Confirmation from the Saudi Arabian energy minister that drone strikes had reduced the country’s oil output by around half is set to resonate across the energy markets, given that the country is responsible for around 10% of the world’s oil production.
Early trading on Monday has seen the price of oil increase from $60.22/bl to $71.95/bl for the front month ICE Brent Crude contract, a four month high. However, the contract subsequently surrendered some of its gains to reach approximately $66/bl, while price increases have also been seen across GB gas and electricity contracts in early activity.
The incident, which echoed a similar attack on Saudi oil infrastructure in August, has taken the Abqaiq crude processing plant offline. The site is seen as critical to Saudi oil production and, according to information released by state-owned oil major Saudi Aramco, processed around half of the nation’s crude oil production in 2018. Also hit was the Khurais oil field, the second largest oil field in the country, with the combined effect set to curtail oil production and exports alike.
Although officials in Saudi Arabia have indicated that they expect to compensate for the loss of production by drawing on the nation’s crude oil stocks, information from the Joint Organisations Data Initiative (JODI) released earlier in the year indicated that these inventories stood at their lowest level in over a decade – implying its ability to use these for any extended period may be limited.
In addition, fellow OPEC members – who have been adhering to production quotas to comply with the output sharing agreement the group has with Russia – may now be expected to provide more oil to the market to compensate for lost Saudi production. However, the two nations with the greatest amount of spare capacity – Iran and Venezuela – will not be able to respond due to the effects of US economic sanctions. The ability of the US to respond, despite its growing emergence as an oil exporter, is also limited due to the timescales associated with bringing new sources of production online.
At the time of writing, no formal statement has been made by Saudi Aramco as to the duration and severity of any outage, press reports indicate that more information may be available by the middle of the week. In its own statement, the International Energy Agency (IEA) said that it was monitoring the situation and that markets were “supplied with ample commercial stocks”.
This reflects the fact that IEA members are required to retain 90 days’ worth of oil imports in the form of emergency stocks, which may now be called upon, representing a slight cushion for the sector. However, the need to draw on this safety net – coupled with questions as to how fellow oil producers can work together to meet the shortfall – is likely to provide support to prices across the board until greater clarity emerges, with consequences for GB energy suppliers.
With an increase in oil prices expected to lead to a commensurate rise in gas and electricity prices, this will be reflected in higher tariffs for customers going forward, while existing fixed-price fixed-duration tariffs may also be withdrawn. There are also considerations in the context of the domestic tariff caps, which have recently had their total levels lowered by Ofgem, as suppliers may not able to fully pass through rising wholesale costs to all customers. The rise also comes at a key point in the financial year for suppliers, with Renewables Obligation (RO) policy costs due in September and the expected re-introduction of Capacity Market payments.
While trading and hedging strategies for suppliers and market participants need to be dynamic and reactive, addressing an event of which there is no immediate benchmark may lead to an attitude of “hope for the best, but plan for the worst”. Furthermore, coming off the back of the events of Tuesday 10th September when energy prices jumped in response to news from France, Belgium and The Netherlands (see our blog, “Wholesale gas and electricity prices surge amid perfect storm of adverse news”), the prospect of an oil-led commodity price spike raises the spectre of higher bills for customers.
Unfortunately, events such as the loss of a large share of production from one of the world’s largest oil nations are those that are very difficult to anticipate. Such instances are referred to as Black Swan events and – in line with the theory that underpins such occurrences – are outliers with an extreme impact, but which can be seen as predictable with the benefit of hindsight. It is also very difficult to mitigate the impacts of a Black Swan event, as they are typically due to factors external to the relevant market.
The risk to the GB energy market from internal and external events alike can have serious economic and commercial consequences for all market participants. The prospect of higher and more volatile prices caused by the uncertainty will typically cause traders to fear the worst – and price in risk premiums – until they have more information.
Our Energy Market Bulletin service consists of two products designed to ensure you can stay ahead of the game without taking valuable resources away from your core business:
- Energy Market Bulletin – bringing transparency to wholesale energy markets, this weekly report gives you the information you need to analyse and evaluate changes in the marketplace and possible impacts on your business
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