• OUTLOOK ARENA
  • SEPTEMBER 17, 2019

Saudi Drone Attacks - What Next?

Vijay Bhambwani

It was an unforgettable Saturday for oil traders last week.

Not since 30 December 2006 when Saddam Hussein was hanged, did oil traders feel this nervous.

Houthi rebels allegedly sent ten explosive drones to hit the Hijra Khurais and Abqaiq oil installations and caused heavy damage.

While I have been advocating higher oil prices in my articles this event is a shocker. Naturally, market traders have a lot of questions. I attempt to answer them below -

Question - Is the world running out of oil because of this attack?

Answer - No.

{inlineads1}

Do remember how a week ago, even falling US crude inventories could not revive oil prices. The Saudis were trying to get fellow OPEC members to cut output to boost prices. The Russians too have cut output. So oil reserves are not the problem here.

Abqaiq is an almost depleted oil well which needs EOR (enhanced oil recovery) techniques to keep pumping oil. The Saudis have a giant GOSP (Gas Oil Separation Plant) onsite. It is this plant that was severely crippled. So it's not the Saudi oil reserves that were hit but the oil refining capacity.

And capacity can be rebuilt. The wildcard here is the element of time.

Q - Did the Saudis hit their own installations to push prices higher?

A - Conspiracy theorists think so. Frankly, the thought did cross my mind too.

But the weight of evidence seems to point the other way. Why did the Saudis keep pumping oil even at US$ 30/barrel in 2016? They wanted to retain market share. They also wanted to drive US shale oil sellers out of the export market.

{inlineads2}

These threats exist even now. Also, the US is a net oil exporter now. The Russians are raring to export more. The utter horror of the Saudi administration will be if Iran (its bitter competitor) gains Saudi market share.

So far oil prices were "boosted" by causing chokepoints in Bab-el-Mandeb, Straits of Hormuz, Malacca Straits, and Somali pirates. These tried and tested formulae worked just fine.

My gut feeling is the Saudis probably did not set fires to these installations themselves.

They have more to lose than gain from zooming oil prices. Price rise is fine. A skyrocketing price is not.

Then there is demand destruction that occurs at high prices. Alternate energy becomes viable. Let us not forget the Houthis have bombed the Riyadh international airport recently using missiles from Beirut. Drones are tiny, maybe mistaken as birds on radar and lethal. I would give the Saudis a benefit of doubt.

{inlineads3}

Mathematically speaking, the probability of the attacks being stage managed is under 25%-30%. Besides, the Houthis have recently owned responsibility for the attacks.

Q - How high and how long will oil prices stay high?

A - Saudis have claimed losing 5.7 m barrels/day capacity. This is approximately 5% of global output and approximately half of Saudi daily output. Since this is a disruption of refining capacity rather than loss of reserves, the problem is not as severe.

A 5% temporary drop in supplies should not send oil prices beyond 20-25% higher on a sustainable basis.

Sure, a bear squeeze may cause sentiment based volatility but prices will stabilise sooner than you expect.

{inlineads4}

Remember the Gulf war of 1990, Gaddafi's killing, the London bombing? Crude shot up only to cool off within weeks. I expect this time to be no different. All we need is word from the Saudis that their capacity is restored. The fall will be as spectacular as the rally.

Q - What should I do with my portfolio?

A - Don't panic and leave it be. When you look back and think of Saddam's occupation of Kuwait, do you feel panic? No, right?

A few quarters from now, these attacks will evoke a similar response. Stay invested.

Remember, ships are safest in the harbour but that's not what they're made for.

Have a profitable day.

Warm regards,


Vijay L Bhambwani
Editor and Research Analyst, Weekly Cash Alerts

Copyright © Equitymaster Agora Research Private Limited. All rights reserved.
Any act of copying, reproducing or distributing this newsletter whether wholly or in part, for any purpose without the permission of Equitymaster is strictly prohibited and shall be deemed to be copyright infringement.

LEGAL DISCLAIMER: Equitymaster Agora Research Private Limited (Research Analyst) bearing Registration No. INH000000537 (hereinafter referred as 'Equitymaster') is an independent equity research Company. Equitymaster is not an Investment Adviser. Information herein should be regarded as a resource only and should be used at one's own risk. This is not an offer to sell or solicitation to buy any securities and Equitymaster will not be liable for any losses incurred or investment(s) made or decisions taken/or not taken based on the information provided herein. Information contained herein does not constitute investment advice or a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual subscribers. Before acting on any recommendation, subscribers should consider whether it is suitable for their particular circumstances and, if necessary, seek an independent professional advice. This is not directed for access or use by anyone in a country, especially, USA, Canada or the European Union countries, where such use or access is unlawful or which may subject Equitymaster or its affiliates to any registration or licensing requirement. All content and information is provided on an 'As Is' basis by Equitymaster. Information herein is believed to be reliable but Equitymaster does not warrant its completeness or accuracy and expressly disclaims all warranties and conditions of any kind, whether express or implied. Equitymaster may hold shares in the company/ies discussed herein. As a condition to accessing Equitymaster content and website, you agree to our Terms and Conditions of Use, available here. The performance data quoted represents past performance and does not guarantee future results.

SEBI (Research Analysts) Regulations 2014, Registration No. INH000000537.

Equitymaster Agora Research Private Limited (Research Analyst)
103, Regent Chambers, Above Status Restaurant, Nariman Point, Mumbai - 400 021. India.
Telephone: +91-22-61434055. Fax: +91-22-22028550. Email: info@equitymaster.com. Website: www.equitymaster.com. CIN:U74999MH2007PTC175407