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Oil markets price in 'taper lite' as Syria risk fades

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Benchmark crude prices are likely to extend declines this week as the risk of imminent U.S.-led military action against Syria diminishes, reducing the chances of a broader conflict which may curtail supply from the Middle East which supplies a third of the world's oil.

"I am reversing my bullish bias of the last two week as it looks like Syria has evolved into a diplomatic bun fight rather than a call to arms," said Warren Gilman, Chairman and CEO of CEF Holdings.

Brent crude touched a near one-month low of $108.73 in Monday's session, sliding 2.4 percent, its steepest single-day decline since June 20 after the U.S. agreed to call off military action against Syria in a deal with Russia to remove Damascus's chemical weapons.

(Read more: Syria continues to be your reason to buy oil)

Brent has lost more than 6 percent since hitting a six-month top of $117.34 in late August when a U.S. military strike against Syria appeared imminent while West Texas Intermediate (WTI), its U.S. counterpart, has dropped almost 6 percent since rising above $112 on Aug. 28, its highest in more than two years.

More than half of the respondents in CNBC's latest poll of oil market sentiment (about 56 percent, or 15 out of 27) believe prices will fall this week. However, a minority of less than a fifth or 5 out of 27 are not ruling out gains if the current round of diplomatic pressure on Syria fails setting the stage once more for miliatry action.

"Oil will at best be range-bound with a bias on the bearish side unless Syria comes back onto the table, said Kelly Teoh, a Singapore-based strategist with IG Markets.

(Read more: Supply picture signals limited upside for oil prices, analysts say)

Oil bulls claim the recent Syria-led run-up in prices has been accentuated by perceived supply tightness in oil-producing nations outside North America and surprisingly stronger-than-expected demand from Asia. "Crude oil fundamentals in Asia are super tight," said Johannes Benigni, managing director of JBC Energy. "Premiums paid for crude are at record highs, independent from the Syria situation softening."

Libya took the first steps towards restarting some of its oil output on Monday as the government said a tentative deal with protesters in the country's west allowed pumping to resume from a major field, Reuters reported on September 16. Still, hopes of a full output resumption from the OPEC producer remained slim after an attempt at a similar deal with protesters in the east collapsed, meaning two-thirds of the country's output would remain shut for the time being.

(Read more: War or no war, oil to stay strong)

"Even if there is no war in Syria, the reduction in oil output from Libya and with the worst likely over for most emerging markets, I believe we'll see stronger demand placed upon the supplies of oil," said Sean Hyman, Editor of Moneynews at Ultimate Wealth Report. "I'm still looking for $117 on WTI and at least $125 on Brent."

David Nevin, an energy broker at Xconnect Trading in London said the market focus will remain on the Middle East. "I expect Brent to still find buyers on dips," he said. "The Syrian situation looks to drag on into the coming weeks. The market feels that the whole Russian peace plan is just a delay tactic by the Syrian regime."

Awaiting taper

In a what may be a defining week for U.S. monetary policy, traders, strategists and analysts said the U.S. Federal Reserve's widely expected move to reduce asset purchases by $10 billion when the central bank meets this week is already factored into current pricing.

Even though the market expects the Fed to taper, "it will still have a bearish effect on oil but with the Middle East situation, this effect will be short-lived and buyers will be lurking to pick up bargains on the dip," Xconnect's Nevin said. Upside targets for Brent crude stand at $112.40 and then towards $114.50, he said.

A larger than average number of respondents (7 or more than a quarter) are neutral this week, expecting the market to trade around current levels, CNBC's poll showed, underlining the level of uncertainty as investors await the Fed's move and as diplomacy take its course with Syria.

Benchmark U.S. 10-Year yields continue to hold beneath 3 percent on a closing basis, signaling "that the market is comfortable with the current estimates of tapering already priced in," said Dhiren Sarin, Chief Technical Strategist for Asia-Pacific at Barclays.

"For oil, however, the market is likely moving independent of these factors for the time being," Sarin said. "A modest bid is still in place while above $104.20 and especially above $106.40 in WTI crude while for Brent an uptrend is still maintained while above the $108.50 area. We are largely neutral at current price points but looking to buy dips towards these areas."

Jay Richards, Investment Manager at GTL in Sydney is also neutral on oil for the near-term and expects U.S. crude futures to remain range-bound between $107 and $112.

Though so-called 'taper lite' may already be reflected in prices, a larger than expected withdrawl or no move at all by the Fed may be negative for oil markets.

A recent Reuters poll showed economists expect the Fed to reduce monthly asset purchases by a relatively modest $10 billion. The dollar index staged a recovery from a four-week low of 80.968 set on Monday.

"I think $10 billion is baked in so the bigger question is the reaction of either a $20 billion plus move or if nothing is really done until Bernanke's successor takes over," said John Licata, Chief Commodity Strategist of Blue Phoenix Inc., an independent energy and metals research company based in New York.

Federal Reserve Vice Chairwoman Janet Yellen emerged as the front-runner to become the White House's nominee to lead the central bank, a day after Lawrence Summers pulled out of the contest amid congressional resistance, according to people familiar with the matter cited by the Wall Street Journal.

Oil & Energy Daily's Chief Investment Strategist, Karim Rahemtulla said a large taper would be a negative surprise but didn't expect that to happen until next year. "The thought is that the taper will occur in stages and will not have the impact that the markets feared," he said.

Ric Spooner, chief market analyst at CMC Markets in Sydney warned commodity and stock markets are vulnerable to "a bout of 'buy the rumor, sell the fact' and even more so if the taper is not as light as anticipated."

David Kotok, chief investment officer at U.S. money managers Cumberland Advisors with $2.3 billion assets under management said small tapering is priced in but the "worse" case scenario for markets is "if they do not taper." Such a status-quo may suggest the broader economy is in worse shape than thought and needs the full heft of stimulative monetary policy for a longer period of time.

- By CNBC's Sri Jegarajah, folow him on Twitter @cnbcSri

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