Here’s How The Oil Market Would Deal With Another Massive Saudi Outage

Crude slipped again on Wednesday after plunging in the previous session after new Saudi energy minister Prince Abdulaziz Bin Salman said the kingdom is well on its way to restoring production following the attacks on Aramco that crippled 50% of Saudi output.

Despite the pullback, prices were still some 6% higher than they were last week and generally speaking, analysts expect the market will henceforth be wary of failing to price in a geopolitical risk premium.

“Even if the current situation normalizes quickly, the threat of sidelining nearly 6% of global oil production is no longer a hypothetical”, RBC said of the strikes. “At a minimum, the attack is a key reminder that the geopolitical risk premium, which has long been absent, should make a pronounced return back into the market”.

Prince Abdulaziz’s assurances notwithstanding, prices are likely to spike anew in the event forthcoming intelligence reports from Washington and Riyadh suggest retaliatory strikes are in the offing. Those reports are imminent.

So far, Donald Trump and Mohammed Bin Salman haven’t demonstrated a predisposition to rush into an armed conflict (Trump’s “locked and loaded” bombast aside), but the public release of information directly implicating the Iranians will leave both leaders in a somewhat awkward position.

(Goldman)

“While the current Saudi outage may prove short-lived, risks of delays or new disruptions remain high”, Goldman writes, in a followup note to a lengthy assessment delivered on Sunday.

How might the market deal with another outage on par with what happened last weekend?

“The balancing mechanisms to offset a large oil disruption consist of (1) higher production from other producers, (2) commercial and government inventory drawdowns as well as (3) lower demand due to lower economic growth and price elasticities”, the bank writes, adding that “with a price-induced shale production response likely to take several months and demand adjustments typically observed over a couple of quarters, inventories as well as production spare capacity would act as the initial balancing mechanisms”.

For those interested in the specifics, below is a table from the bank which attempts to map out a hypothetical which, as noted on Sunday by RBC in the notes cited above, isn’t actually a “hypothetical” anymore.

(Goldman)

If you ask Goldman, the bottom line is that “the global oil market has enough resources available [between] Saudi and China destocking [and] core-OPEC spare capacity, to balance a larger outage without requiring an OECD SPR release”.

Given that, the bank is confident “that prices are likely to remain below $75/bbl Brent prices even if the outage proves much more persistent than current guidance”.

Of course, there’s no way to model “Reality TV show host invades Iran”, so you know, caveat emptor.