Saudi oil strike| Where is crude headed and how worried should India be?

The disruptive weekend attacks on Saudi Arabian oil fields have left oil prices rocketing and geopolitical environment tensed. With around 60 percent of the kingdom’s output at stake and disruption in nearly 6 percent of the world oil production, there have been talks of further price surge. In the event of any further geopolitical action and escalation, near-term firming up in crude prices cannot be ruled out.

While the prices would remain elevated in the near term, we see prices to normalise in the absence of retaliatory action. Though the extent of damage and the restoration period is unknown at present, we do believe that there is capacity in the global markets that would be willing to grab the lost barrels. Large inventories, spare capacity and strategic reserves could also provide some cushion. This would enable normalisation of the crude supply sooner than anticipated right now.

In the shorter term, however, elevated crude prices could stand as a negative for Indian downstream oil and gas companies that source a major portion of their supply from the international market, which could get costly now. It would also mean higher raw material costs and lower margins for allied sector companies. However, higher crude price could bring short-lived respite for upstream oil and gas producers.

Nearly 60 percent of Saudi production at stake

In the early hours of September 14, 10 unmanned aerial vehicles struck the world’s biggest crude-processing facility in Abqaiq and oil fields in Khurais, triggering huge fires. Saudi Aramco, the kingdom’s state-owned oil company, said the attack has impacted nearly 60 percent of the kingdom's output and the company had to suspend around 5.7 million barrels from its production. This accounts for almost 6 percent of the world oil production. The price of Brent crude, the international benchmark, rose by more than 10 percent in the early hours of trading.

Iran widely alleged to be behind the attacks

For oil markets, this is one of the biggest disruptions surpassing all previous ones due to attacks and invasions. Houthi rebels, a Shia group backed by Iran, have taken the responsibility for the attacks. There have been previous smaller attempts by them to damage Saudi pipelines and infrastructure. However, anything of this scale has come as a shocker. Lack of access to high-end technology on its own by a rebel group like Houthis is the main reason why Iran is being suspected as the mastermind behind the attacks.

Escalating tension could spike up oil

Escalation in the current geopolitical tension in the Middle East and retaliatory measure are being anticipated currently. The US has indicated unrelenting support to ensure quick action against the suspects. Military action cannot be ruled out. In such a scenario, we expect sharp uptick in crude globally. Any escalation could also lead to further disruption in supplies and further aggravate the supply disturbance.

Huge inventories to make up for the lost barrels

Disruption in the crude oil supplies could lead to rapid drawdown of the global crude oil inventories in the medium term. The US has already ordered to release its strategic reserves in order to make up for the lost supply. According to latest estimates by IEA, OECD countries have nearly 2.9 billion barrels of commercial petroleum inventories and 1.5 billion barrels of strategic government-controlled petroleum reserves. OPEC nations, on the other hand, have around 3.14 million barrels per day of spare capacity which could enter the system. Combining both these, there could be ample cushion to make up for the barrels gone in the medium term.

Outlook

Crude import volume has been steadily rising in India, in sync with its total crude oil consumption. India imports almost 80 percent of its total crude requirements.

We believe that in a no-retaliatory action situation, the global supply would normalise sooner than expected.  Given the spare capacity with oil producing nations, inventory stocks and US shale production, we see the void to be filled up fast and eventual stabilisation of crude prices.

However, further escalation of geopolitical tensions in the Middle East remains the key to higher crude prices.  While the current uptick in price is in a manageable range for Indian downstream companies, very sharp increases might lead to eventual contraction in margin as they might have to shoulder part of the burden of rising prices.

If crude sustains current levels, along with the depreciating rupee, fiscal maths might come under pressure and RBI’s ability to go for aggressive rate cuts to revive the economy might get hampered. High crude will impact input costs for many industries, impacting earnings and margins.

Along with OMCs, fertilizer, gas downstream, petrochemicals, paints companies might see pressure on margins. However, it spells cheer for oil producers like Oil India, ONGC and HOEC by way of better realisations. But a sustained rise is not desirable for PSUs as they might then have to bear a share of the subsidy burden.

Overall, oil woes would further worsen the fragile economic climate facing India today. Having said that, the availability of spare capacity in global oil market, the slowing global growth outlook aggravated by US-China trade war and long-term transition towards environment friendly fuels make us optimistic that despite the short-term disruptions, the long-term outlook for crude oil remains benign.