What’s behind the spike in oil prices?

Marius Paun | London, UK | Senior dealer | Wednesday, 18th September 2019

First the facts:

Saudi Arabia’s oil production was crippled last Saturday making headlines worldwide. It’s now known that the world’s largest crude processing facility in the country and its second-largest oil field were knocked out by a series of drones strikes. The Saudi facility, Abqaiq is an important part of preparing the oil (removing impurities) to be sold to market. The hits were allegedly extremely accurate, targeting vital segments of the treatment infrastructure.

It was reported that Aramco, Saudi’s national oil company had no alternative but to cut production by 5.7 million barrels per day or roughly 50% of its capacity. That also represents about 5% of the global oil supply. As a consequence, the US oil prices spiked by 15% at the opening, moving above $62 from a low of $54.75 at the close on Friday. The last time we have seen this sort of price spike was in 1990 when Saddam Hussein invaded Kuwait, so it is understandable that serious alarm bells were raised.

So, who was responsible?

It is public knowledge that Saudi Arabia has been involved in the war in Yemen, going back a few years. Houthi rebels, who are backed by Iran, claimed responsibility for the attacks admitting they used drones. History shows they have attempted to use drones in the recent past in similar attacks, but those were largely intercepted.

However, the US is highly sceptical about that scenario, pointing the finger at Iran. President Donald Trump said the US is ‘Locked and loaded’ and they are waiting on Riyadh to verify and confirm who launched the strikes before giving the green light. To calm things down, he added that he ‘authorised the release of oil from the strategic petroleum reserve to keep the market well supplied’. Iran, on the other hand, denied involvement and dismissed the allegations as ‘meaningless and pointless’.

Yesterday, Saudi Energy Minister Prince Abdulaziz bin Salman did his part in trying to restore confidence. He held a press conference assuring the market the Kingdom would have its oil supply back online by the end of the current month. That was enough to allow US oil prices to pull back, now trading just above $58 a barrel.

Even President Trump seemed to have changed his mind about releasing oil from the strategic reserve because ‘prices have not jumped very much’. Although the immediate crisis seemed to have been averted, the spectre of further escalation in the region’s tensions remains elevated. Saudi Arabia’s budget for defence apparently ranks third in the world nowadays behind the US and China. If a few rather cheap drones can get through and cripple key oil facilities what’s to stop that from happening again?  Is Gulf war 3 out of the question? Heated exchanges between the US and Iran are quite common these days with ships from both sides detained.

Wednesday, the US decided to increase sanctions on Iran instead of military action which might allow further retracement in oil prices. Although the genie is out of the bottle in terms of risk premium, there are plenty of voices out there saying that US-China trade war will probably keep demand for oil in close check and in turn override any ongoing tensions in the Middle East region.

The chart shows the long-term trend is still down.

Before the spike, US oil prices were rather in the consolidation phase. The gap which happened on the opening Sunday evening was quite significant and we know that sooner or later that gap will need to be filled. Already the market price is on its way down, doing just that.

However, the short-term moving averages (9MA) moved above the longer-term ones (21MA) at the end of August thus giving bulls reasons to be joyful.

On the way down, immediate support is seen around $57.2 mark, which acted as a rather strong resistance (turned support) recently. Further down $54.75, $53 are also levels to watch. Ultimately $50.50 to $51 area was tested a few times this year and held, eventually triggering a sizeable jump.

On the way up, resistance just below $60 is the next level bulls will target follow by $61 and $62.5. If the $61 is broken then the medium-term trend will switch to bullish ($50.5 to $62 is the sideways trend since the mid-May). Nonetheless only a break above the $66.55 mark, the high of 23rd of April, will convincingly change the long-term outlook to bullish.