Oil and the Middle EastPrepared: March 15, 2012

OverviewFor three generations, global economic growth and development has been highly dependent upon carbon-based forms of energy, especially crude oil. The discovery of substantial oil reserves in the Middle East transformed an economically destitute region into a linchpin of the global economy. The combination of ongoing tensions (attributed to a variety of causes) mixed with the plentiful nature of such a key commodity has long been a source of concern to the world. Recent developments, including political instability created by events related to the Arab Spring and Iran’s recent foray into the development of nuclear technology has raised concerns that the oil spigot from the Middle East could be turned off for a period of time, hampering the global economic recovery.

It is estimated that the Middle East accounts for nearly 40% of world oil exports. Add in North African countries such as Algeria and Libya, and about half of the world’s oil imports originate from the region. History has shown that even a small disruption in oil exports from the Middle East can send economic shock waves around the world. The first example of this occurred with the 1973 Arab Oil Embargo. This unprecedented exercise of economic power by oil producing countries in the Middle East caused crude oil prices to double in less than a year. Most analysts attributed the oil shock as the primary driver of a painful economic recession in the U.S.

Middle East Oil Producers

Important disclosures provided on page 5.

Situation Analysis

At the root of concerns over the oil producing countries of the Middle East and their neighbors in North Africa are a variety of issues:

• Widespreadgeopoliticalinstability

• Civilunrest

• Economicinequality

•Potentialforarmedconflictbothwithin the borders of several nations and with neighboring countries

This paper examines tensions within the region, discusses how these tensions could result in a disruptionintheflowofoilexportsandestimatesthe economic impact on the global economy under various scenarios. Recommendations on how to potentially protect a portfolio in the event another oil crisis should unfold are also included.

IRAN4.9

SAUDI ARABIA12.1

Minorunrest

KUWAIT2.5

UAE3.2

QATAR1.7

No civilunrest

ALGERIA2.4

OMAN1.0

Unrest

IRAQ2.8TUNISIA

0.1

Majorunrest

BAHRAIN0.1

LIBYA2.1 EGYPT

0.8

Civilwar

SYRIA0.5

0.3YEMEN

Numbers shown represent % of global oil production

Source: Energy Information Administration; data as of 2010

Important disclosures provided on page 5.

Page 2Oil and the Middle East

Situation Analysis

The Haves and Have NotsIt is notable that in terms of their importance as suppliers of oil to the rest of the world, not all countriesintheMiddleEastarecreatedequal.Forexample, with daily oil production of barely 400 thousand barrels per day, Syria’s oil production is dwarfed by the more than 12 million barrels per day that come out of Saudi Arabia. Nevertheless, as has been tragically evident in recent months, civil unrest and a violent government crackdown in Syria have increased tensions within the region and added to growing geopolitical uncertainties.

The following chart shows the estimated oil exports of various countries within the region.

World Oil Producers/Exporters

Source: Energy Information Administration; data as of 2010

The largest supplier, Saudi Arabia, is not likely to face any significant supply disruption given its considerable military defenses and its status as a strategic ally of the U.S. The same cannot be said, however, for other countries in the region such as Iraq.TherecentwithdrawalofU.S.troopsinthatcountry resulted in a power vacuum that has given rise to increased sectarian violence in an already fragilesociety.Iraqwastheworld’stwelfthlargestoil producer in 2010 but has the world’s fourth largest proven petroleum reserves (trailing only Saudi Arabia,CanadaandIran).Iraqwillremainoneofthecritical players in the region’s oil output.

Another challenge that has developed in recent months is the tension over Iran’s apparent attempts

to develop nuclear weapons. The U.S. and its allies have indicated a determination to prevent this from occurring. Both sides are on a collision course, with the most likely outcome being the imposition of punishing economic sanctions in an effort to deter Iran from its nuclear ambitions. These sanctions could include steps to curtail Iranian oil exports, adding to the strain on global energy supplies.

Iran’s military goals appear to stand in stark contrast to those of countries like Saudi Arabia. Although the Saudis maintain a significant military force, its focus is mainly defensive. Iran, on the other hand, is not only pursuing an aggressive military expansion, including the possible development of nuclear weapons, but has consistently meddled in regional politics. Its actions have been both overt, such as the 1990s war with Iraq,andcovert,includingsupportforHezbollahandother militant groups. For these reasons, Iran has long been viewed as one of the most dangerous countries in the world. This greatly contributes to the region’s instability and to oil price volatility.

Sectarian Differences and Other Great DividesBeyond the threat of military confrontation is the issue of sectarian tensions between the Shiite and Sunni branches of Islam, a centuries-old rift that continues to give rise to the intense distrust and competitionwithintheregion.Whilethisrelationshiphad been relatively harmonious for much of the 20thcentury,conflictbetweenthetwogroupshasintensified in recent times, particularly in the wake ofthewarinIraq.Differencesinreligiouspractice,traditions and customs are among the points of dispute between these two factions of Islam.

There are other significant differences that contribute to tensions across the Middle East. These tend to be philosophical distinctions related to:

• Economicopportunity

• Internationalalliances

• Militarygoals

• Theexistenceorlackofdemocraticinstitutions

NigeriaNorway

Venezuela

Mexico

CanadaBrazil

China

RussiaUnited States

Middle East

0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100%

% of Production Exported as Crude

Prod

uctio

n of

Oil

(% o

f glo

bal p

rodu

ctio

n)

40%

35%

30%

25%

20%

15%

10%

5%

0%

Important disclosures provided on page 5.

Page 3Oil and the Middle East

Situation Analysis

Shipping Choke Points

Withanestimatedflowofmorethan15millionbarrelsofoilperdaythroughtheStraitofHormuz,it is easy to understand why Iran views its control of these shipping lanes as leverage to respond to international pressure regarding its nuclear ambitions. Although it is highly unlikely that such an attempt would succeed, the impact on the global economy could be dramatic.

Oil Price ImpactsSome disruption to oil supplies from this volatile region is possible in the near future, but, as in previous instances, it is not likely to be permanent. Prudentinvestorsshouldconsideraplanforthepotential impact of such events. History reminds us that during past periods of turmoil, the cartel of Oil PetroleumExportingCountries(OPEC)shutoffpartsof the global oil supply. At times, the amount of the oil supply disruption exceeded the amount of oil that other countries were able to produce to make up for the disruption. There have also been oil embargoes, which constrained supplies to certain markets and causedlocalizedspikesinoilprices.Thethreatofsuch events can lead to premium energy pricing in response to these risks. The following table provides a summary of various risks and the potential impact on oil prices.

A prime example of the paradoxes that confront the Middle East is the fact that the region is home to some of the wealthiest nations on earth and some of the poorest.

2011 Gross Domestic Product (GDP) Per Capita

Source: International Monetary Fund

Finally, as was so vividly illustrated by the recent “Arab Spring” movement are the vast differences in the region in terms of the implementation of democracy and rule of law. Even within countries as outwardly peaceful as Saudi Arabia, there are deep currents of unrest surrounding the lack of human rights. All of these factors combine to form a region that is one of the most geopolitically unstable regions of the world.

Geography 101 — Choke PointsAs if social and political tensions in the Middle East weren’t enough, geography also plays a crucial role in underscoring the fragility of oil exports from the region. As indicated in the following illustration, the flowofoilexportsishighlydependentontheabilityto transport oil through sometimes sensitive “choke points,” including:

• TheSuezCanal

• TheBabel-MandebStrait(commonly referred to as the “Gate of Grief”)

• TheStraitofHormuz

2011

GD

P Pe

r Cap

ita($

in th

ousa

nds)

$100

$80

$60

$40

$20

$0JordanQatar

United ArabEmirates

KuwaitBahrain

OmanSaudiArabia

LebanonLibya

IranEgypt

SyriaIraq Yemen

IRAN4.9

SAUDI ARABIA12.1

KUWAIT2.5

UAE3.2

QATAR1.7

ALGERIA2.4

OMAN1.0

IRAQ2.8TUNISIA

0.1

BAHRAIN0.1

LIBYA2.1 EGYPT

0.8

SYRIA0.5

0.3YEMEN

ShippingChoke Point

Bab el-Mandeb3.2

Suez Canal1.8

Strait of Hormuz

15.5

Numbers shown represent % of global oil production

Source: Energy Information Administration; data as of 2010

Important disclosures provided on page 5.

Page 4Oil and the Middle East

Situation Analysis

Investorsmayalsoconsiderequitiesofoilproducingcompanies. Stock prices of these firms tend to move in relation to oil prices. This can occur even though an increase in oil prices may boost operating expenses.

Appropriatelyqualifiedinvestorsmayconsiderprivateequityinvestmentsorpipelineandpartnership-type investments, although we believe these are likely to provide little capital appreciation as protection against oil price spikes. However, there maybesomebenefitfromlargercashflowslinkedtooil production. These investments may be beneficial over the long term, if higher oil prices persist, but may not offer much hedge protection in the near term duetoilliquidityandproductionterms.

Investment PositioningThe inherent instability in the region, combined with the magnitude of potential price reactions, promptsthequestionofwhatresponseinvestorsshould consider if these events transpire. One problemisthatconflictsintheregionoften develop on short notice, resulting in a sudden spike in oil prices. Such actions typically have an adverse impact on global economic growth and,inshortorder,onequityprices.

Werecommendinvestorsconsideramodesthedge in their portfolios when appropriate with their long-term investment objectives. Effective hedging strategies may be comprised of investment vehicles that tend to experience price movements in correlation to the direction of oil prices, including:

• Exchange-tradednotesorfundslinked to oil prices

• Structurednoteslinkedtooilbenchmarks

Source: Energy Information Administration; *data as of 2011

10%-15%

30%-50%

30%-100%

75%-100%

100%+

Range of Estimated % Price Increase

0 20% 40% 60% 80% 100%

Threat

Shutdown of Oil Producer — Bottom Tier (Yemen or Syria) Shutdown of Oil Producer — Middle Tier (Libya)

Shutdown of Oil Producer — Top Tier (Iraq or Iran)

Shutdown of Spare Capacity Oil Producer (Saudi Arabia)

Transportation Disruption of Key Middle East Choke Points (Flow as % of Seaborne Traded Oil) Strait of Hormuz (35) Suez Canal (7) Strait of Yemen (5)

0.3-0.5

2.12

2.8-2.4

10*

Average Production(% of World 2009)

Scenario Analysis: Potential Oil Price Outcomes

Page 5Oil and the Middle East

Situation Analysis

Given the tension-related realities within the Middle East, it may be appropriate for investors to consider a suitable strategy that may provide a hedge against potential oil price spikes. This may include exchange-traded notes or funds or structured notes that are linkedtooilpricesorbenchmarks.Webelievetypicalhedgedexposureshouldbe2%-5%ofthetotalportfolio value. Investors should be certain that any changes made to their portfolios are appropriate with their long-term investment objectives.

ConclusionThe status of the Middle East as the most important region for global oil production is unlikely to change fordecades.Thepersistenceofconflictseemslikelyto trigger ongoing volatility for a commodity that plays such a critical role in the global economy. Also unlikely to change in the near term is the ongoing economicandsocialinequalitythatcontributestofurtherpoliticalinstability,andconsequentlyoilpricevolatility.Dependingonthedegreeofmarketdisruption, we estimate potential oil price increases torangefromalowof10%-15%ifonlysuppliesfrom smaller oil producers are dislocated to 100% or more if oil producers with spare capacity are removed from the market.

IMPORTANT DISCLOSURES

This information was developed on March 15, 2012 and represents the opinion of U.S. Bank. It does not constitute investment advice and is issued without regard to specific investment objectives or the financial situation of any particular individual. Since economic and market conditions change frequently, there can be no assurance that the trends described here will continue or that the forecasts will come to pass. The information presented is for discussion purposes only and is not intended to serve as a recommendation or solicitation for the purchase or sale of any type of security. The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness. U.S. Bank is not responsible for and does guarantee the products, services or performance of its affiliates or third-party providers.

Past performance is no guarantee of future results.

Based on our strategic approach to creating diversified portfolios, guidelines are in place concerning how investments should be allocated to specific asset classes based on client goals, objectives and tolerance for risk. Not all recommended asset classes will be suitable for every portfolio. Hedged equity and hedged fixed income investment strategies are typically available via hedge funds which may not be appropriate for all clients due to the speculative nature and high degree of risk involved in these investments.

Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. International investing involves special risks, including foreign taxation, currency risks, risks associated with possible difference in financial standards and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility. Alternative investments very often use speculative investment and trading strategies. There is no guarantee the investment program will be successful. Alternative investments may not be suitable for every investor, even if the investor does meet the financial requirements. It is important for investors to consult with their investment professional prior to investment in these investments. Hedge funds are speculative and involve a substantially more complicated set of risk factors than traditional investments in stocks or bonds, including the risks of using derivatives, leverage and short sales, which can magnify potential losses or gains. Restrictions exist on the ability to redeem units in a hedge fund. Structured products are subject to market risk and/or principal loss if sold prior to maturity or if the issuer defaults on the security. Structured Products Pricing Supplements and prospectuses should be reviewed by the investor prior to approving or directing an investment in these securities. Investors should contact their investment advisor directly to request and review these documents for each structured product they may wish to purchase. Exchange-traded funds (ETFs) are baskets of securities that are traded on an exchange like individual stocks at negotiated prices and are not individually redeemable. Shares of ETFs may trade at a premium or a discount to the net asset value of the underlying securities. Private equity consists of investors and funds that make investments directly into private companies or conduct buyouts of public companies that result in a delisting of public equity. Potential investors should remember that investments in private equity are illiquid by nature and typically represent a long-term binding commitment.

©2012 U.S. Bancorp (3/12)

privateclientreserve.usbank.com

Contributed by: John M. De Clue, CFA – Chief Investment Officer, The Private Client ReserveRobert L. Haworth, CFA – Senior Investment Strategist, U.S. Bank Wealth Management