Iran Crisis - Far From Over

Published September 20, 2019 | 3 min read

Helima Croft recently returned from the Middle East, where she attended the 24th World Energy Congress and OPEC’s Joint Ministerial Monitoring Committee Meeting. Whilst at OPEC, Helima interviewed HRH Prince Abdualaziz Bin Salman in his first public appearance since becoming Saudi Arabia’s Energy Minister. In this article Helima and Michael Tran provide their views on the “unprecedented attack on Saudi Arabia’s energy infrastructure” and where the ongoing Iran standoff is heading.

Once again, we believe market participants are far too optimistic about prospects for de-escalation. The Islamic Revolutionary Guard Corps (IRGC) and proxies are unlikely to halt attacks on energy infrastructure unless President Trump pulls back sanctions. While unclear how much additional pain the US Treasury can impose on Tehran, President Trump’s announcement will likely lead to further shows of force from the IRGC as they seek to dictate the terms of any truce. With senior officials in Saudi and US publicly blaming Iran for the unprecedented attack on Aramco’s facilities, and Secretary of State Pompeo calling it an “act of war”, we think risks are high and that this conflict goes kinetic before year-end. Another major attack on Saudi would likely lead Crown Prince Mohammad bin Salman Al Saud to greenlight a military response. Though Saudi is the third largest defence spender globally, the US would likely have to provide significant back-up assistance in the event of a Saudi strike. Hence, our strong view that oil remains an entirely broken barometer.

The attacks on Saudi oil facilities is just the culmination of what we have seen since May, Helima speaks with CNBC.

Oil: Anticipated Physical Tightness?

Conflicting and ambiguous headlines have plagued the oil market. While the duration of the outage, the extent of the damage and the Saudi ability to meet export commitments remains fluid, the market remains paralyzed from a risk deployment perspective until the physical market provides further cues (as indicated by weakening spot prices despite bidding of call skew). Tanker pricing from the US Gulf Coast spiked over 30% earlier this week as Asian refineries scrambled to secure barrels. Refineries keen to lock in cargoes from the US despite lengthy voyage times is a sign of anticipated physical tightness. Even if the outage is short in duration, increased tanker loadings could lead to counter-seasonal draws in US crude this shoulder season, or at a minimum, mean that inventories could be lower and US balances tighter than previously anticipated. Tangentially, this could be exacerbated if Iraqi Basra swing barrels are pulled away from the US and toward Asia to plug gaps.

Michael Tran discusses oil trading after a record spike.

Three Indicators to Watch

1. Asia’s Pull of Atlantic Basin Barrels

Asia is most impacted by the outage given that some 75% of Aramco’s crude exports deliver into the region, leaving refiners scrambling to lock in alternative sources. China is the world’s fastest import growth hub and while 10 mb/d are purchased from various sources, five countries make up nearly 60% of total Chinese imports. The Kingdom is China’s largest trading partner, owning over 15% market share. While the IEA suggests that the global market remains well supplied, global trade routes are being re-written in real time. US exports to Asia were already scheduled to be heavy this month, but expect Japan, Korea and Taiwan to lean heavily on North Sea and West African crudes as the swing barrel given shorter delivery times. Assessing the daily pull on these Atlantic Basin crudes is the best gauge of real time tightness in the physical market.

2. Crude Quality

The notional outage grabs headlines, but crude quality dictates market tightness. The global sour market is tight given existing disruptions in Iran and Venezuela, meaning that losing Saudi heavies would exacerbate balances that have already propelled Dubai prices to uncharacteristically narrow discounts to the Brent benchmark. While IMO 2020 loosens heavy, sour balances, the upcoming fuel spec change disproportionately shifts global demand toward light, sweet grades, or the type that makes up over 66% of aggregate Saudi production. The attack on Abqaiq is particularly consequential given it is Aramco’s primary processing center for Arab Light and Extra Light streams. Outages can disrupt global trade patterns and wreak havoc on pairing crude availability and quality with suitable refiners. Delivering the right crude to the right region is critical. Complexities along the supply chain typically lead to higher prices.

3. Refining Margins – Is Demand Destruction a Moving Target?

While volatile, global refining margins have been trending lower, on balance, over the past year. Weaker margins typically point to soft end use product demand. The market has been classically conditioned to deem major crude outages as bullish, which is usually the case, but exactly how bullish? In a market led by softening demand, a meaningful disruption, triggering a material rally in crude prices may squeeze refining margins from both ends (higher crude prices and lower refined product prices), resulting in weaker or even negative margins. This could lead to wide-spread economic run cuts and the cannibalization of crude demand. Ultimately, product demand, or prices, must improve alongside crude prices to keep margins healthy; otherwise, a spike in crude would prove unsustainable and kick off a vicious cycle of widespread run cuts.

Source: RBC Capital Markets, Chinese Customs General Administration, Saudi Aramco, Oil & Gas Journal, HIS Markit, Bloomberg

Helima Croft
Global Head, Commodity Strategy

Helima is a Managing Director and the Global Head of Commodity Strategy at RBC Capital Markets. She specializes in geopolitics and energy, leading a team of commodity strategists that cover energy, metals and cross-commodity investor activity. Helima is a member of the National Petroleum Council, a select group of individuals who advise, inform and make recommendations to the Secretary of Energy with respect to any matter relating to oil and natural gas. She also is a CNBC contributor, a member of the channel’s exclusive family of experts, is on the Board of Directors for the Atlantic Council, a Life Member of the Council on Foreign Relations, and is a member of the Oxford Energy Policy Club. Helima joined RBC Capital Markets from Barclays, where she was a Managing Director and Head of North American Commodities Research. Prior to that, she worked in Lehman’s Business Intelligence group, the Council on Foreign Relations and the Central Intelligence Agency, where she focused on geopolitics and commodities. Helima has received many industry accolades throughout her career and received her PhD in economic history from Princeton in 2001.

Michael Tran
Managing Director, Energy Strategist, Global Research

Michael Tran is a Managing Director within the Energy Strategy Research team at RBC Capital Markets based in New York. He is responsible for views pertaining to global energy markets including macro supply and demand fundamentals. He was formerly in a similar capacity at CIBC World Markets where he was part of a team that was previously voted most accurate forecaster of WTI oil prices by Bloomberg. Prior to that, he worked on the energy sales and trading desk at CIBC in Calgary and UBS Investment Bank in London. He has also held various roles at BP and has experience in energy investment banking.

Mr. Tran's energy views are frequently quoted in media outlets and he routinely appears on television networks like Bloomberg and BNN. Mr. Tran frequently provides market insight to the Alberta government on issues pertaining to energy policy and budgeting. He serves on the Board of Directors of the New York Energy Forum and is a member of the Energy Advisory Board for Orbital Insight, an Artificial Intelligence tech company specializing in geospatial analytics. He is also a former co-chair of the Commodities committee for New York Energy Week. He graduated with distinction from the University of Alberta with a Bachelor of Commerce majoring in Finance and Economics.

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