The Fuse

Abqaiq Attack Highlights Oil Risk

by Nick Cunningham | September 18, 2019

Saudi energy minister Prince Abdulaziz bin Salman spoke at a press conference on Tuesday, reassuring the world that operations would resume quickly at the badly damaged Abqaiq processing facility. He went to lengths to insist that the market would not be short of oil, despite the largest oil supply disruption in history.

Despite the reassurances, perceptions of supply risk are not going away.

Oil prices spiked on Monday, surging by 15 percent, one of the largest price gains on record. But benchmark prices fell back by 6 percent on Tuesday after it appeared that Abqaiq might recover quicker than anticipated. Despite the reassurances, perceptions of supply risk are not going away.

Largest supply disruption in history
Abqaiq is the largest oil processing facility in the world, capable of processing 7 million barrels per day (Mb/d), equivalent to about 70 percent of Saudi oil production. The coordinated attack on the facility on September 14 knocked 5.7 Mb/d of production offline, including output from Saudi Arabia’s legendary Ghawar oil field.

The outage immediately raised fears about a shortage of supply. In an instant, the global oil market fell into a deep supply deficit. Saudi Arabia has adequate inventories to cover for the supply gap, but only for a few weeks. Even more worrying is the fact that much of the country’s spare capacity may have become unusable, if only temporarily. And because Saudi Arabia accounts for the majority of the entire world’s spare capacity, the disruption would leave precious little to fall back on.

But on Tuesday, newly-minted energy minister Prince Abdulaziz bin Salman sought to tamp down fears. At a press conference in Jeddah, he said that roughly 2 Mb/d of the 5.7 Mb/d of disrupted capacity was back online. He also said that the facility would return to about 4.9 Mb/d of production by the end of September, back up to production levels prior to the attack. Saudi Arabia would drawdown inventories for exports so that export levels remain unaffected for the next few weeks while repairs are ongoing. In essence, everything was under control and would soon return to normal.

He used the incident to highlight the professionalism of Saudi Aramco, which comes as no surprise as the Kingdom presses forward with the partial initial public offering of the company. “During the two past days, we managed to contain the damage by recovering more than half of the production that we had lost during that terrorist attack,” bin Salman said. “Thus the company will be able to meet all its commitments to customers this month by drawing on its crude oil reserves.”

The price decline on Tuesday is remarkable in the context of the largest supply disruption in history.

Oil prices fell on the news, a reflection that Aramco appeared able to recover faster than many analysts had anticipated. In fact, the price decline on Tuesday is remarkable in the context of the largest supply disruption in history. Brent fell back to $63 per barrel, which is within the price range of where it traded for much of the summer.

Risk remains
Prince Abdulaziz bin Salman succeeded in convincing the oil market that the crisis was manageable and could be quickly overcome. But many serious questions linger.

First, he said that Saudi Arabia would not return to 12 Mb/d of capacity until the end of November. Not to be confused with production, capacity refers to the ability to produce. This is important because it implies that some level of Saudi spare capacity could remain offline for months.

That may not be a huge problem in an oil market that has seen rising non-OPEC supply and flagging demand. In fact, the world is staring down a supply glut in 2020.

More importantly, the days in which the market perceived Saudi supply as impenetrable are decidedly over. It is notable that several days after the attack took place, it is still not definitively clear what exactly struck the Abqaiq facility, or where the strike originated. This raises the question about future attacks. “No matter whether it takes Saudi Arabia five days or a lot longer to get oil back into production, there is but one rational takeaway from this weekend’s drone attacks on the Kingdom’s infrastructure — that infrastructure is highly vulnerable to attack, and the market has been persistently mispricing oil,” Ed Morse of Citigroup Inc. wrote in a research note.

The result, at a minimum, could be a return of a geopolitical risk premium to the price of oil.

The result, at a minimum, could be a return of a geopolitical risk premium to the price of oil. That is not a problem just for Saudi Arabia. A supply outage anywhere affects prices everywhere, as the old adage goes.

But this also may complicate Aramco’s plans for a public offering. How do investors put a value on a company that could see half of its output slashed overnight by an unexpected attack? It is in that context that Prince Abdulaziz bin Salman addressed the markets on Tuesday, trying to strike a calm and confident tone. Riyadh needs to convince investors and global markets that there is nothing more to worry about.

However, there could be more twists and turns to this story. The U.S. Department of Defense is preparing an assessment that is expected to blame Iran as the culprit behind the Abqaiq attack. Some reports suggest the Pentagon plans on identifying specific sites in southern Iran where missiles and drones were launched. The report could be made public this week. If and when that report is released, there will likely be some calls to retaliate, although there is anything but unity on the issue in Washington.

On Monday, when oil prices jumped, so did the share prices of U.S. shale companies. However, U.S. shale is not a swing producer and cannot plug any supply gap on a short-term basis. Moreover, after racking up debt and losing the patience of investors, there is little scope to suddenly ramp up spending and drilling. “There will be no intention to add rigs over and above our original plan,” Pioneer Natural Resources CEO Scott Sheffield said on Monday, according to the Wall Street Journal. He added that some shareholders told him they would sell Pioneer’s stock if the company added more rigs into the field.

There are endless permutations on what happens next, so the supply risk to the oil market is far from over. The bottom line is that the oil market’s vulnerability and dependence not just on a single country, but on a single facility, was laid bare on September 14.