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Despite production outages the oil price should fall

As the threat of US military action recedes and seasonal demand eases, the oil price should drop

The global economy is gathering some steam, led by positive data in the US, UK, China and even the eurozone. So the last thing it needs is a Syria-induced spike in the oil price to derail the recovery.

That is what oil markets were gearing up for in late August, as the US tried to muster support domestically and internationally for an attack on Bashar Al-Assad's regime in Syria after chemical weapons killed hundreds of civilians in a suburb of Damascus.

Syria is not a major oil producer. Before the conflict, output was only around 350,000 barrels a day (b/d); it is now thought to about 60,000 b/d. But a punitive attack by the US was fraught with dangers for the oil market. It would prompt a reaction from Iran, some analysts believed, and damage any hopes of a nuclear deal between Tehran and Washington. The US may also get sucked into a regional war, others argued. If Syria fell apart, the meltdown could spread into its neighbours, Iraq and Lebanon. "The fragmentation of Syria is the real weapon of mass destruction," tweeted one Iraq analyst. The market was spooked.

A deal hatched in Moscow, which would see Assad hand over his chemical weapons (details of when and to whom remain hazy), may have averted the crisis. Brent prices have retreated from highs above $116 a barrel in late August to around $112/b as Petroleum Economist went to press. It could be the beginning of a more gradual softening as 2013 winds down.

That won't be because short-term supplies are in good shape. Disruptions across the Middle East and Africa have stripped about 3 million b/d from output. Not much of that oil is likely to come back on line soon. The recent strength in prices has yet to appear in consumption projections for the coming quarters, too. So it is possible that supply problems will keep prices inflated for some time, even while demand growth outlooks are trimmed.

This is particularly a problem for Opec. The group's market share is slipping rapidly and there are few signs of a turnaround. The call on its oil this year will average 29.9 million b/d, 500,000 b/d less than last year, says Opec's secretariat. In 2014, it will fall by another 300,000 b/d. The International Energy Agency (IEA) thinks the call could be even lower next year.

That makes Opec a casualty of the high prices that have spurred so much supply growth outside the group. The rise of non-Opec supplies - from output from the long-delayed Kashagan development offshore Kazakhstan to North America's burgeoning unconventional sector - contrasts starkly with the troubled upstreams of Opec's members. A few years ago, Opec said its members would spend $155bn to increase output capacity by 12m b/d. Outside the Gulf, however, years of triple-digit oil prices have yielded none of this. Meanwhile, non-Opec producers are expected to add 1.1m b/d and 1.2m b/d to their production this year and next.

The unrest and sanctions in the Middle East and West Africa have decimated the group's spare capacity, removing Opec's lever over the market. Libya's output is now less than 100,000 b/d, according to some sources, removing at least 1.3m b/d of high-quality oil from the market. Iran has lost 1m b/d or more. Nigeria's output of under 1.9m b/d is 400,000 b/d beneath capacity. Iraq's production growth has stalled at just over 3m b/d (with 250,000 b/d lost in the north).

The Energy Information Administration said last month Opec's lost output in total amounted to 2.1m b/d, but the number is surely now higher. The IEA calculates Opec spare capacity (excluding the troubled countries) has fallen to 2.94m b/d. But that statistic merely confirms Saudi Arabia's domination of Opec. It controls three-quarters of that spare capacity, and has lifted production to more than 10m b/d as it tries to plug the gaps left by other members.  

Throw in the outages in non-member countries like South Sudan (still about 100,000 b/d beneath capacity), Syria (about 300,000 b/d gone), and Yemen and you can see why prices remain strong. For all the new North American crude and despite the tepid demand picture, too much oil has been shut in.

This will cause longer-term problems for Middle Eastern producers, too. Even if some kind of stability returns to the region - a long shot - regaining their lost market share will make for fractious politics. If Iran's oil came back on stream in six months time - an even longer shot - which Opec member would cut back output to accommodate it?

Weakness persists

Yet there is also weakness lingering in the price. Despite everything - the lost chunk of supply, the threats of more war in and around producing countries, and Opec's dwindling spare capacity - a spike has been avoided. That implies a better outlook for consumers than a glance at Nymex's front-month numbers suggest.

This could become obvious if supplies in the Middle East and North Africa begin to recover again. As it is, refinery turnarounds in the West and the end of the driving season ought to loosening the market. OECD stocks are in good shape, says Opec, and the market "is well-supplied". The IEA says stocks could exceed their five-year average by December. Saudis are about to turn down their air-conditioners, too, freeing up more oil for export.

Unless things flare up again in the Middle East, all this should bring about a gradual deflation in the oil price in the coming months. This would be helpful for consumer economies. It will pose a different problem for Opec. Given the volume of its oil already offline, there won't be much room for cutting supplies to defend the price, especially given Saudi Arabia's long-standing view that $100/b is an appropriate level. So the rally in August might have been the market's swansong. Syria's war might not end soon, but its impact on the oil market could soon be overtaken by more bearish fundamentals.  

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