Image Shown: Saudi Arabia’s oil infrastructure was attacked over the weekend, causing WTI and Brent to rally at the start of the trading session.
By Callum Turcan
Disaster struck this weekend when several drones took out the Abqaiq oil processing facility and the massive onshore Khurais oil field in Saudi Arabia (KSA) on Saturday, with WTI and Brent both surging on the news once trading resumed at the start of the week. The Khurais oil field produces around 1.5 million barrels of crude per day and the Abqaiq oil processing facility is the largest in the world. Saudi Arabia’s oil production capacity was reduced by 5.7 million barrels of crude per day due to these attacks and the country is reportedly considering delaying the IPO of ARAMCO, an IPO that we covered in detail in this piece here.
First and foremost, caution is in order. We can’t stress enough how events like these can quickly get blown out of proportion, especially when they are as serious as what transpired over the weekend. Yes, initial reports seem to indicate the Houthi rebel group operating in Yemen, and backed by Iran, attacked Saudi Arabia’s oil infrastructure with drones. This brought back memories of the Gulf War in 1990-1991, when then-dictator of Iraq Saddam Hussein attacked Kuwait’s oil infrastructure. Back then oil prices skyrocketed, but we are living in different times now that the shale boom has fundamentally altered the supply-demand dynamics of crude oil. Saudi Arabia plans to bring a third of its disrupted production back online by Monday, but it isn’t clear when the rest of its disrupted oil output capacity will be operational.
Saudi Arabia produced 10.3 million barrels of crude per day last year, and is thought to have the ability to produce around ~12 million barrels of oil per day if warranted. Depending on when Saudi Arabia can resume normal operations, the world will no longer have any spare oil production capacity in the interim and will instead need to lean on existing inventories to make ends meet. Back during the Gulf War, oil prices eventually receded as it became clear the damage Saddam Hussein’s forces tried to levy on Kuwait’s oil infrastructure wasn’t nearly as bad as expected.
President Trump has authorized the use of the Strategic Petroleum Reserve (“SPR”) in an attempt to hold down oil prices and ultimately prices at the pump. More importantly, WTI over $60/barrel is likely to stimulate drilling and completion activity across America’s shale patch, driving non-OPEC supply higher at a time when it’s really needed. Canada’s (EWC) shale patch is another region that may see upstream development activity perk up in response to higher oil prices. As they say, the cure for high oil prices is high oil prices, meaning the supply response (in light of non-OPEC becoming a much more important part of the global supply story over the past two decades) will drive prices lower over the medium- or long-term. Rising North American production (specifically from the US and Canada) should bolster utilization rates at oil & gas infrastructure, behooving the future financial performance of midstream companies to a degree (depending on how long Saudi Arabia’s production capacity is kept offline).
Upstream and most midstream oil equities are getting bid up aggressively on September 16 (Monday), and several independent refineries are selling off (as feedstock prices are set to increase materially while supply disruptions may hamper utilization rates at certain refineries heavily dependent on foreign supplies). On the upstream front, Occidental Petroleum Corporation (OXY) is up almost 7% as of this writing while California Resources Corporation (CRC) is up over 31%. Refiners Valero Energy Corporation (VLO) and Marathon Petroleum Corporation (MPC) are both down as of midday Monday, though MPC has recovered somewhat from steep initial losses. Midstream giant Enterprise Products Partners L.P. (EPD) is up over 1% while energy giant BP plc (BP) is up almost 4% as of this writing. Also noteworthy, defense stocks are performing relatively well over fears that this event may cascade into a multi-faceted war in the Middle East. Lockheed Martin Corporation (LMT) and Raytheon Company (RTN) are both up as of this writing.
As it relates to upstream companies, what matters most is the futures curve and not the front-month price. While the price for oil deliveries in 2020 and 2021 both increased after this news, the price increase was less dramatic as investors expect Saudi Arabia’s production capacity will recover. Please note that WTI futures are in backwardation and that while deliveries to Cushing are expected to fetch over $60/barrel for the rest of 2019, the futures curve slips below $56/barrel for July 2020 deliveries. It’s possible that upstream equities will overshoot the fundamentals of this latest development, as long-term oil price realizations aren’t expected to change much (unless war between Saudi Arabia and Iran breaks out).
Concluding Thoughts
We will be monitoring this situation very closely going forward. The pace at which Saudi Arabia can bring capacity back online will have an outsize impact on global oil markets going forward, as the world no longer has any spare capacity to turn to during times like these (when supply is severely curtailed). Geopolitical tensions are clearly growing and that could spill over into a war directly between Saudi Arabia and Iran, but for now there’s no signs of troops mobilizing for such an endeavor.
Oil & Gas (Majors Industry) – BP CVX COP XOM RDS.A RDS.B TOT
Independent Oil & Gas Industry – APA COG CLR DVN EOG MRO OXY PXD
Refining Industry – HES HFC MPC PSX VLO
Oil & Gas Pipeline Industry – ENB ET EPD KMI MMP
Aerospace & Defense Industry – BA FLIR GD LLL LMT NOC RTN
Related: ARMCO, USO, OIL, XLE, VDE, AMLP, AMZA
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Callum Turcan does not own shares in any of the securities mentioned above. Kinder Morgan Inc (KMI) is included in Valuentum’s simulated Dividend Growth Newsletter portfolio. BP plc (BP), Enterprise Products Partners L.P. (EPD), and Magellan Midstream Partners L.P. (MMP) are all included in Valuentum’s simulated High Yield Dividend Newsletter portfolio. Some of the other companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.