Barclays Why the Syria bombing matters for oil

Amid inventory draws and sharp supply cuts, such events can exacerbate an upward price trend

The US launched Tomahawk missiles at Syria overnight, escalating the conflict there.  In a response to the recent chemical attack on a town in Idlib province that killed almost 100 people, the Trump administration launched missiles on a base that allegedly was the source of the chemical attack.  Oil and other safe-haven assets such as gold increased on the news.  Prompt and deferred month prices all increased, while time spreads did not move much. This comes on the eve of Iranian elections, an OPEC meeting, and dramatic Gulf OPEC member supply cuts.

Why this matters for oil.  There are three main reasons why this matters for the oil market. First, it likely signals a more interventionist Trump administration policy in the Middle East, a policy that, in our view, could be seen as more aligned with Saudi Arabia’s goals, which could further deepen Sunni/Shia and external-actor fault lines in the region. Second, the market is tightening, and almost any escalation in geopolitical risk in the region that exports roughly 25 mb/d in crude and petroleum products increases prices.   Third, with a major OPEC meeting just over a month away, such a conflict puts at risk an amicable outcome due to the critical role that heads of state played in the prior agreement.

First, it signals a more interventionist foreign policy in the Middle East.  With the Obama administration’s aversion to military strikes in the aftermath of the Assad regime’s attack in August 2013, Iranian and Russian support of the Assad regime has increased.  This action is a clear contrast and in our view is a signal of US willingness to use military force against not just to the Assad regime but against other countries as well.  Moreover, it is an effort by the Trump administration to move off the sidelines on diplomatic efforts to drive the outcome in Syria.

From the oil perspective, the probability of military conflict elsewhere puts the market on edge.  More direct proxy conflict between Saudi Arabia and Iran, in Yemen and in Iraq, given the destabilization in the status quo in Syria adds to geopolitical risk. Though heightened conflict with other Middle Eastern countries would likely be bullish for oil, conflict with North Korea would hinder trade routes and, depending on China’s stance, would likely have bearish implications.  The risk of a Persian Gulf blockade, direct and proxy conflict between Saudi Arabia and Iran, and the targeting of critical energy infrastructure by state and non-state actors has increased since the Arab Spring in 2011.

Second, the market is tightening. Crude inventories in the OECD increased in January and February, but will likely begin to draw in earnest in April and May when refinery turnarounds are complete.  The oil market is never immune to geopolitical risk; however, the critical variable is the state of inventories.  In an environment where inventories are building and the market is in contango, geopolitical risks to supply tend to have less price impact.  Though the market today is not yet in backwardation, inventories are expected to draw through June, and the global balance of supply and demand is one that is currently, and forecast to be, far different than the 1-2 mb/d build/quarter environment that characterized 2015-2016.

Third is the timing of the upcoming OPEC meeting.  This event is yet another turning point that comes on the eve of Iranian elections, an OPEC meeting, and dramatic Gulf OPEC member supply cuts. As we have noted before in our reports (see The Blue Drum: OPEC-onomics, 4 April 2017), the involvement of heads of state was a key determinant of success at the OPEC meeting in Vienna in November 2016.  Our base case expectation remains that the meeting rolls over the agreement, but is likely to change some of the quotas.  The escalation of the conflict in Syria complicates those delicate relationships.  Will the Russia-Saudi energy ministerial channel remain open if Mohammed bin Salman and President Putin are no longer seeing eye to eye?  We cannot answer that question, but it certainly imperils the fine balance that led the diverse interests to the historic agreement.

On balance, if the conflict continues to escalate, or if, for example, Iran retaliates in some form, prices are likely to continue their upward drift this quarter, supported by already strengthening fundamentals.  A bearish scenario would entail OPEC failing to achieve a deal on May 25.  Or, in the longer term, there would be bearish effects from a political scenario that brings about an endgame in Syria more quickly.  We see the latter bearish scenarios as less likely than continued conflict, given the Assad regime’s consolidation of power and reassertion of control over eastern territory.

Marketing communication : This document has not been developed in accordance with legal requirements designed to promote the independence of investment research and its author(s) is/are not subject to any prohibition on dealing in the relevant financial instrument ahead of the dissemination of the marketing communication.

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