The Fuse

After Abqaiq, Major Questions About Security of Supply

by Nick Cunningham | September 25, 2019

Oil prices have fallen back close to levels seen before the Abqaiq attack as Saudi Aramco rushes to make repairs. The facility is expected to reach pre-attack production levels by the end of the month, and will use inventories to cover for the gap in the interim.

More broadly, some analysts believe the market is overlooking rising geopolitical risk.

As such, after a few days of panic, the oil market has largely chalked up the outage to a fluke, a one-off disruption that has nearly been resolved. But there are questions over the repair timeline. More broadly, some analysts believe the market is overlooking rising geopolitical risk.

Rapid turnaround
Saudi Aramco has scrambled to rush the repair job, bringing in thousands of employees and pulling them off of other jobs to work around the clock. The company is reportedly restored roughly 75 percent of its production that was disrupted after the Abqaiq attack, and sources told Reuters that the company was on track to full recovery by next week. Production at the Khurais plant stood at 1.3 million barrels per day (Mb/d) as of September 23, while Abqaiq is producing 3 Mb/d. Roughly 5.7 Mb/d went offline from both facilities after the September 14 attack.

Aramco has turned to its inventories to keep exports uninterrupted, but it also has had to inform buyers in Asia that they will receive heavy oil instead of light oil, and shipments may be delayed by a few days. That somewhat undercuts the assurances from Aramco’s CEO that oil flows and shipments would be entirely unaffected.

It is also possible that the problems could be deeper than Aramco has been letting on. The Wall Street Journal reported on September 22 that their sources say repairs could take many months longer than expected to fully repair the facilities. Aramco had said that it would take until the end of November to bring back all damaged capacity, but some officials told the Wall Street Journal that it could take as long as eight months because parts and equipment are highly specialized. “We are still in a frantic search for spare parts,” one Saudi official told the WSJ. “It is not really as great [and] rosy as you may think.”

“If the outage lasts for weeks, [Saudi Arabia] would have no choice but to declare force majeure on some of their Asian customers,” Mia Geng, oil-market analyst at consulting firm FGE, told the WSJ.

Also, Saudi officials have weighed delaying the public offering of Aramco. The partial IPO is tentatively slated to launch before the end of the year, but Saudi officials told Reuters that an IPO is unlikely. Aramco’s production was briefly cut in half, and the damage to the company’s finances could be significant. “They need to build confidence – in addition to restoring production,” the source said.

To be sure, however, there are conflicting reports on this front. The Wall Street Journal reported that not only is Aramco pressing forward with its IPO, but it may double the offering from 5 percent of the company to 10 percent. Saudi crown prince Mohammed bin Salman is reportedly convinced that a larger float would provide the country with revenue to invest in other areas of economic development, according to the WSJ.

A broader concern is the security of global oil supplies.

Geopolitical risk on the rise
Whether or not Aramco finishes its repairs on a swift timeline or if delays drag on, a broader concern is the security of global oil supplies. Roughly 5 percent of global production was knocked offline in an instant on September 14, and in a country long thought to be impervious to such attacks.

Oil prices have since fallen back to pre-attack levels, moving down on news that Aramco would make quick repairs. But the aura of invincibility is shattered, and that should put a significant risk premium on oil, experts say. “People thought about a bombing of Abqaiq as being something that would happen in an all-out war scenario,” Amy Myers Jaffe of the Council on Foreign Relations, said on the Capitol Crude podcast. “I don’t understand the market only goes up by $4 a barrel. It seems crazy to me. You’re talking about a cataclysmic risk factor now.”

A series of air strikes on one of the most critical pieces of oil infrastructure in the world, coming from the direction of one of your most hated enemies, seems to be a shocking failure of Saudi Arabia’s defense. But it also highlights the risk to so much of the world’s oil supply. According to IHS Markit, the attack, which may have included a swarm of drones, could easily be replicated.

“The United States – and open societies with readily available drone technology and easy access to infrastructure – may have the most to fear. On Amazon you can order drones capable of small payloads for less than $300. For $250,000 you can buy professional drones that carry payloads of 500 pounds.  Even a small payload could disrupt a refinery, power transformer, or dam,” Carlos Pascual, senior vice president for global energy and international affairs at IHS Markit, said in a statement.

Meanwhile, U.S. shale continues to slowdown, and offers little security of supply. The rig count is down by 169 since hitting a peak last year, a decline of nearly 20 percent. Production has also come to a screeching halt. On an annual basis, U.S. oil production may grow by around 1.2 Mb/d this year, but that obscures the significance of the slowdown since the 2018 figure changed so much over the course of the year.

In the first half of 2019, U.S. oil production growth was almost non-existent, rising some months but declining in others. Going forward, spending cuts and a pullback in drilling could yet mean that forecasts for strong growth prove to be overly optimistic.

Most analysts have argued that shale still has several years of growth left, but the current deceleration is a reflection of shaky finances for shale drillers. Further growth will require higher prices, especially at the back end of the futures curve, which would provide the price signal for drillers. But prices that might be sustainable for the financially stressed shale sector remain elusive.

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