War Gaming

Syria Matters for Oil Tomorrow, Not Today

Growing uncertainty in the region is a headache for Saudi Arabia.

Syria is not a big oil producer. So the extra buck or so added to Brent crude prices in the wake of Thursday night's U.S. missile strike is clearly more about the addition of risk rather than the subtraction of actual barrels. And that extra buck or so wasn't exactly game-changing, even before it was all given back by early Friday morning:

Strike Out

The initial spike in Brent crude oil futures had disappeared by Friday morning

Source: Bloomberg

Note: Intraday prices reflect Eastern Time.

Despite that minimal immediate impact, though, this event should raise one troubling thought for a near-neighbor of Syria: Saudi Arabia. Not because of the country's proximity to all that misery, conflict and military hardware (though that is, of course, reason for alarm). It's because of how things like Thursday night's surprise complicate Saudi Arabia's effort to support the price of its vital source of income.

Saudi Arabia, as I wrote here, is in the expectations-management game these days. It's a tricky one to get right.

The supply cuts Saudi Arabia and various other countries are undertaking (to varying degrees) must be real enough to force oil inventory out of storage.

Too real, though, and the effort risks stoking competing supply from U.S. shale, blunting demand and -- if expectations for future prices spiral up -- actually pushing barrels into storage via carry trades. That's because if producers, consumers and speculators expect much tighter oil markets in the future, then they will tend to do what they can to produce more, consume less, and store as much as possible in anticipation (those links there point to evidence of all three happening already).

Situations like Syria's complicate this already delicate process further.

You may have read umpteen stories Friday morning speculating on what could happen next. The scenarios on offer range from nothing to, oh, thermonuclear war (that one comes courtesy of a member of Congress). You possibly have your own view. The point is, when the dramatis personae include America's mercurial president, Russia's shirt-stripping strongman, a Syrian leader willing to poison his own citizens, and all the other interested parties like Iran and Saudi Arabia, you may as well be trying to guess the ending of The Sopranos.

What is clear from that brief jolt to oil prices -- and a more sustained one for gold -- is that the risk of something worse happening has edged up in the eyes of the markets.

And this is the problem for Saudi Arabia as it tries to play central banker to an unruly oil market. In fact, it's two problems.

The immediate issue arises if oil prices strengthen further on this sort of fear trade. Because, remember, nothing has actually changed in terms of physical supply and demand. Indeed, from the oil market's cold-hearted perspective, even a much bigger war in Syria, provided it was contained to Syria, wouldn't affect the flow of barrels.

What it would do is stoke fears of other, more consequential things happening: The U.S.-Iran nuclear deal breaking down, for example, or the spread of conflict to oilier parts of the Middle East. Or even a face-off between Russian and U.S. forces (even the most committed oil traders might just quietly back away from their desks at that point ... OK, maybe not).

This would raise expectations of disruptions further down the line, which, even if they didn't end up happening, would provoke immediate responses from those producers, consumers and speculators that would tend to loosen things rather than tighten them. This doesn't appear to be happening yet; spreads between near and farther-dated oil futures haven't shifted noticeably. That would change if fears intensified.

The wider problem Saudi Arabia faces is a little more existential. Consider what's happened in just the past decade.

We had oil spiking to an all-time high in 2008, in part because OPEC, the self-styled champion of market stability, failed utterly to foresee and meet the increase in Chinese demand. This helped tip the global economy over the edge and gave a crucial jolt to -- from OPEC's perspective -- the Frankenstein's monster of vehicle electrification.

This was followed by a second spike as the political and economic weaknesses of several OPEC members boiled over into the Arab Spring. This spike, which became more of a high plateau for several years, kept the torch of Tesla Inc. (and others) burning on one hand, while also providing just the right laboratory conditions for the U.S. shale boom.

These events played out similarly in the 1970s and 1980s. Every time oil producers get a geopolitical windfall, they have eventually paid a price, as rival sources open up and consumers hunker down. The difference today is that oil's core market -- transportation -- while still very much tied to the fuel, is no longer completely shielded from the threat of rival technologies.

Saudi Arabia is on the verge of trying to monetize its vast oil reserves via an IPO. So it needs stronger oil prices. But it ultimately needs that strength to reflect the qualities of the product it's selling, not the drawbacks.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Liam Denning in New York at ldenning1@bloomberg.net

    To contact the editor responsible for this story:
    Mark Gongloff at mgongloff1@bloomberg.net

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