Drone attacks on Saudi to see oil trading higher

However, the geopolitical threat could see investors exiting developing markets

By MARK RAO / Pic By AFP

CRUDE oil is expected to trade at a premium after attacks on key Saudi Arabian oil sites put 5% of global oil production offline, benefitting net oil exporters. The geopolitical threat, however, could see investors exiting developing markets.

Brent futures spiked 19.5% to US$71.95 (RM301) per barrel seconds after trading commenced on Monday, the highest intraday jump on record since the contract was first launched back in 1988, as 5.7 million barrels of daily crude oil production were disrupted.

This fall in production represents close to half of total daily oil production from Saudi Arabia, which is the second-largest oil producer in the world, and more than 5% of total global supply.

The disruption to supply was caused by drone strikes on an oil-processing facility in Abqaiq and the nearby Khurais oilfield on Saturday. Iran-backed Houthi rebels in Yemen claimed credit for the attack.

Brent oil pared back some of its gains yesterday, trading between the US$68 and US$69 per barrel level for the better part of the day, but this is still at a 13% to 15% premium to last Friday’s close of US$60.22 per barrel.

Saudi Arabia’s state-owned Saudi Arabian Oil Co (Saudi Aramco) aimed to restore about a third of its disrupted crude output by Monday, but it was reported that operations returning to normal production could take months.

AxiTrader Asia-Pacific market strategist Stephen Innes said the damage assessment following the attacks will be crucial to gauge the interval of this weighty unscheduled market disruption and the consequential duration for higher oil prices.

“The relative ease of which this attack was staged suggests that other global oil supply chain focal points are also extremely vulnerable to terrorist attacks, suggesting that global risk premium could remain elevated for some time,” he told The Malaysian Reserve (TMR).

Oanda Corp senior market analyst for Asia Pacific Jeffrey Halley said both the US and Saudi Arabia moved quickly to deploy reserves to maintain supply lines, while Saudi Aramco is planning to restore a large portion of the disrupted oil supply.

“This will alleviate immediate supply concerns, but not the potential military, geopolitical and infrastructure vulnerability concerns,” he told TMR.

“We would expect oil prices to remain around 10% higher this week than (Friday’s close) with the potential for higher prices, should any of the above deteriorate.” FXTM chief market strategist Hussein Sayed said the oil market has shifted from being oversupplied to undersupplied, with the combined global spare capacity unable to make up half of the disrupted 5.7 million barrels of oil per day supply.

He said oil prices hitting US$100 per barrel is no longer an impossible scenario with US representatives putting the blame on Iran for the drone attacks, while US President Donald Trump said the US is “locked and ready” assuming the culprit is known.

“If investors begin pricing in the possibility of an attack against Iran’s crude infrastructure, oil may quickly hit the US$100 benchmark,” he said in a research note on Monday.

Crude oil trading at a premium for the remainder of the year will benefit Malaysia as a net exporter of oil. The Malaysian government also based its Budget 2019 on an average Brent of US$70 per barrel.

Year-to-date (YTD), the benchmark Brent oil contract is averaging just short of US$65 per barrel, but oil trading higher for the remainder of 2019 will help mitigate some of the revenue shortfall to be incurred if oil prices average below the government’s budget.

Innes said the most favourable investment sensitivity is in Malaysia as the country is a consistent net exporter of oil and gas, running a trade surplus in these products of 2.7% of GDP in the past year.

Oil prices driven by demand have historically been positive for equities in Asia-Pacific markets, while oil price spikes on supply shortages tend to be less embraced, he said in a research note on Monday.

Halley, meanwhile, said the attacks on Saudi Arabia’s oil production facilities could put a damper on risk sentiment.

“The caveat (is) that an increase in Middle East hostilities would probably see a rotation out of developing markets and into safe havens,” he said.

YTD up to Sept 6, foreign funds have sold RM7.62 billion net worth of Malaysian equities, largely driven by external uncertainties and lacklustre corporate earnings.

The oil supply disruption in Saudi Arabia was reportedly the worst in the history for the oil market, exceeding the supply loss noted during Iraq’s invasion of Kuwait back in August 1990 and the loss of oil output in 1979 during the Islamic Revolution in Iran.

Halley said oil reserves in storage can easily meet the production shortfall over the near to medium term, with OPEC and other nations also capable of making up the deficit. “The US and Saudi Arabia alone can meet this demand, but I would expect other OPEC nations and countries such as China to also announce deployment of additional reserves, if necessary, to calm markets,” he said.

Trump announced on Sunday that he authorised the release of oil from the US strategic petroleum reserve — a tool to keep the oil market well-supplied if needed.

Innes said he does not believe the US will need to use their strategic reserves as the supply void will be quickly filled by other OPEC nations, Russia and US shale producers.

“Offering up the strategic reserves is a goodwill gesture to the rest of the world (to show) how vital oil is,” he told TMR.