How To Play The Attacks On Saudi Oil Infrastructure

I am often asked about risks to the global oil supply. My response is always that the worst case scenario would be an incident that takes a large amount of oil production offline in Saudi Arabia.

Why Saudi Arabia? After all, the U.S., Russia, and Saudi Arabia are all global oil superpowers, with each topping 10 million barrels per day (BPD) in 2018. Below, I provide context and trading advice for this unexpected event.

Why Saudi Arabia Is Different

The difference is that oil production in the U.S. and Russia is diversified across numerous producers, and across a much larger geographical area. Saudi Arabia’s production is from a single entity — Saudi Aramco. Further, Saudi Arabia moves and transports a large fraction of the world’s production through relatively small geographical areas. That makes it extremely vulnerable to attack.

Those attacks happened early Saturday, when drones fired missiles at one of Saudi Arabia’s largest oilfields and the world’s biggest crude processing facility at Abqaiq. A total of 5.7 million BPD of production was taken offline, which represents more than 5% of the world’s oil production.

For perspective, according to the Energy Information Administration (EIA), between 2008 and 2018, the shale oil boom in the U.S. added 5.9 million BPD of oil to the world’s oil markets. That means that the attacks in Saudi Arabia knocked offline the equivalent of the entire U.S. shale boom. I have argued that without the U.S. shale boom, oil prices would have never dropped back below $100/bbl.

As an aside, imagine that the U.S. had banned fracking, and then 5 million BPD of Saudi oil went offline for an extended period of time. I can’t even imagine where oil prices might end up under that scenario. This event reminds us of the importance energy plays in our lives.

Multiple analysts expected oil prices to gap up by $5-$10/bbl as a result of the attacks, and indeed they did. The U.S. benchmark West Texas Intermediate (WTI) and Brent North Sea crude, on which international oils are priced, were both up double-digits at the first market open following the attacks.

The Impact on You

Should this event concern you? After all, isn’t the U.S. essentially energy independent?

First, yes, it should greatly concern you. Saudi Arabia issued a statement the day after the attack that said they could get maybe 40% of production back online quickly. They expect the rest to take a few weeks.

The ultimate impact on oil prices will be determined by how quickly Saudi can get production back online. If there are additional attacks, or if the situation there deteriorates, then all bets are off.

But this was an unprecedented attack on the global oil infrastructure. To my knowledge, there has never been another event that sidelined this much oil in a single event. More importantly, this attack has highlighted the vulnerability of Saudi Arabia’s oil infrastructure. That means that a fear premium will likely return to oil prices.

It is true that U.S. dependence on Saudi Arabia’s oil has declined, but oil is a globally traded commodity. We import and export oil. We are still a net oil importer, but even if we weren’t, global oil prices will impact prices in the U.S. Note that the jump in the price of WTI wasn’t that far behind the jump in the price of Brent after the attacks.

Oil that we import will go to the highest bidder, and there are Saudi customers that will be looking to replace oil imports. That impacts us here.

The biggest risk is that higher oil prices will put additional stress on the U.S. economy. While the housing crisis gets top billing as the cause of the 2008 recession, oil prices that had reached $100 a barrel for the first time were also a big factor. Higher oil prices lead to less discretionary income which leads to less spending.

How to Respond

How should you play this? First, as a consumer I would make sure that you top off your tank early in the week. Gasoline prices will almost certainly be headed higher later in the week. But as an investor, which sectors will benefit? None will benefit more than U.S. oil producers. They are highly leveraged to oil prices, and after being beaten down over the past year, their share prices will likely head higher this week.

This event will probably also cause more money to flee to safe havens. But you have to be really selective, because higher oil prices will help drive inflation higher. Make sure you don’t play it too safely and lose purchasing power in the process.

In any event, regardless of how bad this turns out to be, it highlights a major vulnerability that will probably bring back a fear premium to the price of oil. There aren’t that many oil vulnerabilities around the world capable of sidelining millions of barrels a day of crude oil, but the Abqaiq crude processing facility is certainly one of them.

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