When All Else Fails, They Take You to War

Back in July we wrote in the Weekend Markets and Money that there was a kind of tussle going on in the oil market. We argued the spreading problems in the Middle East were clashing against the uplift in production thanks to increased North American output. We saw that tussle reflected in the price action this week.

The US Energy Information Administration had actually surprised everybody when it said US crude oil inventories were up by 3 million barrels just last week. That was the largest rise in three months. Normally you’d expect to see a lower oil price thanks to something like that. But not with Syria in the headlines. US oil futures hit a two year high on Wednesday. Energy stocks bounced.

Syria produced less than 1% of the Middle East’s oil output last year. The country does, however, border Iraq, with Iran not too far away. Combined, these two account for a fifth of the output capacity from OPEC, according to Bloomberg.

Iraq, don’t forget, is home to the last great known fields of largely untapped, long life and low cost reserves. The oil bears are (were?) banking on this oil coming to market alongside North America. Iraq needs a combination of infrastructure and peace to get it there.

Whether or not Iraq will get those and can get near to producing at anything like full capacity anytime soon has always been the question. Syria might be on the front page, but Iraq is in turmoil too.

Take this from BBC News:‘The intensity of attacks in Iraq this year by mainly Sunni Muslim insurgents has reached levels not seen for five years. More than 1,000 Iraqis were killed in attacks in July, the highest monthly toll since 2008, according to United Nations statistics.

And don’t forget the forgotten campaign in Afghanistan. From the New York Times:

The Taliban breached an international military base in eastern Afghanistan on Wednesday, in a complex attack that left at least one Western soldier, four Afghan police officers, and two other Afghans dead, Western and Afghan officials said…Ghazni Province has remained one of the more violent areas of the country, and in recent weeks there has been an uptick in attacks there.

Not exactly the era of peace and democracy that was once touted.

All this follows on from the recent news that China is on track to overtake the US as the biggest oil importer in the world. At least that’s according to consultancy group Wood Mackenzie, which puts 2017 as the auspicious occasion for the historic handover. The new energy superhighway, as Dan Denning likes to say, is now between Riyadh and Beijing.

Dan’s portfolio over at The Denning Report is heavily geared towards oil and energy. So far, that’s proven a profitable strategy. It’s the one sector of the commodity market relatively spared from the rout in natural resources over the last two years. Oil has stayed high. But Dan is warning off speculating in energy stocks at this level as a play on a US attack on Syria. The trade is too obvious now.

Perhaps it might have been even more obvious if you happened to be a US Congressman or at the heart of the US military industrial complex. Take a look at the chart for giant global ammunition and defense firm Alliant Techsystems (ATK):

Source: BigCharts

ATK has been on the move since last year. That’s long before Syrian President Bashar al-Assad’s regime was all over the headlines as being under immediate threat from a US strike.

Do you get the impression something has been on the table for a bit longer than you might otherwise be lead to believe? ATK is not alone either. Other big US ‘defence’ companies Lockheed Martin (LMT), Raytheon (RTN) and Northrop Grunman (NOC) are all up over 30% for the year.

We do feel slightly assuaged that UK Prime Minister David Cameron tells us that the coming conflict is not actually about the Middle East or even Syria,’ wrote your regular DR editor Greg Canavan this week as he mused on the brewing war.  ‘And Gareth Evan’s opinion piece in today’s Financial Review also provides comfort when he explains that a strong moral case justifies war even though international law doesn’t. That’s good to know.

Those ‘defence’ stocks actually dipped a few percent toward the end of the week, presumably reacting to the news David Cameron hadn’t managed to drag the UK Parliament with him into the war just yet. Suddenly, an attack seemed less likely. Or maybe it was just a ‘selling the fact’ trade.

And then this came across the wires from the Wall Street Journal:

The Obama administration laid the groundwork for unilateral military action in Syria, a shift officials said reflected the U.K.’s abrupt decision not to participate and concerns that President Bashar al-Assad was using the delayed Western response to disperse his military assets…

‘Mr. Obama is prepared to act without Britain, officials said, noting that unlike U.S. involvement in the 2011 military operation in Libya, the options under consideration in Syria are smaller-scale and wouldn’t require a coalition to be effective.

In other words, no matter what happens, we’re pretty sure the US government will find its way into a fight eventually. Hang on to your hard assets.


Callum Newman
for Markets and Money


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