Supply risks remain, Brent price likely to rise back to $68-69 zone

Oil prices have remained strong in the wake of the attacks on Saudi Aramco’s infrastructure. The largest-ever disruption of crude production in Saudi Arabia amid drone attacks on its key facilities may keep oil prices elevated in the near term. Global oil supplies may be adequately met through large inventories and strategic reserves, however, moderation in oil prices will depend on full restoration of Saudi’s production, which may at least take a few weeks. Any further escalation of geopolitical tensions in the Middle East may add to the woes.

Prices got further support after US President Trump ordered a substantial increase in sanctions against Iran. The latest sanctions affect the Central Bank of Iran and the National Development Fund of Iran, the last remaining source of funds. The impact of the new sanctions on the development fund depends on how active or well-funded it is. If the fund has access to oil revenues the sanctions could have an impact.

On the other hand, Storms in Texas also triggered the shutdown of some pipeline and terminal capacity, but the impact on the market is not yet clear as it coincides with a period of extensive refinery turnarounds in the region. The temporary threat to refineries raised concerns about motor fuel supplies while putting pressure on crude in Thursday’s session on expectations for reduced demand.

Inventory report
A bearish inventory report from the US Energy Information Administration (EIA) did little to bring oil prices down. An unexpected 1.1 Mbpd jump in commercial crude stocks against forecasts calling for a 2 Mbpd drop and an API report of a 592,000 barrels increase. Total crude oil in storage was at 417.1 million barrels, 2 per cent lower than the five-year average for this time of year. The Cushing oil stocks were at their lowest level since October 2018 and there was a 3.7 per cent YoY drop in imports. Domestic oil production increased slightly at 12.43 Mbpd.

The US oil and gas rig count fell again, decreasing by 18 for the week. The total oil and gas rig count now stands at 868 or 185 down from this time last year. The total number of active oil rigs in the United States decreased by 14 according to the report, reaching 719. The number of active gas rigs decreased by five to reach 148.

Saudi Arabia oil attacks
Aramco is determined to keep export levels from falling, choosing to draw down inventories to keep shipments unaffected. It is also opting to slash refining throughput by about 1 mb/d, which will cut into product exports but will free up crude. Currently, a lot of October arrival barrels were already on water so hole is going to show up toward late October. The actual long-term impact of attacks on the Saudi oil infrastructure is still difficult to judge because the country is likely to play down any potential problems given the importance of its customer relations and the upcoming IPO of Saudi Aramco. If Aramco loses its perception as a reliable supplier it would have severe implications for its valuation when the company goes public.

There are reports that the Saudi government is bullying wealthy facilities into buying its IPO to ensure its success. Riyadh is clearly concerned about the perception of Aramco in the wake of the Abqaiq attack. Also, news surfaced that Saudi Arabia is importing oil from Iraq to cover its obligations for customers, which raised questions about Aramco’s ability to keep exports level. But if one of the world’s largest oil producers and exporters is suddenly scrambling to import oil that raises some red flags. For its part, Aramco denied having asked Iraq’s state-owned oil marketing company for oil.

The other interesting factor is the price reaction for physical crude told a somewhat different story to that of the futures market. Dubai swaps for January gaining 13 per cent in the wake of the attacks, while the equivalent Brent contract rose 12.7 per cent.These may not seem like massive differences, but the fact that physical crude prices rose by more than futures indicates a level of concern among the actual traders and consumers of crude oil that is somewhat higher than those investors in the paper market.

Natural Gas
Natural gas futures closed lower, fuelled by a larger-than-expected government storage report and a warm pattern into October that could curb heating demand. The potential for the widespread above-normal temperatures in the forecast to start having an impact on demand as the calendar flips to October and as warmer-than-normal weather extends further into October, air conditioning demand will largely disappear and early-season space heating demand will remain depressed. The EIA reported an 84 Bcf injection into US natural gas storage compared with the consensus estimate of 75 Bcf.

Outlook
The risk of high-impact attacks against Saudi energy infrastructure is high and there is a clear risk of a slower restart to Saudi Arabian oil production despite the optimistic guidance by Saudi Aramco.

Unless repairs happen much quicker than Rystad expects, it is estimated that the Abqaiq processing facility will only reach 90 per cent capacity by October end. Given that there is a consensus that Iran was the source of the attacks, the market is now awaiting any possible retaliatory action by the Kingdom or its allies, including the US, Brent could go to $68-$69 in light of geopolitical risk that push prices higher.

It is not just the flat price that is poised to move higher, nearby time spreads are also likely to move deeper into backwardation, reflecting the tightening in the prompt physical market.

(Investors are advised to consult financial advisers before taking an investment calls based on these observations)