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Is Oil Poised For A Breakout?

Nick Cunningham

Oil prices are now only slightly higher than they were prior to the Abqaiq attack, but the outage injected a dose of upside risk to the oil market, which may not go away anytime soon.

Bank of America Merrill Lynch left its Brent oil price forecast for 2020 at $60 per barrel, but noted that the risks are more “symmetric” now. In recent weeks, a lot of analysts saw oil prices lingering at around $60 per barrel for the time being, but pointed to the trade war and the looming global economic slowdown as huge downside risks to oil. If prices were going to make any big moves, it would be down.

The Abqaiq attack has scrambled that outlook. The “steady drop in speculative positions in the oil market recently and relentless oil producer selling could be partly to blame for the muted price reaction,” Bank of America analysts wrote in a September 20 note. “However, the inventory picture is delicately balanced and, despite the weak macro, we believe risks to the oil market have become more symmetric going forward.”

The possibility of economic recession has not gone away, but there is also “upside coming from a variety of sources: light market positioning, potential delays to the tight Saudi production ramp up schedule, a possible escalation of tensions in the Middle East, increased strategic Chinese oil buying, a higher chance of a US-China trade deal, and slower US production growth.”

Bank of America said that it is “not hard to envision” a scenario in which a much greater volume of Saudi oil is held off of the market. With Brent at $65 per barrel, traders are pricing in a scenario where only 40 to 80 million barrels of Saudi oil is lost, but Bank of America said it’s possible that the disrupted total surpasses 100 million barrels.

“Any delays could quickly push Brent prices back above $70/bbl,” Bank of America analysts warned. “Also, retaliation risks hardly seem priced into current oil prices and most paths…likely lead to higher oil prices.”

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The Wall Street Journal reported on Sunday that it could take “many months” to restore full-scale operations at Abqaiq, rather than the maximum 10 weeks that Saudi Aramco said. Aramco is in “emergency talks with equipment makers and service providers” to accelerate repairs, but the WSJ says it could take much longer.

“We are still in a frantic search for spare parts,” one Saudi official said to the WSJ. “It is not really as great [and] rosy as you may think.” The WSJ added that it could take contractors a year to manufacture, deliver and install unique parts. Some Saudi officials said that the timeline for restoration of normal operations could stretch to eight months.

The danger for oil is that Saudi spare capacity is limited right now, so any further outages would have a pronounced impact on the oil market and on prices.

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“There are growing doubts that Saudi Arabia will really be able to offset the enormous production outages following the attacks on its oil facilities a good week ago as quickly as was initially announced,” Commerzbank analysts led by Carsten Fritsch wrote in a note on Monday. The odds of an escalation in military conflict is also not trivial. “In our opinion, this justifies a risk premium that should at least equal the current premium of approx. $5 per barrel.”

On Monday, Iran released the detained British oil tanker, the Stena Impero, which had been held since July. The move might soften tensions just a bit. British Prime Minister Boris Johnson said that Iran was likely responsible for the Abqaiq attack and he also declined to rule out British participation in a military response.

The UN General Assembly is also underway this week, where there could be efforts by the U.S. to build a coalition of some kind to counter Iran. But as the WSJ reports, Trump will face an “uphill battle” in his effort to mobilize international pressure against Tehran.

By Nick Cunningham of Oilprice.com

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