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Why the oil market reacted to recent news on the Syria conflict

Ingrid Pan, CFA

Understanding Syrian tensions and how they affect oil prices (Part 3 of 3)

(Continued from Part 2)

The potential U.S. strike

In response to proposed U.S. military action in Syria, Russia’s president Vladimir Putin wrote an op-ed piece calling for the United States to step back from its aggressive stance.

Putin commented, “The potential strike by the United States against Syria, despite strong opposition from many countries and major political and religious leaders, including the Pope, will result in more innocent victims and escalation, potentially spreading the conflict far beyond Syria’s borders. A strike would increase violence and unleash a new wave of terrorism. It could undermine multilateral efforts to resolve the Iranian nuclear problem and the Israeli-Palestinian conflict and further destabilize the Middle East and North Africa. It could throw the entire system of international law and order out of balance… The world reacts by asking: if you cannot count on international law, then you must find other ways to ensure your security.”

The oil market reacts to an agreement

Over the past weekend, after several days of talks, the U.S. and Russia reached an agreement with the goal of disarming Syria’s chemical weapon arsenal. The agreement targets the destruction or removal of Syria’s chemical weapons by mid-2014, and has for now forestalled any military action on behalf of the United States. Within a week, Syria’s government is to provide a full report of its chemical weapons arsenal. According to a source cited by the New York Times, Syria has 1,000 tons of chemical weapons that are under the control of the government. With the risk of U.S. intervention at least temporarily reduced, oil prices fell to their lowest level in three weeks, with WTI ending the day at $106.59 per barrel—down from $108.21 per barrel last Friday.

The working agreement, however, doesn’t eliminate the risk of future U.S. military action in Syria. George Little, the Pentagon Press Secretary, has asserted, “We haven’t made any changes to our force posture to this point. The credible threat of military force has been key to driving diplomatic progress, and it’s important that the Assad regime lives up to its obligations under the framework agreement.” With the still-present possibility of U.S. military action, oil prices may remain elevated despite any changes to the fundamental supply and demand outlook.

However, with the recent deal between the United Sates and Russia, the market believes that the risk in the Middle East has been somewhat tempered. This is overall a negative for oil prices, as it reduces the possibility of crude oil supply shocks. This also reduces the possibility of outperformance by oil stocks such as ExxonMobil (XOM) and Chevron (CVX), as well as energy ETFs such as the Energy Select SPDR ETF (XLE) and the Vanguard Energy ETF (VDE) over the broad market.

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