“Houthis in Yemen have claimed a massive attack on Saudi Arabia’s oil infrastructure. Here are the key points:
Initial reports indicated that 5.7 mbpd of crude production was lost, or about 58% of the KSA current output. Saudi officials have indicated that they expected to bring about a third of that production back early this week. However, recent reports suggest that outlook may have been overly optimistic.
The attacks appear to be strategically sophisticated as 19 different points of impact were reported. First, the processing facility at Abqaiq was struck. This facility processes 7.2 mbpd of oil; therefore, even if Saudi fields continue to pump oil it can’t be exported until this facility is restored. Second, 1.2 mbpd of the Khurais oil field was also damaged. About 18% of the KSA’s natural gas production is offline, as is 50% of its NGLs that were affected.
Here is our “back of the envelope” analysis of the oil situation. OPEC has been producing around 29.9 mbpd; its total capacity is about 34.6 mbpd. Thus, at first glance, this problem appears manageable. The loss of Saudi production is 5.7 mbpd but excess capacity is 4.6 mbpd. Thus, the world only needs 1.1 mbpd, which could easily be filled from the OECD’s SPRs around the world. However, it isn’t that simple:
Although the KSA’s capacity is thought to be 11.5 mbpd, it is still likely that much of that oil would still need to flow through Abqaiq. Thus, a conservative estimate would have to assume that the KSA’s current full production is probably closer to 4.1 mbpd, at least initially. We would expect some of that capacity to be restored in the near term, although full recovery may take months.
If our back of the envelope analysis is correct, this action against the KSA cuts OPEC excess capacity by 7.4 mbpd.
In addition, 1.6 mbpd of the cartel’s excess capacity resides in Iran. It is unlikely the U.S. will lift sanctions on Iran now as excess capacity is down 9.0 mbpd.
Taking this all into account, a rough estimate is that OPEC can now produce around 26.6 mbpd. That means the world must find 4.4 mbpd of lost production.
Essentially, the world oil market is now running without any buffer. For most of the history of the oil market, some producers have held production off the market to stabilize prices. This offline capacity has acted to dampen price spikes when events occur. The world mostly relies on the KSA for maintaining this buffer. For the time being, that buffer is missing which means price volatility will rise.
The loss of a buffer turns our attention to the Strategic Reserves (SPR). The estimated operational drawdown capacity of the U.S. SPR is 4.4 mbpd. It takes about 13 days from the time a presidential order is made until oil begins to reach the market. The SPR has never had a sustained drawdown of this magnitude and thus, we don’t know for sure if it will work. At the same time, given high U.S. production and rather elevated levels of commercial inventory, the likelihood of an extended supply shock is rather small…if consumers act rationally.
The KSA is no longer a reliable swing producer. To some extent, this attack is “the big one.” Anyone who has analyzed oil markets has always acknowledged the possibility of an attack on the KSA oil facilities. Even after repairs and the return of production, forevermore, we will know that these facilities are not completely safe.
The timing of this attack was inauspicious. There are two problems. First, CP Salman had just fired the leadership of the energy ministry and Saudi Aramco. That means this crisis will be handled by the new, untested leadership. This crisis would have challenged a seasoned staff, but the odds of a mistake are elevated with an untested group. Second, the IPO of Saudi Aramco is in doubt; a company that faces these sorts of threats will face a significant discount.
Finally, a sustained spike in oil prices will further undermine global economic growth.
Overall, the attack is a new, significant risk factor for not just the oil markets but for the world economy. It will take a few weeks to determine the significance of this weekend’s activities.”
(Daily Comment dated September 16, 2019 by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez CFA of Confluence Investment Management LLC)
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