Market underpricing Middle East oil risk
Last month’s drone attack on two major Saudi oil facilities made clear just how exposed Middle East energy infrastructure is to sudden disruption. The market, however, appears not overly concerned about this serious risk to global supply.
Crude prices spiked more than 10 percent on the first trading day after the Sept. 14 attack, but that increase was largely gone within a day. The apparent lack of concern has only strengthened in the weeks that followed – the cost of a barrel is now below the pre-attack price.
We think the attack on the Saudi crude-processing plants at Abqaiq and Khurais could portend riskier times ahead – escalating attacks and reprisals that could engulf the tense region, which is home to five of the 10 largest oil-producing countries, accounting for a quarter of global daily production and roughly half of the world’s proven reserves.
A disruption in crude flow would be felt almost everywhere in terms of price, but in terms of availability, the effects would be more localized. Europe and Asia, the biggest importers of Middle East oil, would be hit hardest – we think shortages could tip Europe into full-on recession and shave 2% or more from Asia-Pacific GDP growth.
The United States would remain well-supplied – domestic crude production along with imports from Mexico and Canada more than meet U.S. daily needs.
In our view, companies highly levered to U.S. oil production would stand to benefit greatly in the event of a Middle East supply crimp, with the revenue gains from a significant decline in crude availability more than offsetting any increase in cash costs.
While higher oil prices could further slow the global economy, even to the point of recession, we would expect the demand for energy to hold up fairly well. During the 2007-09 Great Recession, for example, global crude demand fell little more than 2 percent (from 86 million barrels per day to 84 million bpd).
Current oil demand is running at about 100 million bpd, so a similarly deep recession might be expected to lower demand by 3 million bpd. A Middle East disruption has the potential to cut up to 20 million bpd from current global supply (also 100 million bpd), so it’s easy to see how significant the price impact would be.
We are not saying a Middle East disruption is the likeliest outcome, but even at a 10 to 20 percent chance, it is a potential scenario that we think the market should be taking more seriously.