Waddell & Reed

Market Perspectives

Tension in the Mideast: Syria gets the headlines, but there are other (bigger) oil supply concerns

Story Highlights

  • Although the world is focused on Syria, it is not a major oil producer.
  • The impact on oil prices could become more pronounced if the conflict expands beyond Syrian borders.
  • Tight supply/demand fundamentals are expected to continue and we believe the energy sector will benefit over the long term.
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Investment Management

Manager Name

David P. Ginther

Portfolio Manager

ALTHOUGH SYRIA IS NOT A MAJOR OIL PRODUCER, and sanctions in recent years by both the U.S. and European Union have curtailed what exports it does offer to the global market, rising tensions in the Middle Eastern nation have impacted oil prices in recent weeks. David P. Ginther, portfolio manager of both the Ivy Global Natural Resources Fund and the Ivy Energy Fund, shares his views about what Syria means to oil markets and points out the bigger concern might be in other parts of the region.

Mideast instability

Overall, the situation in Syria is yet another example that the political situation across the region is extremely fragile, and that a high level of instability continues. In this case, there are arguably no good possible scenarios, only some that might be considered less bad than others.

In Syria, what had been a civil war has turned into an alliance conflict, with regional and global powers becoming involved. Syrian President Bashar al-Assad’s government is receiving military support from both Iran and Hezbollah in Lebanon. Russia is one of Syria’s largest arms suppliers and always has had a policy goal of wanting to block Western influence in the region. China also has stepped in to warn Western powers against military action in the region.

On the other side of the conflict, the Syrian rebel forces have received support from western countries and the Gulf States. Saudi Arabia has agreed to provide surface-to-air and surface-to-surface missiles to the Syrian opposition. All of this involvement, of course, has the potential to at least complicate any path toward easing tension – let alone a resolution.

The most immediate concern in terms of a spillover is to Iraq and Lebanon, which both border Syria.

From a market perspective, the spillover into Iraq may present one of the more significant risks. Iraq is OPEC’s second-largest oil producer, generating 3 million barrels of crude a day last year, and has a long history with Syria, including periods of both hostility and cooperation. The situation with Syria has provided another source of tension in Iraq’s own sectarian conflict. Generally, Iraqi Prime Minister Nouri al-Maliki’s Shiite government is seen as siding with Assad, while Iraq’s Sunni opposition leaders side with the Syrian rebels. It might be worth noting that, as events unfold in Syria, bombings in Iraq are becoming more frequent. This may be the start of increasing civil unrest in that nation and could plague Iraq through its 2014 elections.

Another concern in terms of oil markets is the continuing instability in Egypt, where the military recently overthrew the government of President Mohammad Morsi. Although Egypt also is not a big producer of oil, the nation controls the Suez Canal and the Suez- Mediterranean pipeline, known as the Sumed. The Canal, which is a chokepoint between the Red Sea and the Gulf of Suez, is used to transport about 800,000 barrels of crude and 1.4 million barrels of petroleum products daily, according to the Energy Information Administration. The Sumed, meanwhile, handles 1.7 million of barrels of crude oil per day, according to the EIA.

Oil markets

It is important to recognize that while the situation in Syria is dominating headlines in the mainstream media, the oil market is facing other significant issues that more directly influence supply.

In Libya, civil unrest in both the oil fields and at the docks has included protests over low pay and allegations of corruption and has greatly reduced oil production. In terms of actual oil supply, the situation in Libya, home to one of the world’s largest supply of oil reserves, is the most severe. By late August, production was down from what the National Oil Corp. (NOC) considers an optimal capacity of 1.6 million barrels per day to 200,000 barrels per day. Production also has slowed in other nations, including Iraq and in Nigeria, amid violence there. Maintenance work in the North Sea also has reduced production from that region. The decline in production has already lasted longer than was initially expected and it may be another six months until production levels can begin to move higher.

Setting the events in Syria aside, the situation in Libya and the slowed production in other regions has proven to the market that the oil supply/demand balance is perhaps far more delicate than some market participants previously realized. In this environment, the Syrian situation is compounding existing supply concerns that some fear may lead to oil prices spiking to $150 a barrel or higher if the Syrian situation spreads into Iraq or spawns a civil war in Iraq. There is limited spare capacity to replace what might be lost in terms of Iraqi oil production.

Over the long term, we expect the energy sector to benefit from tight supply/demand fundamentals. Higher oil prices will lead to higher capital spending, which will benefit oil service companies and allow exploration and production companies to increase spending to expand production. Currently, the world seems set on continuing to feed its ever-growing appetite for more energy. The risk would be a significant spike in oil prices that raises gasoline prices enough to curb consumer confidence. The last two times oil hit $130 per barrel, we saw a slowdown in economic activity. If we see prices prompt another slowdown, it could result in lower oil demand.

Past performance is no guarantee of future results. The opinions expressed in this article are those of the Fund’s investment team and are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed. The opinions are current through Sept. 6, 2013.

Risk factors. As with any mutual fund, the value of the Fund’s shares will change, and you could lose money on your investment. An investment in the Fund is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Investing in companies involved in one specified sector may be more risky and volatile i than an investment with greater diversification. Investing in the energy sector can be riskier than other types of investment activities because of a range of factors, including price fluctuation caused by real and perceived inflationary trends and political developments, and the cost assumed by energy companies in complying with environmental safety regulations. These and other risks are more fully described in the Fund’s prospectus.

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