Reflecting on September 2019
What has happened?
The price of oil has experienced a volatile month. Brent crude, the international benchmark, began the month at a level of $60.4 per barrel and intra-day has traded as high as $71.95 and as low as $57.23. The difference between its highest and lowest closing prices, at 18.5%, is the largest since December 2018.
The predominant driver of the oil price volatility this month has been events in Saudi Arabia. On 14th September a series of drone strikes hit the Khurais oilfield and the Abqaiq oil processing facility, the largest in the world. This resulted in the loss of 5.7 million barrels per day of crude production, approximately 5% of the world’s supply. Iranian-backed, Yemeni rebel group the Houthis claimed responsibility, adding to already elevated tensions between Saudi Arabia and Iran.
Brent crude spiked by almost 20% on news of the attack and traded as high as $71 per barrel while it was unclear exactly how long it would take to return supply to the 10m barrels that Saudi Arabia had been producing before the incident. Oil futures subsequently pared their gains as it became apparent that it wouldn’t take them very long, with 80% of production restored within ten days and Saudi Arabia announcing yesterday (3rd October) that output is back to pre-attack levels. At the time of writing the price of Brent crude is trading at close to its lowest level since January.
What should you take away from it?
Geopolitical events and supply shocks have been a common feature of the oil market since the creation of OPEC in 1960. The size and the duration of subsequent oil price rallies have varied and have been contingent on a number of factors.
The first, as we have seen in the most recent incident, is how quickly lost supply can be restored.
Second, is whether there is any spare capacity in the market that can take up the slack, should the production outage be long-term. For example, had the Saudi outages been prolonged, OPEC countries could have cancelled the production cuts that are currently in place to support the oil price. Additionally, strategic petroleum reserves (SPR) could be deployed. SPRs are oil inventories that are held by governments as backup in order to support their economies in the event of an energy crisis. The US SPR held 645 million barrels of oil as at the end of July 2019 according to the US Energy Information Administration.
Third, is whether there is the potential for the cause of the supply shock to be drawn-out. For example, the 1973 oil crisis was a result of an embargo by members of the Organization of Arab Petroleum Exporting Countries (OAPEC) on a number of countries, including the US and UK. The embargo lasted for close to six months, during which time the price of crude quadrupled.
The impact of supply shocks can be significant, with higher oil prices often a hindrance to global economic growth. Currently, with concerns over the global economy, a sustained rise in the price of crude would be especially unwelcome. With Saudi Arabia able to restore production quickly, this hasn’t proven to be the case. However, with tensions still elevated between Iran and Saudi Arabia, it is something to keep an eye on going forward.
Please contact your Investment Manager should you have any questions.