The weekend attack on an enormous Saudi crude oil-processing plant reintroduces a key factor – a geopolitical risk premium – that had largely disappeared from the price. The premium could remain permanent if any next attack were to take out a giant oil field. This one did not.
The skillful attack on the Abqaiq plant, which prepares crude for delivery in pipelines by removing its sulphur and other guck, and the nearby Khurais oil field put the vulnerability of Saudi oil infrastructure on full and instant display. Drones, or possibly cruise missiles, hit several big tanks at Abqaiq and other equipment, sending clouds of black smoke billowing upward. The Iran-backed Houthi rebels in Yemen took credit for the damage, though U.S. Secretary of State Mike Pompeo, without supporting his claim with evidence, placed the blame squarely on Iran even though some reports said the attacks may have come from Iraq or from within Saudi Arabia.
On Monday morning, when the markets reopened, oil surged, climbing as much as 19 per cent. After reassuring words about ample supplies in storage around the world, the price for Brent crude, the international benchmark, retreated from its highs. By the afternoon, they were up about 14 per cent, taking the price per barrel to US$68 and change.
There was no panic – Brent is still down 12 per cent over the past year. The attack did not even make page-one news in most of the British papers, which were dominated by politicians trashing away on the Brexit file. The Organization of Petroleum Exporting Countries (OPEC) decided not to hold an emergency meeting. Russia, which is in effect an associate member of OPEC, declared it would not open the spigots to bring prices down. “Right now there is a fairly large amount of reserves in the world,” Russian energy minister Alexander Novak told Russia’s Interfax news service. “There is no need to take some sort of extra urgent [measures].”
Still, the oil markets changed over the weekend as the risk premium returned with a vengeance. Given the political volatility in the Persian Gulf and the Middle East, it’s amazing the premium had all but vanished. There is fresh civil war in Libya, an OPEC member; an interminable civil war in Yemen, which pits the Houthis against Saudi-led forces; and a U.S.-led embargo against oil powerhouse Iran, which has been tightened by President Donald Trump with the full support of Saudi Arabia and Israel, though not the European Union.
The attack will temporarily remove almost six million barrels a day of Saudi production, the equivalent of almost two-thirds of total production. Satellite imagery suggested to analysts that the damage is not as extensive as initially feared, and the Saudis indicated that Saudi Aramco’s production could be restored within weeks. But various analysts predicted that the return of the risk premium will ensure that prices won’t drop to pre-attack levels any time soon. In a note, Stifel, a U.S. investment bank, said “we think a $5-10/bbl increase in oil prices from current levels could likely be sustained into 2020 due to increased perception of geopolitical risk.”
The OPEC countries will, of course, not be displeased by the suddenly higher prices. Nor will the American shale industry, which has made the United States the biggest oil producer in the world (the Saudis are still the top exporters). The shale-oil drillers will soon be hauling out idle rigs. Refiners will be happy to tack a few more cents on to retail pump prices.
The problem is that higher sustained prices are bad news for just about everyone else, especially countries on the verge of recession, like Germany and Italy. Another attack could expand the risk premium tremendously. The accuracy of the Saudi hit, and the Saudis’ apparent failure to detect the incoming drones or missiles, exposed the country’s most vulnerable asset – its oil infrastructure.
Imagine if Aramco’s mighty Ghawar field were attacked. Huge and prolific, it is the world’s biggest conventional field and has been Saudi Arabia’s top wealth generator for decades. In the 1970s, it supplied fully 10 per cent of world demand; today, the figure is still a hefty 5 per cent. Were it to get severely damaged, prices would surely soar and stay high for a long time.
Thanks to an Aramco debt prospectus filed early this year, we know that Ghawar produces 3.8 million barrels a day, equivalent to a third of Saudi Arabia’s entire production capacity, and almost triple the capacity of the Khurais field that was hit, though apparently not badly, along with the Abqaiq processing plant. The Saudis would not be happy if Ghawar were damaged. The field is the key to Aramco’s initial public offering on the Saudi market, which, according to various reports, was to happen later this year and might now be delayed yet again. It is unimaginable that the IPO would go ahead if more Saudi oil infrastructure, notably the Ghawar field, were to go up in smoke.
For oil consumers and oil-importing countries, the waning oil price was a blessing. It was also a ruse. Given the extremely high tensions in the Gulf and elsewhere in the Middle East, the risk premium should never have petered away. Investors don’t always get it right.
Eric Reguly