(Bloomberg Opinion) -- Five bucks? Are you kidding me?
A mysterious attack took out almost six million barrels a day of Saudi Arabian oil supply, and almost a week later we’re up less than the price of a beer. Which means the market worked. Prices spiked in the immediate aftermath, and then soothing words from Saudi Arabia calmed everyone down to the point they remembered how bleak things look for oil in 2020. So prices fell again, albeit not the whole way back; after all, explosions are unsettling things – more unsettling than the price indicates, in this case.
Caught between the trade war and flashes of actual war, oil seems more preoccupied with the former. Saudi Arabia’s press conference on Tuesday was actually more ambiguous on the status of the country’s production than oil’s relief retreat implied. Still, it was enough for a broadly bearish market.
The most obvious risk that persists is retaliation. Both Saudi Arabia and the U.S. blame Iran for the attacks, and the risk of a counterstrike and further escalation is more gray than black swan now. The less-obvious risk concerns insurance.
The oil market relies on a lot of insurance, but insurance only works if you can count on it. And two of oil’s most important policies now look more ambiguous.
One is Saudi Arabia’s spare production capacity. The market treats this like oil inventories, only better, because it is effectively inexhaustible. Saudi Arabia’s 2.3 million barrels a day of it account for two-thirds of the world’s buffer (and much of the rest is in neighboring Gulf states). While the vulnerabilities of a critical site such as Abqaiq have been war-gamed for years, few actually expected a direct attack of this magnitude. Even by Saudi Arabia’s (likely optimistic) estimates, this previously seemingly untouchable capacity won’t be fully available until the end of November.
The other is something like a reinsurance policy supporting that spare capacity: U.S. security guarantees. Since Secretary of State Mike Pompeo’s swift accusation against Iran and President Donald Trump’s “locked and loaded” tweet, the White House has struck a more equivocal posture, swinging between threats and calls for diplomacy. Trump has also emphasized that while he backs Saudi Arabia, America’s own surging oil supply makes it less reliant on the region.
This may reflect mere political expediency, as U.S. involvement in a Middle Eastern conflict that sends pump prices higher would be a disastrous backdrop to Trump’s reelection campaign.
It is striking nonetheless that Washington has stayed its hand despite apparent certainty of Iran’s role in an attack on oil’s holy of holies. And the equivocation cannot be wholly dismissed, given the context of America’s newly transactional approach to alliances and guarantees that once seemed to be fixed points on the geopolitical map. Trump is more Barter Doctrine than Carter Doctrine.
Oil retains other insurance policies. The futures market is one, although there has been a marked withdrawal by speculative money of late, whiplashed by the unexpected and succumbing to a broader apathy toward energy in general.
There are also physical stocks such as the Strategic Petroleum Reserve and almost 3 billion barrels of commercial inventory in the OECD countries. While less clear, China may hold roughly another 820 to 940 million barrels of strategic and commercial stocks, Michal Meidan at the Oxford Institute for Energy Studies estimates.
Yet stocks are also an imperfect insurance policy. Mechanisms such as the collective releases envisioned for members of the International Energy Agency have seldom been used, even when oil prices spiked to economy-threatening levels. Trump’s tweets about the SPR last weekend suggested no coordination with other IEA members. In a real pinch, there’s a strong impulse to hoard rather than distribute for the greater good.
The unifying theme here is, oddly enough, fragmentation. As Sarah Ladislaw and Nikos Tsafos of the Center for Strategic and International Studies wrote in a report published the day before the Saudi attacks:
For several decades, energy security has been defined and pursued in a multilateral world with relatively open markets and technology transfer, where energy relations have become increasingly commodified. But that world may soon disappear - energy relationships might become more political, open trade might give way to friction, and great powers might leverage energy relations or energy technology to gain an edge over each other.
Oil’s postwar rise to preeminence in energy has been a testament to globalization, underwritten largely by muscular U.S. commitment to free markets. Oil became ubiquitous not merely because it is useful but because we regard it as effectively ubiquitous.
Energy dominance, like trade war, is a radical departure from the world we have known, whereby the free flow of molecules cannot necessarily be taken for granted. One of the biggest developments in energy of the past two decades is the increasing globalization of regional natural gas markets, making them more like oil. But it’s possible we’re entering a period where oil is reversing to meet gas in its less-integrated arena.
We aren’t there yet. But energy’s vital importance means national interest asserts itself quickly if confidence in the security of supply deteriorates. A more disjointed energy market is a jumpier energy market, which in turn pushes importers to seek alternatives for strategic reasons, on top of existing climate concerns. The week that began with explosions in oil’s heartland is, after all, ending with mass protests against it across the world. Those explosions in Saudi Arabia didn’t change the world; rather, they illuminated that which is changing already.
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Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal's Heard on the Street column and wrote for the Financial Times' Lex column. He was also an investment banker.
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