Attack on Saudi Arabia: What We Know So Far | Stratas Advisors

Attack on Saudi Arabia: What We Know So Far

On Saturday September 14, a coordinated aerial assault took place against Saudi Aramco’s Abqaiq oil processing facility and the nearby Khurais oilfield. The attack, one of the largest on direct oil supply ever, took an estimated 5.7 mmb/d of Saudi Arabian production capacity offline. Saudi Aramco representatives have not yet confirmed the extent of the damage

or presented a recovery timeline, leaving markets to speculate on the length of the outage.

Oil prices have jumped on news of the outage, and will continue to react to updates in the weeks ahead. The attack has serious implications for both the fundamental balance picture as well as the geopolitical risk outlook in the region. Inside we outline the current major questions and potential outcomes.

What Has Been The Price Impact?

On Monday, Brent crude closed 15% above Friday’s level. The changes were relatively even between the major marker

grades. Brent, WTI, and Dubai all increased approximately 15%. However, given that these same crudes had lost nearly 20% between their 2019 peaks and September 13, prices have yet to even revisit their 2019 highs. The Brent-WTI

differential also saw a significant change, widening by 12% versus Friday close. The gap could have been wider, except that there is a belief emerging that the outage could open a window for increased US exports of crude or refined product to fill the gap. This is possible to a certain extent, but production limitations and export infrastructure limitations will place a cap

on possible volumes.

Future month spreads now show that markets do not expect a swift resolution to the outage although sentiment appears

mixed on the likelihood of a resolution taking more than six months. The Brent 13 spread closed Monday at $2.47/bbl, a

53% increase from Friday as the third month contract increased roughly the same as the front month. The Brent 1-6 spread

increased to $4.95/bbl, a 95% increase as the six month contract increased only 11% versus Friday’s close versus 15% for

Page 1 of 5 © 2018 Stratas Advisors. 1616 South Voss Road Suite 675 | Houston, TX 77057 | United States | +1.713.260.6426 | stratasadvisors.com the front month. Both time spreads are comparable to levels briefly seen after the May/June Strait of Hormuz attacks. The longer it takes for a comprehensive damage assessment and timeline of recovery to be released, the narrower these spreads are likely to get as markets assume the worst.

The outage has implications for not only flat prices, but differentials as well. The Brent-WTI differential widened 14% on Monday versus the Friday close. US crude could serve as a potential substitute in Asia for some of the missing Arab Light and Arab Extra Light volumes although not a perfect quality match. If exports tick up to meet that demand, the differential would likely narrow. In the meantime, the US system remains relatively insulated from any supply issues around Saudi Arabia and thus is not seeing the same level of sustainable price impact as other marker grades. The Brent-Dubai differential also widened, as Dubai saw less strength than Brent, however the spread remains below last year’s levels. The Brent-Urals differential initially widened significantly (from a discount of $0.63/bbl to a Brent premium of roughly $1/bbl) but this should tighten if Urals is called upon to replace missing volumes. India’s Energy Minister has already announced intentions to increased imports from Russia in the wake of the outage.

Given ample global supplies and an expected swift timeline of repairs, the bulk of price support will come from geopolitical concerns, not physical. After the initial uptick, prices are swiftly falling and are likely to retain a $5/bbl geopolitical risk premium. However, if another attack were to occur prices could spike by as much as $20/bbl before sliding down to a risk premium in the range of $10-$15/bbl. This would in part depend on the size of a follow-up attack and the reason – whether it was again unprovoked or a direct response to military or political retaliation for the first attack.

What’s The Damage And Who Can Replace It?

Current reports indicate that 5.7 mmb/d of oil production capacity has been taken offline. The 7 mmb/d Abqaiq oil processing facility and the 1.5 mmb/d Khurais oil field were targeted. The Abqaiq oil facility processes crude oil pumped from the Ghawar, Shaybah, and Khurais oil fields. These fields have a combined crude oil production capacity of 6.3 mmb/d.

Abqaiq is the primary processing center for Arab Extra Light and Arab Light crude oil in the country. Arab Extra Light is a light sour crude oil that constituted 36% of Saudi production in 2017. Arab Light is a medium sour crude, medium sour

crudes constituted approximately 53% of Saudi Arabia’s production in 2017. The oil is processed and then either exported

or sent to various local refineries. Crude oil processed at Abqaiq is typically sent to the Ras Tanura refinery, the Jubail

refinery, the Yanbu refinery and the BAPCO refinery in Bahrain. All told, Abqaiq processed approximately 50% of Saudi

Arabia’s crude oil production. The domestic refineries serviced by Abqaiq have a combined capacity of 1.1 mmb/d. The BAPCO refinery in Bahrain processes 260 mb/d of crude oil, with nearly 220 mb/d of that oil coming from Saudi Arabia via

the Abqaiq facility. Initial reports indicate that Saudi Arabia has suspended deliveries to the BAPCO refinery although

whether that is due to damage or strategic decision to meet export requirements is unclear. BAPCO has announced that it

Page 2 of 5 © 2018 Stratas Advisors. 1616 South Voss Road Suite 675 | Houston, TX 77057 | United States | +1.713.260.6426 | stratasadvisors.com will continue operations uninterrupted as it sources crude oil from international markets.

In short, Saudi Arabia is not only facing a significant crude oil disruption, but a disruption to refined product production as well. Estimates of how much of the impacted volumes will swiftly return to market have ranged from one half to one third of the impacted volumes. This would leave a gap of 2.9 mmb/d up to 3.8 mmb/d in global crude oil supplies. Saudi Arabia could theoretically reduce run rates at its own domestic refineries to ease some of the shortage although this would then leave the Kingdom short on refined products. With Abqaiq having serviced many of its domestic refineries, even a reduction in run rates provides only minimal relief. In the immediate term, Saudi Arabia has enough crude in storage to meet crude export demand for the next couple of weeks. The latest JODI data indicates that Saudi Arabia had roughly 190 million barrels in storage, which theoretically covers 33 days of a 5.7 mmb/d outage. But oil isn’t a perfectly fungible commodity and it is unclear what crude types have been stored versus what crude types were impacted by the attack. Globally, other oil stocks could also fill in the gap, although they would be far from completely filling in.

Stratas Advisors’ Global Hydrocarbon Supply team regularly monitors global supply, and per their calculations there is approximately 1.8 mmb/d of crude available from the remaining OPEC+ countries but much of this is unlikely to be a direct match for the missing volumes. However, with global run rates easing from their summertime highs, there could be an opportunity for unaffected refiners to step in and provide missing refined product volumes.

Saudi Arabia has scheduled a press conference for 1700 GMT Tuesday September 17, at which further clarity on the extent of the damage is expected. Based on satellite imagery available, Stratas Advisors engineers estimate that repairs will take three to five weeks. Damage to storage facilities can be repaired although adequate time is needed for repairs, inspections and testing before operations can resume. If there is damage to rotating and engineered equipment this can take more time to repair or replace. However, Saudi Aramco is well-positioned due to its size and scope to quickly source parts – either from its own warehouses or other facilities – as well as a global network of suppliers. Thus making it likely Saudi Aramco is able to find at least temporary solutions to the worst of the damage within the five week timeframe. However, this is uncertain until the full extent of damage is confirmed. This report will be updated after that announcement to provide additional supply-side details.

Who Is To Blame?

Houthi rebels, via an official spokesperson, have taken credit for the attack on the Abqaiq facility and Khurais oilfield and have threatened further attacks. However, it is highly unlikely that the Houthi rebels acted in isolation as an aerial attack of

this scale and complexity would mark an exponential increase in the group’s military abilities. The Houthi rebels have been in conflict with Saudi Arabia since the start of the Yemeni Civil War in 2015. Attacks have escalated significantly this year, as

Saudi Arabia remains the only visible foreign opposition force to the rebels after the United Arab Emirates’ withdrawal

earlier this year.

Page 3 of 5 © 2018 Stratas Advisors. 1616 South Voss Road Suite 675 | Houston, TX 77057 | United States | +1.713.260.6426 | stratasadvisors.com Previous drone attacks by the rebels have been much smaller in scope and effectiveness. The drones in Saturday’s attack had to travel over 800km while remaining undetected, and would likely have been guided via satellite link due to the distance. The distance that the drones would have had to travel in order to have been launched from the Houthi rebels’ Yemeni stronghold also raises the possibility that the attack originated from within Iran or Iraq’s borders. If the attack was launched from within Iraq’s borders it also raises the possibility that other militant groups could have been involved. Although security forces are still investigating the exact origins of the attack, it appears to be consensus that Iran was involved. Indeed, Colonel Turki Al-Maliki, spokesman for the Arab Coalition announced in a briefing on Monday that “The preliminary results show that the weapons are Iranian and we are currently working to determine the location” [of the origin of the attack]. The Arab Coalition discredits the rebels’ claim that the attack originated from within Yemen.

Iran has denied any role in the attacks. However, Iran has also repeatedly threatened to disrupt exports in the region as long as crippling economic sanctions remain in place. With sanctions dragging on, Ayatollah Khamenei has been under pressure from conservative hardliners in the country to respond more aggressively to US President Trump’s “maximum pressure” strategy. The dismissal of notoriously hawkish US National Security Advisor John Bolton could have also played a part in reassuring Iranian authorities that the current administration would be loath to resort to a military confrontation in most situations. The timing also coincides with a shake-up in the Saudi Arabian Energy Ministry as King Salman dismissed Khalid al-Falih and instead appointed his halfbrother Prince Abdulaziz as Saudi Energy Minister. The move appears partly to have been in preparation for the anticipated Saudi Aramco IPO. Saudi leadership has made no secret of its desire to swiftly and lucratively take a portion of Saudi Aramco public, but the deal is now likely to face additional impediments after Saturday’s attack.

Although Saudi Arabia has one of the top five military budgets globally, military forces appeared unprepared and unable to defend an attack of this magnitude. Radar used to monitor civilian and military aircraft was unable to detect the drones, and surface-to-air defenses were not in place at the facility. Saudi leadership will also likely point to the sheer size of exposed area (more than 814 km of shared border with Iraq, more than 2000km of shared border with Yemen) in explaining why an impenetrable defense is impossible. However, investors and allies alike will continue to question why defenses were not installed, as Saudi Arabia’s oil processing facilities are an obvious target for military disruption given their relatively concentrated area of vulnerability compared to the oil fields. Markets will closely watch future briefings from the Arab Coalition, Saudi leadership, and the United States for an indication of what potential retaliatory actions are being

considered. The potential for a sharp escalation in the conflict will provide price support even if the outage is quickly resolved.

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