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Oil’s violent swings reinforce Saudi Arabia’s key role in markets

September 21, 2019

BY Alexander Kalis
MANAGING PARTNER

By the MSN Money, 17 Sept 2019

The surge in oil prices after the attack on Saudi Arabian production facilities has reminded investors that the market is still largely driven by the world’s largest exporter, despite the flow of U.S. shale output onto the market.

The importance of Saudi Arabian exports for the global energy market and the prospect of future attacks in the region are a recipe for continued volatility, according to investors.

Supply fears saw Brent crude, the global oil gauge, soar 15% to $69.02 on Monday, its largest one-day climb since 1988. On Tuesday, Brent slid almost 6% to $64.95 a barrel, while U.S. crude futures fell 5.4% to $59.50 after Reuters news agency reported that Saudi output could return more quickly than initially expected.

Saudi Arabia remains the only country with meaningful spare capacity—supply that can be quickly turned on in an emergency. It also produces a variety of grades of crude that it ships to large Asian buyers such as China, Japan and Korea.

Some of those grades have different densities and other unique characteristics, meaning they could be difficult to replace, particularly for countries that have few other options to access crude.

The threat of supply shortages comes after worries about weakening demand had pushed down fuel costs for global consumers, relieving some pressure on the global economy that was feeling the effects from the U.S.-China trade war. Now, consumers could face higher retail gasoline and heating costs in the coming weeks, cutting into available income.

While other countries have sizable production potential, analysts say that supply can’t necessarily cushion the market when Saudi exports get disrupted.

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“It’s definitely a pretty harsh reminder of that,” said Rebecca Babin, a senior energy trader at CIBC Private Wealth Management. The disruption “was completely unexpected.…People are so hypersensitive to this because it’s a topic we had largely taken off the table.”

Ms. Babin said investors who had bet oil prices or shares of energy producers would fall, or used so-called short bets to hedge against drops, were unwinding those positions Monday, exacerbating the market’s moves. Some shares of producers including Devon Energy Corp. and Marathon Oil Corp. soared 12% or more.

The powerful moves came after short positions held by commodity trading advisers, or CTAs—many of which use algorithms to follow trends—in oil and natural-gas futures recently hit record levels, according to a JPMorgan Chase & Co. analysis. That could mean more big swings lie ahead.

“There’s definitely some unwinding going on,” Ms. Babin said.

The attacks over the weekend knocked out 5.7 million barrels a day, or roughly 5% of the world’s supply. They also targeted Abqaiq, the world’s largest crude processing facility and the heart of the kingdom’s energy infrastructure.

Satellite images of Saudi Arabia showed significant damage to complex, expensive pieces of equipment that could be tough to repair or replace, analysts said. The strikes were the latest in a string of attacks on the kingdom’s oil infrastructure in recent months as tensions continue between Iran and the U.S. and Saudi Arabia.

“This is the largest oil supply disruption on record,” said Jason Bordoff, founding director at the Center on Global Energy Policy at Columbia University. “People recognize that an asymmetric attack in the region can cause catastrophic damage to the most important oil producer in the world.”

Although the kingdom is trying to get production back online and use its inventories to avoid sizable shortages, the scope of the attacks fueled bets on higher energy prices as analysts weighed the specter of a broader conflict in the Middle East.

Said Haidar, head of New York-based Haidar Capital Management, purchased investments tied to Brent crude on Monday, betting that Saudi Arabia will struggle to get its production back online.

“This is going to last for a while and it looks like it has the potential to push prices higher,” he said.

Mr. Haidar also noted the U.S. lacks the capability to export much of its oil production. His fund sold the currencies of oil importers that could be hit by higher prices, such as India and Indonesia, and bought the currencies of countries that could benefit from the rally, including exporters Canada and Russia.

Despite Monday’s outsize swings, analysts said plentiful inventories around the globe could limit some of the gains until more details are released about the damage in Saudi Arabia. President Trump said Sunday the U.S. would be willing to dip into its Strategic Petroleum Reserve if needed to keep markets well supplied. The SPR currently contains more than 600 million barrels.

Analysts said they were also awaiting updates from the International Energy Agency, which said over the weekend it was still monitoring the situation but didn’t provide information about a possible inventory release.

Saudi Arabia held a series of calls with members of the Organization of the Petroleum Exporting Countries and other allies over the weekend and told producers that they wouldn’t need to respond with additional supply, Saudi and OPEC officials said Monday.

Until more details are released, though, investors said they expected momentum in the sector to continue, benefiting companies in a position to capitalize on higher prices.

“You absolutely have to look at U.S. shale producers and look at producers who are in the safest locations and have the lowest disruption risk,” said Shawn Reynolds, portfolio manager for investment manager VanEck’s natural-resources equity strategies. “There’s going to have to be a premium on those barrels and the companies that produce them.”

Others have been happy to take profits given the uncertainty moving the market.

Vinay Pande, head of trading strategies at UBS Global Wealth Management’s chief investment office, locked in gains on investments linked to the oil price Monday.

“My inclination . . . is to lighten up,” he said.

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