Oil: expect a supply shock

Conflict in the Middle East could contribute to rising oil prices.

"What happened to the geopolitical risk premium?" asks Peter Warburton of Halkin Services. Turmoil in Gaza, Russia provoking Kiev, and Islamists terrorising Iraq areall events you'd expect to send oil prices soaring. Yet following a jump to $115 abarrel in June, prices have fallen by more than 11% to a 14-month low around $102.

The tension has had no impact on oil production, especially in Iraq, where it has been confined to the north, not the oil-exporting south. Output in traditional trouble spots, notably Iran, Libya and Iraq, has actually picked up recently.

Meanwhile, a surge in US output and weakening Chinese demand appear to be starting to take their toll.

Yet, the market still looks "highly vulnerable to a supply shock", reckons Barclays.Spare capacity comprises just 3% of global demand, and the spare oil is all in Saudi Arabia, which is currently burning through its oil at the fastest rate in three years.

The conflicts in the Middle East could spread rapidly and unpredictably, hitting supplies, while markets are also underestimating the extent to which turmoil deters future investment and exploration, undermining long-term supplies, says Investec'sTom Nelson. Barclays sees oil averaging $106 a barrel next year.

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