Geopolitical risk rises as attack highlights fragile oil supply chain

Geopolitical risk rises as attack highlights fragile oil supply chain

Moreover, the International Energy Association requires its members to hold strategic reserves equivalent to 90 days’ consumption and the US alone has about 660 million barrels in government reserves, with another 400 million or so barrels of privately-owned reserves. Donald Trump authorised the release of the US reserves at the weekend, if they are required.

The attack, and the role that strategic oil reserves could play when there is a major disruption to supply, highlights the potential importance of those reserves – and Australia’s paucity of them. We import all our fuel requirements but have only 28 days in strategic reserve.

The Morrison government has been negotiating with the US to get access to their reserves in any crisis, arguing that it would be a lower-cost option than buying and maintaining a reserve itself.

The weekend’s events underscore the urgent need for either an agreement to be reached with the US or the creation of a proper reserve of our own.

While the Saudis might be able to restore their processing capacity and global supply relatively quickly, the attack on the Abqaiq facility and the reaction of the oil market to the loss of capacity showed how tight the supply equation is if large slabs of Saudi capacity are taken out.

OPEC and some aligned producers such as Russia had been cutting supply to try to put a floor under oil prices that have been sagging as the global economy weakened but most of those production cuts have been borne by the Saudis.

Before the weekend there was a fear of an oil glut. The loss of the 5.7 million barrels a day would, if it were prolonged, have threatened a supply shortage.

Iran, which supports the Houthi rebels and has been accused by the US of being behind the attacks on its regional rival’s infrastructure, could make good any supply shortfall but has seen its production shut down by US sanctions. Another major producer, Venezuela, has seen its output crippled by its economic woes and US sanctions.

If the interruption to supply caused by the drones is likely to be short-lived, the impact of the attacks on the price is likely to be more lasting.

That’s because it highlights the vulnerability of key points within the industry’s supply chain.

Tensions – and the number of attacks on Saudi’s oil infrastructure – have been rising in the Middle East as a result of the reinstatement of the US sanctions on Iran by the Trump administration and the Saudi-led coalition of Middle Eastern and African countries’ intervention in Yemen’s protracted and bloody civil war.


Until the weekend, the oil market hadn’t responded to the Houthi attacks on targets inside Saudi Arabia, nor had it been moved by the escalating disruptions to shipping, including oil tankers, in the Strait of Hormuz.

The weekend’s events demonstrated how susceptible and fragile the key components of the industry’s supply chain are, which produced an immediate and significant response in the market.

That could be seen as a geopolitical risk premium and unless and until the US and Iran reach an agreement that sees the sanctions lifted and the stalemate in Yemen is resolved that premium might be a continuing element of crude oil prices.

The demonstration of the oil sector’s vulnerability hasn’t come at a good time for the Saudis.

Just over a week ago Crown Prince Mohammed bin Salman dumped his highly-respected energy minister, Khalid al-Falih, replacing him with his half-brother, Prince Abdulaziz bin Salman. He also appointed the head of the Saudi sovereign wealth fund, Yasir al-Rumayyan, chairman of Saudi Aramco, the world’s largest oil company, again displacing al-Falih.

The drone attack has come at an awkward moment for Crown Prince Mohammad bin Salman .

The drone attack has come at an awkward moment for Crown Prince Mohammad bin Salman .Credit:Reuters

Al-Falih is credited with the success of the Saudis in corralling OPEC and its aligned producers into production quota deals that have largely been complied with and also with improving the efficiency of the state-owned Aramco’s operations.

The Crown Prince has been pushing for, and preparing for, an initial public offering of 5 per cent of Aramco’s capital, with a hoped-for (and massively over-ambitious) initial market capitalisation of $US2 trillion. The IPO was expected to be launched either late this year or early in 2020.

The reshuffling of the effective leadership of OPEC and Aramco and the drone attack on the Abqaiq complex that processes half the Saudis’ crude oil output don’t exactly provide the kind of positive backdrop for a $US2 trillion float that the Crown Prince might have wanted.

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