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Between Abqaiq and a Hard Place (Macro Macchiato 16/09/19)

However many billions the Saudis have spent on defence, it wasn’t enough to prevent the weekend attacks on Abqaiq. Half of Saudi oil production, around 5 Mn bpd, has been taken offline for an indeterminate period. Oil prices jumped by USD 20 per barrel on Monday morning, before falling back a bit to add abut USD 10 per barrel, which traders seem to accept as the appropriate geopolitical premium. How will the attack and its consequences bear upon the shipping markets?

  1. War risk in the region will rise. The problem is not that this attack happened, it’s that it could presumably happen again and again. The US is pointing its finger at Iran for the attacks and will use them to ratchet up pressure on the country. However, with John Bolton invited to pick a window conveniently just before the attack, there is one less hawk in the White House to advise immediate bombing raids on Iran. Knocking out Iranian oil production would make little difference to its exports, which have fallen to zero, officially. Setting off a full-scale regional war between Saudi Arabia, backed by Israel and the US on one hand and Iran, backed by Russia and China on the other, would be Bad News.

  2. Variable effects on inflation and GDP. The rise in oil prices is probably baked-in now. There is no viable alternative producer, though a combined Opec+Russia effort could go some way to plugging the gap in oil supplies. Higher oil prices will filter through to consumer inflation figures. How will central banks react, given that recessionary signals have pressured them to cut interest rates? Higher oil prices might drive a spike in inflation but they may also undermine economic growth rates, increasing recessionary risk and reducing oil consumption growth rates which are already below one per cent for this year.

  3. Variable effects on Forex. Higher oil prices will impact negatively on importer-consumer nations but positively on exporter-producer nations. There will be opposing pressures on growth and consumption and therefore on foreign investment and on forex rates. Variable reactions by governments and central banks will follow. Indebted, energy import dependent, developing economies face the biggest challenges. India, we’re looking at you.

  4. Bunker prices will rise. Just what we need, with IMO2020 looming…If higher oil prices are now baked-in, then higher bunker prices will follow. That may lead to an increase in demand for scrubbers, as ship owners seek the cheapest fuel, assuming it is available. If Saudi exports are replaced by heavier crudes produced elsewhere, then more fuel oil grades might be produced. Conversely, if Saudi crudes are replaced by more US shale and other sweet, light crudes, then more light ends will come out of refineries. Whether ship operators will be able to pass through higher bunker costs in total or in part remains to be seen.

  5. Tanker trades will alter. In the short term, Saudi exports have been cut by about three VLCCs per day, most of which are intended for the Far East, in particular for China. Assuming that China decides not to go for sanctions-busting purchases of Iranian oil, its most likely alternative supplier is Russia. China may also draw on the strategic petroleum reserve it built up in 2014-16 when oil prices were lower. Alternative Opec suppliers may add exports from the Middle East. West Africa faces logistical impediments to export growth. US exporters may find China links additional purchases to its trade discussions with the Trump administration. In previous moments of supply constraint, China has bought spot cargoes from Europe, in particular the North Sea, which may happen again. If half of Saudi production remains off-line for months, we may well see some buyers, like Japan and China switching from oil to natural gas imports to make up some of the shortfall in crude availability.

The Take Away

The out-turn for the shipping markets depends on the balance of these five consequences. Tanker markets will be most directly affected. If the loss of three Saudi VLCC exports per day can’t be replaced by other Gulf nations, then crude oil tanker tonne miles will grow, unless higher oil prices choke off demand by three VLCC loads per day. A five per cent reduction in global oil demand seems unlikely. It didn’t even happen in the maelstrom of the global financial crisis, so expect a short-term scramble for cargoes to drive crude oil tanker freight prices. Spot gas tanker markets may benefit if there is any fuel switching or if petrochemical buyers find gas feedstock cheaper than oil feedstock. Liner companies will press customers for bunker adjustment factors in the midst of what has been a rather damp peak season. Good luck with that! Bulk carrier markets are being driven by other fundamentals. They should not be derailed in the short-term. All ship operators will have to find a way to pass through higher fuel costs, beyond what was expected under the new emissions regime. Finally, the situation is extremely fluid, and all of these conclusions could change in short order.

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