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Oil Markets Turn Bullish Amid Spiking Geopolitical Risk

Offshore

The surprise airstrikes by the U.S. on a Syrian airfield late last week brought an element of geopolitical risk back to the oil markets, adding support to crude prices. Historically, conflict, or even just the threat of conflict, has pushed up oil prices, particularly back when supply was already tight and oil was trading at $100 per barrel. But the three-year bust in oil prices has moved geopolitical risk to the backburner because even a sizable outage in supply could have easily been handled by the enormous glut in the market.

To be sure, the Syrian war is not new – it is more than six years old. But the involvement of the U.S. could mark the beginning of a new, wider conflict and it comes just as the oil markets are showing some signs of tightening. The result is a sudden uptick in oil prices, pushing WTI and Brent to a one-month high.

However, Syria produces a negligible volume of oil, so why should oil prices rise on the news that the U.S. dropped cruise missiles on a Syrian airfield? “Obviously, this is an insignificant player, but as any real estate agent will tell you, this is a bullish headline because of location, location, location,” Stephen Schork of The Schork Report told CNBC on Monday. “We have the United States which now is responsible for 15 percent of the world’s energy production now dropping bombs on a country whose puppet masters in Tehran and Moscow are none too pleased. So when we add Russia, Iran, Iraq, Saudi Arabia and so forth, we’re talking about bombs being dropped in a region of the world that accounts for about 60 percent of the world’s energy production. So, clearly this is a potential black swan, something that is very difficult to try to sell against.” Related: How U.S. LNG Transformed The Market

For now, that is just speculation. The Trump administration could limit its action to the few dozen airstrikes launched last week, which was reportedly one of the narrower options presented to the president by the U.S. military. If the U.S. doesn’t take any more dramatic steps, the effect on oil supply should be minimal, and WTI and Brent could give up a bit of ground as expectations of deeper military action wane. "If these strikes are not followed up by a serious effort to oust the Syrian leader [Bashar Assad], none of these scenarios may materialize and the oil implications will remain negligible,” Helima Croft, RBC Capital Markets Head of Commodity Strategy, wrote in a research note.

But the markets are clearly on edge because a new round of conflict that sucks in the U.S. and Saudi Arabia on one side and Russia and Iran on the other has no shortage of possible risks to the market.

With that said, a more immediate impact on crude oil fundamentals is unfolding in North Africa with a lot less fanfare. Libya has promised to ramp up production from 700,000 bpd to 1.1 million barrels per day by the end of the summer, likely to be one of the largest sources of new supply in the world after U.S. shale. But ongoing conflict could derail those plans.

In recent weeks the battle over a major oil export terminal has disrupted production in Libya, with output temporarily dropping by 100,000 or 200,000 bpd on several occasions. On April 9, an oil pipeline from Libya’s largest oil field, Sharara, stopped operating for unknown reasons. The field produces 200,000 bpd. That could add a lot more price pressure to WTI and Brent than the Syrian airstrikes, despite the latter’s splashy international headlines. "It means that at least one potential source of additional supply has fallen away for the time being," said Carsten Fritsch of Commerzbank, according to Reuters.

The Libyan outage and the potential action from the U.S. also comes at a time of a more underlying bullish trend in the oil market. Refinery maintenance is winding down and gasoline production is ramping up ahead of the summer driving season. Demand growth is also humming along at a steady pace. Oil inventories around the world are falling and could begin to fall in the U.S. as well, which will start to erase doubts about the tightening market. Related: Why Breakeven Prices Are Plunging Across The Oil Industry

“Here in North America we’ve already added 900,000 bpd of demand into the market. We’re going to add another 600,000 bpd by the time we get into July as refineries start to ramp up for the summer season. So from the demand perspective, we certainly have a bullish trend that began at the end of March and I’d suspect it’s going to continue into the driving season,” Stephen Schork said on CNBC.

The shift in sentiment from bearish to bullish is evident on Wall Street. Hedge Funds and money managers boosted net-long bets on crude oil futures for the first time in six weeks for the week ending on April 4. "The oil bears were in retreat because OPEC appears to be complying pretty well to the quota and the likelihood that the cuts will be extended," Michael Lynch, president of Strategic Energy & Economic Research, said in a Bloomberg interview.

Other analysts agree. “We see it grinding higher over the back half of the year,” Helima Croft of RBC Capital Markets told CNBC. “We’re coming out of refinery maintenance season so we are going to start seeing draws in U.S. inventory levels…We think that will give crude a bounce.” She sees oil moving up to $60 per barrel later this year.

By Nick Cunningham, Oilprice.com

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