While strategic stocks around the world can be brought on line to allow time for Saudi Arabia to rebuild its facilities, the fact that the nerve centre of global oil supply has sustained an attack on this scale means an additional risk premium will now likely be embedded in the oil price.

Following the attack, oil prices jumped by a record amount, surging as much as 20 per cent intra-day, then paring the gain to around 10 per cent at the time of writing. Yemen’s Houthi rebels took responsibility, but the US blamed Iran, which backs the Houthi rebels.

It’s still unclear how long the outages will last, with media reports ranging from 24 hours to weeks. National oil company Saudi Aramco has said it will release a full update within 48 hours from Saturday night. If Aramco reaffirms that the impact will be short-term, then prices could stabilise; but they will probably still stay $3-$5 above previous levels. A longer duration could be much more meaningful and start to impact longer-dated oil futures, which tend to drive energy stocks. 

Inventories to meet shortfall, but geopolitical risk premium to persist

Fortunately, the world has plenty of crude inventories to meet any near-term shortfalls. Saudi Arabia has about 33 days’ worth of the impacted supply, or 188 million barrels. Meanwhile, refining customers are being reassured that they will still be supplied in full, according to media reports. In addition, the US and China have more than a billion barrels combined in strategic petroleum reserves. These could be gradually released to supply the market as the Saudi facilities are repaired.

Nonetheless, this represents a major escalation in the regional conflict and hawkishness towards Iran will only increase. Until now, this year’s oil market has mainly focused on the risks of soft demand, driven by the weakening global economy and the US-China trade war. This is a stark reminder of the ongoing geopolitical risk in the Middle East.

Saudi oil processing facilities were previously seen as relatively immune from large-scale threats, having thwarted all sorts of attacks on their infrastructure in the past. As the market re-prices the risk of Saudi supply disruption, we expect a 5 to 10 per cent geopolitical risk premium to be embedded into oil prices. Even if supply is restarted relatively quickly, as in weeks rather than months, this premium is likely to persist due to the shedding of this perception of immunity.

President Donald Trump said the US was “locked and loaded” to respond to the attack, pending confirmation from Saudi Arabia as to the culprit. If Iran was behind the drone attacks, then sanctions from the US could be more severe and long-lasting, while the likelihood of US military intervention goes up significantly. Both these factors could increase oil prices further. 

James Trafford

James Trafford

Analyst and Portfolio Manager

Justin Teo

Justin Teo

Investment Analyst