Volatile Oil Prices in August amid Fears of Strike against Syria

Source: ZE

Western Texas Intermediate (WTI) and Brent have been in a tight race recently, but the fear of yet another war in the Middle East made this race even more interesting to watch. On the New York Mercantile Exchange (NYMEX), Brent Prompt-Month contract rose to the highest level in six months and WTI prices were at the highest levels since May 2011 on the heels of a U.S. government statement that the U.S. will hold the Syrian government accountable for the use of chemical weapons.

Below is the historical comparison of NYMEX Crude Oil Brent Vs. WTI Prompt-Month Contract from February 2008 to August 2013:

Historical Comparison NYMEX Prompt-Month Brent vs WTI

Figure 1: Brent, WTI and Brent-WTI Spread (Graph data source: CME)

The Buildup

World oil prices saw large fluctuations in the past four weeks before finally falling on the Friday, August 30, as the possibility of Western military strike against Syria over its alleged use of chemical weapons reduced. Also in the last week of August, the U.K. parliament voted against action in Syria, which provided some relief to the market that could have been seriously shaken by the fear of Syrian violence spilling over to key producers in the region, like Iraq or Iran. Such volatility in the market mirrors the days before the 2003 U.S. invasion of Iraq.

In February 2012, the Brent prices went above $115 over speculation on the unrest in the Middle East and Iran’s controversial nuclear program (Figure 1). Generally, geopolitical turmoil and supply risks in the Middle East translate into higher oil prices as the region is considered to be a major supplier of the world’s petroleum. According to the International Energy Agency (Bloomberg), the Middle East accounted for 35% of global oil output in the first quarter of 2013.

The Fall in the First week

On NYMEX, the Prompt-Month contract for WTI finally passed the European benchmark on the last days of July and started this month’s rally with $3 USD/bbl ahead of its European counterpart. Oil prices fell in the first week of August. WTI prices capped the longest stretch of declines since December in the first week of August as the U.S. production levels were strong.

The Businessweek reports that 333,000 American workers applied for unemployment benefits, which was below the expectations. While people in the U.S. were worried about the government tapering with the good economic data, Brent price drops were mostly due to strong production volume and weak future demand outlook. However, Brent started to gain momentum in the second week of August as Chinese data signaled improvements in global economy and a record high crude oil imports.

The Story of the Second and Third Week

Into the second week of August, Brent prices continued to rise on concerns about delays to oil supplies in the North Sea and unrest in Middle Eastern oil-producing countries. In fact, the shaky situation in Libya and Iran makes the North Sea more reactive on supply. The spread between two benchmarks almost reached zero on the 21st of August, as the weekly report on U.S. commercial energy stockpiles by the Energy Information Administration was due and the market lacked the fresh economic data.

Brent received further support from the supply disruption in Libya where more than 1.2-million-barrels-per-day export capacity remained shut down. On the other hand, there were many factors affecting Texas light sweet in the third week of August as Reuters reported, U.S. crude stocks fell as refineries boosted output, the Seaway pipeline carrying 400,000 barrels a day shuts down for more than 12 hours, the dollar gained some momentum but remained near a half-year low against the euro, and traders awaited the release of the U.S. Federal Reserve’s latest meeting’s minutes.

The Last Weeks of August: Escalating Conflict in Syria

U.S. intelligence agencies determined Syrian President Bashar al-Assad’s forces may have used chemical weapons in an August 21 attack that killed at least 1,400 people, including over 420 children. Following an anticipation of a Western crackdown on Syria in the final week of August, WTI did rise above $106 USD/bbl, whereas the Brent reacted more swiftly. From August 26 to 28, the Brent prices rallied 3.26%. The sudden spark in Brent prices noticeably affected the Brent-WTI spread – from a discount of $0.40 USD/bbl to the Brent on August 26 to a premium of $2.33 USD/bbl for the European benchmark by August 28.

The Easing Concern on the Strike Against Syria

After the UK Parliament rebuked the prime minister’s call for military intervention in Syria, concerns about a potential disruption to oil supplies eased. In the last two days of the month prior to the market closure on August 30, the Brent prices slid from$109 USD/bbl to $106 USD/bbl and for WTI from $106 USD/bbl to $105 USD/bbl.

Here is a close comparison of NYMEX Crude Oil Brent Vs. WTI Prompt-Month Contract in August 2013:

NYMEX Crude Oil Prompt-Month Brent vs WTI(August 2013)

Figure 2: Brent, WTI and Brent-WTI Spread (Graph data source: CME)

The Opposing Views

When it comes to taking sides in analyzing the war with Syria and its possible effects on the oil market and, ultimately, the global economy, there are two opposing views. The predominant view is supported by the likes of Michael Wittner, Societe Generale’s head of oil market research. He states any military action will “reverberate through the region, increasing the spillover into other countries and possibly resulting in a larger supply disruption.” Supporters of this view believe that Brent may spike to $150 USD/bbl, if the conflict in Syria spreads to other parts of the Middle East. In July 2008, Brent traded at $147.50 USD/bbl, the highest intraday price on record . (If you are interested to read more about the NYMEX Brent-WTI futures in August, please go to our NYMEX Crude Oil Brent Vs. WTI Forward Curve Market Analysis here.)

There is, of course, an opposing view to the predominant perspective. The opposing view claims that it is “specious” to expect oil supplies to be threatened by a cruise-missile attack on Syrian military targets as the country is neither a major oil exporter nor a conduit. The supporters of this view include Stephen Schork, president of the Schork Group Inc., who believe that Syria is not a major producer and their close allies (like Iran) have no interest in reducing shipments as they desperately need the money.

Here are few important facts about Syria’s energy sector; in particular, the oil sector:

  • After international sanctions came into force against Syria since late 2011, the country has not exported any oil.
  • Prior to the sanctions, Syria produced 370,000 barrels-a-day, roughly 0.4 % of global supplies, and exported less than 150,000 barrels-a-day, mainly to Europe. Currently, the country produces at just 50,000 barrels per day, all of which is refined domestically.
  • Syria is not considered a major oil producer like Iran or Libya, nor is it a major transit point for oil and gas exports like Egypt.

Final Words

Although oil markets have shown volatility in recent weeks due to fluctuations in the global economy and fears of further uncertainty in the Middle East, the threat of another escalation in the region could be reflected exponentially in oil prices. It is easy to predict that prices are likely to peak shortly after the start of any military action, but the real dilemma is when and by how much?

According to BNP Paribas, Saudi Arabia theoretically has the capacity to offset any decline in crude oil production in the event of a conflict (The Wall Street Journal). However, in the same article, Wall Street Journal highlights the lack of flexibility left in Saudi’s production as the country is already set to average 10.5 million barrels-a-day in the third quarter of 2013, its highest level in 30 years.

The situation gets even murkier when the domino effect of strike against Syria is taken into account. Military action against Syria will definitely be a threat to the country’s closest allies, Iran and Russia. One factor to consider when it comes to Iran is that the country tends to act independently as the Iranian regime wouldn’t necessarily follow common economic or accounting principles; rather, it acts according to its own values and “red lines.” Abbas Araqchi, Iranian foreign ministry spokesman, stated the following in regard to a military attack in Syria, “these complications and consequences will not be restricted to Syria. It will engulf the whole region” (The Telegraph). At the same time, Russia warns that a Western military intervention in Syria will have “catastrophic consequences” for the Middle East (The Telegraph).

Certainly, this is a rather interesting time to watch the oil market as the story of war with Syria unfolds. The market is feeding on itself due to the lack of sustainable promising economic prospects. While I hope to see diplomacy and constructive talks between the officials save many human lives and resolve the current Syrian crisis peacefully, I expect to see oil market rally on any news regarding a new war in the Middle East.

At ZE PowerGroup we’ll be watching the crude oil market very closely, using our award-winning enterprise data management solution, the ZEMA Suite, to conduct in-depth market analysis. ZEMA provides access to energy and commodity data, including data on crude oil, petroleum products, coal, electricity, foreign exchange, weather, and other economic indicators.