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Syrian Conflict: What It Means For The Oil Markets

Stocks in this article: CLREOGOXYWLL

By Brian Michaud

Syria

It seems that any time rhetoric surrounding military action in the Middle East finds its way onto the front pages of newspapers, the most profound impact is felt by the commodity markets. Most notably, the price of internationally traded crude oil often sees a significant value spike consistent with the uncertainty and instability surrounding the proverbial “powder-keg” that the Middle East has become.

Winds of insurrection and revolution have swept over the region in recent memory, and the ongoing conflict in Syria is no exception. As expected, just the mere reference to possible military action in the region has pushed the price of oil upwards.

Between August 26 (the day of Secretary of State John Kerry’s first public statement on the matter) and August 27 the price of oil rose almost 3% in a single trading day, settling above $115 for the first time since February. The wild gesticulations in price aren’t new, but are certainly fueled by rampant speculation of an emerging conflict.

The interest in Syria, and the aftermath of any serious military action targeted against the Middle Eastern country lies mainly in its existence as an oil country. The tricky aspect of Syria is although it may be flush with oil, international trade sanctions have been in effect since 2011 effectively eliminating Syria as any form of oil exporter.

Even today, Syria is only estimated to produce approximately 50,000 barrels per day of oil, making them a miniscule player in the international crude oil trading market. The major concern lies in the fact that the nation is in close proximity to key oil infrastructure that could greatly affect global oil trading.

While it doesn’t run directly through Syria, a major oil pipeline called the KeyKuk-Ceyhan oil pipeline runs within miles of Syria’s northern border. Alarmingly, the pipeline is largely contained within the borders of Turkey, a notable country in opposition to the Syrian regime, but a county with which Syria shares a border. The pipeline is a major transportation method for Iraqi produced crude oil, and provides an outlet and export ability for the mostly landlocked nation to export their produced crude.

The pipeline, while designed to transport as much as 1.15 million barrels of oil per day, is a frequent target of sabotage. Being in such close proximity to Syria, any aggression towards Syria may lead to extensive attacks on the oil pipeline from Syrian sources as a retaliation.

Additionally, Syria does maintain some geographical advantage to the Strait of Hormuz. The Strait of Hormuz is not physically located in Syria, but it is bordered to the north by Iran, an outspoken anti-West nation with strong political ties to the Syrian regime.

Any actions against Syria may incite Iran to cut off access to the Strait of Hormuz. This is significant in the fact that roughly 20% of all of the oil traded in the entire world passes through the Strait of Hormuz at one point or another. Disruption here could seriously impact the global oil market and undoubtedly would impact the price of globally traded oil resulting in serious price appreciation.

All that fighting sounds frightening at first, but a rise in international oil prices can only spell good things for domestically operating oil exploration and production companies. While the environment may not be perfect, American independent oil companies are arguably operating in the least strict and most comfortably regulated oil environment in the world.

Their ecosystem is solid, and their potential to carve out huge profits in lieu of yet another Arab-focused military campaign is even higher. Over the past six months, oil traders have seen the WTI-Brent Crude differential retrace from levels around $20 per barrel to a low point of only $1.34 (July 19th, 2013).

Simultaneously, the tightening of this spread coincides with an upward trend of oil prices overall. After putting all of this together, it can be observed that as the price of international oil has risen significantly in the past, the price of domestically produced oil has risen to match it.

What this means for domestic oil producers is that they will likely be able to enjoy the higher prices of an international trade market right here at home where the oil company is still able to operate relatively freely.

The freedom from constricting regulations and the ability to produce on a growing scale means that the overall cost of operation can be lower than other domestic producers, and this lower cost of operation can reflect in better margins and pricing differentials. With everything added together, this can be an exciting time period for domestic exploration and production companies. Higher oil prices internationally have virtually translated to higher oil prices here in America, even as import/export ratio continues to drop.

Obviously, none of these developments would be half as exciting if there wasn’t some profit to be made. So who stands to benefit the most from Middle Eastern crises like those being witnessed in Syria? The companies that stand to gain the most are the companies that are able to sell their product at a higher price, with lower expense, and on a large scale with less regulation.

We believe the companies that stand to gain the most are large-scale domestic based producers like Occidental Petroleum (OXY), Whiting Petroleum (WLL), Continental Resources (CLR), and EOG Resources (EOG).

These companies stand to benefit specifically because they are some of the largest independent oil producing companies in North America, and a vast majority of their oil production comes from conflict free areas like the United States and Canada.

Domestic exploration and production companies like these may benefit from military action against Syria because they are able to reap the reward of an inflated oil market while never having to worry about insurgency or loss of production due to the fighting.

They are large enough to maintain great scale throughout the country, but aren’t international enough to be forced to absorb some of the more difficult aspects of being an international oil company. While they are free to produce and sell at high prices, the major oil companies may be left trying to clean up some of their interests in high tension areas.

We feel strongly about domestic producers moving forward, and any military action in Syria can only intensify our interest in these names. At the end of the day, the United States has firmly placed themselves back on the global oil production grid. Any takeaway or turmoil in the world’s most oil-fertile region can only mean good things here at home.

Photo Credit: Freedom House

All opinions included in this material are as of September 7, 2013 and are subject to change. The opinions and views expressed herein are of the portfolio manager and may differ from other managers, or the firm as a whole.  All investments involve risk (the amount of which may vary significantly) and investment recommendations will not always be profitable. Past performance does not guarantee future results.

Tyler Kocon

Tyler Kocon

Split Rock Private Trading & Wealth Management is a registered investment adviser based in Minneapolis, MN. Split Rock provides access

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