The withdrawal of US troops from northern Syria has been the most thoroughly covered story in global news over the last week. In the oil patch, investors are watching the situation with a close eye looking for signs of further Middle East destabilization which could transmit upside risk into prices.
To that end, we’ve come across a steady stream of written pieces and interviews from energy pundits who think the market is seriously undervaluing the geopolitical risk created by the vacuum of the abrupt, unexpected US withdrawal. The practitioners, however, still seem to be more concerned with the downside risks associated with slowing global growth and the US/China trade war than they are with the upside potential of Middle East chaos. To that point, Brent crude has moved sideways near $59 this week while bullish headlines have swirled. Our view at the moment is that the Syria situation deserves respect and close attention, but we’re with the practitioners in thinking the oil market’s upside risks are equally matched by its downside risks.
To back up for a moment, there’s no question the escalating situation in Syria is a serious geopolitical issue which we should seek to understand. The removal of US troops creates opportunities for Turkish advances against the Kurds, for ISIS to regroup and expand and for Iran and Russia to take a larger role in settling territorial disputes. ISIS had a moderate impact on oil prices prior to the US shale boom and their presence will naturally stir bullish concerns. However, we’re skeptical the current scene could create meaningful unplanned outages within a fundamental regime of chronic oversupply and falling demand. The conflict would also need to expand geographically on a massive scale to endanger key oil logistics and supply hubs, which seems unlikely given that Putin and Erdogan already had a formal meeting on Tuesday to discuss how to divide their new ‘prize.’
The more impactful oil market repercussions of the current chaos could actually be a breakdown between Saudi/Russia oil market cooperation as the former could opportunistically align themselves with the Iranians in a Northern Syrian power grab. This theme could take several years to develop, but it’s worth noting the geopolitical consequences of the current Middle East turmoil could actually be bearish on a longer timeline if it leads to Russian disinterest in helping OPEC tighten global crude supplies. After all, Russia can balance its budget with crude in the $50s while the Saudis need oil over $80. The circumstances for a divorce are already in place and a major conflict in which Russia sides with the Saudis most fierce geopolitical opponent will undoubtedly lead to further stress on the relationship.
In the short term, while the headlines are screaming ‘Middle East Risk!’ actual oil traders still seem to be more concerned with downside risk. The EIA lowered its 2020 Brent forecast to $59 due to persistently high global inventories and poor demand growth and options markets continued to price put options at a premium to call options on similar deltas. Hedge funds are holding on to a relatively bearish position on oil and physical traders keeping time spreads in a modestly backwardated structure. On the macro side, the IMF cut their 2019 world economic growth forecast to 3.2% and their 2020 forecast to 3.5% citing deflationary pressure from the US/China trade war.
We’re with the practitioners for now and think oil in the high $50s / low $60s is a fair price given current fundamentals and macro forces. We’ll keep an eye on the conflict in Syria, but for now, we’re more worried about the downside.