Over the years, I have often been asked about scenarios that could rapidly drive oil prices higher. My response is always that the worst case scenario is an incident that takes a large amount of oil production offline in Saudi Arabia.
Why Saudi Arabia? After all, the U.S., Russia, and Saudi Arabia are the world’s leading oil producers, with each topping 10 million barrels per day (BPD) in 2018.
The difference is that production in the U.S. and Russia is diversified across numerous producers, and across a much larger geographical area. Saudi Arabia’s production is from a single entity — Saudi Aramco. Further, Saudi Arabia moves and transports a large fraction of the world’s production through relatively small geographical areas. That makes it extremely vulnerable to attack.
Those attacks happened early Saturday, when ten drones attacked one of Saudi Arabia’s largest oilfields and the world’s biggest crude processing facility at Abqaiq. A total of 5.7 million BPD of production was reportedly offline, which represents more than 5% of the world’s oil production.
For perspective, according to the Energy Information Administration (EIA), between 2008 and 2018, the shale oil boom in the U.S. added 5.9 million BPD of oil to the world’s oil markets. That means that the attacks in Saudi Arabia have knocked offline the equivalent of the entire U.S. shale boom. I have argued that without the U.S. shale boom, oil prices would have never dropped back below $100/bbl.
Andrew Lipow, President of Lipow Oil Associates, said “This is a big deal. Fearing the worst, I expect that the market will open up $5 to $10 per barrel on Sunday evening. This is 12 to 25 cents per gallon for gasoline.”
Other analysts have also suggested a $10/bbl impact, but that assumes that most of the offline production is quickly brought back online. Kevin Book, Head of Research at Clearview Energy, put out a note that said in part:
Our baseline assumptions, which incorporate public assessments of strategic petroleum reserve capacity and OPEC spare capacity, imply a net shortfall of ~1 MM bbl/d, or at least a ~$6/bbl premium to the ~$60 Brent close. Exclusive of this supply offset, and assuming a three-week shutdown, our models imply ~$10/bbl of upside.”
So, most of the forecasts for a $10/bbl impact on oil prices aren’t looking at the implications of an extended outage. I expect Saudi Arabia to make a statement to reassure the markets. If they can get production back online pretty quickly — or at least assure the markets they can — you might not see an enormous price spike. But if 5 million BPD of oil production stays offline for very long, that’s a prescription for a quick return to $100/bbl oil.
Now, imagine we had banned fracking, and 5 million BPD of Saudi oil went offline for an extended period of time. I can’t even imagine where oil prices might end up under that scenario.
In any event, regardless of how bad this turns out to be, it highlights a major vulnerability that will probably bring back a fear premium to the price of oil. There aren’t that many oil vulnerabilities around the world capable of sidelining millions of barrels a day of crude oil, but the Abqaiq crude processing facility is certainly one of them.