By Amine Chaieb, Partner, Spearvest
The September attacks on Saudi Aramco’s largest oil processing facility and its second-largest oil field sent shockwaves through commodity markets. Abqaiq, which processes up to 7 Million barrels per day of crude oil and its second-largest oil field, Khurais, which pumps up to 1 Million barrels per day were both targeted by drone attacks.
The attacks resulted in the largest jump ever in oil futures; almost 20% intra-day. The extreme market reaction to the attack underlines the new wave of uncertainty the incidents brought by significant damage to highly strategic infrastructure. The attacks knocked out more than half of Saudi Arabia’s global daily exports which accounts for between 5 to 8% of the global oil supply.The disruption due to the attack was even bigger than the one caused by the Iranian revolution or Iraq’s invasion of Kuwait in absolute terms.
The initial anxiety in oil markets was met with swift and decisive action by Saudi Aramco as the company successfully restored production capacity above 11 million barrels per day, beating its own self-imposed deadline by about a week. Moreover, the company successfully executed a meticulous communication plan to restore calm in the oil market. More importantly for the domestic economy, Finance Minister Mohammed Al Jadaan said the attacks had “zero” impact on Aramco’s revenues or the growth rate of the Saudi economy, which was further affirmed by S&P Global Ratings’ reiteration of Saudi Arabia’s stable sovereign credit outlook.
A number of attacks on regional oil assets took place over the past year, but the context has changed. Saudi equities are now part of the mainstream emerging market indices (with 3% weight in MSCI and FTSE emerging market indices) and the share of local daily trading and total ownership by foreign investors has grown tremendously. Historically, GCC markets did not suffer that much from periods of regional insecurity because the oil price spike that accompanies these periods has provided a macro hedge. However, after a year of substantial global inflows into the GCC across both equities and bonds, the spike in insecurity risk might have a more meaningful impact on local asset valuations this time.
Following the attacks, most commodity strategists and traders were bracing for at least one month of oil supply disruption, at a time when many developed and emerging market are struggling to maintain economic growth at a healthy level, especially in manufacturing. Certain industries such as automakers are already facing a perfect storm of collapsing demand, drastic changes in regulation and higher costs due to trade war disruptions and a jump in fuel prices would have been extremely detrimental. It was therefore a big relief to marketswhen Saudi Aramco announced that all production was restored sooner than expected and customer deliveries will not be impacted.This has brought calm back to the markets and stabilized oil prices around their pre-attacks levels.
Meanwhile, regional tensions remain and the risk of additional similarly damaging attacks is on investors’ minds. Should the situation escalate further, the market may have to deal with more extended periods of reduced production capacity and traders will have to price-in a certain risk-premium in future oil contracts. In such a scenario, many oil-importing emerging markets wouldcome under pressure, especially those already witnessing large current account deficits. An increase in these countries’ net oil imports bill would come at a time when their public finances are suffering due to large deficits and mounting external debts.
The 2014-2016 period when Brent oil averaged $65 at a time of global manufacturing slowdown is a good case study for what may await such vulnerable emerging markets in case of new supply disruptions. Pakistan, Sri Lanka, Jordan, Lebanon, Jamaica and Ukraine are all countries with not only substantial oil import needs but also high public debt, large fiscal deficits and fragile economies. Many of these countries also have substantial US Dollar bonds which are currently trading at distressed levels, which indicates that they have very little room to absorb a possible oil shock.
A more extreme scenario where we see more regular attacks or potentially greater infrastructure damage would certainly increase the chances of a recession across the US and Europe as both consumers and producers would feel the pinch of sustainably higher oil prices, adding to an already challenging growth outlook.While opportunistic US shale producers are likely to take advantage of such a scenario and boost production substantially in North America, European economies not only lack domestic oil resources (outside UK and Norway) but they are also more reliant on industrial exports. They stand to suffer more from further pressure on the hugely important Auto sector and related industries such as steel and chemicals, in addition to the negative impact on consumer spending at a time when many European economies are on the brink of recession.