Liam Denning, MDT/Bloomberg
Brent crude is, once again, scraping $70 in the aftermath of a missile attack on critical Saudi Arabian oil facilities. Yet in every other respect, Monday is nothing like the last time this happened in September 2019.
There are obvious physical differences. The Ras Tanura export facility targeted over the weekend is the biggest of its kind in the world, as is the Abqaiq processing facility targeted two years ago. Yet Abqaiq is more critical to the actual production of Saudi oil; and it suffered real damage, whereas Ras Tanura’s operations appear unaffected.
Hence, while crude futures jumped 15% the day after the Abqaiq strike, they are actually slightly down as of this writing. And that explains a lot about what’s changed.
In the aftermath of the Abqaiq attack, Saudi Arabia acted quickly to soothe the market by drawing down on its own stocks of oil and rushing in repair crews. Yet oil-market fundamentals were weak that fall. Demand in the first half of 2019 had grown at the slowest pace since late 2016, when OPEC+ first felt compelled to come together. On the supply side, shale output was still surging: U.S. crude oil production jumped almost 1.3 million barrels a day in 2019, having risen by 1.6 million a day the year before.
This time around, the attack hasn’t affected oil flows. But the oil futures curve was looking strong anyway. Why? Because far from touting its ability to bring extra barrels to the market, Saudi Arabia just capped off another OPEC+ meeting where it promised to keep supply tight. After the damage inflicted by the Covid-19 pandemic, Saudi Arabia and its fellow oil exporters are keeping millions of barrels a day of production capacity offline to put a floor under prices.
Whereas in 2019, Saudi Arabia might have worried that a geopolitical shock would just encourage the frackers — for whom such disruption represents free money — its energy minister Prince Abdulaziz Bin Salman now feels confident enough to say “drill, baby, drill is gone forever.” Covid-19 was merely the coup de grace for a shale model that had lost the confidence of investors already. Today, the U.S. horizontal rig count is less than half what it was when Abqaiq came under fire.
And while oil demand is still well below pre-pandemic levels, it is expected to rise by more than five million barrels a day this year, and OPEC+ can be reasonably certain of grabbing most of that for itself. As an added bonus, the attack on Ras Tanura will likely complicate the Biden administration’s plans to revive the Iran nuclear deal, deferring the return of sanctioned barrels to the market.
I suspect the prince is right about drill-baby-drill’s demise given the havoc it wrought on sector valuations, with even Exxon Mobil Corp. forced to rein itself in. But OPEC’s own history should tell him higher oil prices always beget higher production in the end.
Another big difference between today and September 2019 is that the futures strip for Nymex crude oil — essentially the rolling average of 12-month forward prices — is back above $60 a barrel today. That’s where many frackers can profitably hedge production. While any excess cash flow this year is likely to be dedicated to paying down debt, the itch to boost production could prove irresistible in 2022 if prices remain here or go higher.
The forward curve isn’t a price forecast. But looking back at that chart of pre- and post-attack curves above, notice how all converge in the upper fifties. Over time, oil prices should track the marginal cost of production, and for most non-OPEC projects that could come onstream in the next few years, that breakeven price is $50 a barrel or less.
One thing that hasn’t changed since 2019 is that oil resources are abundant. And if prices rise on the back of tight supply — be it the result of missiles or ministerial meetings — those resources will find their way to the surface. Liam Denning, Bloomberg
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