Oil price predictions always end in disaster but complacency in the market poses a number of risks, given global uncertainty.
This point was highlighted by the mid-September attack on production facilities in Saudi Arabia, which took around 5.7 million barrels per day of capacity offline. Oil prices surged by nearly 20% during the first day of trading after the attack, the single largest ever increase, but fairly swiftly fell back.
This was driven by three factors: Aramco’s ability to resume supplies in rapid order, US shale supplies and a gloomy demand outlook. All three of these issues, though, are more finely balanced than may appear from the oil price stasis.
The September 14 attacks on Saudi facilities are thought to have involved a combination of drones and missiles. Saudi and US officials have pinned the blame for the attacks on Iran.
The response from the Saudi government and company was remarkable. Steps were taken to reassure the market and strategic stores deployed to reduce the disruption. While there was an amount of change – for instance in crude grades being changed at short notice – it was mostly remarkable for the ease with which exports continued to flow.
Production from Khurais resumed within a day of the strike while Abqaiq has also now been restored. Work is ongoing to tackle the damage, but the amount of redundant capacity at Aramco’s facilities has provided it with sufficient scope to weather the storm.
Aramco’s CEO Amin Nasser described the strikes as an “attack on the global economy” in comments at the Oil & Money conference, in London this week. “The attacks were by Iran for sure, there’s no doubt.”
While the response has been strong, there are concerns. Fitch Ratings cut its outlook for Saudi, and subsequently Aramco, in part owing to the strikes. Aramco is in the process of planning for an IPO, in which it hopes to be valued at $2 trillion, and as such feels particular pressure to put its best foot forward.
The mid-September attacks are not as isolated, though, as they may seem. In May, drones were used to attack Saudi’s East-West pipeline. This has capacity of 5mn bpd and is expected to increase to 7mn bpd by the end of the year. The same month four tankers were damaged in the Gulf of Oman, with another two in June. The US has accused Iran of carrying out the tanker attacks with limpet mines.
“There’s been a number of attacks on pretty significant energy infrastructure and the market has shrugged it off,” RBC Capital Markets’ head of commodities Helima Croft said at the same conference. “There’s complacency in the market that this is going to be the worst that we’ll see. I’ve yet to hear anyone provide a road map for how we off-ramp from this stand off and why we’re not going to see further attacks.”
Continuing the theme of rising Middle Eastern aggression, Cornerstone Macro’s global energy economist Jan Stuart asked what Iran could do next. “We are in the kinetic phase now. When’s the next attack on the Gulf Co-operation Council (GCC) infrastructure? Perhaps 2020.”
There was some disagreement over whether there was a risk premium in the oil price. Vitol’s CEO Russell Hardy told the Oil & Money conference that this accounted for $8 per barrel and that the price should $50 per barrel. In terms of pricing, the Vitol executive put it down to a “tussle between geopolitics, demand and shale. At the moment, demand is winning. The sell side is dominating the flows in derivative markets and producers in the US having to be hedged – all of that is putting pressure on the oil market.”
Cornerstone’s Stuart picked up on Croft’s point of violence and instability, saying the outages had been effectively matched against US domestic production. As prices spiked following the attack, there was a substantial amount of hedging work carried out by US shale producers.
“On that Monday, the market synthetically put US production up against the lost Saudi production, and then Aramco took action, and the markets said ‘I’m so bored, I will just price what I can see in front of me’,” Stuart said.
There are also broader political questions for shale. The next US presidential election is likely to offer choices between two very different outlooks. A second term for US President Donald Trump may see continuing withdrawal from hotspots around the world, coupled with a tough trading outlook and escalating tariffs.
A Democratic victory, on the other hand, could see Senator Elizabeth Warren take the top spot, who has vowed to ban hydraulic fracturing. While an outright rejection of fracking is unlikely, there is clearly scope to toughen regulations and impose higher costs on areas such as infrastructure, which would certainly slow production rises.
Tight oil production flattened in the third quarter, the Energy Information Administration said this week, although it went on to say this should rise in the fourth. The US will produce 1.3m bpd more this year than in 2018, but growth will slow in 2020 to a rise of 900,000 bpd.
“The political winds are probably the greatest factor in the future for shale investors but price is the short-term factor. Growth peaked in 2017-18, that was dictated by price. The expectation going into 2019-20 had been for an additional 2 million bpd of growth, we figure it’s around 1.1-1.2 million bpd now,” Vitol’s Hardy said.
Cornerstone’s Stuart voiced a more bearish position than many on shale’s prospects, predicting the sector would not be able to work with oil prices at $65 per barrel. These concerns chime with a report from Rystad Energy, in May, which reported that only 10% of shale companies were cash-flow positive.
While the sense of supply is abundant, oil prices are also depressed by concerns about demand. Looking at the US administration, at China’s slowdown and a lacklustre showing in the second quarter for the global economy and there is a sense that there is unlikely to be a major recovery in the near term, Cornerstone’s Stuart said.
Forecasts for demand have been reduced over the year by a number of agencies, including the International Energy Agency (IEA) and OPEC. The latter, in its most recent monthly report, put growth at 980,000 bpd this year, down by 40,000 bpd from its previous estimate.
The US’ trade war with China has been repeatedly cited as one driver of slowing demand. As frictions show no signs of abating between the two sides, this is taking its economic toll, particularly on China.
Uncertainty has the impact of making companies focus on short-term investments, so money can be quickly recouped. “The return on investment in a shale well is about 12 months, you don’t have to worry about getting your money back. Long-cycle are big deepwater projects and these are not going to be done because people are terrified about the future,” said Goldman Sachs’ head of commodities research Jeff Currie. “This can’t go on forever, at some point we will have to have long-cycle capex. This means that it’s likely we’ll see inflation, because you’re not investing. The question is how long do you have to wait for the inflation to kick in?”
Concerns over demand have set the pace, for now, but it is clear that major disruptions could occur, with the possibility of driving prices.
The single item with the greatest scope for change is Iran. Sanctions are tightening and the country has demonstrated an ability and willingness to carry out strikes previously thought to be unacceptable. On the other hand, it is not impossible to imagine a deal with the US, which could unlock another 2 million bpd of additional production. Either way, complacency must be recognised as a risk in itself.