American crude supply offers a plentiful alternative
Written on September 18, 2019
The attack on Saudi oil facilities over this past weekend knocked out more than half the kingdom’s current daily production of 9.8 million barrels, amounting to about 5% of global supply. To be sure, a major disruption that shattered investor complacency and exposed the vulnerability of an important global energy source. On Monday, the price of crude oil for nearby delivery shot up by almost 20%, the largest one-day move on record. A consensus quickly formed around the possibility of future similar attacks, necessitating increased risk premium and ushering in an era of permanently higher crude prices.
The incident also raised broader concerns. Investors are naturally wary of oil price shocks and for good reason. According to Steven Kopits of Princeton Energy Advisors, many of the recessions since 1945 have been triggered by Middle East wars and oil politics. The 1956-57 Suez Crisis, the 1973 Yom Kippur War and resulting oil embargo, the 1979-83 Iran-Iraq war, the first Gulf War in 1991 and the 2011 Arab Spring all produced negative economic fallout in the US and other advanced economies. See https://bit.ly/2kSJJ4j.
But what looked to be a potentially game-changing event in the markets on Monday morning was already fading in the rear-view mirror by Tuesday afternoon. Prices in the futures market had largely retreated to near levels seen before the attack after Saudi assurances that production capabilities would be fully restored in the next few weeks, sooner than initially expected. See https://fxn.ws/2knw84S . However, that is only part of the story.
Global crude supplies remain plentiful, especially as expanding shale production in the U.S. provides a reliable alternative to Middle Eastern oil. Already the world’s leading producer, domestic American supply is expected to increase by another 1 million barrels per day over the next year to 13.3 million barrels, an almost 50% jump from this time in 2016. Bloomberg reports that more than ten export terminal projects along the Gulf of Mexico coast are in the works to handle the expected surge, notably from the oil-rich Permian Basin. See https://bloom.bg/2kDMyX7. Ironically, according to Donald Luskin at Trend Macrolytics, OPEC was already looking to cut production among its member countries to offset the increase in American crude and prevent an outright glut in the marketplace. See https://on.wsj.com/2kTfL0f. He notes that the last thing the Saudis need in the lead-up to the Aramco IPO is a collapse in prices or a war with Iran.
Another limiting factor to any potential oil shock is the diminishing impact of the price of crude on the economy. In a Barron’s interview, Barry Banister, head of institutional equity strategy at Stifel Nicolaus figures that the $2 trillion spent annually worldwide on oil at current prices amounts to only about 2.6% of the $85 trillion global economy, far less than the 6.5% of the early 1980s. He calculates that even if crude were to average $100/barrel (from $63 currently) that figure would rise to only around 4%, still well below historical standards https://bit.ly/2knG7qS.
The lesson of the past several days, as calm has quickly returned to both energy and equity markets, is that Middle Eastern oil matters but not nearly as much as it used to in the past.