What The Syrian Crisis Means For Oil Prices

By: David Goodboy of Street Authority

For a brief time in 1991, there was no question that I was going to earn a fortune.

By making a few lucky stock and option trades, I had accumulated a modest sum of trading capital in my brokerage account. Knowing that the United States was about to invade Iraq, I had no doubts that the markets would plunge as fears of Iraq's weapons and military capacity reached a fever pitch around the globe.

I decided to short the market with all of my meager funds. Knowing that the U.S. would invade any day, buying put options on the SP 100 index provided the most return for when the market plunged. As fate would have it, my timing on the invasion was dead on -- the U.S. launched the first airstrike the day after I purchased the put options.

But I couldn't have been more wrong with the direction of the market. U.S. stocks skyrocketed on the invasion news. My puts became completely worthless within an hour of the market open.

Talk about a difficult but very valuable lesson. I lost my entire stake on that one very bad trade. I learned never to bet everything on a single idea, no matter how certain you are.

More importantly, I learned that markets hate uncertainty. Financial markets were in turmoil in the weeks leading up to Operation Desert Storm. This uncertainty resulted in very bearish conditions. As soon as the uncertainty was resolved with the invasion, markets responded by surging higher.

To put it simply, uncertainty of any kind creates a very bearish environment for financial markets. At the same time, certainty, even if it's about something as dire as war, has a very bullish effect on financial markets.

This lesson -- buying certainty in geopolitical events and selling uncertainty -- has been very valuable to me over the years. The situation in Syria reminds me of this hard-earned lesson, particularly for oil investors.

The United States Oil Fund ETF (NYSE: USO) has been steadily climbing since April 15. It climbs, then plateaus for a while, then repeats, inching higher all the while. This exchange-traded fund is currently facing upward resistance at $39.50.

The U.S. has made threats to retaliate against Syria for the alleged use of chemical weapons against its own citizens. Syria has been embroiled in a civil war for more than two and a half years. More than 100,000 people have died, with millions more displaced from their homes.

Despite Syria's minor role in the global oil trade (the nation produces less than 1% of global supply), U.S. threats of intervention have created uncertainty, sending oil prices higher. The fear is based on the idea that a U.S. strike will create a domino effect over the entire region. These worries have added an "uncertainty premium" to the price of oil and been exacerbated with Russian opposition to a U.S. military strike.

Negotiations between the U.S. and Russia are underway for Syria to turn over control of its chemical weapons to international oversight. As of this writing, the Syrian rebel forces have rejected the proposal, but President Bashar Assad has agreed to the offer in an effort to avoid U.S. intervention. Oil traders are anxiously awaiting the outcome of these efforts at a diplomatic resolution.

If a U.S. strike is averted though diplomatic means, we can expect a drop in oil prices as the "uncertainty premium" in the oil market will have been removed. At the same time, a U.S. strike would likely result in a drop in oil prices. In my view, the fear of the domino effect is overblown.

Risks to Consider: Although I am convinced that oil prices will drop as soon as the current U.S.-Syria impasse is resolved, I don't think it matters to oil prices whether the solution is diplomatic or small-scale military strike. However, there is the potential for the U.S. to be overly heavy-handed and possibly getting other countries involved. Should the conflict expand beyond Syria's borders, the continued uncertainty will result in climbing oil prices. Be sure to use stops and position size properly when investing.

Action To Take -- I think there will be a resolution to the Syrian issue very soon. This resolution will remove the "uncertainty premium" in oil prices, meaning it's time to short oil. I like the United States Oil Fund as a short right now. Shorting between its current price and $40 with stops at $40.75 and a 12-month target price of $33 makes solid sense.

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7 thoughts on “What The Syrian Crisis Means For Oil Prices

  1. Yes there is plenty of oil in the world. But---the easy to extract stuff is pretty much gone and burned up. As prices went up it made sense to go after the harder to get stuff.

    Shale oil like that in the Bakken formation costs more to get out. Maybe about $60 a barrel. It is technically more challenging. It requires heavy specialized rigs to drill horizontal wells. Fracking requires huge diesel powered pumps to force sand and water under extremely high pressure into the rock to split it and to open and stuff with sand the resulting fracture cracks so they do not close when the pressure is turned off. The sand keeps these cracks propped open so oil can flow out. It all costs a heck of a lot more than the old wells did. If prices drop, drillers will stop drilling, supplies will drop and prices will again rise.

    Drilling under the ocean is even mroe expensive. Some fields are not worth drilling if oil is under a hundred dollars.

    The cheap stuff has mostly all been burned up already. If we want to burn more in our cars it will cost more. There is no going back because the cheap stuff is gone.

  2. I found this article very interesting, but am slightly confused. You said uncertainty produces bearish effects, and certainty, bullish. Yet you expect oil prices to rise due to uncertainty. Please could you explain the misunderstanding. Thanks.

  3. As usual a temporary bump up in spot oil pricing relating to Syria's instability and then normal pricing after the situation gets old.

  4. I think the possibility of a missile strike by the U.S. against Syria provided traders who were long on Oil a chance to sell off their positions at highly inflated prices. The truth is that there is plenty of oil, all around the world, that will ultimately be extracted thru fracking and other new extraction technologies. However, despite this abundancy of oil, the futures market, probably due to manipulation, has significantly overvalued this commodity. As I understand it, the trading price of oil or "benchmark" is not the same price actually paid by the Refiners, which is less. Like the U.K. Government, the United States Energy Department should initiate an investigation into price fixing in the oil market rather than spending all its time and resources on Syria, which really is not even close to being a threat to our National Security.

  5. Good article and story from your trading past. I know from experience how much it hurts when trades like that blow up. Regarding USO, my thought is that it's a little premature to short here given that USO is in a pretty solid uptrend. Your "risks to consider" area is a good caution. We'll see how long the solution to Syria actually takes.

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