Monday, September 16, 2019

A drone attack on a Saudi petroleum plant causes market jitters; are Brexit negotiations finally progressing?

  • Dollar
  • Gold
  • Euro
  • Pound
  • Stocks
  • Oil

Market recap: Safe haven assets rise as oil supplies drop after Saturday’s strike

Oil prices surged today after Saturday’s attack on a Saudi Arabian petroleum processing plant. The Abqaiq – Saudi Aramco is the world’s biggest oil processing facility, and the drone strike is expected to cut the country’s production (which is roughly 5% of the world’s oil supply) by half.

Brent crude oil opened almost $12 higher at $71.95 per barrel, but retreated back to $66.76 (although it was still up 10.86%). US WTI Oil also spiked as the market opened by around $9 per barrel, but eased back to $60.19 per barrel (although prices were still up 9.74%). Wall Street saw futures retreat as investors reacted to the news, with Dow Futures dropping 0.55% and the S&P 500 falling 0.63%.

The attack on the Saudi Aramco facility saw investors shift to safe haven assets, with fears rising over disruption to global oil supplies and escalating tensions between the US and Iran. The developments caused gold to spike by 1.04% on open, and the USD/JPY to fall by as much as 0.05%.

Wall Street closed on Friday with the DJIA up 0.14% and the S&P 500 down 0.07%. The Nasdaq was also down 0.22%, as investors reacted to better-than-expected retail sales and consumer sentiment, while also keeping one eye on the Fed’s meeting on Wednesday this week.

Yields continued their advance thanks to positive US economic data and the temporary suspension of new trade war tariffs from the US and China. 10-year yields surged to 1.90% from Thursday, while 30-year-yields also increased to 2.31% on Friday.

Today’s analysis: Brexit negotiations expected to progress following Johnson and Juncker’s lunchtime meeting

Boris Johnson will meet with European Commission President Jean-Claude Juncker today in Luxembourg. The British PM is expected to reaffirm his plan to take Britain out of the EU by October 31st, with or without a deal, and is expected to turn down the offer of another Brexit deadline extension.

Investor sentiment is positive. Sterling rose over the past week, in part because the chances of a no-deal Brexit have been reduced thanks to new parliament legislation that has been passed to prevent the UK crashing out of the EU.

But the key issue of the Irish backstop is still a thorny one. The EU is adamant it has to be part of any Brexit deal, to ensure all goods imported and exported in and out of Ireland meet EU standards. Johnson declared last week that a Northern Ireland-only backstop solution will not be accepted as part of a Brexit deal, after a meeting with the Democratic Unionist Party (DUP), who Johnson’s Conservative party formed a government with after the last UK general election. Alternatives to the backstop include a hard border, or a new solution to ensure produce passing through the Irish border meets EU standards.

Johnson has also proposed a single zone in Ireland for all food standards. But while this may work to prevent a Northern Ireland-only backstop, it would mean Northern Ireland would still have to adhere to EU produce standards. Furthermore, should produce from the UK pass through Northern Ireland’s ports, it would also need to meet EU standards, as the DUP declared it will reject any plan that would see Northern Ireland treated differently to the rest of the UK. This proposal only covers food and agriculture and not other economic goods, which would have to be negotiated as well.

None of these solutions work for all parties, so a compromise will likely be needed in order to finalise a Brexit deal before October 31st. Otherwise, Johnson will be required to abide by the law and ask for an extension.

Both parties will need to find a solution the entire UK can agree on regarding agricultural and food produce while also ensuring there will not be a border in the Irish Sea. Such a deal will also be a benchmark for future negotiations on other economic goods that will flow between Ireland and Northern Ireland.

The issues surrounding agriculture and food produce are another example of why you won’t see a Brexit deal rubber-stamped in the near future. The EU is adamant a backstop has to remain a part of any exit plan, meaning Johnson needs to find the perfect solution to ensure EU standards are met without a hard border. Market optimism may plummet should the EU refuse to budge, and in that case, sterling still has room to fall to test its previous low in the mid-term.

Saudi’s supply woes could have a long-term impact on the price of oil

Oil supply disruption caused by Saturday’s drone attack is not yet fully reflected in the current price of oil, although Saudi Aramco announced in a statement this week it is temporarily shutting two plants that were damaged in the attack, which has cut the Kingdom’s oil production by about 5.7 million barrels per day (bpd).

But the market has seen a shutdown of this size before - when Iraq invaded Kuwait in 1990. The current disruption is bigger than that seen during Operation Desert Storm in 1991, Hurricane Katrina in 2005, and the Libyan supply disruptions of 2011.

Brent crude oil in history during massive disruption on oil supply

Despite Saudi officials announcing they hope to restore around two million bpd starting today, it is still not expected to be enough to meet demand.

The price of oil, along with supply and demand, may not be affected too much in the US, though. The US Strategic Petroleum Reserve currently holds about 644 million barrels, according to the US Department of Energy, which equates to 52 days of production. But the shortfall is expected to strongly impact Asia, as Saudi Aramco exported more than seven million bpd last year, with almost four million exports delivered to customers in Asia, including China, Japan and India. Saudi currently has only about 188 million barrels in reserve, or roughly 37 days of Abqaiq’s processing capacity, according to Rapidan Energy Group.

The price of Brent Crude oil may reach last year’s high at US$80 per barrel in the future, should production from Saudi and OPEC not meet demand, and it is expected the embargo of oil exports from Iran will not be resolved, especially as US-Iran tensions could intensify in the near future. The US may soon impose some light sanctions on Iran, and the price of oil could be boosted in the short term.