- Coordinated attacks against Saudi Arabia took 6% of the world's oil supply offline—the largest sudden stoppage in modern history.
- Our base-case outlook is that oil prices will continue to move higher due to reduced spare capacity and lower stockpiles, likely driving higher volumes and prices for exploration and production (E&P) companies and higher throughput volumes for midstream energy companies.
- We believe the adoption and evolution of drone warfare substantially increases oil production risk, contributing to a sustained geopolitical risk premium in crude oil prices and reinforcing shale’s strategic importance in diversifying energy supply, which could help to fast-track remaining pipeline permits.
Early Saturday morning (September 14, 2019), Saudi Arabia’s oil infrastructure in the Northeast provinces came under attack, taking 6 million barrels of oil per day (bpd) offline. A catastrophic halt of this magnitude—half of Saudi’s processing volume and 6% of global supply—is unprecedented in modern history, potentially even more impactful than closing the Strait of Hormuz.
The drone strikes targeted the Abqaiq oil processing plant, one of the largest in the world, and Khurais, the country’s second-largest oilfield. Houthi rebels in Yemen have claimed responsibility, though the attack’s precision appears beyond their known capabilities and U.S. Secretary of State Mike Pompeo has placed the blame squarely on Iran.
Although the damage assessment is still underway, Saudi Aramco has stated that the country may remain short of full production capacity for weeks. Quantifying the long-term effect on energy markets will depend on the extent of the damage, Saudi retaliation and potential U.S. involvement.
Here is how we are assessing the range of outcomes going forward:
Worst case: If the entire 6 million bpd stays offline for a prolonged period, we think the price of Brent crude could breach triple digits by early 2020. In this scenario, we would expect large amounts of strategic reserves to be released, U.S. crude production to ramp significantly, and the fragile, trade-war-challenged global economy to slip into recession under the weight of extremely high prices for crude oil and crude products (gasoline, diesel, jet fuel, etc.).
Base case: Saudi loses about 1–2 million bpd temporarily, partially offset by spare capacity from Russia, the U.S. and other oil-producers, and drawing down stockpiles. In this scenario, we would expect Brent crude to drift higher through year end, as reduced spare production capacity and lower stockpiles would likely keep spot prices elevated.
In our view, the base-case scenario would not be enough on its own to tip the global economy into recession, but it would make Europe’s situation more challenging and could keep global interest rates low for the foreseeable future. As long as oil stays below $100 per barrel, we think the U.S. is in a stronger position; the rise of shale has made it a swing oil producer, meaning that positive effects from higher energy investment could provide some cushion to the negative effects of lower consumption.
Either way, we believe this is a huge deal for oil markets:
- Tension in the Middle East is at its highest point since Iraq invaded Kuwait in 1990, when oil prices jumped 160% over four months.
- This is a new type of drone warfare, exposing the extreme vulnerability of any oil field or processing unit in the world. Consider that Saudi Arabia has the third-largest military budget, yet the unmanned drones—which typically have no heat signature and are made of composite materials—went completely undetected, flying below the Saudi’s “iron dome” defense system. This permanently changes the risk of oil production, forcing Saudi (and everyone else, for that matter) to alter how it protects assets.
- Saudi is likely to retaliate after they stabilize oil production, with potential for significant escalation depending on the target and whether the U.S. or others become involved.
- Any chance of de-escalation between the U.S. and Iran is now off the table.
Regardless of whether Saudi’s capacity is restored in a week or a month, we believe a geopolitical risk premium the likes of which has not seen in recent history is back in the oil markets and should continue to be reflected in oil prices. We expect this to support higher prices throughout the energy value chain.
In particular, we believe the disruption will shift increasing focus to opportunities in North American midstream energy and E&P companies:
- It highlights the strategic importance of U.S. shale for diversifying energy supplies.
- Higher energy prices tend to result in stronger counterparties and higher throughput volumes.
- Concerns that slower global demand could push crude oil to $40 per barrel have been largely removed.
- President Trump has indicated he may seek to fast-track remaining pipeline permits.
The situation remains highly fluid and our investment teams are following developments closely. We will provide further updates as we gather more information.
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Data quoted represents past performance, which is no guarantee of future results. The views and opinions in the preceding commentary are as of the date of publication and are subject to change without notice. There is no guarantee that investors will experience the type of performance reflected in this commentary. There is no guarantee that any historical trend referenced in this commentary will be repeated in the future, and there is no way to predict precisely when such a trend will begin. There is no guarantee that a market forecast made in this commentary will be realized. The mention of specific securities is not a recommendation or solicitation for any person to buy, sell or hold any particular security and should not be relied upon as investment advice.
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