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Long Story Short – Drone Attack Disrupts 5% of World Production and Sends Spot Oil Prices up 20%
Attack on Saudi Refinery: What Does it Mean for You, the Investor?
An oil processing facility at Abqaiq was attacked by drones on Saturday, knocking out 5.7 million barrels/day of oil production. Brent crude futures rose 19.5% to $71.95 per barrel before declining on the news that the refinery will be repaired faster than initially anticipated. The Energy Select Sector SPDR Fund (XLE: NYSE) jumped 3.5% on the open Monday morning. Is now a good time to invest in energy stocks or has the market overreacted to temporary events?
Abqaiq is an Important Location. The refinery represents 50% of Saudi Arabia’s oil production and 5% of the world’s oil production. It is connected to some of the world’s largest oil fields, including the Ghawar field, estimated to be the largest oil field in the world. The plant performs a crucial step of oil refining, removing impurities such as Sulphur and heavy metals. It also separates natural gas from the oil stream, making the refined oil stabile for export. Commercial satellite imagery indicates that the facilities used to separate energy components were targeted.
The Attacks Indicate Hostilities are Escalating. The attacks may just be the first salvo in an escalating battle between the US and Iran (largely thought to be behind the Saudi refinery attack). The US has pushed Iran into a corner by threatening sanctions against any country trading with Iran. It granted waivers to eight countries but eliminated those waivers last May. Iran responded by bombing a Japanese tanker on June 13th. President Trump threatened to attack Iran after the June 13th incident but changed his mind. The recent refinery bombing sends a clear message that Iran will be aggressive whether it is attacked or not. This increases the likelihood of a US response.
Repairing the Refinery is Easy, Repairing Investor Psyche May Take Longer. The Abqaiq refinery was well fortified; it had a heavily guarded perimeter following an attempted truck bomb attack by Al Qaeda in 2006. The use of drones highlights a new vulnerability for energy facilities. It will only take a couple weeks to get the facilities back to near-full production. However, Saudi Arabia may be hard pressed to prevent similar attacks in the future.
Repairs Will be Quick. Initial estimates indicated that, given the complexity of the system, repairs could take up to three months. However, Saudi officials claim most of the plant’s production could be returned within weeks. Saudi Aramco, the state oil company owning the facilities, has the financial means and interest to commit enough resources to assure a quick return.
Countries Will Release Reserves to Lessen the Impact. The US announced its intent to offset the 5.7 million barrel/day reduction in production by releasing reserves. The US has approximately 650 million barrels of oil in its strategic reserves that can release up to 4.4 million barrels/day. China has about 325 million barrels in its reserves and Saudi Arabia has some 100 million barrels. India and Korea also have strategic reserves of unknown quantities. In total, world-wide strategic reserve may be able to offset the decline in production for a year. It certainly will be able to offset the decline for the few weeks estimated to repair the Saudi refinery.
Saudi and OPEC Impact on World Oil Prices (and Stocks) Has Diminished. We wrote several articles over the summer discussing the increased importance of US oil production and OPEC’s decreased influence on oil prices. If this attack had happened just ten years ago, the impact would have been much more severe. For the US, which has now grown to be one of the largest producers of oil in the world, the impact will be less. In fact, the US Energy Information Administration believes the United States will become a net exporter of energy in 2020.
The refinery attack is most likely just one component of escalating tension between the US and Iran. Although the impact of a production reduction is manageable, further conflict could have an immediate significant impact on oil prices and energy stocks. A reduction in hostilities, on the other hand, comes more slowly. We would expect energy prices to remain at elevated levels for the foreseeable future so the recent rise in energy stocks is justified.
https://www.cnbc.com/2019/09/15/us-crude-oil-jumps-15percent-after-drone-strikes-disrupt-saudi-crude-production.html, Yun Li, CNBC, September 15, 2019
https://www.cnbc.com/2019/09/17/oil-slips-following-the-biggest-climb-in-history-after-saudi-attacks.html, Yun Li, CNBC, September 17, 2019
https://www.usatoday.com/story/money/2019/09/16/saudi-arabia-oil-attack/2341141001/, Nathan Borney, USA Today, September 16, 2019.
https://www.eia.gov/todayinenergy/detail.php?id=38152, U.S. Energy Information Administration, January 29, 2019.
https://www.nytimes.com/2019/09/16/business/oil-prices-markets.html, Clifford Krauss, New York Times, September 16, 2019.
https://www.ft.com/content/0b89f8e2-d885-11e9-8f9b-77216ebe1f17, David Sheppard, Financial Times, September 15, 2019