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A drama of supply and geopolitics

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The 14 September 2019 drone attack on Saudi Aramco’s oil processing facilities at Abqaiq and Khurais in eastern Saudi Arabia has left oil prices in dismay. What does this mean for the stability of Saudi economy and its credit profile?
THURSDAY 03, OCTOBER 2019

The attack on the world’s largest oil facility, processing up to seven million barrels per day of Saudi crude production, is said to be the biggest disruption to the oil market ever. According to industry estimates, damage to the two sites reduced Saudi Arabia’s oil production from about 9.8 million to 5.7 million barrels a day.

The 25-drone and missile attack wiped out approximately five per cent of the world’s oil supply and forced the Kingdom to shut down half of its oil production. This recorded the steepest price surge in 30 year, the biggest jump in oil prices since 1988. The attack caused spot Brent crude to spike 19 per cent to $71.95 per barrel at market open the next week before the oil benchmark slipped back to around $66 per barrel.

With fingers pointed at Iran for the attack, the Iranian government has categorically denied the accusations. Nevertheless, S&P suggests that the question that really concerns the market is what the response will be from Saudi Arabia, the US, and many Western nations if it’s believed that Iran supported or was behind the attacks.

The threat of an extended supply outage from Saudi Arabia, the world’s top crude exporter, highlights the lack of spare production capacity in the market, with the impact of this being felt across upstream and downstream markets.

However, in a recent press conference, Saudi Energy Minister Prince Abdulaziz bin Salman affirmed that production will be back to normal by the end of September, with another official indicating that the Saudi Aramco initial public offering (IPO) will continue as is.

Although this has brought a bit of calm to the oil markets, analysts are sceptical and say the numbers do not assure the oil markets about current production levels and that the outage will leave the Kingdom with little spare capacity, keeping markets on edge. Analysts at S&P have questioned the level of stocks still available to meet supply to Aramco’s customers as neither Prince Abdulaziz nor Aramco CEO, Amin Nasser shed light on the level of oil stocks still available.

Economic impact

According to Indosuez Wealth Management, a subsidiary of Crédit Agricole Corporate and Investment Bank, Saudi Arabia’s nominal GDP was SAR 718,543 million in Q1 2019. Crude petroleum and natural gas extraction represented approximately SAR 188,759 million and petroleum refinery was SAR 27,251 million, together representing around 30 per cent of nominal GDP.

Assuming that half of its daily capacity is lost, this would translate into a yearly GDP loss of 15 per cent, or 0.3 per cent per week. Paul Wetterwald, Chief Economist, Investment Intelligence at Indosuez Wealth Management explained, “The length of the loss of capacity is of the utmost importance here. The current oil price is now 10 per cent higher than its 2019 average.

Therefore, the loss in revenue for the Saudi government due to the decrease of production will be mitigated by the higher price.” Prior to the attack, the current oil price would not have been high enough to balance the Saudi budget.

According to the IMF’s fiscal monitor report in April 2019, the general government deficit could have been as high as 7.9 per cent of GDP in 2019, which translates into a deteriorating net debtto-GDP ratio. The IMF forecasted that the general government revenue would be 31.3 per cent of GDP in 2019.

“If we apply this rate of government revenue loss to this latter figure and taking into account the decrease in nominal GDP, this would push the debt to GDP ratio up to 50 per cent. This would make the Aramco IPO all the more necessary, at a time when it seems much less attractive. To conclude on a positive note, the rough figures that we have computed rely on an assumption that the disruption lasts for one whole year, which is a worst-case scenario,” said Wetterwald.

Credit profile

The drone attacks are undoubtedly a credit negative for the Kingdom’s credit ratings. However, Moody’s in a commentary does not expect it to leave a long-lasting impact on Saudi Aramco’s financial profile on the back of its robust balance sheet and strong liquidity buffers.

“This event however highlights the credit linkages the company has to Saudi Arabia both in terms of geographic concentration and more importantly exposure to geopolitical risk,” said Rehan Akbar, a Moody’s vice president.

Highlighting the geopolitical risks that entail, Steve Wood, Managing Director at Moody’s explained, “The attack on Saudi Arabian’s oil facilities highlights the role of geopolitical risk on oil prices, which will likely reflect a risk premium even after Saudi production resumes. Higher oil prices will help producers and hurt refiners in the very near term, but the longer-term effect on energy companies will depend on the timing and magnitude of Saudi Aramco’s lower production”

The International Energy Agency does not feel the need to immediately release emergency stocks, but according to reports, it has indicated the need to be prepared for an escalation of military conflicts between Saudi Arabia and Iran.

“The attack underscores Saudi Arabia’s exposure to geopolitical risk and a widening of the channels through which a crystallisation of such risks can impact its sovereign credit metrics by highlighting that oil production and vital oil infrastructure could itself be targeted and disrupted in a significant way.

Nevertheless, the ability to quickly restore production to normal, if confirmed later this month, would demonstrate an important degree of resilience to potentially very damaging shocks, and likely reflect a combination of strategic redundancies in Saudi Aramco’s processing facilities as well as very well managed operations and disaster recovery processes,” added Alex Perjessy, a Moody’s vice president.

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