The Phony Oil Shock: Why There Is Nothing To Be Alarmed By The Attack On Saudi Oil Facility

Global crude oil prices surged from $60 per barrel today, by an average seven dollars, following a Saturday pre-dawn drone attack on Abqaiq — Saudi Arabia’s largest oil processing complex.

Early reports say that the attack was conducted by Yemeni Shia Houthi militants, that the damages were extensive, and that the giant processing plant has been shut down.

For Saudi Arabia, the stoppage in the treating of 5.7 million barrels of crude oil per day represents approximately half of its current production. For the world, it means that a full 5 per cent of global supply is temporarily unavailable.

The sprawling facility is situated to the east of the super-giant Ghawar oilfield, and the Khurais complex (consisting of giant Khurais, Abu Jifan and Mazalij oil fields). Its function is to pre-process sour crude (meaning, having higher sulfur content) prior to being piped to the Ras Tanura port and refining complex on the Saudi coast in the Persian Gulf.

The Indian press was swift to express grave concern. Some predicted the return of an ominous age, in which oil prices would rise to hover above the dreaded three-figure mark. For other analysts, the projected price impact of the Abqaiq attack looked like the proverbial last nail in the Indian economy’s coffin.

If oil prices spiralled out of control, all of Finance Minister Nirmala Sitharaman’s multiple, recent reassurances to Indian industry would look like platitudes in the face of a dam-break.

Containing the fiscal deficit would become next to impossible, social spending would suffer, stimulus plan figures — if any — would shrink, inflation would rise, and growth would dip further, lowering revenues.

These alarmist views were mirrored by both BBC and CNN, who took the editorial line that the attack on Abqaiq plant was one of the gravest developments of the past few decades, with portentous geopolitical implications.

According to unnamed and unverifiable intelligence sources, the culprit by proxy was Iran, via the Shia Houthi militia whom they support.

For further effect, and just to reassure everyone, US President Donald Trump confirmed in his inimitable style, that American forces were ‘locked and loaded’, and ready to do bloodcurdling things to Iran.

But strangely, not everyone is weeping: Share prices of American oil majors like Exxon, Chevron and Marathon are up 3-4 per cent. Naturally, since the less oil Saudi Arabia produces, the more the United States of America benefits.

Such a statement may appear prima facie counter-intuitive, and it is a complex juggling act; but, if major oil exporters cut production for some reason, and if the oil price were to be somehow held in the $55-65 band, the surge in domestic American oil production from tight sands would seek to make up the shortfall — and give a remarkable fillip to the American economy in the process.

It’s been done before and it can be done again (as pointed out in an earlier Swarajya piece by this writer).

Further, only last week, OPEC, the oil-exporters’ cartel, had issued a morose forecast predicting a further reduction in global oil demand growth, because of prevailing sluggish economic conditions.

Internally, OPEC bureaucrats would have sighed, contemplating the vicious infighting over export quotas and associated production cuts, amongst member nations, which they would have had to somehow manfully contain.

Yet today, with 5-6 million barrels per day off the negotiating table, these perennial quota-wars have been set aside for the moment.

This is because, the simple truth is that there is presently a massive glut in the oil market. This is an aggregate effect, caused by two decades of untrammeled capacity-building in both North America and the Middle East, which has led to both over-production and stocking.

In that scenario, the temporary disappearance of 5-6 million barrels per day from the shelves is actually not such a big deal.

Surprisingly, a principal beneficiary of the past year’s upheavals has been Russia. As a result of American efforts to reduce oil production from Venezuela and Iran — which they did quite successfully, few know that there was an associated, and largely unnoticed, increase in both the sale price and volumes of Russian Ural crude — primarily to Western Europe.

This is an ironically unintended effect, which Bloomberg reported with their customary wit, as a gift to Russia from Donald Trump:

The reason for this odd rise in the demand of a rarely-referenced oil is because the Ural crude properties are similar enough to Venezuelan ones — sour and heavier, for European refineries to make the switch to Russian oil without having to revamp their refining process.

Even more interestingly, the Abqaiq plant was designed in part, to handle precisely such crudes. What this means is that with the Drone attack, demand for Ural crude could go up further.

Not surprisingly, Ural crude is trading today at less than 10 cents’ premium under Brent blend (the traditional international yardstick).

But such side developments have limited scope, since the Saudi government has declared that is has over 200 million barrels of oil in reserves storage, ready for sale,

This translates to five weeks — enough time for Abqaiq plant to commence recovery. In addition, official Saudi statements released today indicate that the Abqaiq plant could be back on line in some weeks.

This means that the absence of many millions of barrels of oil per day from the global market is expected to only be a transitory phenomenon — if at all felt in real terms.

Consequently, one may infer that current expressions of alarmism are overstated, and that both the truncation of Saudi oil production, and the abrupt spike in oil prices, is temporary.

There may be some public posturing as various nations declare the release of strategic crude reserves to tide over the ‘crisis’, and some opportunism may be displayed in the crude, commodity and currency markets.

But in the midterm, analysts will demonstrate that grave apprehensions of major crude oil shortages are misplaced, that the global oil glut remains, and, that global crude demand growth remains meager.

For these reasons, the drone attack on Abqaiq plant must not be blown out of proportion, and Indian commentators in particular, may abjure the adoption of an alarmist tone.

There is enough oil in the world, with Abqaiq in operation, or without.