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Our market view - week 31

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Escalating tensions in the Middle East support oil prices, despite the string of bad economic news

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Oil prices fell 4% last Monday on bad EU economic news and then climbed slowly for the rest of the week, largely on assurances from EU leaders that they will not let the Eurozone collapse, which raised expectations of new ECB action to solve the debt crisis. Also, slow growth in the US has triggered expectations of stimulus measures from the Fed. Such economic stimulus measures could boost the outlook for oil demand.

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Brent futures (source: Reuters)

Interest rates in Spain soared to new highs, hence a general bailout by the EU or a default seems inevitable. Germany is refusing to grant further extensions to Greece. It is feared that a Greek default would cause a chain reaction that would tear the Eurozone apart. The UK economy contracted more than expected in 2Q and has now contracted three quarters in a row.

The ECB, Germany and France assure that they would do whatever it takes to keep the Eurozone from collapsing. The next two months could be critical for the future of the Eurozone and the stability of the global economy. In September, a German court will rule on the legality of the new Eurozone rescue fund. Another decision must be made on bailing out Greece again or cutting it free. By the end of the year, the picture should be clearer.

The only positive economic news last week was that Chinese manufacturing in July grew at the fastest pace in 9 months, indicating that the government stimulus measures were having an impact. Chinese coal and electricity consumption continue to grow, but at a much slower pace than in recent years.

Oil prices are finding support from escalating tensions in the Middle East, with rising violence in Syria threatening to further destabilize the region. Last week Al Qaeda launched a series of attacks across Iraq, killing and wounding hundreds. The development raised concerns about whether the Iraqi government has the ability to control terrorism without the presence of US troops, which could prevent the country from achieving substantial increases in its oil exports in the years ahead. Few think the situation in Syria can continue for much longer, but with all the outside interests involved, the outcome of the Syrian uprising is difficult to foresee.

The Washington Post reported that Iran is rapidly gaining capabilities to strike at US warships in the Persian Gulf by means of hundreds of small fast boats armed with sophisticated missiles. The US republican Presidential candidate Romney said that his administration would “respect” an Israeli decision to attack Iranian nuclear sites; while the Obama administration has emphasized that military action should only be a last resort. Any attack on Iran could easily escalate, slowing oil exports from the region and bringing oil prices to new record highs.

We expect oil prices to remain volatile, as escalating tensions with Iran and other geopolitical issues counteract gloomy economic data and weakening oil demand.
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