Crude Oil Prices Soar (podcast)

Following the attacks on oil facilities in Saudi Arabia, 5.7mn barrel per day of Saudi production i.e. 58% of the production level reported to OPEC in September have been knocked out. What are the potential impacts on oil markets?

A speech by Joel Hancock, Oil Analyst within Commodities Research Team, explains you his analysis through this podcast to discover.


Crude Oil Prices Soar (podcast)

 

To start, what details do we have about the incident?

On Saturday 14th September, a combined missile and drone attack targeted Saudi Arabia's 7mn b/d Abqaiq processing facility, and the Kingdom's second largest field, Khauris, which produces ~1.5mn b/d. The attacks knocked out 5.7mn b/d of Saudi production, or 58% of the production level reported to OPEC in September.

Abqaiq has been described as "the most valuable piece of oil real-estate in the world" and the attack was a sharp wake up call for the market. Previous incidents this year targeting Saudi's Yanbu pipeline, as well as tankers in the Straits of Hormuz, have been firmly in the nuisance category. This attack represented a sharp escalation in both impact and ambition and consequently, oil prices traded sharply higher following the attack once markets opened the following Monday. The Intercontinental exchange reported a record trade volume in Brent futures, with prices spiking as much as 20% intraday, although largely limited to front months with longer dated portions of the curve seeing limited movement. Open interest and flat prices have since moderated, in large part due to a robust PR exercise from Saudi Aramco and the oil ministry, which has released an optimistic timeline for repairs and the return of "business as usual" operations.

Let's look into the details of how much oil is off the market, the longevity of the outage and the market implications.

The Abqiaq facility has a processing capacity of 7mn b/d, but throughput was recorded as 4.9mn b/d at the time of the attack, suggesting roughly 70% utilisation. This underutilised capacity represented the vast majority of Saudi's 2.5mn b/d spare capacity, which acts essentially as the oil market's insurance policy. So, although the underutilisation of the facility has resulted in the quick return of 2mn b/d of the 4.9mn b/d outage from Abqaiq, Saudi's spare capacity is largely exhausted. When the 2mn b/d from Abqaiq is combined with the resumption of operations at Khauris (0.5-1mn b/d back online), Saudi has been able to return 2.5-3mn b/d of initially lost production in a little over a week.

There remains significant confusion regarding the terms supply, production and production capacity Supply largely refers to the volume of oil supplied to customers, from either production or stock withdrawals. Production = fields and processing plants. Production capacity = pre attack levels.

The timeline provided by Aramco in the post-attack press conference suggested that there would be no disruption to supplies to customers, and that pre-attack production would be returned by the end of September. Full production capacity of 12mn b/d is expected to be available by the end of November. Whilst the discrepancy between reaching previous production levels recorded in August, and full capacity suggests that some of the damaged units at Abqaiq will need to be replaced, the signal to the market is that there will be no supply disruption.

The lack of disruption, despite the time required to reach prior production levels, reflects the multiple levers Saudi Aramco can pull to prioritise supplies to customers.

  • Saudi can call upon both domestic and international inventories, although there remains confusion in the market surrounding exact levels. JODI reporting 188mn bbl, whilst the Saudi oil minister suggested 60mn bbl, which was later corroborated by satellite sources.
  • Saudi Aramco has also reduced processing rates at its domestic refineries. Runs, which averaged 2.55mn bbl were cut by 1-1.5mn b/d and we expect this to continue as Saudi prioritise supplies to customers.
  • Saudi also does have some spare capacity (0.5mn b/d) in offshore fields that have been running below capacity as part of Saudi Arabia's OPEC commitments. These fields produce Arab Heavy grade crude, that does not require Abqaiq for processing (Manifa and Safaniyah).
  • Given the outage to Abqaiq (which processes Arab light crude), customers have been provided with alternate grades, with several Asian Arab Light consumers offered Arab medium and Heavy.

 

In the Aramco timeline, market needs to manage just two weeks of outage. In this case, the market is relatively well equipped.

Indeed, the one resounding message that has become apparent in all Saudi communications is the strong signalling that Saudi can handle the outage internally. With no requirement for spare capacity from Kuwait, the UAE and Russia to be deployed, nor the release of strategic stocks from either the US' strategic petroleum reserve, or IEA strategic stocks.

Many in the oil market are sceptical, especially when journalists were allowed to tour Aramco facilities a few days after the attack, some parts of the Abqaiq facility appeared to still be smouldering. This has been compounded by contractor reports saying facility will take up to 8-months to get up to full capacity, contradicting official Saudi sources. Indeed, Saudi does have several reasons to paint a more optimistic picture.

  1. For one thing If OPEC are encouraged to ramp, may not be able to get them to cut.
  2. Saudi will also want to Maintain reputation as a reliable supplier.
  3. And finally, US SPR – inventories and Trump.

If the outage does extend beyond Saudi Aramco's initial expectations, it could be argued that Brent is currently under-priced.

When we consider how to price the attack and its aftermath, there are two factors to consider.

  • The first is the heightened geopolitical risk, given the exhaustion of most of Saudi's spare capacity until at least November.
  • The second is the price impact of any supply outage. If Saudi's base case it to be believed, the impact on flat prices should be relatively limited – as it will remain an "in-house" issue.

The market has calmed significantly, OI has settled and oil prices have moved into slightly higher range, reflecting a higher risk premium. We expect process to stabilise at these levels, if Saudi's timeline is legitimate. There is still potential for relatively significant oil market volatility, if Saudi prove to be more optimistic in their estimates on supply replacement or if regional tensions escalate.

 

In a nutshell 

  • Any major price impact may be felt on oil products before flat prices, given the decline in Saudi refinery throughput. Woodmackenzie estimates that refinery throughput will normalise towards 1H19 levels (2.5mn b/d) by end 2019, resulting in a higher import requirement for both Saudis domestic needs and, also to meet export commitments. Cracks are likely to remain volatile as Saudi's import requirement fluctuates.
  • Any price spike would be a drag on economic growth, especially in EM economies already struggling with a higher dollar.
  • Although most US producers fully hedged for 19 and 20 moves was limited, few dollars may support higher US crude production next year, which would ultimately be bearish for next year's crude balance.