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How to Play the “Syrian Premium” in Oil Prices – Kent Moors – Money Morning

This is a syndicated repost published with the permission of Money Morning. To view original, click here. Opinions herein are not those of the Wall Street Examiner or Lee Adler. Reposting does not imply endorsement. The information presented is for educational or entertainment purposes and is not individual investment advice.

There’s an uneasy lull in the Syrian crisis.

Now that the Obama administration has decided to seek Congressional approval for a Syrian strike, we are in a hazy period before some major decisions are made.

And while a Senate committee has approved a military move against Syria, further action will be slow to come. Congress is officially on recess until Monday.

Meanwhile, the geopolitical maneuvering goes on.

A Russian call for an emergency session of the UN Security Council has been followed by Vladimir Putin’s public decision to call U.S. Secretary of State John Kerry a liar, even as U.S. President Barack Obama arrives in St. Petersburg for the G-20 summit.

Pushing the rhetoric to new heights is a statement from UN General Secretary Ban Ki-moon that any strike without UN approval would be illegal and a violation of the UN Charter.

However, Ban also said a report from the inspectors confirming the use of chemical weapons would likely break a longtime Security Council impasse over Syria and justify military action.

Against all of this conflicting information is the heightened price of oil.

So what’s the real “Syrian Premium” built into the price of a barrel of oil these days?

Here’s my take on its effects… and the best way to play it…

The “Syrian Premium” in Oil Prices

As one might expect, it is difficult to estimate the “crisis premium” put into each barrel of oil so early in the cycle.

Nonetheless, as of [Thursday] morning, I would estimate that the factors already impacting oil prices (those, in other words, that existed before the escalation in military talk) should have provided for a West Texas Intermediate (WTI, set on the NYMEX for oil futures contracts) price of about $103 a barrel along with a Brent price (set in London) of $107.

Based on [Wednesday’s] close, that translates into a “Syrian Premium” of about $4 a barrel in New York and $8 in London, or 3.9% and 7%, respectively. Keep in mind that this premium is likely to become more significant (and increase) as the crisis deepens.

We are, after all, in the very early stages of this march to an attack.

Of course, markets have a way of equalizing the unknown with performance by absorbing new events into perceptions of volatility. But until the real impact is known, uncertainty will likely drive the price of oil higher.

Therefore, even when the price level of oil settles, it will be at a higher level than what we see now until the crisis is past.

And that means the “Syrian Premium” is likely to continue increasing, especially if the instability extends to a wider regional concern.

Playing the “Syrian Spread”

In the meantime, the two benchmarks for crude trade are still trending up. Oil prices closed [Wednesday] at more than $107 for West Texas Intermediate and almost $115 for Brent.

WTI is down 1.5% for the latest week but up 3.5% for the month. Brent is accelerating faster – up 0.5% for the week and 7.7% for the month.

This has resulted in a widening of the spread between Brent and WTI. The difference stands this morning at 7.2% of the WTI price (the better way of gauging the real impact of the spread).

Now, unsettling events in the Middle East will almost always prompt a higher price rise in Brent than in WTI. That is because these developments have a more immediate impact on supply concerns in Europe.

As I have noted before, investors can play this spread by using two exchange-traded funds (ETFs) that are already part of the Energy AdvantagePortfolio: PowerShares DB Energy Fund (NYSE Arca: DBE) and the United States Brent Oil Fund (NYSE Arca: BNO).

DBE allows investors to play the difference or spread between Brent and WTI on the one hand while also accounting for the effect of crack spreads (the difference between crude prices on the one hand and the prices of refined products such as gasoline and low sulfur content heating oil on the other). As a result, DBE is now up more than 5% for the month.

Meanwhile, BNO provides for a direct dollar-denominated play on the price of Brent itself.

Since the London futures contract standard is increasing faster than the level set in New York, this should allow an investor to profit directly from the increasing spread between the two benchmarks.

BNO did split 2:1 on Aug. 29, making an initial estimation somewhat more difficult. However, the effective increase for BNO over the past two weeks of trading (since August 21) has been 5.4%, outpacing the rise in the crude prices themselves. That is normally an indication that further price increases are expected.

Oil Prices and Syria

Of course, some of these increases have resulted from factors having nothing to do with Syria.

There are currently constrictions forming in the global oil market resulting from more localized supply considerations, augmented by another increase in worldwide demand.

Remember, oil prices are set by the supply-demand dynamics in places other than North America or Western Europe. The so-called “mature” developed nations have not been determining the price for some time.

In normal times (as if we have experienced the “normal” market of textbooks recently), a trade will set a contract at the expected price of the next available barrel.

However, in circumstances under which supply concerns are causing uncertainty, there is a tendency for the price to be set using the expected most expensive next available barrel.

Some of that was taking place anyway before the Syrian crisis escalated, resulting in an increase of prices in general and the Brent-WTI spread in particular. Still, it was not an accelerated result and would provide for a more gradual rise in the level.

The crisis in Syria is changing all of that, and the degree of uncertainty it has injected has revised the dynamics.

As we sit in this uncomfortable place between two outcomes, investors can expect the “Syrian Premium” to rise.

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