(Bloomberg Opinion) -- Events in 2019 served as a reminder for just how vulnerable the world’s oil supply is, and Iran was usually blamed as the culprit for attacks on ships, pipelines and processing plants in the Middle East. But the knock-on effects blew over quickly in a world that appeared oblivious to the geopolitics of oil. Now in the wake of the U.S. killing of Qassem Soleimani, the Iranian general who led the Revolutionary Guards’ Quds force, the big question hanging over the market is whether Iran will target oil in its response.
There is no particular reason to expect that Iran’s retaliation will target oil, except that even the best guarded of the industry’s installations have been shown to be vulnerable and the steady stream of oil tankers passing through the Strait of Hormuz presents multiple opportunities to disrupt flows. About 34 million barrels of crude from Saudi Arabia, Iraq and Kuwait was passing through the channel on their way out of the Persian Gulf and toward U.S. ports last month, according to Bloomberg tanker tracking.
Attacks in September on Saudi Arabia’s oil processing facilities at Abqaiq and Khurais briefly took 5.7 million barrels a day of the country’s oil production capacity offline, the single biggest disruption in supply on record. It served as a wake-up call that the world’s oil security blanket — the spare production capacity that is almost uniquely held by the kingdom — was not nearly as secure as once was thought.
While responsibility was claimed by [[Iran-backed]] Houthi forces in Yemen, who have been on the receiving end of a Saudi-led aerial bombing campaign since 2015, the U.S. and the Saudis blamed Iran directly. United Nations investigators dispatched to Saudi Arabia were unable to verify U.S. and Saudi claims that Iran was behind the strikes. Iran denied it was involved.
Those attacks briefly sent oil prices soaring, but the rally was short-lived. A combination of a gloomy outlook for oil demand and quick action by the Saudis to calm markets by tapping stockpiles and spare capacity meant that prices were back below pre-attack levels within days.
Things look a bit different now, though. Oil prices have been on an upward trajectory since early October and the killing of Soleimani boosted them to their highest level since April.
Although forecasts for oil-demand growth in the first half of 2020 haven’t yet improved, the promise that a “first-phase” trade deal between the U.S. and China will be signed later this month has injected a little more optimism. Meanwhile, the supply side of the balance may tighten, although I remain skeptical about how much real supply will be removed from the market by the new agreement between the Organization of the Petroleum Exporting Countries and its big oil-producing counterparts (known collectively as OPEC+).
Saudi Arabia’s pledge to cut an additional 400,000 barrels a day beyond its agreed target would only take its production back to the average level it has pumped since March. Russian production of crude and condensate, a form of light oil extracted from gas fields, hit a post-Soviet high last year on an annual average basis. The exclusion of condensates from its new quota, which brings Russia into line with the OPEC countries, will make it easier to comply with its new output target — a quarter of the reduction in crude output by the end of December was offset by higher condensate production, according to the country’s energy ministry.
The supply-side tightness is more likely to come from the slowdown in U.S. output growth and the potential for further losses of supply from OPEC’s own Shaky Six. Higher oil prices may have allowed U.S. shale producers to hedge more of their 2020 production, but that won’t necessarily translate into increased drilling, or supply, as investors continue to demand tighter fiscal discipline.
Just-released official U.S. production data for October show output up by a healthy 170,000 barrels a day over September, but still 90,000 barrels a day short of where the Energy Information Administration had forecast it would be. Continued under-performance in the shale patch could tighten supply further in the coming months.
That tightening market means that any eventual attack on regional oil facilities might have a more prolonged impact than it did in September. That’s good reason for oil markets to be jittery.
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Julian Lee is an oil strategist for Bloomberg. Previously he worked as a senior analyst at the Centre for Global Energy Studies.
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