Energy markets underestimate Middle East supply vulnerability
Buoyed by ample supply, global energy markets continue to underestimate risks to output from the Middle East, despite the recent escalation in tensions between the United States and Iran.
This disconnect between risk and prices was highlighted in September when Iran launched an audacious coordinated attack using drones and missiles to hit Abqaiq, Saudi Arabia’s largest crude oil processing facility.
The attack knocked out nearly 6 million barrels per day (b/d) of supply but barely raised oil prices by $5 a barrel. Saudi Aramco tapped into its considerable inventories to supply full volumes of oil to its customers in order to avoid a global energy shortage and within weeks declared that it had restored the Kingdom’s oil production capacity to 11.3 million b/d, near pre-attack levels.
“This was the worst incident we’ve seen in terms of supply disruptions, and yet the effect was so transitory,” said Dr. Helima Croft, managing director and global head of commodity strategy, global research, RBC Capital Markets, LLC. Croft spoke as part of a panel at the Atlantic Council’s Global Energy Forum in Abu Dhabi, United Arab Emirates on January 12.
Complacency over risks and the belief that the market is abundantly supplied has meant that oil prices can no longer be used as a barometer of stability in the region. Instead of rising in anticipation of potential disruption, the market now reacts, briefly, before falling back on fundamentals. This is a very different dynamic to just a few years ago.
Earlier this month, US drones launched an unexpected attack in Iraq, killing Qasem Soleimani, one of Iran’s most influential military officials. Many commentators feared the onset of World War Three.
“And as extreme a view as that was, the minute the [retaliatory] missile attack happened on airbases in Iraq the view was it’s over—the escalation is over, this round is over, we’re back to where we were three months ago, everything’s fine, we’re back, the region is as normal,” said Amos Hochstein, senior vice president, marketing, Tellurian Inc. and a former top energy diplomat under the Obama administration.
Both reactions look equally flawed. “We are back to the same point that Iran is facing crippling sanctions without a clear path out of it, and it needs to get a clear path out of it. And if we don’t provide one, they will try to create one,” argued Hochstein.
Iraq’s vulnerabilities exposed
Soleimani’s Al-Quds Force, the international wing of Iran’s Islamic Revolutionary Guards Corps, hold sway over Iraq’s militias, as well as influencing proxies across the region, from Syria and Lebanon to Yemen.
With dozens of sympathetic militias, as well as considerable US interests, Iraq is a likely battleground. Along with militia attacks, any upheaval in Iraq could also risk recreating the conditions which allowed the rise of the Islamic State militant group. Both would imperil Iraq’s existing fragile oil sector and have a paralyzing effect on key upstream oil projects.
Unlike Saudi Arabia, Iraq would not be able to quickly recover from any attacks.
“I don’t think it’s clear at all that they [Iraq] have the type of redundancies that they could recover from it, again. And so I do think that we still have to be concerned about the Iranians going back to the more shadow wars in terms of the effects that could have on infrastructure, and Iraq is where I am most concerned,” warned Croft.
Beyond Iraq, there is an array of critical energy infrastructure across which remains vulnerable, which paradoxically, the oil markets do not appear to have priced in.
“There is this idea that we can have it both ways, believing that the US conflict with Iran will continue, that there will be retaliatory attacks, but also that the price of oil will remain that same as it is today,” said Hochstein. It is wishful thinking.
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