Crude oil price can top $80 but speed of recovery by Saudis will be key

Brent crude opened for trading this week, exploding 20 per cent higher, its biggest jump in 28 years after attacks on Saudi Aramco’s facilities. This led to the disruption of 5.7 MMbbl/d, which is close to 60 per cent of the gulf nation’s production, putting dent to global supply.

For now it is uncertain how long this disruption will last, but what is clear is that the longer this outage lasts the more bullish it will be for oil prices.

The US Department of Energy has said that it would act if needed, by turning to its strategic petroleum reserves, which stand at 645 MMbbl, which bring some floor to the prices.

At present, the US SPR held 644.8 million barrels of crude in four sites in Texas and Louisiana, including 250.3 million barrels of sweet crude and 394.5 million barrels of sour crude.

Oil prices came under pressure last week after US President Donald Trump fired National Security Advisor John Bolton. The move appeared to ease supply disruption fears. The vocally hawkish Bolton was seen by market participants as the main advocate for taking a tough line against Iran, including via military means.

Inventory report
Market gained support after data from EIA, which erased concerns of demand slowdown as US crude oil inventories fell sharply last week to their lowest since October last year on slowing imports. Gasoline and distillate stockpiles also declined.

Crude inventories fell 10 Mbpd compared with expectations for a decrease of 2.1 Mbpd. At 427.8 million barrels, US crude oil inventories were at a five-year average for this time of year. The decline was broadly in line with an 11 Mbpd draw API.

Net US crude imports fell in the week by 1.51 Mbpd to 2.9 Mbpd, while imports on the Gulf Coast region dropped by 387,000 bpd last week to their lowest on record at 1.2 million bpd. Crude production rose 200,000 bpd to a new weekly record at 12.5 million bpd. Crude stocks at Cushing, Oklahoma, delivery hub fell by 1.98 million barrels to their lowest since December at 40.4 million barrels
The US oil and gas rig count fell again this week, decreasing by 12 for the week. The total number of active oil rigs in the United States decreased by 5 according to the report, reaching 733. The number of active gas rigs decreased by 7 to reach 153.

Saudi Attacks
Oil prices rallied after 10 drones hit 7 MMbbl/d Abqaiq plant and 1.45 MMbbl/d Khurais oilfield in Saudi Arabia. The Saudi energy ministry said 5.7 MMbbl/d crude oil output has been affected, along with 2bcf/d of natural gas production.

There have been reports that production could return to normal in a matter of days, which if the case, means the upside would reflect more of a risk premium, rather than a significant tightening in the market.

If we see a disruption of only several days, then the market should be able to absorb these losses fairly easily. However, if outages start to run into weeks, this would leave the market increasingly tight.

Meanwhile, looking beyond the supply lost from this incident, the attack does highlight the vulnerability of the Saudi oil infrastructure. Furthermore, how Saudis plan to respond to the attack, is something that the market needs to price in as a risk premium for the simmering tension in the region.

The Saudis have said they will use inventories to meet exports. The nation’s crude oil inventories have been in steady decline since 2015, and this is no surprise with ongoing production cuts.

At the end of June, crude oil inventories stood at almost 188 MMbl, down from around 205 MMbl at the end of 2018. This is equivalent to around 26 days of crude oil exports. Current levels are likely to be even lower, with the continued deep production cuts that we see from Saudi Arabia.

Crude consumers in both North East Asia and India hold adequate oil reserves to cover any shortages of Saudi oil for a few months and refining companies have a wide range of alternative supply sources.

Brent could go to $ 80, while WTI could go to $ 75, but that would depend on Aramco’s 48-hour update. The supply problem won’t be clear right away since the Saudis can still deliver from inventory. 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.