Given Syria factor, here's how to play oil
With the involvement of Russian and now U.S. forces, the conflict in Syria has gained in complexity and relevance for investors. The shared goal to defeat ISIS will likely prevent a deterioration of the conflict for now, but it may not be sufficient to keep the interests of all parties aligned over the medium term. The risk of an escalation has increased, but the likelihood of a prolonged impact on global financial markets is still low, in our view.
Recently, the U.S. decided to deploy special operations troops to northern Syria to "train, advise and assist" rebel groups in their fight against ISIS. The deployment marks a relevant shift in the US policy as it looks to strengthen non-ISIS opposition forces, and put pressure on all parties to find a political resolution. Diplomatic talks have intensified in recent weeks, though reaching a peace agreement will prove difficult in the short-term with the future of President Bashar al-Assad remaining contentious. Russia, , and various other groups support President al-Assad, whereas the U.S., several European countries, Turkey, and Saudi Arabia and its allies aim to replace his regime.
The situation increases the risk of an escalation of the conflict, with possible implications for investors via rising energy prices or adverse sentiment. Upward pressure on energy prices would be doubly significant because surplus supply in the oil market is likely to clear in the second half of next year. Prices are likely to trend upwards over the next six to 12 months even in the absence of geopolitical volatility or a larger-than-expected decline in U.S. production. Under a supportive if unlikely scenario, Brent crude could trade at $80 a barrel in six months' time, compared with our $60 base case.
Still, the threat of energy supply interruption from Syria is low. The bulk of Syrian oil production is offline, while global inventories remain high. Even so, supply interruptions could lead to spikes in energy prices, especially if the crisis grows into a broader regional conflict between Shia and Sunni states, or if measures against ISIS are extended to countries like Iraq, Afghanistan, and Tajikistan.
For investors, however, it is still inadvisable to take on additional direct exposure to oil. Prices remain volatile, the near-term outlook is cautious, and the longer-term upside depends on growth in China. Rather, investors seeking to mitigate the fallout from any oil price rises should look to U.S. and euro zone energy equities, where valuations are cheap and balance sheets are typically resilient or improving.
For now, we think the common goal to weaken ISIS provides enough incentive for Russia and the West to cooperate, as it could ease the hostilities in Syria and ultimately the refugee crisis in Europe. Nonetheless, given the Kremlin's manifold interests in the region, the conflict could intensify even if new sanctions are announced against Russia, as the West has threatened.
Another concern is that armed forces from Russia, the U.S., and Turkey are operating within a few miles of each other. Recent reports about Russian fighter jets violating Turkish airspace, and misguided cruise missiles accidentally hitting Iranian soil, are a reminder that tensions between the groups and countries involved could spark due to military incidents.
Although unlikely in our view, an escalation of the Syrian conflict would result in at least a temporary increase in global risk aversion, with rising pressure on emerging market assets. Countries like Turkey would probably suffer more than others. A prolonged energy supply interruption – although also unlikely at the moment – would likely result in a more meaningful sell-off.
For now, while we are closely monitoring the situation, the conflict is not changing our allocations to individual countries within our emerging markets portfolio. Within a global portfolio, an overweight position in US and euro zone energy equities remains attractive on a six-month horizon and should experience additional tailwinds if the oil price escalates further.
Commentary by Michael Bolliger, head of emerging market asset allocation in the Chief Investment Office at UBS Wealth Management, which oversees the investment strategy for $1.9 trillion in assets. at .