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Oil: panic in the House of Saud

The 14 September attack on Aramco’s oil facilities has aroused the worst fears over the supply of oil. However, setting aside the risk of escalation, which would be harmful to everyone, including Trump in his re-election campaign, we think this daring act will remain an isolated incident that will only upset the oil order for a short period. In 2020, the oil market will essentially remain exposed to a decline in consumption, with oil prices trending 

Pétrole, panique dans la maison des Saoud

The dreaded scenario of a disruption in the supply of oil from the Arabian Peninsula is perhaps no longer a repressed fear but rather a very real risk. The Saturday 14 September drone attack on two Aramco facilities, one of them a crude oil processing unit in Abqaiq, almost instantly halved Saudi Arabia’s production capacity and reduced the global supply of oil by 5%.

The devastatingly effective attack highlights just how vulnerable oil facilities are, both in general and in the Persian Gulf in particular. No need to try to destroy individual oil wells to deprive oil-producing countries of their income: a well-placed bomb dropped on a collection and processing unit is much more effective. The vulnerability of oil facilities ought to make the various protagonists present in the Gulf stop and think before giving in to the temptation to trigger a military escalation that might cut oil supplies by a quarter.

The attitude of the United States, partly responsible for tensions in the Gulf after pulling out of the nuclear deal, will be decisive for the price of oil. The US could – as immediately implied by President Trump – retaliate against Iran, suspected of having helped organise the attack. Saudi Arabia will not hesitate to incriminate Iran in order to involve the United States. The risk of a severe, large-scale counter-attack by the United States would lead to an uncontrolled military escalation and widespread conflict, with grave consequences for the global economy, and therefore the US economy. Such a US response would also be particularly risky for President Trump with the US presidential election just a year away. The early September Taliban attack that took the lives of a dozen Americans triggered no official military response from the United States. Although a large-scale US response does not appear to be on the agenda, President Trump’s unpredictability must not be underestimated. Conversely, it is hard to imagine a de-escalation with the withdrawal of sanctions against Iran, which would then resume production on a massive scale. The oil market, which is having to face less buoyant demand for oil than in years past, no longer needs Iranian oil in the short term. If Iranian oil were to come back onto the market, this would drive down the price of oil and worsen the financial position of independent US producers already hit by the fall in prices since the fourth quarter of 2018. On the contrary, the attack on the Saudi facilities could enable Trump to maintain sanctions against Iran without having to organise a risky large-scale military operation against it. Militarily speaking, then, Saudi Arabia could well find itself standing alone against its Shiite enemies. US aid will no doubt be confined to logistical support and equipment to help secure oil facilities against the threat of drone attacks.

This attack could have been a crippling blow to Saudi public finances, which the authorities have been trying to balance by increasing levies on oil revenue since 2018 and raising oil prices. The production capacity damaged by the 14 September attack represents a maximum potential shortfall of around $250 million a day (based on a price of $65 a barrel) for the Wahhabi kingdom’s public finances. However, if Saudi Arabia manages to quickly restore its capacity, as it announced 72 hours after the attack, the public deficit should not deepen. The 14 September attack will nevertheless have been a blow to Saudi pride.

With the OPEC meeting and talks over an extension to the production deal just a few weeks away, Saudi Arabia is in a weak position relative to other major producers. In the current environment, the new Saudi oil minister, Prince Abdulaziz bin Salman, might struggle to convince Iraq and Nigeria to comply with production quotas drawn up last year, for which the latter have little respect. It will also be harder to convince Russia to extend its production cuts. Although Saudi Arabia is not planning to further delay Aramco’s IPO, it must nevertheless repair and secure its facilities to reassure markets and its customers.

Ruling out the risk of military escalation in the Persian Gulf, and of similar repeat attacks in the short term (notably thanks to beefed-up security around oil facilities), the impact of the 14 September attack on oil prices should only be temporary. The scale of the impact on market equilibrium will, of course, depend on exactly what equipment has been damaged or destroyed and how long it takes Aramco to carry out repairs. Saudi Arabia would do well to undertake the necessary work as quickly as possible to reassure its customers and financial markets and win back its central position on the oil stage. OECD oil stocks are quite high and above the average for the past five years so as to be able to cushion a short-term drop in supply.

Our oil price scenario for 2020 assumes that Saudi production capacity will be restored by end 2019. The oil market will remain under pressure from the risk of economic downturns. We think OPEC production is likely to stay at around its current level of 30 million barrels a day over the whole of 2020. In the event that the OPEC/non-OPEC deal is not renewed, we think Saudi Arabia will stretch itself a little further to make up for part of the production gains, and in particular those arising from Russia. In the absence of a sudden and lasting surge, the current price of oil should contain growth in US production. Lastly, less buoyant growth in demand for oil in 2020 will pull down prices: our central scenario assumes that Brent will average $62 a barrel in 2020.

 

Stéphane Ferdrin - stephane.ferdrin@credit-agricole-sa.fr

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