How Will the Oil Markets Be Affected By the Attacks on Key Saudi Arabian Oil Facilities?

Image source: Kittipak Arunrat © 123RF.com

Two of Saudi Arabia’s biggest and most important oil facilities in the provinces of Abqaiq and Khurais were targeted yesterday in coordinated strikes using unmanned drones. Yemeni Houthi rebels have claimed responsibility for the military operations, which were labelled as acts of terrorism by Saudi Officials. The military strike against the Saudi oil industry is the most substantial of the kind on record since the first Gulf War when Saddam Hussein used missiles to target major oil plants and refineries.

Prince Abdulaziz bin Salman, Saudi Arabia's Energy Minister, has said in a statement for the Saudi Press Agency (SPA) that the attacks "resulted in a temporary suspension of production" at the two plants at Abqaiq and Khurais. In the press release, it is stated that there are no reported casualties of the attacks; however, the resulting explosions have damaged the plants severely, leading to disruptions in the production capabilities of the two installations. According to Prince Abdulaziz, the capacity for crude oil production has been diminished by 5.7 million barrels per day, which is more than half of the kingdom's total output.

The immediate threat to the oil market

As the consequences of the explosions at the plants unfolded in the first hours following the attacks, global economists and policymakers scrambled to analyse the perceived short-term and longer-term impacts of the situation on the oil market. The immediate concerns stem from the potential disruptions in the international supply of crude oil, which could have multiple ramifications for the global economy.

The two sites, which are part of the state-owned Saudi Aramco, comprise a significant portion of the oil industry. According to Katie Prescott, business correspondent of the BBC:

“The Khurais oilfield produces about 1% of the world's oil, and Abqaiq is the company's largest facility - with the capacity to process 7% of the global supply. Even a brief or partial disruption could affect the company, and the oil supply, given their size.”

Saudi officials have stated that they are prepared to counter the temporary severance of production, by using some of the oil reserves to compensate for the cuts in the supply. However, even if the market does not register any immediate changes in the actual supply of the precious commodity, substantial price speculation activity is expected to hit the oil market during Monday's open nonetheless. Subsequently, the resulting heightened volatility could undoubtedly scare investors as the price is anticipated to soar markedly during the first trading hours on Monday morning. Depending on the severity of the speculation, the fluctuations in the price of the crude oil could be felt across different markets; chiefly in bonds, stocks and commodities.

The WTI crude oil finished Friday’s trading session from last week at 54.87 dollars per barrel and owing to the expected partial cuts in the production of Saudi Aramco in the near-term, the price is likely to soar above the 38.2 per cent Fibonacci retracement level at 57.24. Depending on the size of the initial opening gap, the market could appreciate to as much as 60.75 dollars per barrel before the price corrects itself eventually. The huge gains that are expected to hit the market, however, are unlikely to last long as the force of the initial volatility should wane by the end of Monday.

Saudi Arabia is going to attempt to repair the damages as soon as possible and restore the previous production output, and in the meantime, the spare capacity could be filled with Iranian exports, which are currently suffering from US restrictions. Thus, any sudden gains in the crude's price, though massive, will not be sustainable and should revert shortly to the 54.50 – 55.50 range.

The recent recovery in the US bonds market could also be impeded to a degree by the interim disruption in Saudi oil production, as investors weigh in on the possibility for escalation of the geopolitical situation in the region. The yield of the US 10-Years Government Bond increased to 1.899 last Friday from the historic low of 1.428, that was recorded in early September. Investors' enthusiasm, however, could be promptly interrupted because of the possibility for longer-lasting negative consequences for the already troubled relationships of the Gulf states with each other. The US' involvement in the conflict could also inadvertently stimulate the polarisation between Saudi Arabia and Iran, which supports the Houthi rebels in Yemen.

If the spat between Saudi Arabia, with the support of the US, and Iran continues to escalate, US investors are likely to flood the bonds market once more, as fears and uncertainly increase parallel to the escalation of the situation.

The long-lasting threat to international stability

Even though the war between the Saudi coalition, which supports Yemen’s President Abdrabbuh Mansour Hadi, and the Houthi rebels, who are supported by Iran, has been going on since 2015, yesterday's drone strikes could potentially have global, political implications.

Mike Pompeo, the US Secretary of State and top American diplomat under the Trump administration, was the first US official to comment on the situation by directly accusing Iran of the deed.

Tehran is behind nearly 100 attacks on Saudi Arabia while Rouhani and Zarif pretend to engage in diplomacy. Amid all the calls for de-escalation, Iran has now launched an unprecedented attack on the world’s energy supply. There is no evidence the attacks came from Yemen.

— Secretary Pompeo (@SecPompeo) September 14, 2019

Mr Pompeo's remarks are surprising because he claims that there is “no evidence” for Yemeni involvement, and instead has directly accused Iran. Nevertheless, his assertions could prove to be dangerously off point with long-lasting consequences. Yehya Sarea, the Houthi spokesman, was the one who admitted the movement’s involvement in the attacks in a statement for al-Masirah TV, which is controlled by the Houthis, and he also threatened Saudi Arabia with future attacks.

As of yet, Iran's total involvement is not clear and political analysts are uncertain as to the degree of support that Tehran is providing the Houthi movement. It is also uncertain as to whether the latter can carry out future attacks all by themselves, which could be the difference between the situation remaining a local conflict and it escalating to a regional war.

Regardless, Mr Pompeo's comments are indicative of the US interest in the region, as the Trump administration is still struggling to develop a systematic policy towards Iran. The US sanctions on Iranian oil exports have exerted a heavy toll on Tehran's economic ambitions; however, the Islamic republic has continued on its path to undermining the nuclear deal in a bid to develop Weapons for Mass Destruction (WMDs).

Iran and the US are already at odds with each other politically, and if the situation in Saudi Arabia gets mishandled, the polarization of the two countries could continue to grow. Overall, the long-term threats to oil production in the region stem from political fragility as opposed to temporary disruptions in infrastructure. The energy markets are going to be struck if yesterday's attacks are used as a trigger for a large-scale conflict in the Gulf.

Meanwhile, oil futures are seemingly ready to enter into a new trend environment after the extended period of narrow-range trading, which has been influenced by the relatively uneventful summer period, looks close to being terminated. The price of crude oil futures with December maturity is currently consolidating between the 23.6 per cent and the 38.2 per cent Fibonacci Retracement levels with the long-term bullish momentum starting to build up parallel to the increasing trading volume. Thus, the recent political developments in the region could trigger the anticipated Markup in the futures market, on the condition that the overall situation is not resolved shortly. According to our research, the price of crude oil is going to test the critical level at 62.75 before the year-end.