The Attack on Saudi Oil Infrastructure: What does it Reveal?

This satellite image shows where the damage was done at the Abqaiq site

Highlights

The September 14 attack on Saudi Arabia’s oil infrastructure is unprecedented and has always been considered by the international oil market a "design event”. A contingency that goes into the calculations oil stocks levels and supply security strategies, among others.

The relatively modest move in oil prices and the world financial markets following the attack, considering its gravity and potential impact on the oil market and the world economy, is, on the surface, unexpected.

The responses to the attack reveal the dynamics governing the international oil market, specifically:

• The effectiveness of the International oil supply system;

• The potential role of shale oil as a residual supply;

• The high credibility of Saudi Aramco;

• The elevated absorptive capacity of the world economy for oil price shocks;

• Emerging domestic and international US policy constraints;

• Saudi Arabia’s deepening international isolation;

• Iran’s high vulnerability to US sanctions; and

• China’s strategic challenges in the Gulf.

Introduction

On a Saturday morning on the 14th of September, Saudi Arabia sustained a military attack on its oil production and processing facilities in Khurais and Abqaiq, taking out approximately 5.7 million barrels - over half of its oil production. Such unprecedented incident has always been considered a ‘design event” by the international oil market. A contingency that has been a primary input into the calculations of international oil stock levels, whether operational or strategic. It was also an event around which the military defence strategies of the Gulf oil facilities and infrastructure were based, and associated alliances made.

The success of the perpetrators in conducting such an attack without triggering the vast and presumably effective defence systems covering the region would have been the main surprise of the day. The greater surprise, however, was yet to come. On Monday-the first day of business following the attack -when the world markets opened, rather than breaking historical records as one may have feared, oil prices rose by about twenty percent, a relatively modest move considering the gravity of the event. The price was even less than its peak of 2019, and far below its historical peak level. On Tuesday, prices retreated by five percent and returned to their pre-attack levels soon afterwards, thus erasing all gains made due to the incident.

The world economy, as judged by the behavior of the main stock markets, also shrugged off the incident, with the Wall Street Dow Jones Industrial Average closing only half a percentage point lower on Monday and the world’s main currencies remaining within normal ranges. In spite of strong, albeit confusing pronouncements from the Trump administration at the outset, the risk of escalation into a wider and sustained military conflict was discounted. There was no rush to safety among investors that would be indicated by unusual spikes in gold or sovereign bond prices. Less than two weeks into the aftermath, the incident almost faded from international media headlines, and all the fears that it had stoked seemed to have evaporated.

Is this predominantly lethargic attitude toward the incident justified?

Given that the share of Saudi Arabia’s crude oil production in total world supply has hardly changed over the past three decades, what has changed over these years to warrant this diminished concern about the security of her supply?

Are we under a new energy paradigm? If so, what are its defining features?

The answers to the above questions and many others surrounding this historical incident lie in its outputs and outcomes. Systems theory informs us that to determine the state dynamics of an unknown system (i.e. black box), we may apply an impulse function to its input and then observe its output. The output will be identical to, and thus reveal, the state dynamics of the unknown system. The attack on the Saudi oil facilities is equivalent to such an impulse applied to the multi-dimensional international energy system, and what we have witnessed in terms of responses embody the state dynamics and characteristics.

What does the response to this incident reveal?

The Physical Market of Oil

The effectiveness of the International oil supply system: In the wake of the 1973 oil crisis, the Paris-based Organization for Economic Co-operation and Development (OECD) established in 1974 the International Energy Agency (IEA) primarily responsible for developing collective response to physical disruptions in the supply of oil. The IEA later became a primary source of information and statistics about the international oil market. In implementing its mandate, the IEA required its members to maintain total oil stock levels sufficient to cover at least 90 days of their net oil imports.

At the time of the attack at the Saudi oil facilities, The OECD commercial stock levels stood around three billion barrels, sufficient to cover the 5.7 million barrels loss in Saudi production for over five hundred days. Furthermore, the world holds additional large stocks of oil as strategic reserves, most prominent of which are the US strategic reserves of over 700 million barrels, and the fast-growing Chinese strategic and commercial reserves estimated at about 790 million barrels.

Consequently, while the scale of the attack and the resultant loss of production was unprecedented, the international oil market has ample capacity to cope with such or even bigger contingencies.

The potential role of shale oil as a residual supply: Prior to the oil shale era, the project cycle to bring new traditional oil supply to market would range between three to five years. Consequently, any fear of long-term curtailment in supply was more likely to drive prices to untested levels. In contrast, the project cycle of shale oil is much shorter, estimated between three to six months for producing fields. The shale oil industry can respond to a rise in prices in a relatively short order and bring new supplies to the world market.

The high credibility of Saudi Aramco: Aramco, the Saudi State oil company, is a highly capable company that has successfully coped with similar, though smaller scale, emergencies in the past. As a result, it enjoys a high level of confidence from the industry for its ability to cope with such events. The announcement during the news conference held on Tuesday by the newly appointed energy minister Prince Abdelaziz bin Salman that Aramco would fully restore oil production by the end of September, went a long way in calming market fears. Oil prices dropped by more than five percent on Tuesday and went on to surrender all its gains due to the incident before the end of September, after production was fully restored to its pre-attack levels.

The Oil-Economy Nexus

The attack was almost a non-event if judged by the performance of the world stock and bond markets. While stock market indexes generally declined on Monday-the first day of trading following the attack on Saturday- this decline was modest and well within the band of short-term variations. For reasons that shall be addressed later in this article, the world has quickly discounted the possibility of military escalation and wider regional conflict.

The other contributing factor to the sanguine response of world markets is believed to be the relatively moderate reaction of oil prices. Such prices, even if sustained over the long term, would not result in major structural dislocations in the world economy. The state of the world economic capital stock, particularly in the developed economies already incorporates much higher oil price levels than those reached after the attack, and consequently are well within the absorptive capacity of the world economy.

The Geo-Politics of Oil

“We have witnessed distinct growth in Iranian aggression…This attack wasn’t against Saudi Aramco or Saudi Arabia; it was against the international community.” Saudi Defence Ministry spokesman Col. Turki al-Maliki said in a briefing after the attack on Abqaiq and Khurais.

Saudi defence strategy since the founding of the Kingdom and the discovery of its huge oil reserves has been built on the assumption that the Kingdom’s stability is vital to the economic welfare of the world. Presumably, the world would always come to her defence, as long as her oil policy served world market stability and oil price moderation. This understanding was also shared by members of the NATO alliance, particularly the United States, whose military strategy prior to the Trump administration has always considered the security of the oil supply from Gulf Arab countries of vital national interest. This commitment was demonstrated in 1991 when the United States, under president George W. Bush, Sr., assembled a broad international coalition to push back Iraqi forces who had invaded and occupied Kuwait and posed a clear and imminent danger to the oil fields of Saudi Arabia.

In contrast, this time, save for bellicose statements by senior US officials and a series of contradictory tweets by President Trump, the response was mostly muted. None of the reactions, including those of US officials, treated the incident as an attack on the "international community". It was an exclusively Saudi affair, left to the Kingdom to deal with. It was also curious that armed response and confrontation were discounted at the outset. Even President Trump was looking beyond the incident while lobbing his threats at Iran - allegedly the party behind the attack. According to the NY Times,

Mr. Trump warned that the United States had fearsome military abilities and was prepared for war if necessary. “But with all that being said, we would certainly like to avoid it,” he added. “I know they would like to make a deal,” he said of the Iranians, whom he has been trying to draw into talks over their nuclear program. “At some point, it will work out.”

The response to the attack on Saudi Arabia has been shaped by a number of factors specific to the parties of the conflict and those affected by it. It was also influenced by emerging global concerns such as climate change, human rights and populism. Here are some of these factors:

The United States domestic and international constraints: While it is within the constitutional authority of a US president to order a military strike without first gaining congressional approval (i.e. public support), committing to a sustained military engagement would certainly require such approval. Even the unpopular wars of Vietnam, Iraq and Afghanistan had initial public support (notwithstanding that such support was sometimes gained under false pretexts such as the 2001 Iraq war). It is highly unlikely that the American public would support direct involvement in another war in the Middle East, particularly when the direct responsibility of Iran has not been convincingly proven.

Secondly, The US’ increasingly nationalist and isolationist policy under the Trump administration has strongly constrained its ability to build the international coalitions needed for such an act. While the US is technically capable of fighting any war on its own, being part of a coalition is considered necessary for gaining public support, both domestically and internationally.

Finally, president Trump’s decision to withdraw from the Iran nuclear agreement (formally known as the Joint Comprehensive Plan of Action (JCPOA)) and the re-imposition of harsh sanctions on Iran has severely hurt the Iranian economy. This decision has been extremely unpopular both internationally and domestically, garnering a great deal of public sympathy. Many have opined that Iran’s approval of such an attack, given the great risks and dangers it entailed, was akin to an act of self-defence. A desperate act to bring pressure to bear on the responsible parties to lift the sanctions.

Saudi Arabia’s deep international isolation: The attack on Saudi Arabia’s vital oil infrastructure and subsequent muted response highlights its international isolation. The lack of international solidarity should be of concern to the Saudi authorities. This state of affairs, however, is not surprising due to misconceived policies and behavior which have caused irreparable damage to the Kingdom’s reputation and international standing.

The Saudi military intervention in Yemen’s civil war has become increasingly unpopular, and widely condemned internationally, due to the very high human and economic costs on the Yemeni people. Furthermore, Iranian support for the Houthi fighters, do not make the Houthis foreign agents, or a fifth column. By ignoring the uproar of world opinion and discounting the advice of many of its allies, the Kingdom has spent much of its political capital.

Further irreparable reputational damage was incurred by the murder of the Saudi dissident, Washington Post journalist Jamal Khashoggi. While accepting some responsibility for the killing is a step in the right direction, it is well short of what is needed. The Kingdom has not conducted a comprehensive, transparent and free investigation of the crime. Nor has it brought the perpetrators to an open and fair trial. Further aggravating this is the Kingdom’s failure to improve its human rights record by freeing political prisoners and respecting internationally accepted human rights and freedoms.

The Kingdom is also losing large segments of international public good will due its stance on climate change. Her alliance with climate deniers makes her seem insensitive to the potential harm of climate change to global welfare. By appearing to put her national interests before that of humanity, she alienates a fast growing and influential segment of the world citizenry. This fast-growing segment might welcome heightened uncertainty and exuberant prices in world fossil energy markets if it helps green energy alternatives to grow and flourish. World sympathy will likely be increasingly harder to come by for fossil energy resource-holders if they keep ignoring the threat of climate change to global welfare.

Recently, Saudi foreign policy has not resonated with its best long-term national interests. Specifically, their policy of influencing the executive branches of democratic governments irrespective of where the public stands on the issues is misadvised. For instance, having President Trump use his veto power to override a bipartisan decision by the US congress to withhold arm supplies to the Kingdom in protest over her intervention in Yemen, is not a recipe for success. It is an affront to American public opinion, to whom Saudi policy should be more considerate. Other similar Saudi foreign policy missteps have been taken in recent years, such as its overreaction to criticisms by Canada and the EU concerning its human rights record.

Finally, as the world third largest spender on armaments, with annual purchases amounting to tens of billions of dollars, the Kingdom did not garner much sympathy by failing to defend against the attack on her oil facilities. At best, the Kingdom’s failure to defend herself raised serious doubts about both: the effectiveness of her defence strategy, and her conduct.

For Iran, no regional stability while the sanctions are on: For Iran to sanction such a daring attack at its neighbour’s oil infrastructure and expose itself to the possibility of a costly response by the US and its allies in the region, is more an act of desperation than an act of daring. The US withdrawal from the JCPOA agreement and the re-imposition of economic and financial sanctions, combined with the failure of the EU to provide any meaningful relief, has effectively brought back the same economic pains that she experienced prior to signing the JCPOA in July 2015. It was those pains that forced the hand of Iran’s hardliners, led by Ali Khamenei and the IRCG, to sign onto the agreement. In spite of their fears that the JCPOA could lead to the feared normalization of relations with the West - thus strengthening the hands of Iran’s moderates at their own expense. They took the risk because of their dominating stake in the country’s economy and for fear of the harm that could befall their interests due to sanctions.Contrary to what is advanced as justification, while lengthy and hard sanctions such as those applied on Iraq under Saddam Hussein have proven to be a failed strategy for regime change, they are only effective at exacting economic and social pains on the subject country and its people.

Trump’s withdrawal from JCPOA and the re-imposition of sanctions have revived Iran’s fears and anxieties with one important difference. With the moderates discredited and weakened by Trump’s action, combined with Europe’s failure to offer meaningful relief, the hardliners now have the upper hand. Consequently, with sanctions exacting unsustainable economic and social pain, Iran can be expected to escalate pressure tactics as long as they are in place. Emboldened by the success of the attack and the inconsequential responses it generated, Iran may overplay its hand and plunge the region into a far more serious and consequential conflict.

The dangers of such a path to regional stability and the security of oil supplies from the Gulf region are too obvious. Future incidents may not be as easily contained and damage to the Region’s oil and gas infrastructure, including that of Iran, may be extensive and widespread. Avoiding such an outcome would require direct US-Iran negotiations, with the aim of settling differences around the nuclear program and other outstanding issues such as the Yemen conflict and the role of Iran’s allied militias in Lebanon, Iraq, and other places in the region.

Ironically, the obvious eagerness of President Trump to strike a deal with Iran, where he can substitute his signature for that of former President Barak Obama, is an open window of opportunity. Such a deal need not be materially different from JCPOA, with sufficient changes to allow Trump to claim a personal achievement. Failing to do so means that Iran will have to wait out the current administration, hope he gets impeached or loses re-election for a second term. If he is re-elected, however, Iran will find itself having to confront, or negotiate with, a rejuvenated and more empowered US president.

China-A Challenging Balancing Act: Despite appearing to be watching the developments in the Gulf from the sidelines, security of energy supplies from that region is a main concern for China. In 2017, China surpassed the US as the world’s biggest oil importer, with Saudi Arabia as its biggest supplier. It is reported that about fifteen percent of Saudi exports go to China, and this dependence is expected to increase as her demand for oil keeps growing at high rates.

With increasing tensions between Saudi Arabia and Iran, China has been growing its economic ties with both countries, whom she considers partners in the Belt and Road Initiative. She also has signed Strategic Partnerships with both. Planned Chinese investments in Iran are projected to be in the hundreds of billions of dollars while, in Saudi Arabia, Chinese energy companies have been participating in natural gas exploration for a long time.

China’s policies with both Saudi Arabia and Iran remain constrained by a number of factors. As her dependence on Saudi and the Gulf oil supplies increases, her security concerns will increase in tandem. These are not only concerns about regional stability, but also concerns about the strategic ties between Saudi Arabia and other Gulf Arab states on the one side, and US with other NATO countries on the other. Consequently, China’s security of supply concerns are strongly modulated by developments in her relationship with the US.

Furthermore, in spite of the high complementarity of China’s interests with that of Iran’s, their relationship is also influenced by developments in the US-Iran relationship. In order to preserve her very important trade and economic relationship with the US, China has to be sensitive to the US relationship with Iran. It is thought that the implementation of its ambitious investment plans in Iran has been hindered by the deterioration of the US -Iran relationship under the Trump administration. Otherwise, one would expect that China would move expeditiously on implementation given the strategic importance of Iran’s energy resources to China and Iran’s eagerness to alleviate the pain of US sanctions.

With decreasing perception of risks in the US pertaining to the security of oil supplies compared to the rising perception of such risks in China, it will be interesting to observe the evolution in the geo-political dynamics of the Gulf region, particularly given the present uncertainties shrouding developments in US-China relations. One thing is already clear, China is rushing to geographically diversify her oil supplies and grow the oil and gas reserves and supply capacities of her state-owned energy companies.

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