. It’s fractured by fierce tribal and regional divisions, which preclude the functioning of an effective central government. Prior to the demise of Gadhafi’s reign, which stretched four decades, the country pumped 1.6 million barrels a day. In the ongoing chaos following his ouster in 2011, production has tumbled to less than a third of that amount.
A turnaround in U.S. oil production due to fracking technology that’s opened up tight oil plays in places such as North Dakota and Texas has caused considerable chatter about domestic energy independence. America, understandably, doesn’t want to be beholden to foreign oil. North American oil prices, on the other hand, are already trading around a two-year high and are now firmly back in triple-digit territory.
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Military intervention in Syria holds the potential to send crude prices bounding even higher. As much as we’d like to be sheltered from a Middle Eastern oil shock, we may soon find out that our economies are as vulnerable as ever.
Source: Jeff Rubin's Smaller World
