U.S. shale drillers saw their share prices surge on Monday, lifted by the nearly 15 percent jump in crude oil prices following the attacks on Saudi oil infrastructure.
As of Monday, Saudi Aramco indicated that it would take weeks or months to fully restore operations at the Abqaiq facility, the largest oil processing complex in the world. Saudi production immediately plunged by 5.7 million barrels per day (mb/d), and while some was only sidelined for precautionary reasons, the latest assessments are that less than half of the disrupted capacity can come back online in the short run.
The attack has rattled the oil market and once again raised the prospect of regional war. Oil prices spiked on Monday, and could remain elevated for some time. The longer the outage, the more significant the price increase.
“Should the current level of outage be announced to last for more than six weeks, we expect Brent prices to quickly rally above $75/bbl, a level at which we believe an SPR release would likely be implemented, large enough to balance such a deficit for several months and cap prices at such levels,” Goldman Sachs analysts wrote in a note on September 15. “An extreme net outage of a 4 mb/d for more than three months would likely bring prices above $75/bbl to trigger both large shale supply and demand responses.”
Saudi Aramco is planning to drawdown inventories in order to keep shipments from falling while also bringing offshore oil fields online to replace some lost production.
U.S. shale drillers were the beneficiaries of turmoil in the Middle East. Chesapeake Energy was up nearly 18 percent on Monday. SM Energy surged nearly 28 percent. EOG Resources rose by 7 percent. And so on.
U.S. shale cannot help in the short-term. Despite wrong-headed descriptions in years past describing shale as a swing producer, it takes time to adjust drilling plans and to bring supply online.
But if WTI remains in the mid-$60s rather than the mid-$50s, supply growth could reach 2 mb/d next year instead of just 1 mb/d, Bernadette Johnson, vice president of market intelligence at consultants Enverus, told Reuters.
For its part, Goldman Sachs says that a $10-per-barrel increase in oil prices on top of its base case $60 WTI prices would result in an additional 0.4-0.6 mb/d in the next year.
One of the big questions is how longer-dated oil futures react to the outage, rather than simply the spot price of oil. On Monday, while futures for October delivery spiked by $7.70 per barrel, prices for September 2020 were only up $2.79 per barrel. That reflects a fear that the Abqaiq attack could wreak havoc in the short run, but that the effects will wear off by next year.
With a subdued backend of the curve, there is less of an upside to shale drillers. While the industry is short-cycle in nature, companies usually respond months after major price movements. Moreover, shale drillers have a tendency to hedge their next year’s production in order to provide some certainty and lock in prices. In that sense, a big jump in prices for 2020 contracts would be more beneficial than simply a short-term price spike, especially if it proves fleeting.
On top of that, some of the windfall bestowed upon shale companies at this particularly juncture would likely be used to pay off debt or be returned to shareholders in the form of dividends or share buybacks. The industry is under pressure to abandon free-wheeling drilling practices, to eschew aggressive drilling ramp ups every time prices rise a bit.
Meanwhile, a major release of oil stockpiles from the U.S. – or a coordinated release from IEA countries – would dampen the price impact from the Saudi outage.
With all of that said, the fact that futures prices a year from now jumped by around $3 per barrel at the start of the week is an indication of a swift return of a geopolitical risk premium, which had virtually disappeared earlier this year despite clear signs of turmoil. Some analysts argue that even after Abqaiq comes back online, we are now in an entirely new world where Saudi Arabia is suddenly no longer viewed as a secure, or at least as secure as it was prior to this past weekend.
Not only is that a problem because Saudi Arabia is a massive supplier, but also because it sits on the bulk of global spare production capacity.
“If it [the outage at Abqaiq] is long, which is what we are expecting, at least half of it, I think then that’s when you are going to see the panic set back in again because we don’t have enough spare capacity elsewhere to make up for the shortfall,” Amrita Sen of Energy Aspects, told Bloomberg.
A sustained price increase on the back end of the curve has huge implications for shale drillers.