September 18, 2019

Attack on Saudi Arabia: Update

Tuesday evening Saudi Arabia announced that production would be fully restored by the end of the month and that supplies in the region had been fully restored by drawing on inventories, sending prices crashing. Brent ended Tuesday at $64.55/bbl, $4.47/bbl below Monday’s close and less than $5/bbl above Friday’s close. The Brent-WTI spread tightened by nearly a dollar as Brent saw a steeper decline than WTI. The US grade remained supported by expectations of a crude stock draw amidst a generally healthy domestic market.

Although the specter of a long-term outage has disappeared, several important questions remain unanswered. Chief among them is where did the attack originate, and thus who bears ultimate responsibility? Also, it is unlikely that Saudi Arabia leaves such a challenge unanswered, but what form will the Kingdom’s response take?

While Saudi Aramco has not released extensive information on the extent of the damage, the company has assured markets that production will be fully resolved by the end of September. According to the statements, October production will be 9.89 mmb/d, which is below last year’s level but in-line with Saudi Arabia’s production management goals as part of the OPEC+ deal. Although Saudi Aramco maintains that it is using inventories to meet all export obligations, there are isolated cases of customers being offered different grades than originally contracted or at a delay from the original delivery timeline.

Although the risk to production has fallen off a geopolitical price premium is likely to remain in place for at least a couple weeks. While initial estimates indicated that this premium should be close to $5/bbl, it now appears $3/bbl may be a more comfortable number. This is because it appears Saudi Arabia’s government is taking a measured approach to investigating the incident and assigning official blame. Although Riyadh maintains that Iran played a role in the attacks it has also chosen to await the results of several international investigations. Allies in the United States and Europe also appear to have adopted a much more cautious strategy in formulating a response in an effort to avoid a larger conflict. With cries of patience ringing from every side the chances of a dramatic escalation appear minimal, justifying a lower price premium. However, the chance of future attacks certainly remains, justifying some level of premium. Houthi rebels have announced that they maintain a large list of potential targets in both Saudi Arabia and the United Arab Emirates and could even be emboldened by the lack of retaliation.

Moving forward markets will remain focused on both Saudi Arabia’s eventual political reaction, as well as what this attack could mean for the planned Saudi Aramco IPO.

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