Saudi oil under attack
No other facility in the world holds even remotely the same value for the global oil system as Saudi Arabia’s Abqaiq oil treatment facility, explains Pierre Noel.
A military attack on an oil treatment facility in eastern Saudi Arabia, claimed by Yemen’s Houthi rebels, has triggered a 50% decline in Saudi oil production. The attack at Abqaiq oil treatment facility on Saturday 14 September follows drone attacks, also claimed by Yemen’s Houthi rebels, on Saudi’s east–west oil pipeline, in May 2019. But unlike the latter, Sunday’s attack was a military success. It has resulted in an oil production loss of about 5 million barrels per day (mbd). Assuming that internal consumption will take priority – although Saudi Arabia could import refined products to mitigate the impact on exports – Saudi oil exports could dwindle from 7.4 mbd to about 2.5 mbd. This would amount to 7.5% of global oil trade.
This weekend’s attack is the archetypal event that oil security specialists talk about all the time, but never happens. It was a targeted act of military violence, carried out by a state or non-state actor, which managed to disrupt a significant fraction of global oil supply or trade.
Significant energy-supply disruptions have been triggered by wars in the Middle East, natural disasters in North America, strikes and civil unrest in Latin America, and the escalation of contractual disputes into political contests. However, never in the history of global energy markets has a malevolent act targeted at energy infrastructure been felt globally.
Satellite images released by the United States and published in the press point to a sophisticated military operation. Missiles hit tank-like infrastructure and other key assets with precision. A total of 17 to 19 targets seem to have been hit. Given how large an industrial complex Abqaiq is, it suggests not only capability in delivering the strike, but also competence in target acquisition and reconnaissance.
A strike at the heart of the global oil system
Abqaiq processes two-thirds of Saudi crude. No other facility in the world holds even remotely the same value for the global oil system. Only the Strait of Hormuz is a more strategic node in the system. Note that the disruption achieved by the attack, with a production loss of 5 mbd, represents a third of total current traffic passing through Hormuz (Iranian exports are running very low).
Given that Saudi Arabia has most of the unused (‘spare’) crude oil production capacity in the world, disrupting its production and exports has far more impact on the global market than if it were another producer, because it is more difficult to make up for the shortfall.
Terrorists from al-Qaeda in the Arabian Peninsula had tried to attack Abqaiq in 2006 from the ground, but they were stopped before they could reach any critical areas of the facility.
The importance of Abqaiq for Saudi Arabia’s reputation as a reliable supplier to the world, the ‘near-miss’ in 2006, the drone attacks in May 2019 and the climate of heightened tension with Iran – all of these factors point to an era of maximum security alert for Saudi Arabia’s oil infrastructure. It is quite remarkable that such a high-impact attack could be carried out in this context, with what seems to be relatively modest technical means.
Therefore, the successful attack raises questions about the security preparedness of Saudi Arabia. The Kingdom has failed to protect the foundation of its wealth and importance to the global economy. It is a blow to its reputation as a reliable supplier of oil, as well as to the prestige of its political leadership, and it might frustrate the recently relaunched plans to sell a share of Saudi Aramco, the national oil company, to international investors.
Oil-market implications and policy response
On Monday 16 September the oil price spiked with its biggest one-day jump since the 1991 Gulf war. The questions on traders’ minds are how long the disruption will last, and whether there will be retaliation and escalation into a regional war.
Saudi authorities are still assessing the damage and have not indicated how long it could take to repair. If the disruption lasts, US shale oil output will be boosted by the higher prices, while all other suppliers, including Russia and the United Arab Emirates, will increase their output as much as possible. Higher oil prices will also dampen further global economic growth and, therefore, demand for oil. Once Saudi Arabia has repaired its facilities, it could find itself in a very difficult situation, forced to let prices drop sharply to regain its market share and re-establish cartel solidarity.
The key question for policymakers in G7 countries and China is whether, and to what extent, they should release oil from government-controlled strategic oil stocks. Historical precedents show that governments are reluctant to do so early for fear that the crisis might last or worsen. Eventually, they do too little, too late. As the oil price spike ripples through financial markets, there are grounds to fear that this will again be the case.
The Trump administration and the International Energy Agency have both issued statements highlighting that commercial oil stocks are currently at a high level due to the relatively loose supply–demand situation, implying that the market will be able to cope. However, in order to avoid a damaging price spike, oil from strategic stocks should be released early and in large enough quantities to prevent a massive drawdown from private inventories.
As the US refuses to release oil from its Strategic Petroleum Reserve, oil market operators may conclude that the Trump administration is preparing to retaliate against Iran, and, therefore, that the crisis will worsen. It then becomes a self-fulfilling prophecy, as traders price a future crisis into their decision-making.
Therefore, from the perspective of oil-market stability and the US economy, Mr Trump should refrain from punishing Iran militarily and instead lead a large-scale, coordinated international strategic stock release, while the Saudis rebuild Abqaiq. This choice would entail a degree of humiliation for Saudi Arabia and could embolden Tehran. However, striking Iran could trigger a regional war with potentially catastrophic oil-security implications that would probably bring about a global recession. This, in turn, would seriously damage Mr Trump’s re-election prospects in 2020.