Drone attacks highlight Middle East oil vulnerabilities

Drone attacks on Saudi Arabian oil facilities earlier this month cut global oil supplies by some 5% and prices soared to above $71/b in direct response. Although progress is being made to bring shut-in production back online, and the oil price has fallen slightly, the market is expected to remain highly volatile amidst fears of repercussions.

Iran-aligned Houthi rebels in Yemen were initially reported to be the source of the 14 September 2019 attacks on Saudi Aramco’s Abqaiq oil processing plant and the Khurais oil field, which reduced company output by around 5.7mn b/d. However, the US blamed Iran, issuing satellite images and citing intelligence reports to back its claim; a charge that Iran continues to deny.

Saudi Arabia’s Minister of State for Foreign Affairs Adel al-Jubeir is reported to have warned Iran that if it is confirmed that the attack on the oil facilities originated from Iranian territory, it would be considered an ‘act of war’ and that there would be ‘consequences to their actions’. Meanwhile, US Defence Secretary Mark Esper announced government plans to send US troops to Saudi Arabia.

The pinch point of global oil supply has long been the Strait of Hormuz, with a fifth of global oil supply moving through the narrow waterway each day. However, a chain is only as strong as its weakest link, and the recent drone strikes on key Saudi Arabian oil and gas infrastructure has highlighted the vulnerability of oil markets to an attack on facilities in the Middle East.

Assessing what the current supply disruption could mean in the longer term to Saudi Arabia’s key export market of Asia, Wood Mackenzie Asia-Pacific Vice Chair, Gavin Thompson, notes that, collectively, Asian demand for Saudi Arabian crude is around 5mn b/d, making up almost three-quarters of the country’s exports. Asia’s consumption of Saudi exports is also heavily weighted towards lighter crudes, with Arab Extra Light and Arab Light grades making up around three-quarters of supply. Indeed, despite rising tensions in the Middle East, Asia’s dependence on Saudi crude has increased significantly over the past couple of years.

China, Japan, South Korea and India are the biggest buyers in Asia. Thompson reports that, while China and Japan are ‘most exposed on a volume basis’ – each averaging around 1mn b/d of imports from the kingdom – it is India that is most exposed, in the short-term at least. ‘I see this for two reasons,’ he says. ‘Firstly, while China has its Strategic Petroleum Reserve and additional commercial crude storage and Japan has International Energy Agency (IEA) reserves to fall back on, Indian strategic reserves are limited at around 37mn barrels, equivalent to only around 10 days of current consumption.’

‘In addition, while no oil-importing economy enjoys price spikes, India’s consumers tend to be hit harder. Last October, the Modi government cut taxes to protect end-users and so may have more limited room for manoeuvre if prices remain high. The high percentage of Indian spot purchases from Saudi Arabia exacerbates the problem.’

‘This leads to questions about the duration of the outage,’ continues Thompson. Saudi reserves are expected to be able to cover the shortfall over the next few weeks, with around a third of damaged capacity already claimed to be back online within a week of the attack. However, if full resumption takes longer, then ‘filling the gap with the right type of crude quality will be a challenge for Asian refiners who favour lighter crudes (Abqaiq and Khurais are main processing centres for Saudi Arab Extra Light and Arab Light crudes)’, he warns. Turning to OPEC+ is not a silver bullet as output is mostly medium and heavy sour crudes.

He continues: ‘For Asia’s refiners and petrochemicals producers, the spike in crude oil prices will dent margins further. As an additional thought, a prolonged outage and/or further upside above-ground risks in the near term could have an impact on the preparation ahead of the IMO marine bunker specifications change, although it’s still early to assess the full impact.’

Thinking about the longer term, it is worth remembering that the world is not short of oil. ‘Not even close,’ says Thompson, ‘even if the current loss of Saudi Arabian output has obviously tightened the market given global spare capacity is below supply initially lost on 14 September. As Saudi capacity is restored, and with additional output coming from the US, Brazil, Norway and Canada next year, in reality we can expect further supply cuts from OPEC+ to balance the market.’

However, with a growing dependence on Middle East oil imports, particularly from China and India, Thompson wonders what impact the September attacks will have on the longer-term thinking of Asia’s energy planners. ‘In terms of incentivising domestic oil exploration, this is pretty much a non-starter. Even though the drivers to produce more oil at home are clear, a near-complete lack of domestic significant oil exploration success in the region over the past decade means overall Asian oil output is only going in one direction, regardless of government support.’

Supply diversification then comes into focus. ‘The Saudi attacks highlight how vulnerable major energy infrastructure in the region is to relatively simple attacks. Could the dramatic impact of the attacks encourage further strikes? We all hope not, but put yourself in the shoes of a risk-conscious Asian buyer and you’re likely discussing greater diversification of supply. And while Asia will remain dependent on Saudi crudes for some time, non-Middle Eastern exporters, including the US, could benefit.’ He noted Sinopec increasing shipments of US crude following the attacks, even with ongoing trade tensions.

Looking further ahead, supply disruption and price spikes could also provide policymakers with more momentum in efforts towards greater fuel diversification and a sharper focus on electric vehicles in Asia’s cities. ‘Given the past week’s events, it’s not an illogical argument,’ Thompson concludes.

Abqaiq oil processing plant (prior to 14 September drone attacks)
Photo: Saudi Aramco