Oil Set To Spike After Report Saudi Repairs At Abqaiq May Take "Up To Eight Months"

While S&P futures may spike at the open following Saturday's news from the NYT that the "the delegation of Chinese agriculture officials that had planned to travel to Montana and Nebraska in the coming week didn’t cancel the trip because of any new difficulty in the trade talks" but "instead, the trip was canceled out of concern that it would turn into a media circus and give the misimpression that China was trying to meddle in American domestic politics", oil too is likely to catch a bid after the WSJ reported that it may take "up to eight month", rather than 10 weeks company executives had previously promised, to fully restore operations at Aramco damaged Abqaiq facility, suggesting the crude oil shortfall will last far longer than originally expected.

The official reason for the delay: the supply-chain is unable to respond to the Saudi needs. Specifically, Aramco is" in emergency talks with equipment makers and service providers, offering to pay premium rates for parts and repair work as it attempts a speedy recovery from missile attacks on its largest oil-processing facilities." 

Following a devastating attack on its largest oil-processing facility more than a week ago, Aramco is asking contractors to name their price for patch-ups and restorations. In recent days, company executives have bombarded contractors, including General Electric , with phone calls, faxes and emails seeking emergency assistance, according to Saudi officials and oil-services suppliers in the kingdom.

"One Saudi official said costs could run in the hundreds of millions of dollars", the WSJ reported.

The unofficial, and more likely, version: Aramco is unhappy with how quickly oil prices dropped after the "Iranian attack", and since its objective from the very beginning - especially with its IPO looming - was to get oil prices higher, and with its reputation to prevent "outside shocks" in tatters, it is now creating its own bottlenecks in restoring output. 

Workers at the damaged Saudi Aramco oil facility in Abqaiq; Reuters

Hinting at the second explanation is the fact that until now, Saudi officials and Aramco executives had been consistent in communicating statements aimed at reassuring oil markets that the state-owned company will recover quickly while continuing to supply customers as usual. Just yesterday, Aramco’s CEO Amin Nasser reiterated production would be back to its precrisis level by the end of the month. “Not a single shipment to our international customers has been missed or canceled as a result of the attacks,” he said. The company intends to return to its maximum output capacity by the end of November.

And yet, just a day later, unexpected price boosting bottlenecks emerge:

Saudi officials say there is little sense of calm at the highest levels of the company and the Saudi government, however. It could take some contractors up to a year to manufacture, deliver and install made-to-measure parts and equipment, the Saudi officials and the oil contractor said.

“We are still in a frantic search for spare parts,” one Saudi official said. “It is not really as great as rosy as you may think.”

The bottom line: the extent of the damage means a return to normal operations at Abqaiq could take up to eight months, said some Saudi officials. Most technical experts who have seen the destruction firsthand said they share that view.

“Repairing the damaged units will take time, anywhere from two to nine months depending on the damage, even if Aramco had contingencies in place and spare tailor-made equipment,” said IHS Markit in a note.

So what does it mean for the oil price if millions of barrels of oil in daily output will be delayed from coming back to market? Covneniently, SocGen had a report discussing just that scenario on Friday, in which it said that "if production recovery is delayed (or we have any other supply disruptions), prices do not decline, they rise toward $70/bbl on average. This is a very conservative view based on the simple linear regression shown below on the right. Typically, when time spreads are at the levels we would forecast, the observed flat price does not sit on the regression line. The cluster is above the line and corresponds with prices approaching something more like $75/bbl (red circle)."

In other words, at least $10/barrel upside from here from a mere production delay, is quite likely.

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But that's only in the short to medium term: here SocGen warns that in the longer-term "the higher the price goes, the harder it will fall" and explains:

Energy and oil use per unit of real GDP in the West has been in a steady decline of course. However, the risk remains that a price spike may contribute to both softening GDP and oil demand in the new demand centres (East), and to politicians’ renewed determination to speed up the energy transition away from fossil fuels. The oil majors will not suddenly abandon capital discipline, though they will benefit from the temporary margin and free cash flow expansion of a spike. But the higher the price goes, the harder it will fall. There are many precedents of previous supply shocks reviewed in brief on the next page. Historically, sharp disruptions and oil price spikes drive subsequent oil demand and GDP weakness. It is then just a question of the degree of a country’s GDP sensitivity to oil prices (manufacturing versus service economies) as to how serious that economic impact is. The US is more balanced nowadays between its large consuming sector and a large shale liquids producing sector. But the main drivers of global oil demand growth in the East (China, Japan et al.) will suffer negative effects from higher oil price.

The only question for Saudi Arabia is whether it can pull of the Aramco IPO in time, while Brent prices are still high, and before the "longer-run" arrives.