Response to Saudi Aramco attacks crucial to oil price
The world collectively held its breath when drone attacks on the Saudi Aramco oil production facilities of Khurais and Abqaiq were reported on Saturday. At the opening of trade on Monday, Brent shot up 20 percent on the news that Abqaiq, which is the world’s largest oil processing plant, was down 5.7 million barrels per day (bpd). That is about 6 percent of global production. Markets calmed down when US President Donald Trump said he was prepared to release some of the US strategic reserves. By mid-morning, Brent was trading at $65.8 per barrel, up 9.2 percent.
This may have been the biggest daily jump in the price of oil in history. Market sentiment was akin to when Saddam Hussein invaded Iraq or when the shah was overthrown in Iran. Markets always overshoot and it may make sense to put things in perspective.
Sources told CNBC that Saudi Aramco’s inventory is significant. The US and the International Energy Agency (IEA) hold emergency stocks, which should calm market sentiment. On Monday morning, Russian Energy Minister Alexander Novak stated that inventories were high enough to cover the temporary shortfall from Saudi Arabia.
So much for the positive side. However, we need to drill down on what these attacks mean in the longer term.
Firstly, there is the immediate shortfall because Saudi Aramco’s flagship processing plant is out of commission. This is resulting in a temporary price spike. A lot will depend on how quickly Saudi Aramco can restore the facilities. Oil processing plants are not light switches, which can easily be turned on. It will take time to ramp production up. The quicker this can happen, the quicker traders will be assuaged and the more temporary the spike in the oil price will be.
The second issue has longer-term ramifications. Analysts and observers realize that they might not have put enough emphasis on the geopolitical risk premium to date. Saudi Arabia and the wider Gulf Cooperation Council are islands of stability in a sea of turmoil and armed conflict. The events that unfolded on Saturday show how easily the conflict can hit home. Citibank’s Ed Morse is of the opinion that geopolitical risk has not been adequately reflected in the price of oil. He only gained this insight after Saturday. In that he is not alone among the analyst community.
There can be mitigating factors here. Markets will watch how the Kingdom reacts. It will go a long way if the military apparatus demonstrates that it is beefing up its air defense capabilities — including against low-flying drones.
Let us be clear that the risk premium has come back. However, how high it will be and how long concerns last will depend, to a large extent, on how both Saudi Aramco and the Ministry of Defense deal with the situation. We should also not forget that the news cycle has become ever shorter and that the next global news event may well shift market focus.
The valuation of Saudi Aramco and timing of the initial public offering will likely be affected by how both the country and the company react to the events.
Lastly, we should not forget that the outlook for oil markets is not rosy. Trade wars and slowing economies in Europe cast a shadow on the demand picture. The IEA expects demand growth to be at 1.1 million bpd for 2019. Recent months have disappointed, with demand growth in the June data coming in at about 0.2 million bpd. Monday’s economic data from China also disappointed, which is a harbinger for worse to come on the demand front.
Conversely, the IEA expects non-OPEC supply increases tilting toward oversupply. Indeed, until Saturday the debate was about whether OPEC+ needed to increase the 1.2 million bpd production cuts in its next meeting in Vienna in December.
When the hype is over, price developments in the medium term will depend on how both Saudi Aramco and the country deal with the situation and how the supply-demand balance looks over the next year.
We can take heart from the fact that Saudi Aramco is an incredibly well-run and competent company.
• Cornelia Meyer is a business consultant, macro-economist and energy expert. Twitter: @MeyerResources