The power struggle in the Middle East may well have taken a new and more immediate twist, potentially sending huge shockwaves through the oil markets once the weekend is over and electronic trading commences Sunday evening. As a result, the whole international LPG complex faces a major jolt, not only on the back of any spike in crude oil pricing but also potentially as a result of production cutbacks in Saudi Arabia. The knock-on effect could well be the most dramatic we have seen for some time.
On Saturday, a coordinated drone attack, believed to have been orchestrated by Houthi rebels, currently fighting the Saudi backed Yemeni government, struck two key oil installations at Abqaiq and Khurais inside Saudi Arabia. The damage included Abqaiq’s crude oil processing facilities, that handle nearly half of Saudi Arabia’s oil production, as well as fire damage at Khurais, which is adjacent to Ghawar, the world’s largest Oil field.
Abqaiq primarily processes crude oil from several key fields in the adjacent area, stabilizing the crude oil for onward shipment by oil tanker to the international markets. This process basically means stripping out the gas, including the LPG, in order to reduce the vapour pressure. The plant processes up to 7% of the world’s crude oil output, hence the concern. The Khurais field, as part of the mega project carrying the same name, produces around 300 M Bbls/d of Arabian light crude, with about 70 M Bbls/d of NGLs transported to Yanbu for fractionation. It’s not as big a field as the papers are making out, but it’s as much the intent that concerns market players as it is the actual damage.
The Yemen conflict has recently looked the most likely struggle to escalate in the region. It’s been going-on since the Saudi Arabia / UAE alliance, supported by the U.S., started bombing Yemen in 2015 in an attempt to restore the Sunni government and push the minority Zaydi-Shia followers of Hussein al-Houthi back. But the Saudi-led bombing campaign and port blockade has brought the world’s worst humanitarian crisis to an impoverished Yemen. The concern of the world is the fact that the Houthi’s are regarded as part of the regional network of militant groups aligned with, and backed by, Iran; both Saudi Arabia’s and the U.S. government’s greatest rival in the region.
Everybody is now speculating, where were the drones fired from, how many of them, what damage has been caused and what happens next. From reports circulating the press, there were 10 so-called suicide drones launched at their targets, pretty specific targets, given that these sites are 500 miles inside Saudi Arabia. Even the Houthi’s were thanking help from within the Saudi Kingdom. But the U.N. believes the Houthi’s have been given sophisticated drone technology with a flying range capability of over 900 miles (1500 Kilometres), together with top-level training by Iranian operatives. Without doubt, this has been the most audacious strike yet by the rebels, and most worrying is the susceptibility of these oil installations to such an attack. The last missile incident was thwarted by the Saudi military, yet the drones went undetected as they reached their target just before dawn on Saturday.
The news videos clearly depicted a very serious incident, with fire appearing to be spread over a wide area in the vicinity of both facilities. It is unlikely, that with such specialized equipment being used to process and stabilize the crude oil, that replacements can be quickly found, shipped and assembled. Crude oil production of 5.7 MM Bbls/d was suspended on Saturday, and although Saudi government sources have said that the fires are under control and that production will resume on Monday, the big questions are how much production is expected back online and how long it will take to get things back to normal. Then add in whether this type of direct attack using drones could happen again, the Houthi’s say it will if there isn’t an end to the bombing campaign, what damage that could cause and what will be the reaction in Washington and Tehran.
Therefore, the incident in itself, is likely to springboard the oil markets up to new heights next week, but it is the concern of an escalation in tensions among the U.S., Saudi Arabia and Iran, and its impact on oil supplies, that provides most trepidation, especially the resultant shockwaves that will hit the LPG space.
Directly, the oil price is likely to jump up, and if the damage is serious, then commentators are suggesting around a $10 /Bbl jump. If the damage is less serious, then maybe we are talking about $2 or $3 /Bbl increase. It should push the front of the curve up and the overall impact in the forward market will depend on the nature of the damage. The market is also going to try and price-in the increased risk scenarios of other attacks taking place. There should be a direct correlation between this movement in crude oil levels and the likely upward move in LPG prices. Products may react according to which refineries might be impacted if there are supply dislocations, but I’m not expecting this to be extreme until more information is known.
LPG players will be trying to gauge how much LPG production could be lost. The key is crude oil stabilization and if the fractionation units are damaged then this could be a serious problem. The LPG output from the two facilities could well equate to a similar 50% of total production and this could well have a greater impact on LPG exports. Currently, Saudi Arabia produces over 25 million Mt of LPG per annum, of which 95% comes from gas plant production, the balance from refineries. I would have to assume that the domestic demand of nearly 16.5 million Mt, for mainly retail and petrochemical use, will be preserved at current levels as best as Saudi Aramco can manage under the circumstances. The simple maths would suggest that for some period of time, up to 50% of LPG production could be lost. This is over 12 million Mt, and if domestic volumes were kept whole then exports would have to stop.
Of course, this is the extreme end of the discussion, but we are talking about a significant piece of hardware being severely damaged, and it appears the perpetrators knew this. Say production is cut only 25% and the problem continues for only 3 months, it’s still likely to cut LPG exports by up to 70% over that period. This is amplified by the fact that now is the time where demand starts to accelerate for the pre-winter buying in the northern hemisphere. And then there is the additional concern of China’s need to buy as much of their expanding LPG demand from non-U.S. sources due to the trade tariff war i.e. predominantly from the Middle East, the squeeze on Iranian LPG exports as a result of the U.S. / Iranian sanctions, and let’s not forget India’s buying patterns are heavily reliant, on not just Saudi Arabia, but also the other Middle East producers.
Keep an eye on the freight levels if exports are curtailed in any way, especially if it is over a longer period of time, but it does throw up an interesting angle for US producers. If the capacity is there, we might see a dramatic swing of buying interest into the US Gulf. Then my head gets into a spin! I guess terminal fees/resale levels may well push through double digits, ARBs widen, as long as freight levels don’t crater, and maybe production might start to rebound in the US, especially if WTI goes through $60 / Bbl or beyond. I think I’ll wait to see what happens at the opening bell and report more tomorrow!