Oil Prices May Hit $150 On Syria And Tight Supply Market

Includes: CRUD, OIL, USO
by: Hard Assets Investor

By Amine Bouchenouf

Crude oil prices are on the rise, and many are pointing to a looming military attack on Syria as the reason for this increase. Brent is trading at a six-month high of $117/bbl while its WTI counterpart is also trading at a high of $110/bbl. Since news started coming out of a potential military strike against the Syrian regime, oil prices have risen by almost double digits. In this analysis, I'm going to examine the specific impact of a military strike on Syria and its implications for the global oil markets, as well as place it in a historical geopolitical and commercial context.

War and Oil

Oil doesn't react positively to looming armed conflicts, especially when those armed conflicts involve the geopolitically strategic and sensitive Middle East. The Middle East is home to the largest proven conventional reserves of crude oil globally and, more importantly, is also the region that accounts for the greatest daily supply of oil reaching the world markets. More than one-third of seaborne crude transits the strategic Strait of Hormuz, which connects the Arabian Gulf to the world's oceans and target markets.

The Strait of Hormuz includes oil-producing powerhouses such as Saudi Arabia, Qatar, the UAE, and Iran. Any potential disruption to the world's most important oil artery will result in devastating impacts on the global economy. Think about it this way: How will global GDP react if all of a sudden 30% of the world's high-quality oil was removed from the market? GDP figures across the world would drop precipitously, especially if this oil supply was removed from the market for an extended period of time. This could result in a recession (or worse) for a global economy still fragile and in recovery.

In addition, there simply isn't enough supply on the market to absorb a 30% reduction in global oil supply stocks. Sure, there are strategic petroleum reserves, but those wouldn't be able to last very long and they would only be used up by a few countries. As a result, any threat that would result in the closure of this strategic passage is taken seriously by the market, thus elevating the risk premium per barrel and increasing prices.

Furthermore, the threat of military action doesn't only threaten the distribution of this commodity, but also the production. During Gulf War I, broadcast images of plumes of black smoke rising into the sky after oilfields were lit on fire were seen around the world. The threat of military conflict also endangers production facilities, both onshore and offshore, which are prolific in the Middle East.

Implications of Armed Conflict in Syria

With regard to Syria, it's important to note that Syria itself isn't a major oil producer. However, its relevance in the oil markets lies both in its geographic position as well as its potential for disrupting both production and distribution of Middle East crude to the world. The armed conflict in Syria has been going on for more than two years and has resulted in more than 100,000 deaths. The conflict reached a serious turning point this summer with the discovery that chemical weapons were used against civilians. This has prompted outrage by the United Nations and has prompted calls for military actions.

As we speak, battle plans are being drawn up to strike inside Syria by a U.S.-led coalition. While the attack is expected by military analysts to be relatively short-lived, it is the asymmetric retaliation against such as strike that has the market worried. Specifically, the market is worried that retaliation may include partially shutting down the Strait of Hormuz through underwater bombs. Also, attacks against production facilities inside Saudi Arabia are causing alarm that the kingdom's dominant production might be in jeopardy.

These are similar concerns the market experienced during Gulf War I and Gulf War II, and in both those conflicts production facilities were hit (although their impact was limited), but the passageway remained intact. We saw recently that Libyan production is down to pre-revolution levels after a strike by military and workers has resulted in a loss of production of more than 1 million barrels per day. While we don't expect to see that kind of loss with an armed conflict in Syria, that doesn't mean that the repercussions won't be severe.

Right now, we recommend investors adopt a wait-and-see approach to see what implications and ramifications and spillover effects military strikes against Syria may have on the oil markets. If the ramifications are contained, then prices may stabilize and remain in a plateau. If that doesn't happen, then prices may go parabolic and could reach and even surpass the $150/bbl mark in case of violent ramifications. Either way, investors need to monitor the situation carefully knowing that the bias is certainly toward higher prices in such a tight market.

Disclosure: The author doesn't have any positions in stocks mentioned.

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