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The weekend attack by 10 drones disabled Saudi Arabia’s Abqaiq oil refinery which processes about half of the country’s oil.

In theory the attack led to a temporary loss of 5% of the world’s oil production but in reality Saudi Arabia can cover the shortfall from its vast reserves which amount to roughly 26 days of current production.

This will give the state-owned oil producer Aramco some time to assess and deal with the damage which has currently put the production of 5.7 million barrels a day on hold.

The bigger problem is that the attack claimed by Yemen’s Houthi rebels involved 10 drones and took place more than 500km from where the rebels are located.

Attacks in the Gulf have become the new normal over the summer with a series of attacks on tankers in the Gulf of Hormuz, but the loss of oil from the Abqaiq is far bigger than the previous tanker attacks and the facility is much harder to defend than the Straits of Hormuz where the US Navy is at hand to protect the flow of exports.

Though a large number of Saudi troops protect Abqaiq on the ground, the facility proved as good as defenseless against airborne attacks.

Aramco has not yet said how long it will take to patch up Abqaiq and bring lost production back on line.

Simmering tensions

The attack will add fuel to the more than simmering tensions between the US and Iran despite the fact that Iran is denying involvement and the attack was claimed by Yemeni rebels.

The two countries have been heading towards a larger-scale confrontation ever since the US tore up the current nuclear agreement with Iran and imposed sanctions on the Islamic republic.

President Trump has already tweeted that the US is ‘locked and loaded’ and ready to respond to the attack, pending instructions from Saudi officials while Secretary of State Mike Pompeo directly accused Iran of the attack.

But despite the strong words, the US President is more likely to end up walking a fine line between threat and actual conflict because he is expressly interested in keeping oil prices low, which is in direct contradiction with a conflict in the Middle East.

Brent crude initially shot up 20% but then settled in the range around 10% higher on the day on Monday. WTI remains better buffered then Brent as the US decided to use its state reserves to plug any gaps in the market that may appear in the short term.

However, and there is a however:

Short term versus medium term oil trading

While the Middle East will remain a powder keg capable of blowing up in the short term, the broader oil market is actually sufficiently supplied with crude oil and there isn’t any actual shortage in the market. Over the summer the prices have slipped gradually to the mid $60 range and below reflecting concerns over what Chinese demand will be over the next 6 months to a year.

The engine of Chinese growth, industrial production, is gradually slowing down and in August slipped to 4.4% annual growth, the lowest in almost 30 years.

While it would be convenient to blame the US sanctions for the slowdown it actually has more to do with the fact that the boom we have witnessed since the late 1990s can not be sustained indefinitely at the rate at which it was going.

Typically global markets hang their hopes at China’s economy growing at over 6% to boost demand for various commodities including oil but it is beginning to look as if China may struggle to reach that pace this year and next.

This means that as soon as the geopolitical tensions in the Gulf calm down the oil price is likely to drift lower and stay lower.

Please note this article does not constitute investment advice. Investors are encouraged to do their own research beforehand or consult a professional advisor.

Vanya Dragomanovic

Vanya Dragomanovich

Vanya is an award-winning financial journalist who has worked in both television and newswires. She spent over 10 years at Dow Jones covering commodity markets, including metals, coffee, cocoa and oil. She also reported from the floor of the London Metals Exchange, and appeared on CNBC to discuss international metals markets. Since then she has written for several leading financial publications, including serving as commodities editor for FTSE Global Markets.

Vanya continues to cover international commodities markets globally, specialising in particular on metals and alternative energy. She is also the author of a book on CFD trading.

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