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The Abqaiq Attack – Fallout on Oil Market

Shebonti Ray Dadwal
Shebonti Ray Dadwal is Consultant at the Manohar Parrikar Institute for Defence Studies and Analyses, New Delhi. Click here for detailed profile

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    Shebonti Ray Dadwal
    October 07, 2019

    The September 14 drone strikes on Saudi Aramco’s Abqaiq refinery and Khurais oil field set off a flurry of writing about its impact on the global oil market. After all, Khurais is the kingdom’s second-largest oil field with a capacity to pump around 1.45 million barrels a day (mbd) and Abqaiq is the world's largest refinery processing around 4.9 mbd. The attack was believed to have affected 5.7 mbd or around five per cent of the global oil supplies leading to an immediate spike of 20 per cent in the international crude prices.1 However, with Aramco assuring early restoration of supplies, the prices subsequently came down though not to the earlier levels. Meanwhile, conflicting media reports that the prices will not be affected due to the comfortable supply situation as well as the slow pace of the global economy on the one hand, and that the prices have ended their bearish streak due to falling American inventories on the other have kept the global oil market tense, and with good reason.2

    First, the damage wrought by the strikes for which the Houthi rebels, fighting against the Saudi-backed regime in Yemen, have claimed responsibility was substantial. Of the 20 strikes, 17 hit their targets. Aramco officials claim that 30 per cent of the production has been restored and that it will return to its full capacity by the end of October. Notwithstanding Saudi claims, much will depend on whether full production can be restored, and supplies can be met through inventories and strategic stocks. There are reports that Saudi Aramco has told the Chinese refiners that there would be a delay in shipments for contracts already signed, whereas other Asian clients have been told that they would be supplying mixed crude instead of the usual Arab light from October.3 This lends to the speculation that a portion of the supplies may be coming from Saudi Arabia’s strategic oil reserves and not from Abqaiq, an indication that it may be a while before Abqaiq is fully functional. Some recent reports even suggest that it may take months.4

    Second, the Houthis have warned of further strikes on the Saudi oil facilities. Apart from that, tensions between the United States (US) and Iran are increasing following US and its allies accusing Iran of being responsible for the attacks and threatening retaliation, and Iran warning of an ‘all-out war’ in response. Although an imminent conflict has been ruled out for now, the new punitive sanctions that have been imposed on Iran’s Central Bank and National Development Fund of Iran are keeping the tensions alive.

    Third, the geopolitical risk premium on oil is likely to go up over the next few weeks, particularly if the Saudi claims of normal production by the end of September5 do not bear out. Moreover, over the last few months, the region has seen several attacks and seizure of oil tankers — by Iran and other countries — as well as Israeli attacks against the Iranian-backed militia in southern Iraq. On May 14, the Houthis had claimed responsibility for an attack on Aramco’s East-West pipeline, launched from southern Iraq. The September 14 attacks could also have originated from Iraq.

    Finally, much of the comfortable supply situation in the global oil market is due to the US production and recent laws permitting exports. However, its crude inventories are down over a five-year average and rig counts have dropped substantially due to low oil prices affecting the bottom lines of the smaller shale oil producers.6 Hence, while in the short term prices may not be affected due to shipments having commenced before the strikes, but in the longer term several factors may see a bullish trend returning to the market.

    India Hedging its Bets

    Of immediate relevance to most countries, including India, is the impact of a possible increase in regional tensions on energy markets. While retail oil prices in India have seen a slight increase, the potential impact on the global oil supplies was reflected in other parts of the Indian economy. The stock markets have been volatile given the concerns about potential Gulf conflict and growing domestic political turmoil in the US. The emergence of US as a dominant oil and gas producer could have a major fallout on the global energy market. There were also concerns that inflation would further rise following a rise in oil prices, and that the current account deficit would grow given India’s high oil imports (85 per cent), along with a fall in capital inflows.

    As for the possibility of actual disruption of supplies, there is no immediate shortage of oil as the market is balanced for the time being. Nonetheless, there are concerns that the political and security environment in the Persian Gulf region may worsen. While India’s supplies from Iran have stopped due to the US sanctions, supplies from the Gulf region per se may be affected if there is an escalation in the Saudi-Iran tensions, and prices may spike for the same reason.

    Saudi Arabia accounts for around 17 per cent of the crude imports and 32 per cent of the liquefied petroleum gas (LPG) requirements of India. With Aramco opting to focus on crude exports instead of refined products, there could be a shortfall in the weeks to come. Moreover, after the strikes, Aramco has offered to provide more oil to India, albeit of heavy crude as against previous Arabian light, to keep its export commitments as well as to replace the sanctioned Iranian crude.

    However, in the event of Aramco failing to deliver or if tensions in the region escalates, India will have to look for alternative sources. Following the attack on Abqaiq, India’s Petroleum Minister Dharmendra Pradhan held talks with the head of Russia’s largest oil firm, Rosneft, for supply of crude.7 During Prime Minister Narendra Modi’s recent visit to the US (September 21-27), talks were also held with the US oil and gas firms for increased supplies on concessional terms to help India tide over any potential shortages that may arise. India’s oil imports from the US as well as Africa and Latin America have already increased. Moreover, India has signed a term deal for the supply of liquefied natural gas (LNG) from the US,8 as India looks to meet its carbon mitigation goals by replacing carbon intensive resources like coal and oil.

    While the government is taking steps to tide over any potential shortages, concerns over supply disruption and resultant price spikes are likely to increase, affecting the already nervous market sentiments. With India’s strategic oil reserves currently holding only 12 days of stock, a prolonged supply disruption or price spike will have a trickle-down impact on the economy. Recently, the Asian Development Bank (ADB) slashed India’s growth forecast to 6.5 per cent for the FY 2019-20 from its earlier estimate of seven per cent,9 despite the slew of measures announced by Finance Minister Nirmala Sitharaman. India has already cut its oil imports from the Organisation of Petroleum Exporting Countries (OPEC) to 78 per cent from the previous 83 per cent in order to reduce its dependence on a politically volatile region.10 It is, therefore, time to look more seriously at alternative sources — both in terms of countries as well as alternative energy resources — as attacks on the Saudi oil infrastructure could lead to more geopolitical tensions in West Asia.

    Views expressed are of the author and do not necessarily reflect the views of the IDSA or of the Government of India.

    Keywords: 
    Energy Security
    Oil

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