How the shock of the Saudi attack will linger over the oil market

The attack on Saudi Arabia’s oil facilities was “the big one”, says Spencer Jakab in The Wall Street Journal. The drone strikes on the world’s largest oil processing plant at Abqaiq has forced Saudi Arabia to cut output of of crude oil by 5.7 million barrels per day (mbpd), roughly 60% of its output and as much as 6% of global supply. World oil production is around 100 mbpd. Even if supplies are restored quickly, as Saudi Arabia has reportedly indicated they will be, the “technological sophistication and audacity” of this strike against critical infrastructure, for which Iran-backed Houthi fighters in Yemen have claimed responsibility, “will linger over the energy market”.

Saudi attack is a game-changer
The attack prompted the biggest one-day rise in Brent crude prices in at least 30 years. The benchmark rose by as much as 20% to over $70 a barrel before falling back; major equity indices slipped by between 0.5% and 1%. The 5.7 mbpd taken offline is the biggest disruption to global supplies on record, topping even the outages caused by the 1979 Iranian revolution and the 1990 Gulf War.
The strike could prove a “significant game-changer”, says Stephen Innes of AxiTrader. It suggests that crucial nodes in the global oil supply chain are “extremely vulnerable to terrorist attacks”. So markets must start to price a bigger risk premium into oil. The slump in crude prices this year in the face of growing Iranian belligerence now looks complacent, agrees Jim Armitage in The Evening Standard. The “sub-$60 trend we’ve seen over the summer seems out of touch with reality”.
Oil is an oversupplied market
Nevertheless, oil is still trading significantly below the $86.70 a barrel high it hit last October. That is due to weak global demand. The International Energy Agency thinks that worldwide appetite for Opec oil in the first half of 2020 could be 1.4 mbpd lower than current output. “We are massively oversupplied,” Christyan Malek of JP Morgan told Reuters, noting that “it would take five months of a five mbpd outage to take global crude supply levels back to a 40-year normal average”. The main reason is booming US shale oil production. American oil output doubled in the decade after 2008 to overtake Saudi Arabia as the world’s biggest oil producer. That makes the kingdom’s reserves less crucial. The fact that Opec, the oil exporters’ cartel, has been voluntarily restricting supply in recent years in a bid to support prices also suggests that they have the spare capacity to cover any Saudi shortfall.
The attack itself is “unlikely to be a disaster for the global economy”, writes Jennifer McKeown of Capital Economics. The biggest risk comes not from supply disruption, but rather the fact that the incident raises the odds of a “full-blown US-Iran conflict”. That worst-case scenario could push oil up to $150 per barrel and drive inflation in developed countries as much as 3% higher (see below).
Saudi Arabia’s uncertain future
For Saudi Arabia, the “stakes couldn’t be any higher”, says Andy Critchlow in The Daily Telegraph. The International Monetary Fund estimates that Riyadh needs oil prices around $85 per barrel if it is to balance its budget. If it can’t do that then one of the Middle East’s more stable countries could face an uncertain future. The local Tadawul stockmarket opened down 2.3% on the first day of trading after the strike on Abqaiq. The index has fallen by 16% since May.
Weaning the country off oil
The nation remains overwhelmingly dependent on oil, which accounts for about 80% of exports and more than 40% of GDP, says Abeer Abu Omar on Bloomberg. Yet even that understates petroleum’s real significance: “non-oil activity is heavily dependent on state outlays financed by oil revenue”.
The Saudi budget has suffered from the protracted slump in oil prices, which caused the economy to shrink in 2017 for the first time in a decade. Yet Riyadh has done little to cut back on a generous welfare system that provides many citizens with cushy government jobs. Indeed, last year the government launched a lavish new “cost-of-living allowance” reports Natasha Turak on CNBC. The measure costs more than $13bn and is “intended to stimulate sluggish growth and shore up support” for the regime. That is vital in a country where the unemployment rate is more than 12% and more than half the population is younger than 30.

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