TheBearProwl’s Take on the Saudi Aramco Oil Conflict

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Editor’s Notes: As the trader, Van Tharp once said, “You don’t trade the markets. You trade your belief in the markets.” When it comes to the stock markets, there are a million and one ways to make money from it.

Most if not all of us have a chosen strategy that we stick to. Whether we chase passive income, massive capital gains via buying undervalued/growth stocks, or even taking part in trading or cryptocurrency, we all have a bias and a belief.

Part of that means that in enabling our readers to reach that goal, we have to at times present content that is different and suited to the beliefs of a portion of our readers – there is after all, more than one way to succeed in the stock market.

Today’s article is one such example. Focusing on macro plays and event driven opportunities is by no means an easy task – but it can be massively rewarding.

Readers should be aware that you will need the right skill sets to come to a right conclusion, and that even so, you may not always come out ahead. All the same, we hope the content is educational for you.

Enjoy.

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Situation at Saudi Aramco

We have been following closely the developments with regards to the attacks on Saudi Aramco Abqaiq and Khurais oil production and processing plants. This is a very interesting development as the impact to oil price is notable, with the increasing geopolitical risk our macro trading portfolio is exposed to.

We have initiated a long December19 Brent Crude Oil contract at $63/barrel on 18th September.

We would like to share with readers our thoughts on the oil market going forward due to possible escalation to the Saudi – Iran tensions and why we think Saudi production plants will not resume full production by this week as of which they have assured the market on. Supporting research as below.

Critical Information

Saudi Aramco reported a drone attack on the morning of 14th September 2019.

Saudi Arabian officials stated that the attacks forced the shutdown of the facilities, cutting the country’s oil production from 9.8 to about 4.1 million barrels of oil a day, losing 5.7 million barrels of oil a day or about 5% of global production. 

This was just a few days before a pre-planned Aramco Initial Public Offering, thus making it obvious whoever the attacker is wanted Saudi Arabia to be in a weak position financially.

U.S Secretary of State Mike Pompeo was on the wires within 12 hours of the attack pointing fingers at Iran – not exactly a good image for him since investigations have yet to be concluded.

As expected, within 24 hours of the attack, a wide range of conflicting headlines, in particular – the USA – commented that Houthi rebels who took ownership for the attacks were not responsible for the attacks directly, but Iran was responsible.

There was also mentions of cruise missiles being used in the attacks against Khurais oil field in Saudi Arabia which is noticeable in the pictures provided from attacks by the US and official media.

[Pictures of attacked on  Abqaiq oil facilities, obviously attacked by precision drones]
[Pictures of attacked on  Abqaiq oil facilities, obviously attacked by precision drones]

On 19th September 2019, Saudi Aramco organised a media day, inviting around 80 international media personnel to their facilities in Abqaiq and Khurais.

It is interesting to note that this is a PR event before their pre-IPO assessment with their bankers on 25/9/19. Most of the videos and pictures taken by the Media occur at the Abqaiq area, which houses most of the processing plants.

Almost nothing was released with regards to damage done at Khurais which we think is very surprising as if there is something to hide.

We decided to look at the cruise missiles which Iran is capable of firing to see what kind of damage can be expected.

Satellite images on 17th September 2019, shows Khurais oil facilities still emitting gas flares, which seem to be those from a burning facility. Such pictures would be consistent with the US comments that cruise missiles were used in the attacks in Khurais, which is 200km west of the Al Mubarraz region.

We think no pictures were released by Saudi Amarco or the Media as there were not allowed to take pictures of the serious damage there.

The Khurais Megaproject began in 2006, is led by Halliburton for wells drilling, Snamprogetti for crude and utilities, Hyundai for gas. It is expected to cost $3 billion, and is expected to increase Saudi Arabia’s export capacity from 11.3 to 12.5 million barrels per day.

Serious damage done to the Khurais facility is a key game changer to Saudi Arabia as it threatens her position as the oil central bank of the world, given their key ability to increase production in case of sudden spikes in prices.

We are expecting total damage to take out of around 2 million barrels per day of Saudi oil production for at least 6 months. Saudi Arabia have commented after the attacks that all deliveries to clients are unchanged in October as they can tap on their excess reserves of around 60 million barrels.

Based on our assumption of a 2 million barrels per day loss of production, it would be a 30-day lifeline to rely on the excess available reserves before Saudi will have to either purchase from other oil-producing nations or declare force majeure on some contracts.

[Above chart shows oil production and net exports data for Saudi Arabia. Data is information compiled by BP]

Saudi Arabia have confirmed a 9.8M barrel per day production before the attacks.

Our assumption of a 2M Barrel per day loss of production will put Saudi Arabia on a negative oil flow perspective, and in particular the inability to process oil for their 8M Barrel per day export commitment to global customers.

They have already started sourcing for crude oil from other producers.

We are thus confident our assessment of further delays to full resumption of oil production and refining ability, with this prompting a structural change to the oil markets going forward.

Supporting Case Study from Suncor Energy Inc (2005)

Below taken from Suncor Energy Inc SEC filing after the fire incident.

Suncor Energy announced the occurrence of a fire at its oil sands facility, which started at approximately 9:15 a.m., Mountain Standard Time, on January 4, 2005. The fire was at Upgrader 2, a portion of Suncor’s Oil Sands plant near Ft. McMurray, Alberta, that converts bitumen into crude oil products.

The fire was completely extinguished on January 4, 2005. Suncor has begun an investigation into the cause of the fire. As of the date hereof, production at the facility is operating at about 110,000 barrels per day. It is not yet known when production will resume to full rates of about 225,000 barrels per day. Suncor will provide information pertaining to damage estimates and production impact once the investigation is complete.

The oil production facility only fully resumed production in Q3 2005, which is at least an 8 months downtime.

We think it is truly amazing how the market takes Saudi Amarco words in full fact of a full production resumption by end of September 2019, solving issues from a cruise missile attack in just 2 weeks, when plan supplies have to be shipped from Europe and the USA.

We think words from Saudi Amarco senior management have been carefully modelled to mentioned just the sales and refining capacity to meet customers requirement while hiding the true fact to actual production figures now.

Political Implications of the Attack on Saudi Amarco

24 hours into the attacks, US Sectary of State Pompeo is headed off to the Middle East for meetings to gather allies to build their case against Iran. The UK, France and Germany have also this week joined into the coalition condemning Iran on their actions.

While the investigation is on-going and Saudi have mentioned expecting full investigations to be completed in weeks, all options are on the table from military strikes, to further sanctions, we think the US is keen to use this situation to force Iran back to the table for a better deal.

We think a military strike against Iran drone and missile facilities is imminent in the weeks to come, and any further escalation in middle eastern tensions will be a positive for Crude oil. A serious tit for tat strike against Iran oil production facilities will further tighten sour crude supply.

Trading Idea

A non-directional play for this situation can also be in a form of oil crack spreads, easily executable via Long Brent / Short WTI June 2020 futures, currently valued at $5 premium, with historic highs above $20 premium.

Critical Points Concerning Macroeconomic Moves from TheBearProwl

  • All investors should be aware that the public narrative is more important than the truth as the public narrative is what drives the market
  • Knowing or believing in a certain truth helps, but it needs to surface and become the publicly accepted view before it becomes something that drives price discovery.

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