How resilient is the world’s oil production?

On 14 September 2019, Saudi Arabia suffered a drone attack targeting the Abqaiq crude oil processing facility and the nearby Khurais oil field. Described as ‘the heart of Saudi production’, Abqaiq processes c.7 million barrels per day (bpd), roughly 70% of current Saudi output, while Khurais produces around 1.5 million bpd of crude oil, in turn processed at Abqaiq. An early statement from Saudi Aramco put the production outage at 5.7 million bpd, making it the largest shock to global oil production in history, exceeding the impact of the Iranian revolution and the oil embargo of the 1970s.

Spot oil prices immediately responded, rising 19% at the start of trading, but eventually settling up 15% (or roughly $8 per barrel) – and have tracked lower over the past few days. Higher spot oil prices incentivise the release of inventories, allowing refiners to replace the lost barrels. The cushion for such events in the crude oil network is very large: OECD, ex-OPEC crude inventories stand at c1.6 billion barrels, while Saudi Arabia itself reports 188 million barrels in inventories, meaning it could compensate for an outage of this size for a month. The US holds roughly 400 million barrels in commercial inventories and a further 650 million in its government-controlled Strategic Petroleum Reserve, which it quickly indicated would be available to ease the supply shock. The spot oil price also likely felt some effect from short-covering, although positioning was not extreme going into the weekend, with ‘net speculative length’ roughly mid-range.

An update on 17 September 2019 outlined a path to ‘restored production’ which was quicker than any commentators were expecting. Roughly half the lost production was brought back online within two days, using contingency infrastructure, while a full recovery is expected within two weeks. Spot oil prices quickly gave back some of their gains following the news.

Longer-term, the attacks will likely lead to a higher ‘geopolitical risk premium’ being reflected in the oil price as the world is reminded of the fragility of oil infrastructure. In recent months, expectation had grown that Iranian oil production, currently subject to sanction, may begin to return to the market – an idea thrown into doubt after both the US and Saudi Arabia pinned the origin of the weapons used in the attack to Iran.

The level of risk factored in by the market though has been less than most would have guessed. Although spot prices rallied sharply, futures prices were not materially affected – at one point the latter even fell week-on-week as many companies used the move to hedge production. At time of writing, the geopolitical risk premium baked into futures prices was a meagre $2 per barrel.

The implications for the cohesion of OPEC and inter-country relations in the Middle East are yet to be determined. Further attacks or some form of retaliations could, of course, change the picture quickly, but the gyrations of the past week serve mainly to highlight the flexibility of the global crude oil complex and the size of current inventories. After all, few would have guessed the price impact of 6% of global production going offline overnight would only amount to $2 per barrel.

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