Last weekend, the largest refinery in the world (Abqaiq Crude Processing Facility) was disabled due to a drone strike, cutting the Kingdom’s oil output by half or by 5 million barrels per day! This is a very significant supply shock and will lead to higher oil prices across the globe at a time when global economies were already slowing. Iran has said it was the Yemen-based Houthis coalition. The Saudis and President Trump have refuted this claim on the basis that the Houthis coalition would be unable to access such superior missile technology needed to strike the refinery in such a precise manner.
Saudi Arabia has announced that they believe they will be able to restore functionality to the Kingdom’s facility within three weeks (what will be back on-line and what will not be is still up for question). The initial re-opening of the facility will most likely be partial as the facility is materially damaged. Saudi Arabia’s truthfulness about their oil operations, output, reserve levels, etc. has often been called into question as their motives are mostly self serving. Their most recent projection to be back online in three weeks could likely be another one of their ‘plays’ as they would not want to encourage other market participants to ramp up their production in leu of their production coming off-line
Depending on how things pan out (i.e., depending on whether the US and the Saudis respond militarily), the strikes on the Kingdom’s oil infrastructure may be remembered as an event that changed the course of history. President Trump and Saudi Crown Prince Mohammed Bin Salman appear poised to blame Iran directly, as opposed to accepting the Yemen-based Houthis’ claims of responsibility. This distinction is of extreme importance. The Houthis are obviously backed by Iran, but generally speaking, the group maintains a facade of autonomy which, in turn, allows Tehran to retain plausible deniability when Riyadh goes looking to assign blame for the frequent cross-border attacks. Irrespective of whether retaliatory strikes against Iran (which Senator Lindsey Graham called for on Saturday) are in the offing, and even if Aramco manages to restore all the lost output in an expeditious fashion (which is by no means guaranteed), markets are likely to bake a higher geopolitical premium into crude prices for the foreseeable future. Everyone knew Abqaiq was vulnerable, but the going assumption was that an attack on what Rapidan’s Bob McNally over the weekend called “the most valuable piece of real estate on planet earth,” was unthinkable due to how brazen any would-be saboteurs would have to be to go through with it. Well, somebody went through with it, and things will never (ever) be the same.”
How does this affect markets and what is next?
Conclusion: This is the largest oil supply shock the market has ever seen in history and 5 million barrels per day is roughly the same amount of daily production that comes out of the Permian Basin! The last supply shock we had was an increase of 1.14% in global supply that sent the oil market crashing down from over $100 a barrel to close to $20 a barrel in 2016! The 2016 shock resulted in a flood of new oil to the market and a major supply increase that took the prices down dramatically. Maybe we don’t see a $100 a barrel oil, but this is an example of the price swings that can occur when supplies are disrupted in a surprising manner. The U.S. is a safer option for global oil supply and this is a big tailwind to our current energy positioning across portfolios. Most of the Saudi oil is going to Asia and the U.S. has completely different trade routes to Asia than the Saudis. This shipping route diversification and safety could lead to the U.S. gaining further share of the global oil market. Secondly, this is also an earnings tailwind for midstream energy firms as capacity domestically ranges from 90-95% with the 5-10% of capacity being variable (regarding pricing and quantity supplied). With a clear path to moving those utilization rates closer to 100% and doing so at these higher prices will most certainly be accretive to cash flows and earnings in this upcoming quarter. If the market didn’t believe the 20% YoY EPS growth for US midstream after last quarters guidance and results, it most certainly will now.
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