20 Sept 2019
Last weekend saw a major drone attack on Saudi Arabia’s Abqaiq oil facility, which processes in excess of 5% of the world’s oil.1 It is hard to overstate the importance of this unprecedented attack, which is a major test of the resilience of the Gulf’s oil infrastructure.
Approximately a fifth of the world’s oil output still comes from the Gulf.2 Not surprising then that on Monday oil prices posted their biggest intraday jump in 30 years, before settling in the high US$60s (Brent Crude). On Tuesday, oil prices fell back by 6% and spent the rest of the week drifting around the US$64-65 level.3 Markets took comfort from the Saudi energy ministry’s Tuesday press conference, which suggested that oil production would be back up to its previous level by the end of September and that all exports to customers globally would be met. The country’s ability to draw down reserves and use contingency capacity to offset supply losses also helped reassure markets.
If things play out as the ministry is suggesting, the whole episode will serve to demonstrate the resilience of Saudi Aramco’s oil contingency planning (as well as a degree of good fortune). But nothing is certain at this stage. At the time of writing, prices remained somewhat higher than the previous week’s close, reflecting the reinvigorated geopolitical risk premium and highlighting how investors had become complacent about Gulf tensions in recent months.
The impact on credit spreads in the Middle East has been relatively muted at the time of writing. Investment-grade Gulf spreads outperformed peers over much of the late summer before backing up somewhat given tight valuations and the fading technical tailwind of JP Morgan index inclusion (EMBI). Following the attacks, Saudi spreads underperformed marginally but regained ground as the week progressed.
Therefore, for investors in our sovereign debt strategies, the events outlined above have had limited impact. For our part, in August we had already taken profits on our Saudi Arabia long-dated sovereign bond exposure after the strong outperformance mentioned above. In our EM Corporate Credit strategy we remain comfortable with our positioning and have marginally added into the weakness.
What happens in the oil market is important for emerging markets. Beyond the direct economic impact on fiscal and trade balances of oil importers and exporters is a significant indirect impact on global economic growth, as higher oil prices act like a tax on the consumer. Consumers are one of the few bright spots against the current economic backdrop of weak investment and business sentiment, which the continued uncertainty around US-China trade dynamics is doing little to help.
The international response from here will be key, and it will be a difficult balancing act. With Iran considered the prime suspect behind the attack, the US, Saudi Arabia and its Gulf allies will want to impose costs on the country to deter it from launching a further attack. However, retaliatory action runs the risk of precipitating a wider conflict. With no obvious path forward to a negotiated settlement, either through returning to the Iran nuclear deal (JCPOA) or otherwise, we should expect periodic episodes of escalation and de-escalation. All of this will directly impact oil prices.
We believe that if prices remain in the low to mid US$60s this would be manageable, with limited impact beyond helping EM oil exporters at the margins, while perhaps weighing slightly on some of the more exposed net importers. However, if the geopolitical situation escalates and the oil price moves significantly above US$70 for an extended period, this would start to weigh more heavily on consumers .
As always, there would be winners and losers in emerging markets in a scenario of a persistently high (US$70+) oil price: